FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [Fee required]
For the fiscal year ended December 31, 1997
-----------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [No fee required]
For the transition period from to
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COMMISSION FILE NUMBER 0-20800
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STERLING FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Washington 91-1572822
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
111 North Wall Street, Spokane, Washington 99201
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including
area code: (509) 458-2711
Securities registered pursuant to Section 12(b) of the Act:
None None
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(Title of class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock ($1.00 par value)
8.75% Subordinated Notes Due 2000
9.50% Cumulative Capital Securities Due 2027
(Title of class)
<PAGE>
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes X No
--- ---
As of February 27, 1998, the aggregate market value of the common
equity held by non-affiliates of the registrant, computed by reference
to the average of the bid and asked prices on such date as reported by
the Nasdaq National Market, was $174,627,031.
The number of shares outstanding of the Registrant's Common Stock, par
value $1.00 per share, as of February 27, 1998 was 7,578,552.
DOCUMENTS INCORPORATED BY REFERENCE
Specific portions of the Registrant's Proxy Statement dated April 2,
1998 are incorporated by reference into Part III hereof.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. [X]
<PAGE>
STERLING FINANCIAL CORPORATION
DECEMBER 31, 1997 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business
General
Recent Developments
Growth and Acquisition Strategies
Lending Activities
Investments and Mortgage-Backed Securities
Sources of Funds
Subsidiaries
Competition
Personnel
Regulation
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for the Registrant's Stock and Related Shareholder
Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
General
Net Interest Income
Asset and Liability Management
Results of Operations for the Twelve Months Ended
December 31, 1997 and 1996
Results of Operations for the Six Months Ended
December 31, 1996 and 1995
Results of Operations for Fiscal Years Ended June 30, 1996
and 1995
Liquidity and Sources of Funds
Capital Resources
New Accounting Standards
Year 2000 Issues
Effects of Inflation and Changing Prices
Item 7.A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Item 13. Certain Relationships and Related Transactions
PART IV 56
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
SIGNATURES
Consolidated Financial Statements
<PAGE>
Any trend or forward-looking information discussed in this report is
subject to numerous possible risks and uncertainties. These include
but are not limited to: the possibility of adverse economic
developments which may, among other things, increase default and
delinquency risks in Sterling's loan portfolios; shifts in interest
rates which may result in lower interest rate margins; changes in
accounting policies; changes in the monetary and fiscal policies of
the federal government; changes in the regulatory and competitive
environment, and other risks. Sterling's future results may differ
materially from historical results as well as from any trend or
forward-looking information included in this report.
PART I
Item 1. Business
------------------
GENERAL
Sterling Financial Corporation ("Sterling") is a unitary savings and
loan holding company, the significant operating subsidiary of which is
Sterling Savings Association ("Sterling Savings"). The significant
operating subsidiaries of Sterling Savings are Action Mortgage Company
("Action Mortgage"), INTERVEST-Mortgage Investment Company
("INTERVEST") and Harbor Financial Services, Inc. ("Harbor
Financial"). Sterling Savings commenced operations in 1983 as a State
of Washington-chartered, federally insured stock savings and loan
association headquartered in Spokane, Washington.
Sterling endeavors to provide personalized, quality financial services
to its customers as exemplified by its "Hometown Helpful" philosophy.
Sterling believes that this dedication to personalized service has
enabled it to maintain a stable retail deposit base. Sterling, with
approximately $1.9 billion in total assets at December 31, 1997,
attracts Federal Deposit Insurance Corporation ("FDIC") insured
deposits from the general public through 41 retail branches located
primarily in rural and suburban communities in Washington and Oregon.
Sterling originates loans through its branch offices as well as eight
Action Mortgage residential loan production offices in the Spokane and
Seattle, Washington; Portland, Oregon and Boise, Idaho metropolitan
areas and four INTERVEST commercial real estate lending offices
located in the metropolitan areas of Seattle and Spokane, Washington
and Portland, Oregon. Sterling also markets tax-deferred annuities,
mutual funds and other financial products through Harbor Financial.
Recently, Sterling has focused its efforts on becoming more like a
community bank by increasing its construction, business banking and
consumer lending while increasing its retail deposits. Sterling's
revenues are derived primarily from interest earned on loans and
mortgage-backed securities ("MBS"), from fees and service charges and
from mortgage banking operations. The operations of Sterling Savings,
and savings institutions generally, are influenced significantly by
general economic conditions and by policies of its primary regulatory
authorities, the Office of Thrift Supervision ("OTS"), the FDIC and
the State of Washington Department of Financial Institutions
("Washington Supervisor"). See "Regulation."
<PAGE>
Sterling changed its fiscal year-end from June 30 to December 31,
effective December 31, 1996. Accordingly, results of operations
included herein have been presented for the twelve months ended
December 31, 1997 and 1996, six months ended December 31, 1996 and
1995 and the fiscal years ended June 30, 1996 and 1995.
RECENT DEVELOPMENTS
To further enhance its presence in the Pacific Northwest market,
Sterling has been working to expand its community bank delivery
system, focusing primarily on deposit gathering and lending. On
February 2, 1998, Sterling signed an agreement to acquire 33 branch
offices in Washington, Idaho and Oregon from KeyBank National
Association ("KeyBank"). The purchase includes approximately $585
million of deposit balances, the owned branch facilities, branch
furniture, fixtures and certain equipment and approximately $133
million of loan balances. To acquire these branches, Sterling will
pay approximately $72 million based upon a premium on deposits plus
the value of the assets related to these branches. Sterling
anticipates using the net proceeds of approximately $380 million from
this transaction to reduce its borrowings and wholesale liabilities.
As a result of this transaction, Sterling's total assets are expected
to increase by approximately $150 million.
In order to finance this transaction, Sterling will use its existing
cash resources and borrowing capacities supplemented with additional
borrowings of approximately $25 million. Sterling may also increase
its capital resources through an offering of debt or equity
securities, the proceeds of which offering will likely be issued to
retire certain borrowings.
The strategic advantages of the branch acquisition to Sterling are
expected to include (i) a reduction in its cost of funds which should
contribute to an improvement in net interest margin, (ii) an expanded
branch network through which to generate additional loans and retail
deposits, and (iii) an increased presence with Sterling's existing
markets of Washington and Oregon, as well as expansion into certain
markets in Idaho. Sterling's operating costs will increase as a
result of adding these branches and amortizing the core deposit
premium and other intangible assets over time. Sterling anticipates
the amortization period to be 10 to 15 years.
The acquisition is subject to regulatory approvals and other
conditions of closing and is scheduled to close in mid-year 1998.
Management anticipates securing regulatory approvals, meeting other
conditions of closing and obtaining appropriate financing, although
there can be no assurance in this regard.
<PAGE>
GROWTH AND ACQUISITION STRATEGIES
Sterling intends to continue to pursue an aggressive growth strategy.
In addition, Sterling has grown and may seek to grow by acquiring
other financial institutions or branches thereof or other substantial
assets or deposit liabilities. Sterling may not be successful in
identifying further acquisition candidates, integrating acquired
institutions or preventing deposit erosion or loan quality
deterioration at acquired institutions. There is significant
competition for acquisitions in Sterling's market area, and Sterling
may not be able to acquire other institutions on attractive terms.
Furthermore, the success of Sterling's growth strategy will depend on
increasing and maintaining sufficient levels of regulatory capital,
obtaining necessary regulatory approvals, generating appropriate
internal growth and favorable economic and market conditions. There
can be no assurance that Sterling will be successful in implementing
its internal growth strategy.
LENDING ACTIVITIES
FOCUS ON COMMUNITY LENDING. In recent years, Sterling has focused its
efforts on becoming more like a community retail bank. Sterling is
increasing its business banking, consumer and construction lending.
Business banking, consumer and construction loans generally produce
higher yields than residential mortgage loans. Such loans, however,
generally involve a higher degree of risk than the financing of
residential real estate.
BUSINESS BANKING LENDING. Sterling offers business banking loans
primarily collateralized by various types of property including
accounts receivable, inventory and equipment. Business lending is
generally considered to involve a higher degree of risk than the
financing of real estate, primarily because security interests in the
collateral are more difficult to perfect and the collateral may be
difficult to obtain or liquidate following an uncured default.
Business banking loans typically offer relatively higher yields and
variable interest rates. The availability of such loans enables
potential depositors to establish a full-service banking relationship
with Sterling. Sterling attempts to reduce the risk of loss
associated with business lending by closely monitoring the financial
condition and performance of its customers. Sterling's Private
Banking Group provides services to higher net worth and higher income
borrowers by originating a variety of consumer and business banking
loans to meet their needs. Such loans generally meet the same
underwriting requirements as similar loans of the same type but
typically involve larger balances and may have nonstandard terms.
Sterling is permitted to hold 20% of its assets as business banking
loans. At December 31, 1997, business banking loans were 12.9% of
assets.
<PAGE>
CONSUMER LENDING. Sterling's consumer lending program provides loans
for home improvements, automobiles, personal lines of credit, boats
and certain other purposes. Generally, consumer loans are originated
for terms ranging from six months to ten years. Interest rates are
either fixed or adjustable monthly, quarterly or semiannually, based
on a contractual formula at a margin over an established external
index. Sterling also makes loans collateralized by savings accounts
and second mortgage loans collateralized by real estate. Fixed rate
secured financing is available with amortization terms up to 15 years.
The consumer loan portfolio also includes dealer-generated installment
contracts for consumer goods, including automobiles and boats. The
majority of these indirect loans are installment loans with fixed
interest rates. Consumer loans, especially those originated through
dealers, generally have greater inherent risks than other types of
loans.
ONE- TO FOUR-FAMILY RESIDENTIAL LENDING. Sterling originates fixed
rate and adjustable rate mortgages ("ARMs"), which have interest rates
that adjust annually or every three, five and seven years and are
indexed to the weekly average yield on one-year U.S. Treasury
securities. Sterling also originates one- to four-family residential
construction loans.
Sterling continues to originate conventional and government-insured
residential loans for sale into the secondary mortgage market. Within
the secondary mortgage market for conventional loans, Sterling sells
its residential loans primarily on a servicing-released basis to
others. Sterling also sells loans to the Federal Home Loan Mortgage
Corporation (the "FHLMC") and the Federal National Mortgage
Association (the "FNMA"). Sterling endeavors to underwrite residential
loans in compliance with FHLMC and FNMA underwriting standards. Loans
sold into the secondary market are all sold without recourse to
Sterling, except that Sterling may be obligated to repurchase any
loans which are not underwritten in accordance with FHLMC and FNMA or
applicable investor underwriting guidelines.
Conventional residential mortgage loans are originated for up to 95%
of the appraised value or selling price of the mortgaged property,
whichever is less. All loans with loan-to-value ratios in excess of
80% carry a requirement that the customer purchase private mortgage
insurance from approved third parties so that Sterling's risk is
limited to approximately 80% of the appraised value. Sterling's
residential lending programs are designed to comply with all
applicable regulatory requirements. For a discussion of Sterling's
management of interest rate risk ("IRR") on conventional loans, see
"- Secondary Market Activities."
<PAGE>
Sterling makes residential construction loans on custom homes, pre-
sold homes and homes that are not pre-sold. Construction financing is
generally considered to involve a higher degree of risk than long-term
financing on improved, occupied real estate. Sterling's risk of loss
on construction loans depends largely upon the accuracy of the initial
estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of
construction. If the estimate of construction costs proves to be
inaccurate, Sterling might have to advance funds beyond the amount
originally committed to permit completion of the development and to
protect its security position. Sterling also might be confronted, at
or prior to maturity of the loan, with a project with insufficient
value to ensure full repayment. Sterling's underwriting, monitoring
and disbursement practices with respect to construction financing are
intended to ensure that sufficient funds are available to complete
construction projects. Sterling endeavors to limit its risk through
its underwriting procedures by using only approved, qualified
appraisers and by dealing only with qualified builders/borrowers.
Since fiscal year 1994, there has been a significant decrease in the
volume of Sterling's permanent residential mortgage lending. During
the twelve months ended December 31, 1997 and 1996, the six months
ended December 31, 1996 and 1995 and the fiscal years ended June 30,
1996 and 1995, Sterling's residential lending arm, Action Mortgage,
increased its residential construction lending in an effort to offset
this decline in permanent residential lending and to improve its
operating margins.
At December 31, 1997, approximately 15% of Sterling's total loan
portfolio consisted of one- to four-family residential construction
loans, approximately 85% of which were for properties that were not
custom built or pre-sold. Further, approximately 72% of Sterling's
one- to four-family residential construction loan portfolio was
concentrated in the Portland, Oregon market which is served by one
loan production office. A reduction in the demand for residential
housing could have a negative impact on Sterling. In addition, at
December 31, 1997, another 11% of Sterling's loan portfolio consisted
of multifamily residential construction and commercial property
construction loans.
<PAGE>
MULTIFAMILY RESIDENTIAL AND COMMERCIAL PROPERTY LENDING. Sterling
offers multifamily residential and commercial real estate loans as
both construction and permanent loans collateralized by real property
in the Pacific Northwest. Construction loans on such properties
typically have terms of 12 to 18 months and provide for variable
interest rates. Permanent loans on existing properties typically have
maturities of three to ten years. Multifamily residential and
commercial property loans generally involve a higher degree of risk
than the financing of one- to four-family residential real estate
because they typically involve large loan balances to single borrowers
or groups of related borrowers. The payment experience on such loans
typically is dependent on the successful operation of the real estate
project and is subject to certain risks not present in one- to four-
family residential mortgage lending. These risks include excessive
vacancy rates or inadequate operating cash flows. Construction
lending is subject to risks such as construction delays, cost
overruns, insufficient values and an inability to obtain permanent
financing in a timely manner. Sterling attempts to reduce its
exposure to these risks, typically by investigating the borrowers'
finances, and, depending on the circumstances, requiring annual
financial statements from the borrowers, requiring operating
statements on the properties and acquiring personal guarantees from
the borrowers.
<PAGE>
The following table sets forth information on loan origination and
sale activities for the periods indicated.
<TABLE>
<CAPTION>
Twelve Months Ended Six Months Ended
December 31, December 31,
----------------------------------- ----------------------------------
1997 1996 1996 1995
----------------- ---------------- ---------------- ----------------
Amount % Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------ -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage--permanent:
One- to four-family residential $174,285 21.8% $165,246 25.5% $ 72,524 23.0% $124,246 35.2%
Multifamily residential 28,515 3.6 3,419 0.5 2,200 0.7 9,875 2.8
Commercial property 36,410 4.5 19,690 3.0 16,790 5.3 25,861 7.3
Mortgage--construction:
One- to four-family residential 215,758 26.9 195,800 30.3 94,331 29.9 76,137 21.6
Multifamily residential 62,356 7.8 51,601 8.0 12,735 4.0 29,303 8.3
Commercial property 10,825 1.4 28,704 4.4 10,925 3.5 17,455 4.9
Non-mortgage:
Consumer 99,641 12.4 56,163 8.7 33,333 10.6 25,934 7.4
Business banking 173,014 21.6 126,483 19.6 72,676 23.0 44,015 12.5
-------- ----- -------- ----- -------- ----- -------- -----
Total loans originated $800,804 100.0% $647,106 100.0% $315,514 100.0% $352,826 100.0%
======== ===== ======== ===== ======== ===== ======== =====
Residential mortgage loans sold $108,004 $187,121 $ 77,856 $122,797
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Twelve Months Ended
December 31,
-----------------------------------
1997 1996
----------------- ----------------
Amount % Amount %
-------- ------ -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage--permanent:
One- to four-family residential $216,968 31.7% $286,033 43.7%
Multifamily residential 11,094 1.6 19,398 3.0
Commercial property 28,761 4.2 11,460 1.7
Mortgage--construction:
One- to four-family residential 177,606 26.0 144,136 22.0
Multifamily residential 68,169 10.0 29,945 4.6
Commercial property 35,234 5.1 21,850 3.3
Non-mortgage:
Consumer 48,764 7.1 61,769 9.4
Business banking 97,822 14.3 80,330 12.3
-------- ----- -------- -----
Total loans originated $684,418 100.0% $654,921 100.0%
======== ===== ======== =====
Residential mortgage loans sold $232,061 $ 98,192
</TABLE>
<PAGE>
LOAN PORTFOLIO ANALYSIS. The following table sets forth the
composition of Sterling's loan portfolio by type of loan at the dates
indicated.
<TABLE>
<CAPTION>
December 31, June 30,
-------------------------------------- --------------------------------------
1997 1996 1996 1995
------------------ ------------------ ------------------ ------------------
Amount % Amount % Amount % Amount %
---------- ------ ---------- ------ ---------- ------ ---------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-permanent:
One- to four-family residential $ 282,894 24.2% $ 274,757 26.6% $ 302,526 30.0% $ 600,438 53.0%
Multifamily residential 65,621 5.6 69,728 6.8 64,305 6.4 59,776 5.3
Commercial property 118,270 10.1 102,279 9.9 101,243 10.1 85,511 7.5
Land and other 352 0.0 361 0.0 374 0.0 2,271 0.2
---------- ----- ---------- ----- ---------- ----- ---------- -----
467,137 39.9 447,125 43.3 468,448 46.5 747,996 66.0
---------- ----- ---------- ----- ---------- ----- ---------- -----
Mortgage-construction:
One- to four-family residential 178,834 15.3 148,252 14.3 137,930 13.7 113,531 10.0
Multifamily residential 97,059 8.3 77,743 7.5 79,048 7.8 42,158 3.7
Commercial property 26,386 2.3 37,875 3.7 40,003 4.0 22,630 2.0
---------- ----- ---------- ----- ---------- ----- ---------- -----
302,279 25.9 263,870 25.5 256,981 25.5 178,319 15.7
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total mortgage loans 769,416 65.8 710,995 68.8 725,429 72.0 926,315 81.7
Consumer 157,277 13.5 123,340 11.9 111,507 11.1 108,182 9.5
Business banking 241,808 20.7 199,848 19.3 169,830 16.9 99,528 8.8
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total loans receivable 1,168,501 100.0% 1,034,183 100.0% 1,006,766 100.0% 1,134,025 100.0%
===== ===== ===== =====
Undisbursed portion of loans in
process (90,111) (91,791) (112,325) (73,584)
Deferred loan origination costs
(fees) 540 468 891 3,153
Discount on loans acquired pursuant
to purchase transactions (380) (629) (776) (1,122)
Allowance for loan losses (8,959) (7,891) (7,889) (7,361)
---------- ---------- ---------- ----------
Loans receivable $1,069,591 $ 934,340 $ 886,667 $1,055,111
========== ========== ========== ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
June 30,
--------------------------------------
1994 1993
------------------ ------------------
Amount % Amount %
---------- ------ ---------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage-permanent:
One- to four-family residential $ 575,363 64.3% 389,177 63.4%
Multifamily residential 45,188 5.1 50,543 8.3
Commercial property 78,822 8.8 76,125 12.4
Land and other 2,702 0.3 4,406 0.7
---------- ----- ---------- -----
702,075 78.5 520,251 84.8
---------- ----- ---------- -----
Mortgage-construction:
One- to four-family residential 37,054 4.1 14,014 2.3
Multifamily residential 31,856 3.6 6,500 1.0
Commercial property 833 0.1 375 0.1
---------- ----- ---------- -----
69,743 7.8 20,889 3.4
---------- ----- ---------- -----
Total mortgage loans 771,818 86.3 541,140 88.2
Consumer 69,316 7.8 43,870 7.2
Business banking 52,700 5.9 28,507 4.6
---------- ----- ---------- -----
Total loans receivable 893,834 100.0% 613,517 100.0%
===== =====
Undisbursed portion of loans in
process (44,148) (13,009)
Deferred loan origination costs
(fees) 2,082 (177)
Discount on loans acquired pursuant
to purchase transactions (1,508) (1,943)
Allowance for loan losses (5,740) (4,719)
---------- ----------
Loans receivable $ 844,520 $ 593,669
========== ==========
</TABLE>
<PAGE>
CONTRACTUAL PRINCIPAL PAYMENTS. The following table sets forth the
scheduled contractual principal repayments for Sterling's loan
portfolio at December 31, 1997. Demand loans, loans having no stated
repayment schedule and no stated maturity, and overdrafts are reported
as due in one year or less. Loan balances do not include undisbursed
loan proceeds, unearned discounts, deferred loan origination costs and
fees, or allowances for loan losses.
<TABLE>
<CAPTION>
Principal Payments
Balance Contractually Due in Fiscal Years
Outstanding at ----------------------------------
December 31, 1997 1998 1999-2002 Thereafter
----------------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage--permanent:
Fixed rate $ 173,431 $ 15,250 $ 49,821 $ 108,360
Variable rate 293,706 12,006 55,108 226,592
Mortgage--construction 302,279 197,117 84,452 20,710
Consumer 157,277 27,592 63,441 66,244
Business banking 241,808 65,757 51,302 124,749
---------- ---------- ---------- ----------
$1,168,501 $ 317,722 $ 304,124 $ 546,655
========== ========== ========== ==========
</TABLE>
LOAN SERVICING. Sterling services its own loans as well as loans
owned by others. Loan servicing includes collecting and remitting
loan payments, accounting for principal and interest, holding escrow
funds for the payment of real estate taxes and insurance premiums,
contacting delinquent borrowers and supervising foreclosures in the
event of unremedied defaults.
For residential mortgage loans serviced for other investors, Sterling
receives a fee, generally ranging from 0.25% to 0.375% of the unpaid
principal balance of each loan, to compensate for the costs of
performing the servicing function. At December 31, 1997 and 1996 and
June 30, 1996, Sterling serviced for itself and for other investors
residential mortgage loans totaling $1.6 billion, $1.5 billion and
$1.5 billion, respectively. Of such mortgage loans, Sterling serviced
$378.9 million, $530.5 million and $574.6 million, respectively, at
these dates for the FHLMC and the FNMA. Sterling's ability to
continue as a seller/servicer for the FHLMC and the FNMA is dependent
upon meeting the qualifications of these agencies. Sterling currently
meets all applicable requirements.
From time to time, Sterling has sold portfolios of servicing rights
primarily to improve earnings and to increase its regulatory capital
ratios. During the twelve months ended December 31, 1997 and the six
months ended December 31, 1996, Sterling did not transfer any
portfolio of servicing rights. During the fiscal years ended
June 30, 1996 and 1995, Sterling sold in bulk rights to service
conventional loans for others of approximately $172.2 million and
$437.8 million, respectively. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" (hereafter
referred to as "Management's Discussion and Analysis") - Results of
Operations - Other Income."
<PAGE>
SECONDARY MARKET ACTIVITIES. Sterling has developed correspondent
relationships with a number of mortgage companies and financial
institutions to facilitate the origination or purchase and sale of
mortgage loans in the secondary market on either a participation or
whole loan basis. Substantially all of such purchased loans or
participations are secured by real estate. Those agents who present
loans to Sterling for purchase are required to provide a processed
loan package prior to commitment. Sterling then underwrites the loan
in accordance with its established lending standards.
In originating one- to four-family residential mortgage loans for sale
in the secondary market, Sterling incurs market risk from the time of
the loan commitments until such time as the loans are sold. To help
minimize this risk, Sterling typically obtains simultaneous
commitments from investors to purchase such loans at specified yields.
In recent years, the majority of conventional, Federal Housing
Administration-("FHA") and Veteran's Administration-("VA") insured
loans have been sold into the secondary market on a loan-by-loan
servicing-released basis. Sterling generally receives a fee of
approximately 1.0% to 2.0% of the principal balance of such loans for
releasing the servicing.
LOAN COMMITMENTS. Sterling uses written commitments to individual
borrowers and mortgage brokers for the purposes of originating and
purchasing loans. These commitments establish the terms and
conditions under which Sterling will fund the loans. Sterling had
outstanding commitments to originate or purchase loans aggregating
$141.2 million at December 31, 1997. Sterling also had secured and
unsecured commercial and personal lines of credit totaling
approximately $124.6 million, of which the undisbursed portion was
approximately $58.1 million at December 31, 1997. See Note 17 of
"Notes to Consolidated Financial Statements" included herein.
CLASSIFIED ASSETS, REAL ESTATE OWNED AND DELINQUENT LOANS. To measure
the quality of assets, including loans and real estate owned ("REO"),
Sterling has established guidelines for classifying assets and
determining provisions for anticipated loan and REO losses. Under
these guidelines, an allowance for anticipated loan and REO losses is
established when certain conditions exist. This system for
classifying and reserving for loans and REO is administered by
Sterling's Special Assets Department, which is responsible for
minimizing loan deficiencies and losses therefrom. An oversight
committee, comprised of senior management, monitors the activities and
progress of the Special Assets Department and reports results to
Sterling's Board of Directors.
Under this system, Sterling classifies loans and other assets it
considers of questionable quality. Sterling's system employs the
classification categories of "substandard," "doubtful" and "loss."
<PAGE>
Substandard assets have deficiencies which give rise to the distinct
possibility that Sterling will sustain some loss if the deficiencies
are not corrected. Doubtful assets have the weaknesses of substandard
assets and on the basis of currently existing facts, there is a high
probability of loss. An asset classified as loss is considered
uncollectible and of such little value that it should not be included
as an asset of Sterling. Total classified assets increased to
$19.4 million at December 31, 1997 from $16.1 million at December 31,
1996 and $8.1 million at June 30, 1996, respectively. As a
percentage of total assets, classified assets were 1.0%, 1.0% and
0.6%, respectively, for these periods. See "- Major Classified
Loans."
Assets classified as substandard or doubtful require the establishment
of general valuation allowances in amounts considered by management to
be adequate under generally accepted accounting principles ("GAAP").
Assets classified as loss require either a specific valuation
allowance of 100% of the amount classified or a write-off of such
amount. At December 31, 1997, Sterling's assets classified as loss
totaled $462,000. Judgments regarding the adequacy of a general
valuation allowance are based on on-going evaluations of the nature,
volume and quality of the loan portfolio, REO and other assets,
specific problem assets and current economic conditions that may
affect the recoverability of recorded amounts.
REO is recorded at the lower of estimated fair value, less estimated
selling expenses, or carrying value at foreclosure. Fair value is
defined as the amount in cash or other consideration that a real
estate asset would yield in a current sale between a willing buyer and
a willing seller. Development and improvement costs relating to the
property are capitalized to the extent they are deemed to be
recoverable upon disposal. The carrying value of REO is continuously
evaluated and, if necessary, an allowance is established to reduce the
carrying value to net realizable value (which considers, among other
things, estimated direct holding costs and selling expenses).
The following table sets forth the activity in Sterling's REO for the
periods indicated.
<TABLE>
<CAPTION>
Fiscal Years Ended
June 30,
Twelve Months Ended Six Months Ended ------------------
December 31, 1997 December 31, 1996 1996 1995
------------------- ----------------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $ 3,974 $ 4,874 $ 5,298 $ 7,298
Loan foreclosures and other
additions 6,865 1,839 1,628 1,568
Capitalized expenses. 627 181 124 0
Sales and other reductions (2,476) (2,889) (2,108) (3,534)
Provisions for loss (173) (31) (68) (34)
------- ------- ------- -------
Balance at end of period $ 8,817 $ 3,974 $ 4,874 $ 5,298
======= ======= ======= =======
</TABLE>
<PAGE>
MAJOR CLASSIFIED LOANS. Each of Sterling's classified loans with a
net carrying value at December 31, 1997 of more than $400,000 is
described below. The following loans are classified at
December 31, 1997.
Sterling acquired a loan as part of an acquisition from an insolvent
savings association. This nonperforming loan is secured by an
office/warehouse building located in Garland, Texas. A foreclosure
sale is scheduled to occur in the first half of 1998. The carrying
value on this loan at December 31, 1997 was $1.5 million. Sterling
has established a general valuation allowance of approximately
$164,000 for this loan.
Sterling holds a loan secured by a deed of trust on a multifamily
apartment complex located in Tacoma, Washington. The loan matured in
January 1997. Sterling is proceeding against the borrowers with
judicial foreclosure action. The carrying value of this loan at
December 31, 1997 was $1.2 million. No specific allowance has been
established for this loan.
Sterling holds a loan secured by a commercial warehouse plus excess
land located in Beaverton, Oregon. The loan was current at
December 31, 1997, but is classified due to delinquent payment history
over the past year. The carrying value of this loan at December 31,
1997 was $1.1 million. No specific allowance has been established for
this loan.
Sterling holds several loans to a business based in Spokane,
Washington. These loans, secured by accounts receivable, equipment
and inventory, were current at December 31, 1997, although there has
been a history of delinquent payments on the loans. The aggregate
carrying value of these loans at December 31, 1997 was $548,000. No
specific allowance has been established for these loans.
Sterling holds a commercial construction loan secured by two 2-story
office buildings in Richland, Washington. The borrower has filed for
Chapter 11 bankruptcy, and Sterling is preparing a motion for relief
from stay in order to foreclose. The carrying value on this loan at
December 31, 1997 was approximately $1.6 million. No specific
allowance has been established for this loan.
Sterling holds a loan secured by a deed of trust on a pyrolysis (tire
recycling) plant located in Chehalis, Washington and by deeds of trust
on residential properties and assignments of real estate contracts.
This nonperforming loan was acquired through Sterling's past
acquisition of an insolvent savings association. The carrying value
on the loan at December 31, 1997 was $1.0 million. No specific
allowance has been established for this loan.
MAJOR REAL ESTATE OWNED. Each of Sterling's REO properties with a net
carrying value at December 31, 1997 of more than $400,000 is described
below.
<PAGE>
Sterling acquired through foreclosure in November 1997 commercial
property in Spokane and Kennewick, Washington, as well as certain
accounts receivable, inventory, equipment and fixtures. The carrying
value on this property at December 31, 1997 was $3.6 million. No
specific loss allowance has been established for this property, as no
loss is expected. Sterling intends to liquidate this property in
1998.
Sterling is a 99.5% partner in a partnership which owns a commercial
office building in Renton, Washington acquired through an assignment
of interest from a bankrupt Spokane borrower. The carrying value at
December 31, 1997 was $2.7 million, net of a specific loss allowance
of $192,000. The project consists of a five-story office building
with 30,373 square feet of rentable area and adjoining undeveloped
property. The office building is currently 62.2% leased with
continued efforts to lease the remaining 11,553 square feet. Efforts
to sell the project have not been successful, but are on-going.
Sterling acquired a three-story office/retail/restaurant building
located in Olympia, Washington through foreclosure in August 1991.
The restaurant space has been converted to office space and is
currently leased. The carrying value on this property at December 31,
1997 was $656,000, net of a specific loss allowance of $202,000.
Sterling acquired a three-story office building located in Post Falls,
Idaho through foreclosure in October 1997. The office building is
currently vacant and efforts to sell the property are on-going. The
carrying value on this property at December 31, 1997 was $853,000, net
of a specific loss allowance of $116,000.
DELINQUENT LOAN PROCEDURES. Delinquent and problem loans are part of
any lending business. If a borrower fails to make a required payment
when due, Sterling institutes internal collection procedures. For
residential mortgage and consumer loans, Sterling's collection
procedures generally provide that an initial request for payment be
mailed to the borrower when the loan is 15 days past due. At 25 days
past due, the borrower is contacted by telephone and payment is
requested orally. In most cases, deficiencies are cured promptly. At
30 days past due, Sterling tracks the loan as a delinquency. In the
case of delinquent residential mortgage loans a notice of intent to
foreclose is mailed at 45 days past due. If the loan is still
delinquent 30 days following the mailing of the notice of intent to
foreclose, Sterling generally initiates foreclosure proceedings. In
certain instances, Sterling may modify the loan or grant a limited
moratorium on loan payments to enable the borrower to reorganize his
or her financial affairs.
<PAGE>
The following table summarizes the principal balances of nonperforming
assets at the dates indicated.
<TABLE>
<CAPTION>
December 31, June 30,
----------------- -------------------------------------
1997 1996 1996 1995 1994 1993
------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Nonaccrual loans $ 4,755 $ 2,329 $ 3,352 $ 3,395 $ 2,262 $ 5,065
Restructured loans 150 215 240 254 188 283
------- ------- ------- ------- ------- -------
Total nonperforming loans 4,905 2,544 3,592 3,649 2,450 5,348
Real estate owned (1) 8,817 3,974 4,874 5,298 7,298 6,979
------- ------- ------- ------- ------- -------
Total nonperforming assets $13,722 $ 6,518 $ 8,466 $ 8,947 $ 9,748 $12,327
======= ======= ======= ======= ======= =======
Ratio of total nonperforming
assets to total assets 0.73% 0.42% 0.57% 0.58% 0.71% 1.19%
Ratio of total nonperforming
loans to total loans 0.42% 0.25% 0.36% 0.32% 0.27% 0.87%
Ratio of allowance for
estimated losses on loans to
total nonperforming loans (2) 183.00% 305.28% 224.15% 205.70% 234.38% 85.95%
</TABLE>
(1) Amount is net of the allowance for REO losses.
(2) Excludes loans classified as loss. Loans classified as loss
excluded from allowance for loan losses were $47,000, $262,000,
$213,000, $145,000, $7,000 and $314,000 at December 31, 1997 and
1996 and June 30, 1996, 1995, 1994 and 1993, respectively. Loans
classified as loss excluded from total nonperforming loans were
$35,000, $45,000, $167,000, $141,000, $4,000 and $223,000 at
December 31, 1997 and 1996 and June 30, 1996, 1995, 1994 and 1993,
respectively.
<PAGE>
Sterling regularly reviews the collectibility of accrued interest
income and generally ceases to accrue interest on a loan when either
principal or interest is past due by 90 days or more. Any accrued and
uncollected interest is eliminated from income at that time. Loans may
be placed in nonaccrual status earlier if, in management's judgment,
the loan may be uncollectible. Interest on such a loan is then
recognized as income only if collected or if the loan is restored to
performing status. Additional interest income of $258,000, $135,000,
$86,000, $151,000, $224,000 and $231,000 would have been recorded
during the twelve months ended December 31, 1997 and 1996, the six
months ended December 31, 1996 and 1995 and the fiscal years ended
June 30, 1996 and 1995, respectively, if nonaccrual and restructured
loans had been current in accordance with their original contractual
terms. Sterling's quality control staff also reviews various aspects
of loans originated and acquired by Sterling to ensure compliance with
appropriate underwriting criteria. These reviews assist Sterling in
monitoring the performance of its personnel and independent
appraisers. Sterling's mortgage loan quality control function is
intended to conform to guidelines and standards established by the
FNMA, the FHLMC, and, as applicable, other private investors.
ALLOWANCE FOR LOAN AND REAL ESTATE OWNED LOSSES. Generally, Sterling
establishes specific allowances for the difference between the
anticipated fair value (market value less selling costs, foreclosure
costs and projected holding costs), adjusted for other possible
sources of repayment, and the book balance (loan principal and accrued
interest or carrying value of REO) of its loans classified as loss and
REO. Each classified loan and REO property is reviewed at least
monthly. Allowances are established or periodically increased, if
necessary, based on the review of information obtained through on-site
inspections, market analysis, appraisals and purchase offers.
Management believes that allowances for loan and REO losses are
adequate, although there can be no assurances in this regard. See
Note 6 of "Notes to Consolidated Financial Statements."
Sterling is currently evaluating its loan loss allowance in
conjunction with its review of so-called Year 2000 issues. This
review includes an evaluation of (i) Sterling's large borrower's
abilities to respond to their internal Year 2000 issues; (ii) the
effect, if any, this will have on such borrowers' ability to make
timely payments and ultimately, to repay their obligations; and (iii)
the potential effect of increased delinquencies and loan losses on
Sterling. The loan loss allowance may or may not increase, depending
upon Sterling's findings. See "Management's Discussion and Analysis -
Year 2000 Issues."
Management believes that the allowance for loan losses is adequate
given the composition and risks of the loan portfolio, although there
can be no assurance that the allowance will be adequate to cover all
contingencies. The following table sets forth information regarding
changes in Sterling's allowance for estimated losses on loans for the
periods indicated.
<PAGE>
<TABLE>
<CAPTION>
Fiscal Years Ended June 30,
Twelve Months Ended Six Months Ended -------------------------------------
December 31, 1997 December 31, 1996 1996 1995 1994 1993
------------------- ----------------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning of period $ 7,891 $ 7,889 $ 7,361 $ 5,740 $ 4,719 $ 4,745
Charge-offs:
Mortgage--permanent (219) (767) (751) (795) (565) (1,575)
Mortgage--construction (202) (7) 0 0 0 0
Consumer (1,023) (382) (408) (216) (57) (4)
Business banking (119) (19) (5) (9) (3) (7)
------- ------- ------- ------- ------- -------
Total charge-offs (1,563) (1,175) (1,164) (1,020) (625) (1,586)
------- ------- ------- ------- ------- -------
Recoveries:
Mortgage--permanent 58 30 23 61 39 57
Consumer 100 39 45 23 7 2
Business banking 23 8 24 5 0 1
------- ------- ------- ------- ------- -------
Total recoveries 181 77 92 89 46 60
------- ------- ------- ------- ------- -------
Net charge-offs (1,382) (1,098) (1,072) (931) (579) (1,526)
Provisions for loan losses 2,450 1,100 1,600 1,600 1,600 1,500
Allowance for losses on assets
acquired 0 0 0 952 0 0
------- ------- ------- ------- ------- -------
Balance at end of period $ 8,959 $ 7,891 $ 7,889 $ 7,361 $ 5,740 $ 4,719
======= ======= ======= ======= ======= =======
Allowances allocated to loans
classified as loss $ 47 $ 262 $ 213 $ 145 $ 7 $ 314
Ratio of net charge-offs to
average loans outstanding
during the period 0.14% 0.12% 0.11% 0.09% 0.08% 0.29%
</TABLE>
<PAGE>
Allowances are provided for individual loans when management considers
ultimate collection to be questionable. Such allowances are based,
among other factors, upon the estimated net realizable value of the
security or the loan or guarantees, if applicable. The following
table sets forth the allowances for estimated losses on loans by loan
category and summarizes the percentage of gross loans in each category
to total gross loans.
<TABLE>
<CAPTION>
December 31, June 30,
-------------------------------------------- --------------------------------------------
1997 1996 1996 1995
--------------------- --------------------- --------------------- ---------------------
Loans in Loans in Loans in Loans in
Category as a Category as a Category as a Category as a
Percentage Percentage Percentage Percentage
of Total of Total of Total of Total
Amount Gross Loans Amount Gross Loans Amount Gross Loans Amount Gross Loans
------ ------------- ------ ------------- ------ ------------- ------ -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-permanent $3,608 39.9% $3,156 43.3% $3,047 46.5% $3,375 66.0%
Mortgage-construction 3,108 25.9 2,380 25.5 1,969 25.5 1,369 15.7
Consumer 24 13.5 334 11.9 403 11.1 366 9.5
Business banking 1,394 20.7 1,196 19.3 1,075 16.9 856 8.8
Unallocated 825 N/A 825 N/A 1,395 N/A 1,395 N/A
------ ----- ------ ----- ------ ----- ------ -----
$8,959 100.0% $7,891 100.0% $7,889 100.0% $7,361 100.0%
====== ===== ====== ===== ====== ===== ====== =====
<CAPTION>
June 30,
--------------------------------------------
1994 1993
--------------------- ---------------------
Loans in Loans in
Category as a Category as a
Percentage Percentage
of Total of Total
Amount Gross Loans Amount Gross Loans
------ ------------- ------ -------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage-permanent $3,309 78.5% $3.035 84.7%
Mortgage-construction 969 7.8 569 3.5
Consumer 359 7.8 209 7.2
Business banking 660 5.9 463 4.6
Unallocated 443 N/A 443 N/A
------ ----- ------ -----
$5,740 100.0% $4,719 100.0%
====== ===== ====== =====
</TABLE>
<PAGE>
INVESTMENTS AND MORTGAGE-BACKED SECURITIES
Investments and MBS that management has the positive intent and
ability to hold to maturity are classified as held-to-maturity and
carried at amortized cost. Unrealized gains and losses on such
securities are not reported in the Consolidated Financial Statements
as these securities are held for investment purposes. See
"Management's Discussion and Analysis - Results of Operations - Other
Income" and Note 2 of "Notes to Consolidated Financial Statements."
Sterling classifies specific investments and MBS as available-for-
sale. Investments classified as available-for-sale are carried at
fair value. Unrealized gains and losses are excluded from earnings
and are reported net of deferred income tax as a separate component of
shareholders' equity until such securities mature or are actually
sold. These securities may be sold in response to changes in market
interest rates and related changes in the securities' prepayment risk,
needs for liquidity, changes in the availability of and the yield on
alternative investments, and changes in funding sources and terms.
At December 31, 1997 and 1996, investments and MBS classified as
available-for-sale were $656.2 million and $469.8 million,
respectively. The carrying value of these securities includes a net
unrealized loss of $1.0 million (net of a $540,000 related tax
benefit) and $6.0 million (net of a $3.2 million related tax benefit),
respectively. At June 30, 1996, investments and MBS classified as
available-for-sale were $460.1 million. The carrying value of these
securities included a net unrealized loss of $10.3 million (net of a
$5.5 million related tax benefit). The increase in fair value since
June 30, 1996 is due primarily to a decrease in long-term interest
rates.
Sterling invests primarily in MBS issued by the FHLMC and the FNMA and
agency obligations and stock in the Federal Home Loan Bank of Seattle
("FHLB Seattle"). Such investments provide Sterling with a relatively
liquid source of interest income and collateral which can be used to
secure borrowings. Sterling invests exclusively in investment-grade
securities.
The following table provides the carrying values, maturities and
weighted average yields of Sterling's investment and MBS portfolio at
December 31, 1997.
<PAGE>
<TABLE>
<CAPTION>
Maturity
---------------------------------------------------------
Less than One to Five to Over Ten
One Year Five Years Ten Years Years Total
--------- ---------- --------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Mortgage-backed securities,
at fair value(1):
Balance $ 5,580 $ 57,219 $ 89,675 $316,779 $469,253
Weighted average yield 7.00% 5.71% 6.55% 6.70% 6.55%
U.S. government and agency
obligations, at fair
value(1):
Balance $ 6,966 $132,029 $ 20,013 $ 0 $159,008
Weighted average yield 5.90% 6.55% 6.82% 0.00% 6.56%
FHLB Seattle stock, at cost:
Balance $ 0 $ 0 $ 0 $ 27,975 $ 27,975
Weighted average yield(2) 0.00% 0.00% 0.00% 7.61% 7.61%
Municipal bonds(3):
Balance $ 1,032 $ 9,516 $ 2,200 $ 0 $ 12,748
Weighted average yield 3.91% 4.44% 4.78% 0.00% 4.46%
Other:
Balance $ 0 $ 0 $ 0 $ 2 $ 2
Weighted average yield 0.00% 0.00% 0.00% 1.15% 1.15%
Total carrying value $ 13,578 $198,764 $111,888 $344,756 $668,986
======== ======== ======== ======== ========
Weighted average yield 6.20% 6.21% 6.56% 6.77% 6.56%
</TABLE>
(1) Based on contractual maturities.
(2) The weighted average yield on FHLB Seattle stock is based upon
the dividends received for the twelve months ended December 31,
1997.
(3) The weighted average yields on municipal bonds reflects the
actual yields on the bonds and is not tax effected.
<PAGE>
The following table sets forth the carrying values and classifications
for financial statement reporting purposes of Sterling's investment
and MBS portfolio at the dates indicated.
December 31,
------------------ June 30,
1997 1996 1996
-------- -------- --------
(Dollars in thousands)
Mortgage-backed securities $469,253 $376,940 $399,893
U.S. government and agency obligations 159,008 66,919 35,244
FHLB Seattle stock 27,975 25,923 24,911
Municipal bonds 12,748 11,846 11,854
Other 2 33 38
-------- -------- --------
Total $668,986 $481,661 $471,940
======== ======== ========
Available-for-sale $656,236 $469,790 $460,061
Held-to-maturity 12,750 11,871 11,879
-------- -------- --------
Total $668,986 $481,661 $471,940
======== ======== ========
Weighted average yield 6.56% 6.42% 6.26%
SOURCES OF FUNDS
GENERAL. Sterling's primary sources of funds for use in lending and
for other general business purposes are loan repayments, FHLB Seattle
advances and secured lines of credit and other borrowings, deposits,
proceeds from sales of investments and MBS and proceeds from sales of
loans. Scheduled loan repayments are a relatively stable source of
funds, while other sources of funds are influenced significantly by
prevailing interest rates, interest rates available on other
investments and other economic conditions. Borrowings may be used on
a short-term basis to compensate for reductions in other sources of
funds (such as deposit inflows at less than projected levels).
Borrowings may also be used on a longer-term basis to support expanded
lending activities and to match repricing intervals of assets. See
"Lending Activities" and "Investments and Mortgage-Backed Securities."
DEPOSIT ACTIVITIES. Sterling offers a variety of accounts for
depositors designed to attract both short-term and long-term deposits
from the general public. These accounts include certificates of
deposit ("CDs"), regular savings accounts and checking accounts,
including negotiable order of withdrawal ("NOW") accounts. These
accounts earn interest at rates established by management and are
based on a competitive market analysis. The method of compounding
varies from simple interest credited at maturity to daily compounding,
depending on the type of account.
<PAGE>
With the exception of certain promotional CDs and variable rate, 18-
month Individual Retirement Account ("IRA") certificates, all CDs
carry a fixed rate of interest for a defined term from the opening
date of the account. Substantial penalties are imposed if principal is
withdrawn from most CDs prior to maturity.
Sterling supplements its retail deposit gathering by soliciting funds
from public entities. Public funds were 9.1%, 5.7% and 6.2% of
deposits at December 31, 1997 and 1996 and June 30, 1996,
respectively. Public funds are generally obtained by competitive
bidding among qualifying financial institutions. Sterling had no
brokered deposits at December 31, 1997.
With the planned acquisition of KeyBank branches, Sterling anticipates
a significant increase in its checking account balances. Further,
Sterling is reviewing the pricing of all of its products and may
implement changes coinciding with the closing date of the transaction.
See "Recent Developments."
The primary retail deposit vehicles being utilized by Sterling's
customers are CDs with terms of one year or less, regular savings
accounts, money market accounts and NOW accounts. The following table
presents the average balance outstanding and weighted average interest
rate paid for each major category of deposits for the periods
indicated.
<PAGE>
<TABLE>
<CAPTION>
Twelve Months Ended December 31, Six Months Ended December 31,
------------------------------------------ -----------------------------------------
1997 1996 1996 1995
------------------- -------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Average Interest Average Interest Average Interest Average Interest
Balance Rate Balance Rate Balance Rate Balance Rate
-------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Certificates of deposit $620,561 5.70% $585,140 5.71% $578,738 5.64% $629,828 6.01%
Regular savings accounts and
money market accounts 236,057 3.92 216,336 3.83 222,223 3.82 175,479 3.68
Checking accounts:
NOW accounts 78,234 1.33 70,010 1.41 70,944 1.41 66,426 1.50
Non-interest-bearing
demand accounts 29,132 0.00 23,959 0.00 24,875 0.00 26,297 0.00
-------- -------- -------- -------- -------- -------- -------- --------
$963,984 4.74% $895,445 4.76% $896,780 4.70% $898,030 5.05%
======== ======== ======== ======== ========
<CAPTION>
Fiscal Years Ended June 30,
------------------------------------------
1996 1995
------------------- --------------------
Weighted Weighted
Average Average
Average Interest Average Interest
Balance Rate Balance Rate
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Certificates of deposit $610,297 5.90% $626,952 5.23%
Regular savings accounts and
money market accounts 194,346 3.72 163,490 3.56
Checking accounts:
NOW accounts 67,507 1.52 66,060 1.80
Non-interest-bearing
demand accounts 24,346 0.00 21,961 0.00
-------- -------- -------- --------
$896,496 4.94% $878,463 4.53%
======== ========
</TABLE>
<PAGE>
The following table shows the amounts and maturities of CDs that had
balances of $100,000 or more at December 31, 1997.
(Dollars in thousands)
Remaining maturity:
Less than three months $121,016
Three to six months 44,029
Six to 12 months 43,462
Over 12 months 16,442
--------
$224,949
========
The following table presents the types of deposit accounts offered by
Sterling Savings and the balance in such accounts:
<TABLE>
<CAPTION>
Decemer 31, 1997
-------------------------------------------------
Percent Interest Rate
Minimum Minimum of Total Offered at
Term Category Balances Amount Deposits December 31, 1997
-------- --------------------------- -------- ---------- -------- -----------------
(Dollars in thousands, except minimum amounts)
Transaction Accounts:
<S> <C> <C> <C> <C> <C>
None NOW checking $ 100 $ 88,305 8.5% 1.50%
None Commercial checking 100 31,054 3.0 0.00
None Regular savings 100 63,117 6.1 2.55
None Money market demand 2,500 183,795 17.7 3.46
---------- ------
366,271 35.3
---------- ------
Certificates of Deposit:
3 months Fixed term, fixed rate 500 968 0.1 3.92
6 months Fixed term, fixed rate 500 13,401 1.3 5.10
9 months Fixed term, adjustable rate 5,000 65,684 6.3 5.22
12 months Fixed term, fixed rate 500 123,729 12.0 5.32
12 months Fixed term, fixed rate 5,000 368 0.0 2.75
12 months Fixed term, adjustable rate 5,000 4,624 0.4 5.13
15 months Fixed term, adjustable rate 5,000 66,553 6.4 5.22
18 months Fixed term, fixed rate 500 129,783 12.6 5.51
24 months Fixed term, fixed rate 500 81,897 7.9 5.25
36 months Fixed term, fixed rate 500 13,211 1.3 5.26
36 months Zero coupon, fixed term(1) N/A 70 0.0 N/A
18 months Variable rate, IRA 100 5,448 0.5 5.91
18 months Fixed rate, IRA 500 1,914 0.2 5.41
36 months Variable rate, IRA 2,000 15,128 1.5 5.70
7 days Jumbos 100,000 147,359 14.2 5.00
---------- ------
670,137 64.7
---------- ------
Total deposits $1,036,408 100.0%
========== ======
</TABLE>
(1) Not offered as of December 31, 1997.
<PAGE>
The following table sets forth the composition of Sterling's deposit
accounts at the dates indicated.
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996 June 30, 1996
-------------------- -------------------- --------------------
Percent Percent Percent
Total of Total of Total of
Amount Deposits Amount Deposits Amount Deposits
---------- -------- ---------- -------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
NOW checking $ 88,305 8.5% $ 72,686 8.0% $ 69,125 7.7%
Commercial checking 31,054 3.0 24,180 2.7 20,468 2.3
Regular savings 63,117 6.1 72,243 8.0 74,413 8.3
Money market demand 183,795 17.7 148,696 16.5 152,874 17.0
Variable rate certificates:
18 months 5,448 0.5 5,582 0.6 5,478 0.6
Fixed rate certificates:
1-11 months 299,106 28.9 208,976 23.2 201,481 22.4
12-35 months 270,620 26.1 269,606 29.9 270,120 30.1
36-240 months 94,963 9.2 100,309 11.1 104,428 11.6
---------- ------ ---------- ------ ---------- ------
1,036,408 100.0 902,278 100.0 898,387 100.0
Deposit premium 0 0.0 0 0.0 7 0.0
---------- ------ ---------- ------ ---------- ------
Total deposits $1,036,408 100.0% $ 902,278 100.0% $ 898,394 100.0%
========== ====== ========== ====== ========== ======
</TABLE>
Substantially all of Sterling's depositors are residents of the States
of Washington or Oregon. Upon successful completion of the
acquisition of the KeyBank branches, Sterling will add deposits in the
State of Idaho. See "Recent Developments."
Sterling is a member of The Exchange, an automated teller machine
("ATM") system that allows participating customers to deposit or
withdraw from NOW accounts, money market demand accounts and savings
accounts at over 18,000 Exchange system machines located throughout
the United States and Canada. Sterling is also a member of the Plus
System ATM network, with numerous locations in the United States and
internationally. Sterling has installed ATMs in 20 of its branches to
better serve customers in those markets. Customers in these areas can
also access the system through ATMs operated by other financial
institutions.
BORROWINGS. Deposit accounts are Sterling's primary source of funds.
Sterling does, however, rely upon advances from the FHLB Seattle and
reverse repurchase agreements to supplement its funding and to meet
deposit withdrawal requirements. See "Management's Discussion and
Analysis - Liquidity and Sources of Funds."
<PAGE>
The FHLB Seattle is part of a system, which consists of 12 regional
Federal Home Loan Banks (the "FHL Banks") each subject to Federal
Housing Finance Board supervision and regulation, that functions as a
central reserve bank providing credit to savings institutions. As a
member, Sterling is required to own stock of the FHLB Seattle in an
amount determined by a formula based upon Sterling's loans outstanding
and advances from the FHLB Seattle. At December 31, 1997, Sterling
exceeded its FHLB Seattle stock ownership requirement of $12.6 million
by $15.3 million. The stock of the FHLB Seattle has always been
redeemable at par value, but there can be no assurance that this will
always be the case.
As a member of the FHLB Seattle, Sterling is authorized to apply for
advances on the security of its FHLB Seattle stock and certain of its
mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the United States or its agencies),
provided certain standards related to creditworthiness are met. Each
credit program has its own interest rate and range of maturities. At
December 31, 1997, Sterling had advances totaling $455.1 million from
the FHLB Seattle which mature from fiscal years 1998 through 2015 at
interest rates ranging from 5.15% to 8.40%. See "Recent
Developments," "Management's Discussion and Analysis - Liquidity and
Sources of Funds" and Note 9 of "Notes to Consolidated Financial
Statements."
Sterling also borrows funds under reverse repurchase agreements
pursuant to which it sells securities (generally U.S. agency and MBS)
under an agreement to buy them back at a specified price at a later
date. These agreements to repurchase are deemed to be borrowings
collateralized by the securities sold. Sterling uses these borrowings
to supplement deposit gathering for funding the origination of loans.
Sterling had $180.1 million, $229.8 million and $195.8 million in
reverse repurchase agreements outstanding at December 31, 1997 and
1996 and June 30, 1996, respectively. The use of reverse repurchase
agreements may expose Sterling to certain risks not associated with
other borrowings, including IRR and the possibility that additional
collateral may have to be provided if the market value of the pledged
collateral declines. For additional information regarding reverse
repurchase agreements, see "Management's Discussion and Analysis -
Asset and Liability Management," "Management's Discussion and Analysis
- Liquidity and Sources of Funds" and Note 10 of "Notes to
Consolidated Financial Statements."
On June 4, 1997, Sterling issued $41.2 million of 9.50% junior
subordinated deferrable interest debentures (The "Junior Subordinated
Debentures") to Sterling Capital Trust I (the "Trust"), a Delaware
business trust, of which Sterling owns all of the common equity. The
sole asset of the Trust is the Junior Subordinated Debentures. The
Trust issued $40.0 million of 9.50% Cumulative Capital Securities (the
"Trust Preferred Securities") to investors. The indenture governing
the Junior Subordinated Debentures limits the ability of Sterling
under certain circumstances to pay dividends or make other capital
<PAGE>
distributions. The Trust Preferred Securities are treated as debt of
Sterling. The Trust Preferred Securities mature on June 30, 2027 and
are redeemable at the option of Sterling on June 30, 2002, or earlier
in the event the deduction of related interest for federal income
taxes is prohibited, treatment as Tier 1 capital is no longer
permitted, or certain other contingencies arise.
Sterling has outstanding $17.2 million of 8.75% Subordinated Notes
which are due on January 31, 2000 ("the Subordinated Notes"). The
Subordinated Notes are unsecured general obligations of Sterling and
are subordinated to certain other existing and future indebtedness.
Under the terms of the Subordinated Notes, Sterling is limited by the
amount of certain long-term debt that it may incur. Sterling is
limited and is restricted, under certain circumstances, from paying
cash dividends and from making other capital distributions.
At December 31, 1997, Sterling had the authority to incur
approximately $50.1 million of additional long-term debt
notwithstanding such restriction. Interest on the Subordinated Notes
is due the first day of each month. Sterling may, at its option,
redeem the Subordinated Notes in whole or in part at par plus accrued
interest. See Note 11 of "Notes to Consolidated Financial
Statements."
In addition to the borrowings described above, Sterling has a $15.0
million five-year variable rate loan with KeyBank of Washington.
Interest is payable quarterly on this loan. The interest rate at
December 31, 1997 was 7.33%. Principal is repayable in five annual
payments of $3.0 million each, commencing September 1998. Sterling
also has a $5.0 million line of credit agreement with KeyBank of
Washington. Advances under the line of credit accrue interest at
KeyBank of Washington's prime interest rate plus 0.50% (9.00% at
December 31, 1997) and the line of credit matures in 1999. Management
expects that the line of credit will be renewed at that time on
substantially the same terms, although there can be no assurance in
this regard. Borrowings under this line of credit are secured by a
pledge of certain shares of Sterling Savings Preferred Stock which are
owned by Sterling. No amounts were outstanding on this line of credit
at December 31, 1997 and 1996 and June 30, 1996. See "Management's
Discussion and Analysis Liquidity and Sources of Funds."
Sterling Savings has an unsecured $10.0 million line of credit
agreement with KeyBank of Washington. Advances under the line of
credit accrue interest at KeyBank of Washington's federal funds rate
plus an incremental negotiated rate (5.84% at December 31, 1997) and
the line matures in 1999. Management expects that the line of credit
will be renewed at that time on substantially the same terms, although
there can be no assurance in this regard. No amounts were outstanding
on this line of credit at December 31, 1997 and 1996 and June 30,
1996.
<PAGE>
The following table sets forth certain information regarding
Sterling's short-term borrowings as of and for the periods indicated.
<TABLE>
<CAPTION>
Fiscal Years Ended
Twelve Months June 30,
Ended Six Months Ended ------------------
December 31, 1997 December 31, 1996 1996 1995
----------------- ----------------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Maximum amount outstanding at
any month-end during the period:
Reverse repurchase agreements $273,573 $232,885 $195,785 $148,055
Short-term advances 353,847 95,000 171,000 223,000
Average amount outstanding during
the period:
Reverse repurchase agreements 185,698 213,560 156,578 118,064
Short-term advances 207,931 90,833 140,917 201,250
Weighted average interest rate paid
during the period:
Reverse repurchase agreements 5.68% 5.60% 5.91% 6.02%
Short-term advances 5.90% 5.79% 5.88% 5.13%
Weighted average interest rate paid
at end of period:
Reverse repurchase agreements 5.71% 5.62% 5.57% 6.67%
Short-term advances 5.99% 5.75% 6.42% 5.41%
</TABLE>
The following table sets forth certain information concerning
Sterling's outstanding borrowings.
<TABLE>
<CAPTION>
December 31,
---------------------------------- June 30, 1996
1997 1996 ----------------
Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
FHLB Seattle advances:
Short-term $353,847 50.0% $ 90,000 17.3% $ 90,000 19.1%
Long-term 101,238 14.3 169,626 32.5 169,410 35.9
Securities sold subject to reverse
repurchase agreements 180,077 25.5 229,797 44.0 195,785 41.4
Subordinated Notes 17,240 2.4 17,240 3.3 17,240 3.6
Trust Preferred Securities 40,000 5.7 0 0.0 0 0.0
Term note payable 15,000 2.1 15,000 2.9 0 0.0
-------- ----- -------- ----- -------- -----
Total borrowings $707,402 100.0% $521,663 100.0% $472,435 100.0%
======== ===== ======== ===== ======== =====
Weighted average interest rate 6.09% 6.21% 6.25%
</TABLE>
<PAGE>
SUBSIDIARIES
Sterling's principal subsidiary is Sterling Savings Association.
Sterling Savings has three principal subsidiaries which have been
previously described: Action Mortgage, Harbor Financial and INTERVEST.
Additionally, Sterling Financial Corporation and Sterling Savings have
the following wholly owned subsidiaries that are either inactive or
exist solely for the purpose of holding and owning specific assets or
properties:
STERLING FINANCIAL CORPORATION.
(1) Tri-Cities Mortgage Corporation was obtained as part of an
acquisition in April 1988. The corporation's principal asset is
a 99.5% partnership interest in Renton Plaza Investors (a
partnership which owns a five-story office building near Renton,
Washington). See "Lending Activities - Major Real Estate
Owned."
(2) Sterling Capital Trust I was organized in May 1997 as a Delaware
business trust. Sterling owns all the common equity of the
Trust. The sole asset of the Trust is the Junior Subordinated
Debentures issued by Sterling.
STERLING SAVINGS ASSOCIATION.
(1) Fidelity Service Corporation was organized in 1983 to acquire and
sell real and personal property in eastern Washington and Idaho.
The corporation's assets consist principally of office furniture
and equipment used by Sterling Savings.
(2) Evergreen Environmental Development Corporation was organized to
engage in real estate development and was obtained as part of an
acquisition in December 1988. This corporation's assets include
a 33% interest in the Grapetree Partnership, which owns a parcel
of raw land in Spokane, Washington that it intends to develop
into single-family residential lots. Sterling Savings'
investment in the Grapetree Partnership has been deemed by its
primary federal regulators to be an impermissible investment.
Accordingly, Sterling Savings' investment has been deducted from
tangible, core and risk-based capital.
(3) Tri-West Mortgage, Inc. was obtained as part of an acquisition in
1988 and was originally engaged in mortgage banking. The
corporation's sole assets consist of commercial property in
Spokane and Kennewick, Washington acquired through foreclosure,
as well as accounts receivable, inventory, equipment and
fixtures. See "Lending Activities - Major Real Estate Owned."
(4) Evergreen First Service Corporation was obtained as part of an
acquisition in 1988 and owns all of the outstanding capital stock
of Harbor Financial, through which Sterling offers tax-deferred
annuities, mutual funds and other financial products.
<PAGE>
COMPETITION
Sterling faces strong competition, both in attracting deposits and in
originating, purchasing and selling real estate and other loans, from
savings and loan associations, mutual savings banks, credit unions and
commercial banks and other institutions, many of which have greater
resources than Sterling. Sterling also faces strong competition in
marketing financial products such as annuities, mutual funds and other
financial products and in pursuing acquisition opportunities. Some or
all of these competitive institutions operate in Sterling's market
areas.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 (the "Interstate Banking Act") allows adequately capitalized and
well-managed bank holding companies to acquire banks in any state,
subject to certain conditions, regardless of whether such acquisitions
would be prohibited by applicable state law. The Interstate Banking
Act also allows interstate merger transactions beginning June 1, 1997.
Each state was entitled to enact a law before June 1, 1997, expressly
prohibiting merger transactions with out-of-state banks. If a state
"opted out" in this manner, no bank in any other state may establish a
branch in that state. As of June 1, 1997 only the states of Montana
and Texas had opted out of interstate merger transactions. As a
result of the Interstate Banking Act, Sterling's bank competitors may
be able to conduct extensive interstate banking operations and thereby
gain competitive advantages over Sterling.
PERSONNEL
As of December 31, 1997, Sterling, including its subsidiaries, had 510
full-time equivalent employees. Employees are not represented by a
collective bargaining unit. Sterling believes its relationship with
its employees is excellent. As a condition of the acquisition of
KeyBank branches Sterling agreed to hire approximately 190 employees
who work in the new branches. See "Recent Developments."
REGULATION
INTRODUCTION. THE FOLLOWING IS NOT INTENDED TO BE A COMPLETE
DISCUSSION BUT IS INTENDED TO BE A SUMMARY OF SOME OF THE MOST
SIGNIFICANT PROVISIONS OF LAWS APPLICABLE TO STERLING AND ITS
SUBSIDIARIES.
Sterling is a savings and loan holding company and as such is subject
to OTS regulations, examinations and reporting requirements. Sterling
Savings is chartered by the State of Washington and its savings
deposits are insured by the FDIC. Sterling Savings is subject to
comprehensive regulation, examination and supervision by the OTS, the
FDIC and the Washington Supervisor. Furthermore, certain transactions
and savings deposits are subject to regulations and controls
promulgated by the Federal Reserve Board (the "Fed").
<PAGE>
SAVINGS AND LOAN HOLDING COMPANY REGULATION. Sterling is registered
as a savings and loan holding company under the Home Owners' Loan Act
(the "HOLA"). The HOLA generally permits a savings and loan holding
company to engage in activities which are unrelated to the operation
of a savings and loan association, provided the holding company
controls only one savings and loan association and such savings and
loan association meets the Qualified Thrift Lender Test (the "QTL
Test"). Sterling presently controls only one savings and loan
association, Sterling Savings, which at December 31, 1997 met the QTL
Test.
If Sterling Savings fails to meet the QTL Test in the future, Sterling
will become subject to restrictions on the activities in which it may
engage. Such activities would generally be limited to any activity
that the Fed by regulation has determined is permissible for bank
holding companies pursuant to Section 4(c) of the Bank Holding Company
Act of 1956, as amended (unless limited or prohibited by the OTS by
regulation), and certain other limited services and activities.
Sterling currently has no plans to engage in any new activity that
would be restricted if Sterling Savings were to fail to meet the QTL
Test in the future. Although Sterling Savings expects to remain in
compliance with the QTL Test in the future, there can be no assurance
in this regard.
Under the HOLA, no person may acquire control of a savings association
or a savings and loan holding company without the prior approval of
the OTS. As a savings and loan holding company, Sterling is
prohibited from acquiring (i) control of another savings association
or a savings and loan holding company without the prior approval of
the OTS, (ii) the assets of another savings association, or savings
and loan holding company by merger, consolidation or purchase, without
the prior approval of the OTS, (iii) more than 5% of the voting shares
of a savings association or a savings and loan holding company which
is not a subsidiary of Sterling; or (iv) control of a depository
institution, the accounts of which are not insured by the FDIC.
The HOLA authorizes the OTS to issue a directive to a savings and loan
holding company and any of its subsidiaries if the OTS determines that
there is reasonable cause to believe that the continuation by the
holding company of any activity constitutes a serious risk to the
financial safety, soundness or stability of the holding company's
subsidiary savings association. The OTS may impose restrictions
through such directive to limit such risk, including limiting (i) the
payment of dividends by the savings association, (ii) transactions
between the savings association, the holding company and the
subsidiaries or affiliates of either and (iii) any activities of the
savings association that might create a serious risk that the
liabilities of the holding company and its other affiliates may be
imposed on the savings association. Such a directive has the same
effect as a final cease and desist order. The issuance of the
directive can be appealed to the Director of the OTS.
<PAGE>
THE FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") provides for expanded regulation of depository institutions
and their affiliates, including parent holding companies. FDICIA
further provides the OTS with broad powers to take "prompt corrective
action" to resolve problems of insured depository institutions. The
extent of these powers depends upon whether the institution in
question is "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized."
Under OTS regulations which implement the "prompt corrective action"
system mandated by FDICIA, an institution is "well capitalized" if its
total risk-based capital ratio (the ratio of qualifying total capital
to risk-weighted assets) is 10% or more, its Tier 1 risked-based
capital ratio (the ratio of Tier 1 core capital to risk-weighted
assets) is 6% or more, its leverage ratio (the ratio of core capital
to total assets) is 5% or more and it is not subject to any written
agreement, order or directive to meet a specified capital level. At
December 31, 1997, Sterling Savings met the standards for a "well
capitalized" institution.
An institution which is "undercapitalized" must submit a capital
restoration plan to the OTS. The plan may be approved only if the OTS
determines it is likely to succeed in restoring the institution's
capital and will not appreciably increase the risks to which the
institution is exposed. The institution's performance under the plan
must be guaranteed by any company which controls the institution, up
to a maximum of 5% of the institution's assets. The OTS may also
require an undercapitalized institution to take various actions deemed
appropriate to minimize the potential losses to the deposit insurance
fund. Institutions that are "significantly undercapitalized" or
"critically undercapitalized" are subject to additional sanctions.
FDICIA directs each bank regulatory agency and the OTS to review its
capital standards every two years to determine whether those standards
require sufficient capital to facilitate prompt corrective action to
prevent or minimize loss to the deposit insurance funds. FDICIA, as
amended, also requires the OTS to prescribe minimum operational and
managerial standards and standards for asset quality, earnings and
stock valuation for savings institutions. Any savings institution
which fails to meet the standards may be required to submit a plan for
corrective action. If a savings institution fails to submit or
implement an acceptable plan, the OTS may require the institution to
take any action the OTS determines will best carry out the purpose of
prompt corrective action.
<PAGE>
Under FDICIA, only a "well capitalized" depository institution may
accept brokered deposits without prior regulatory approval. FDICIA
also requires annual examinations of all insured depository
institutions by the appropriate federal banking agency, with some
exceptions for small, well capitalized institutions and state-
chartered institutions examined by state regulators. The federal
banking agencies are required to set compensation standards for
insured depository institutions that prohibit excessive compensation,
fees or benefits to officers, directors, employees and principal
Shareholders. FDICIA also contains a number of consumer banking
provisions, including disclosure requirements and substantive
contractual limitations with respect to deposit accounts. FDICIA also
greatly expanded the range of merger, purchase and assumption, and
deposit transfer transactions involving banks and savings associations
that are exempt from payment of exit and entry fees as transfers of
deposits between the FDIC's Bank Insurance Fund ("BIF") and its
Savings Association Insurance Fund ("SAIF"). Many of the provisions
of FDICIA have been implemented through the adoption of regulations by
the federal banking agencies.
REGULATORY CAPITAL REQUIREMENTS. Pursuant to the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"),
the OTS adopted regulations implementing new capital standards
applicable to all savings associations, including Sterling Savings.
Such capital standards require that savings associations maintain (i)
tangible capital of not less than 1.5% of adjusted total assets, (ii)
core capital of not less than 3.0% of adjusted total assets, and
(iii) risk-based capital of not less than 8.0% of risk-weighted
assets. As of December 31, 1997, Sterling Savings met all regulatory
capital requirements. For additional information, see "Management's
Discussion and Analysis - Liquidity and Sources of Funds" and
"Management's Discussion and Analysis - Capital Resources."
TANGIBLE CAPITAL. Tangible capital consists of common shareholders'
equity, including retained earnings; non-cumulative perpetual
preferred stock; certain non-withdrawable and pledged deposits; and
minority interests in equity accounts of fully consolidated
subsidiaries. In calculating tangible capital, certain items must be
deducted. These items are goodwill and other intangible assets,
nonqualifying purchased mortgage servicing rights and investments
(whether debt or equity) in subsidiaries engaged as of April 1989 in
activities which were permissible for national banks. With respect to
purchased mortgage servicing rights, the amount that qualifies to be
included in tangible capital is the lower of (a) 90% of fair market
value if determinable, (b) 90% of original cost or (c) the current
amortized book value. See "Lending Activities - Classified Assets,
Real Estate Owned and Delinquent Loans - Major Real Estate Owned" and
"Subsidiaries."
LEVERAGE (OR CORE) CAPITAL. Core capital generally consists of
tangible capital plus certain other qualifying intangible assets
(which may comprise up to 25% of core capital) which meet a three-part
test of separatability, marketability and market valuation.
<PAGE>
RISK-BASED CAPITAL. The risk-based capital requirement is an amount
equal to 8% of risk-adjusted assets. A risk weight is assigned to
both the on-balance sheet assets and off-balance sheet commitments of
a savings association. Risk weights range from zero to 100% depending
on the type of asset.
Both core capital and "supplementary capital" may be used to meet the
risk-based capital requirement, although supplementary capital cannot
be used in an amount greater than 100% of core capital. For purposes
of the risk-based capital requirement, supplementary capital includes
permanent capital instruments such as cumulative perpetual preferred
stock, perpetual or mandatory convertible subordinated debt, maturing
capital instruments such as subordinated debt, intermediate-term
preferred stock, commitment notes and certain grandfathered mandatory
redeemable preferred stock (although the amount included declines as
the instrument approaches maturity), and general valuation loan and
lease loss allowances up to a maximum of 1.25% of risk-weighted
assets. The risk-based capital requirement was equal to 8.00% of
risk-weighted assets at December 31, 1997.
The following tables set forth Sterling Savings' tangible, core and
risk-based capital positions as reported to the OTS on the quarterly
Thrift Financial Report at December 31, 1997.
Tangible Capital
-------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total shareholders' equity: $148,403 7.96%
Adjustment:
Unrealized losses on certain available-
for-sale securities 1,003 0.06
Less:
Intangibles 7,882 0.42
Excess qualifying purchased mortgage
loan servicing 147 0.01
Investment in non-includable
subsidiaries 353 0.02
-------- ------
Total tangible capital 141,024 7.57
Tangible capital requirement 27,951 1.50
-------- ------
Tangible capital excess $113,073 6.07%
======== ======
<PAGE>
Core Capital
-------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total tangible capital: $141,024 7.57%
Add:
Qualifying identified intangibles up
to 25% of other core capital 0 0.00
Total core capital 141,024 7.57
Core capital requirement 55,902 3.00
-------- ------
Core capital excess $ 85,122 4.57%
======== ======
Risk-based Capital
-------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total core capital: $141,024 12.94%
General valuation allowances 8,912 0.82
Assets required to be deducted (829) (0.08)
-------- ------
Total risk-based capital 149,107 13.68
Risk-based capital requirement 88,115 8.00
-------- ------
Risk-based capital excess $ 60,992 5.68%
======== ======
(1) Ratio of capital to adjusted total assets for tangible and core
capital and ratio of total capital to risk-weighted assets for
risk-based capital.
The OTS has adopted a regulation that adds an IRR component to the
risk-based capital requirement for savings institutions like Sterling
Savings. The OTS may waive or defer inclusion of the IRR component on
a case-by-case basis. Under the rule, institutions meeting or
exceeding a base level of interest rate exposure must deduct an IRR
component from the total capital available to meet their risk-based
capital requirement. That deduction is equal to one-half of the
difference between the institution's actual measured exposure and the
base level of exposure. The institution's actual measured IRR is
expressed as the change that occurs in its net present value ("NPV")
as a result of a hypothetical 200 basis point increase or decrease in
interest rates (whichever leads to the lower NPV) divided by the
estimated economic value of its assets. The base level of IRR which
would require inclusion of a capital component is defined as a decline
in NPV which exceeds 2.0% of an institution's assets expressed in
<PAGE>
terms of economic value. Using a computer model, the OTS will
calculate changes in each institution's NPV based on financial data
the institution submits on its Thrift Financial Report. The OTS will
then advise each institution of its required IRR deduction. The OTS,
using December 31, 1997 financial information, has calculated that no
IRR component deduction was required to be added to Sterling Savings'
risk-based capital.
Savings associations that fail to meet the tangible, core or risk-
based capital requirements are subject to a number of sanctions or
restrictions. Under FIRREA, the OTS must prohibit any asset growth,
except that the OTS may permit growth in an amount not in excess of
net interest credited to the savings association's deposit
liabilities, if (i) the savings association obtains the prior approval
of the OTS; (ii) any increase in assets is accompanied by an increase
in tangible capital in an amount not less than 3.0% of the increase in
assets; (iii) any increase in assets is accompanied by an increase in
capital not less in percentage amount than required under the risk-
based capital standards then applicable; (iv) any increase in assets
is invested in low-risk assets; and (v) the savings association's
ratio of core capital to total assets is not less than the ratio
existing on January 1, 1991.
The OTS also may require any savings association not in compliance
with capital standards (including any individual minimum capital
requirement) to comply with a capital directive issued by the OTS.
Such capital directive may order the savings association to (a)
achieve its minimum capital requirements by a specified date; (b)
adhere to a compliance schedule for achieving its minimum capital
requirements; (c) submit and adhere to a capital plan acceptable to
the OTS; and/or (d) take other actions including reducing its assets
or rate of liability growth and/or restricting its payment of
dividends in order to reach the required capital levels. The OTS, by
such capital directive, enforcement proceedings or otherwise, may
require an association not in compliance with the capital requirements
to (i) increase the amount of its regulatory capital to a specified
level; (ii) convene a meeting with the OTS supervision staff for the
purpose of accomplishing the objectives of the regulations; (iii)
reduce or limit the rate of interest that may be paid on savings
accounts; (iv) limit the receipt of deposits to those made to existing
accounts; (v) cease or limit lending or the making of a particular
loan or category of loan; (vi) cease or limit the purchase of loans or
the making of specified other investments; (vii) limit operational
expenditures to specific levels; (viii) increase liquid assets and
maintain such increased liquidity at specified levels; or (ix) take
such other action or actions as the OTS may deem necessary or
appropriate for the safety and soundness of the savings association or
the protection of its depositors. The material failure of a savings
association to comply with any plan, regulation, written agreement,
order or directive issued will be treated as an unsafe or unsound
practice which could result in the imposition of certain penalties or
sanctions including, but not limited to, the assessment of civil
monetary penalties, the issuance of a cease and desist order, or the
appointment of a conservator or receiver.
<PAGE>
Any savings association which does not meet its regulatory capital
requirements may not accept brokered deposits if such deposits,
together with any existing brokered deposits outstanding, would exceed
5.0% of the association's total deposits, without a written waiver
from the OTS. In addition, the FDIC prohibits, with certain
exceptions, an "insolvent institution" from accepting any brokered
deposits. An insolvent institution is defined as any insured
depository institution which does not meet the minimum capital
requirements applicable with respect to such institution. This
prohibition includes any renewal of an account in any insolvent
institution and any rollover of any amount on deposit. The FDIC may
waive this restriction upon application by an insured depository
institution and a finding that the acceptance of such deposits does
not constitute an unsafe or unsound practice with respect to such
institution. Sterling had no brokered deposits at December 31, 1997.
A savings association which is not in compliance with its capital
requirements may apply to the OTS for an exemption from the sanctions
and penalties imposed upon a savings association for failure to comply
with its minimum capital standards. Pursuant to FIRREA, the OTS may
approve an application for a capital exemption if such exemption would
pose no significant risk to the affected insurance fund, the savings
association's management is competent, the savings association is in
compliance with all applicable statutes, regulations, orders and
supervisory agreements and directives, and the savings association's
management has not engaged in insider dealing, speculative practices
or any other activities that could have jeopardized the association's
safety and soundness or contributed to impairing the association's
capital. Any application for a capital exemption must be accompanied
by an acceptable capital plan. If a savings association receives
approval of capital exemption and operates in accordance with an
acceptable capital plan, it will be deemed to be in compliance with
its capital standards for purposes of OTS capital regulation only.
The savings association must request and receive approval of specific,
express exemptions from the provisions of other rules, regulations and
policy statements as part of the accepted capital plan to be deemed in
capital compliance for purposes of such other rules, regulations and
policy statements.
FEDERAL DEPOSIT INSURANCE CORPORATION. Sterling's deposits are
insured up to $100,000 per insured depositor (as defined by law and
regulations) by the FDIC through the SAIF. The SAIF is administered
and managed by the FDIC. The FDIC is authorized to conduct
examinations of and to require reporting by SAIF member institutions.
The FDIC may prohibit any SAIF member institution from engaging in any
activity the FDIC determines by regulation or order poses a serious
threat to the SAIF. The FDIC also has the authority to initiate
enforcement actions against savings associations.
<PAGE>
On September 30, 1996, federal legislation was enacted which included
provisions regarding the recapitalization of the SAIF. The new
legislation required SAIF-insured savings institutions, like Sterling
Savings, to pay a one-time special assessment based on deposits as of
March 31, 1995. Sterling's SAIF assessment resulted in a pre-tax
charge to earnings of $5.8 million during the six months ended
December 31, 1996. The special assessment capitalized the SAIF up to
the prescribed 1.25% of SAIF-insured deposits.
Deposits insured by SAIF are currently assessed at the rate of zero
for well capitalized institutions displaying little risk to the SAIF,
to $0.27 per $100 of domestic deposits for undercapitalized
institutions displaying high risk. The SAIF assessment rate may
increase or decrease as is necessary to maintain the designated SAIF
reserve ratio of 1.25% of insured deposits.
All FDIC-insured depository institutions must pay an annual assessment
to provide funds for the payment of interest on bonds (the "FICO
Bonds") issued by the Financing Corporation, a federal corporation
chartered under the authority of the Federal Housing Finance Board.
The FICO Bonds were issued to capitalize the Federal Savings and Loan
Insurance Corporation. Until December 31, 1999 or when the last
savings and loan association ceases to exist, whichever occurs first,
depository institutions will be required to pay approximately $0.064
per $100 of SAIF-assessable deposits and approximately $0.013 per $100
of BIF-assessable deposits. Hence, the financial burden on SAIF
member institutions like Sterling Savings is currently greater than it
is on BIF member institutions.
Existing law contemplates a unification of the charters presently
available to banks and savings institutions. The Treasury Department
is required to make recommendations regarding unification of the
available charters and the merger of the insurance funds. The
legislation requires a merger of the SAIF with the BIF on
January 1, 1999 if all savings associations have converted to banks by
that date, but the legislation does not mandate such conversions.
SAIF and BIF will continue to operate as separate funds, if this
unification of charters has not taken place, until such time as
additional federal legislation is passed requiring a merger of the
funds.
Sterling Savings may be required to convert its charter to either a
national bank charter, a state depository institution charter, or a
newly designed charter. Sterling may also become regulated at the
holding company level by the Fed rather than by the OTS. Regulation
by the Fed could subject Sterling to capital requirements that are not
currently applicable to Sterling as a thrift holding company under OTS
regulations and may result in statutory limitations on the type of
business activities in which Sterling may engage at the holding
company level, which business activities currently are not restricted.
At this time, Sterling Savings is unable to predict whether a charter
change will be required and, if it is, whether the charter change will
significantly impact Sterling Savings' operations.
<PAGE>
The FDIC is empowered to initiate a termination of insurance
proceeding in cases where the FDIC determines that an insured
depository institution has engaged in unsafe or unsound practices, is
in an unsafe or unsound condition to continue operations, or has
violated an applicable law, regulation, order or condition imposed by
the FDIC. The FDIC may deem failure to comply with applicable
regulatory capital requirements an unsafe and unsound practice. If
the FDIC terminates a savings association's deposit insurance, funds
then on deposit continue to be insured for at least six months and up
to two years after notice of such termination is provided to the
account holders. Furthermore, if the FDIC initiates an insurance
termination proceeding against a savings association that has no
tangible capital, the FDIC may issue a temporary order immediately
suspending deposit insurance on all deposits received by such savings
association.
RESOLUTION FUNDING CORPORATION. FIRREA provides for substantial
contributions by the FHL Banks to the Resolution Funding Corporation,
which was created under FIRREA to raise funds to be used to resolve
cases involving failed savings associations. The funding obligations
that FIRREA imposes on the FHL Banks may reduce the dividends paid by
the FHL Banks to their savings association shareholders, increase the
cost to FHL Bank members of the services provided by the FHL Banks, or
both. Each of these provisions may increase Sterling's cost of doing
business.
LOANS TO AFFILIATES. FIRREA amended the statutory provisions
governing transactions between a savings association and its
affiliates. Such transactions are subject to the restrictions of
Sections 23A and 23B of the Federal Reserve Act (the "FRA") in the
same manner and to the same extent as if the savings association were
a member bank as defined in the FRA, except that a savings association
may not (i) extend credit to any affiliate engaged in activities that
are impermissible for a bank holding company or (ii) purchase or
invest in any securities of an affiliate other than shares of a
subsidiary.
Section 23A of the FRA limits the aggregate amount of "covered
transactions" with any one affiliate to 10% of the capital stock and
surplus of the member bank. "Covered transactions" are defined in
Section 23A to include extending credit to, purchasing the assets of,
issuing a guarantee, acceptance or letter of credit on behalf of, or
investing in the stock or securities of, any affiliate. Section 23A
also requires a bank to obtain specified levels of collateral for any
extension of credit to an affiliate. Section 23B, in general,
requires that any transaction with an affiliate be on terms and
conditions no less favorable to the member bank than those applicable
to transactions with unaffiliated entities. The OTS has recently
adopted regulations further defining and clarifying the applicability
of Section 23A and 23B to savings associations. The OTS has the
authority to impose any additional restrictions on any transaction
between a savings association and an affiliate that it determines are
necessary to protect the safety and soundness of the association.
<PAGE>
In addition, FIRREA provides that extensions of credit to executive
officers, directors and principal shareholders of a savings
association are governed by the FRA. The FRA requires prior approval
by the board of directors of the bank before a loan can be made to an
executive officer, director or 10% shareholder. In addition, such
loan or extension of credit must be made on substantially the same
terms, including interest rates and collateral, as those prevailing at
the time for comparable transactions with unaffiliated persons and may
not involve more than the normal risk of repayment or present other
unfavorable features. The FRA also prohibits any loan or extension of
credit to an executive officer or a controlling shareholder if such
loan or extension of credit (when aggregated with the amount of all
other loans or extensions of credit then outstanding to such
individual) would exceed the limits on loans to a single borrower
applicable to national banks. The OTS may impose additional
restrictions for safety and soundness reasons.
LIQUIDITY. All savings associations, including Sterling Savings, are
required to maintain an average daily balance of liquid assets equal
to a certain percentage of the sum of average daily balances of net
withdrawable deposit accounts and borrowings payable in one year or
less. The liquidity requirement may vary from time to time (between
4% and 10%) depending upon economic conditions and savings flows of
all savings associations. At the present time, the required liquid
asset ratio is 4%. In addition to meeting the required liquid asset
ratio, savings associations, including Sterling Savings, must maintain
sufficient liquidity to insure safe and sound operations. Sterling
Savings' liquidity ratios at December 31, 1997 and 1996 and June 30,
1996 were 13.01%, 10.91% and 7.31%, respectively.
LOANS-TO-ONE-BORROWER. Under FIRREA, the permissible amount of
loans-to-one-borrower follows the national bank standard for all loans
made by savings associations (except that loans-to-one-borrower not in
excess of $500,000 may be made in any event). OTS regulations
generally do not permit loans-to-one-borrower to exceed 15% of
unimpaired capital and unimpaired surplus. Loans in an amount equal
to an additional 10% of unimpaired capital and unimpaired surplus also
may be made to a borrower if the loans are fully secured by readily
marketable collateral. In addition, institutions which meet
applicable capital requirements may make domestic residential housing
development loans in an amount up to the lesser of $30.0 million or
30% of the institution's unimpaired capital and unimpaired surplus,
subject to certain conditions. At December 31, 1997, Sterling's
loans-to-one-borrower limit was $21.2 million, which management
believes is adequate to allow for loan originations.
QUALIFIED THRIFT LENDER. Under the QTL Test, as revised by FDICIA, an
institution generally is required to invest at least 65% of its
portfolio assets (as defined in the OTS regulations) in "qualified
thrift investments" on a monthly average basis in nine out of every
twelve months. Qualified thrift investments include, in general,
loans, securities and other investments that are related to housing.
<PAGE>
At December 31, 1997, Sterling's qualified thrift investments were
72.3% of portfolio assets. An institution's failure to remain a
qualified thrift lender ("QTL") may result in: (1) limitations on new
investments and activities; (2) imposition of branching restrictions;
(3) loss of borrowing privileges at the FHLB Seattle; and (4)
limitations on the payment of dividends.
COMMUNITY REINVESTMENT. Under the Community Reinvestment Act ("CRA"),
as implemented by the OTS regulations, a savings institution has a
continuing and affirmative obligation consistent with its safe and
sound operation to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial
institutions nor does it limit an institution's discretion to develop
the types of products and services that it believes are best suited to
its particular community, consistent with the CRA. The CRA requires
the OTS, in connection with its examination of a financial
institution, to assess the institution's record of meeting the credit
needs of its community and to take such record into account in its
evaluation of certain applications by such institutions. The CRA
requires public disclosure of an institution's CRA rating and requires
the OTS to provide a written evaluation of an institution's CRA
performance utilizing a four-tiered descriptive rating system of
"outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." Sterling's current CRA rating is "satisfactory."
CHANGE OF CONTROL. Under applicable statutes and regulations, a
person may not acquire control of a savings association without the
prior approval of the OTS and the Washington Supervisor. Control is
conclusively deemed to be acquired when, among other things, a person,
either alone or acting in concert with others, acquires more than 25%
of any class of voting stock of a savings association. Under federal
statutes and regulations, a rebuttable presumption of control arises
if a person acquires, either alone or acting in concert with others,
more than ten percent of any class of voting stock of a savings
association and is subject to a "control factor," or acquires more
than 25% of any class of stock, and is subject to a "control factor."
A person is subject to a control factor as a result of specified
ownership levels of the savings association's debt or equity or as a
result of certain relationships with the savings association.
As indicated above, if a person's ownership of the savings association
stock is below the threshold levels for control, such person may
nevertheless be deemed to be "acting in concert" with one or more
other persons who own stock in the savings association, in which case
all of the stock ownership of each person acting in concert will be
aggregated and attributed to each member of the group, thereby putting
each one over the control threshold. Under certain circumstances,
acquirers will be presumed to be acting in concert. For example: (i)
a company will be presumed to be acting in concert with a controlling
shareholder or management official; (ii) a company controlling or
controlled by another company and companies under common control will
<PAGE>
be presumed to be acting in concert; and (iii) persons will be
presumed to be acting in concert where they constitute a group under
Section 13 or the proxy rules under Section 14 of the Securities
Exchange Act of 1934, as amended.
Restrictions on Activities of State-Chartered Associations. FIRREA
prohibits a state-chartered savings association from engaging in any
type of activity or any activity in an amount that is not permissible
for a federal savings association unless (i) the FDIC has determined
that such activity poses no threat to the insurance fund and (ii) the
savings association continues to be in compliance with applicable
capital requirements. If the FDIC determines that the amount of such
activity does not pose a significant threat to the insurance fund, an
association which is in compliance with applicable capital
requirements may engage in activities in an amount greater than that
permissible for a federal savings association. FIRREA also prohibits
a state-chartered savings association from acquiring or retaining any
equity investment (other than shares in certain service corporations)
of a type or in an amount not permissible for a federal savings
association. A savings association must divest any such equity
investment as quickly as can be prudently done. Pursuant to
applicable equity investment rules, Sterling has excluded its
investment in assets totaling $353,000 from its calculation of risk-
based capital as of December 31, 1997. Sterling is actively marketing
these properties. See "Subsidiaries."
RESTRICTIONS ON CAPITAL DISTRIBUTIONS BY SAVINGS ASSOCIATIONS. The
OTS has adopted a capital distribution regulation which limits the
ability of savings institutions to make capital distributions.
Certain factors are considered by the OTS in determining whether to
permit a savings institution to pay dividends, including, among other
things, whether an institution meets applicable capital requirements.
Those savings institutions which meet the applicable capital
requirements have discretion in making capital distributions, while
those with lower capitalization have less discretion in this regard
and, in some cases, are required to seek the approval of the OTS.
Sterling's income is derived primarily from dividends to the extent
they are declared and paid by Sterling Savings. Current OTS
regulations require Sterling Savings to give the OTS 30 days advance
notice of any proposed declaration of dividends to Sterling, as its
holding company. The OTS has approved all of Sterling Savings'
Preferred Stock dividend payments to Sterling, but there can be no
assurance as to the approval of future dividends.
FEDERAL RESERVE SYSTEM. Sterling Savings is subject to various
regulations promulgated by the Fed, including, among others,
Regulation B (Equal Credit Opportunity), Regulation D (Reserves),
Regulation E (Electronic Fund Transfers), Regulation Z (Truth in
Lending), Regulation CC (Availability of Funds) and Regulation DD
(Truth in Savings). Regulation D requires non-interest-bearing reserve
maintenance in the form of either vault cash or funds on deposit at
<PAGE>
the Federal Reserve Bank of San Francisco or another designated
depository institution in an amount calculated by formula. The
balances maintained to meet the reserve requirements imposed by the
Fed may be used to satisfy liquidity requirements.
Under the provisions of the Depository Institutions Deregulation and
Monetary Control Act of 1980, savings and loan associations, like
Sterling Savings, also have authority to borrow from the Federal
Reserve Bank "discount window," but Federal Reserve regulations
require associations to exhaust all FHL Bank sources before borrowing
from the Fed.
FEDERAL TAXATION. Sterling is subject to federal income taxation
under the Internal Revenue Code of 1986 as amended (the "Code"), in
the same manner as other corporations, except for the application of
the bad debt reserve rules discussed below and certain other
provisions. Sterling files consolidated federal income tax returns on
the accrual basis.
Under applicable provisions of the Code, a savings institution that
meets certain definitional tests relating to the composition of its
assets and the sources of its income ("qualifying savings
institution") is permitted to establish reserves for bad debts and to
make annual additions thereto under the experience method, which
generally permits an annual deduction based upon the institution's
historical loan loss experience. Alternatively, such an institution
may elect on an annual basis to use the percentage of taxable income
method to compute its allowable addition to its bad-debt reserve on
qualifying real property loans (generally, loans secured by an
interest in improved real property). For qualifying savings
associations, these methods generally allow for greater deductions
than other financial institutions such as commercial banks which are
allowed a deduction only for actual bad-debt losses.
As part of the Small Business, Health Insurance and Welfare Reform
Acts of 1996, the tax treatment of the bad-debt reserves has
substantially changed. Effective for years beginning after
December 31, 1995, the special rules for bad-debt reserves of savings
institutions no longer apply. Savings institutions, like Sterling
Savings, will be treated as banks for purposes of accounting for bad
debts. The percentage of income method is no longer available.
Savings institutions that would be treated as "small banks" are
allowed to utilize the experience method applicable to such
institutions, while savings institutions that are treated as "large
banks" are required to use the specific charge-off method. The Code
defines a "large bank" as one whose average adjusted basis of all
assets exceeds $500 million. Sterling Savings is classified as a
"large bank" for purposes of tax accounting for bad debts. The new
law requires that a savings institution's "applicable excess reserves"
be recaptured over a period of six to eight years depending on whether
the savings institution meets certain tests. In Sterling Savings'
case, the "applicable excess reserve" is the amount by which its
<PAGE>
reserves at December 31, 1997 exceed the reserves at December 31,
1988. This amount is estimated to be approximately $665,000.
Further, if Sterling Savings ever fails to qualify as a "large bank",
the balance of its June 30, 1988 reserves are also subject to
recapture over a six-year period beginning in the taxable year the
taxpayer no longer qualifies as a "large bank."
A savings institution organized in stock form may be subject to
recapture taxes on its reserves if it makes certain types of
distributions to its shareholders. Dividends may be paid out of
retained earnings without the imposition of any tax on the savings
institution to the extent that the amounts paid as dividends do not
exceed both the savings institution's current and accumulated earnings
and profits as calculated for federal income tax purposes. Dividends
in excess of the savings institution's current and accumulated
earnings and profits as calculated for federal income tax purposes,
and any redemption or liquidation distributions, are however, deemed
under Section 593(e) of the Code to be made from the savings
institution's tax bad-debt reserves to the extent that such reserves
exceed the additions that would have been made under the experience
method and thereafter from its supplemental reserves. The amount of
tax that would be payable upon any distribution that is treated as
having been made from the savings institution's tax bad-debt reserves
is also deemed to have been paid from these reserves. As a result,
distributions, if any, that are treated as having been made from
Sterling Savings' bad-debt reserves could result in a federal
recapture tax.
STATE LAW AND REGULATION. Sterling Savings is a State of Washington-
chartered institution and is subject to regulation by the Washington
Supervisor, which conducts regular examinations to ensure that
Sterling Savings' operations and policies conform with sound industry
practice. The liquidity and other requirements set by the Washington
Supervisor are generally no stricter than the liquidity and other
requirements set by the OTS. State law regulates the amount of credit
that can be extended to any one person or marital community, and the
amount of money that can be invested in any one property. Without the
Washington Supervisor's approval, Sterling Savings currently cannot
extend credit to any one person or marital community in an amount
greater than 2.5% of Sterling Savings' total assets. State law also
regulates the types of loans Sterling Savings can make. Without the
Washington Supervisor's approval, Sterling Savings cannot currently
invest more than 10% of its total assets in other corporations.
Sterling Savings is currently subject to a supervisory directive from
the Washington Supervisor. The directive requires Sterling Savings to
provide monthly reports, maintain its current "well capitalized"
status, obtain prior approval for significant transactions and take
certain other actions. Sterling Savings operates three branches
within the State of Oregon and therefore is also subject to the
supervision of the Oregon Department of Consumer and Business
Services. Upon successful completion of the acquisition of the
KeyBank branches, Sterling Savings will also be subject to the
supervision of the Idaho Department of Finance. See "Recent
Developments."
<PAGE>
Item 2. Properties
-------------------
Sterling Savings owns 26 offices and leases 12 offices in Washington
and owns three offices in Oregon. Action Mortgage leases four
residential loan production offices (two in Washington, one in Oregon
and one in Idaho). INTERVEST leases one office in Washington and one
office in Oregon. Such offices range in size from 500 to 105,000
square feet and have a total net book value, including leasehold
improvements and furniture and fixtures, of $38.0 million at December
31, 1997. Leases on these properties expire between March 1998 and
December 2014. Sterling believes it will be able to renew the leases
or obtain comparable leases. As a result of the KeyBank acquisition,
Sterling anticipates increasing the net book value of its properties,
including leasehold improvements and furniture and fixtures, by
approximately $10.0 million. See "Business - Recent Developments."
Item 3. Legal Proceedings
--------------------------
Periodically, various claims and lawsuits are brought against issues
incident to Sterling's business. In addition, Sterling succeeded to
several claims as a result of past acquisitions by Sterling and its
subsidiaries, such as claims to enforce liens, condemnation
proceedings involving properties on which Sterling holds security
interests, and claims involving the making and servicing of loans. No
material loss is expected from any of such pending claims or lawsuits,
although there can be no assurance in this regard.
Item 4. Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
No matters were submitted to a vote of security holders during the
quarter ended December 31, 1997.
PART II
Item 5. Market for the Registrant's Stock and Related Shareholder
Matters
------------------------------------------------------------------
Sterling has outstanding one class of Common Stock. As of
February 27, 1998, there were 7,578,552 shares of Common Stock
outstanding. As of February 27, 1998, the Common Stock was owned by
729 Shareholders of record. The Common Stock is quoted on the Nasdaq
National Market under the symbol "STSA." For additional information
concerning the payment of dividends, see "Business - Regulation -
Regulatory Capital Requirements, "Management's Discussion and Analysis
- Liquidity and Sources of Funds," and Note 26 of "Notes to
Consolidated Financial Statements."
The following table sets forth the high and low bid prices per share
for the Common Stock for the periods indicated.
<PAGE>
High Low
------- -------
Twelve months ended December 31, 1997:
Fourth quarter $23 $19
Third quarter 20-3/4 17-1/4
Second quarter 19-1/4 15-1/4
First quarter 17-7/8 13-1/2
Six months ended December 31, 1996:
Second quarter $15-1/4 $13
First quarter 15-1/4 12-1/2
Fiscal year ended June 30, 1996:
Fourth quarter $15 $12-3/4
Third quarter 15 12-3/4
Second quarter 13-7/8 12-1/4
First quarter 15-1/4 10-3/8
Item 6. Selected Financial Data
--------------------------------
<TABLE>
<CAPTION> Twelve Months Ended Six Months Ended
December 31, December 31, Fiscal Years Ended June 30,
-------------------- -------------------- ------------------------------------------
1997 1996 1996 1995 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income $ 131,149 $ 113,177 $ 57,614 $ 57,518 $ 113,081 $ 107,256 $ 76,599 $ 57,793
Interest expense (85,512) (74,536) (37,411) (40,486) (77,611) (71,864) (44,610) (32,292)
--------- --------- --------- --------- --------- --------- --------- ---------
Net interest income 45,637 38,641 20,203 17,032 35,470 35,392 31,989 25,501
Provision for loan losses (2,450) (1,900) (1,100) (800) (1,600) (1,600) (1,600) (1,500)
--------- --------- --------- --------- --------- --------- --------- ---------
Net interest income after
provision for loan losses 43,187 36,741 19,103 16,232 33,870 33,792 30,389 24,001
Other income 9,304 8,984 4,648 4,334 8,670 11,387 8,485 9,446
Operating expenses (37,106) (40,911) (24,742) (15,515) (31,684) (31,272) (25,788) (21,146)
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) before income taxes
and other items 15,385 4,814 (991) 5,051 10,856 13,907 13,086 12,301
Income tax provision (5,749) (2,331) (112) (1,845) (4,064) (4,619) (4,560) (4,638)
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) before extra-
ordinary item 9,636 2,483 (1,103) 3,206 6,792 9,288 8,526 7,663
--------- --------- --------- --------- --------- --------- --------- ---------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Twelve Months Ended Six Months Ended
December 31, December 31, Fiscal Years Ended June 30,
-------------------- -------------------- ------------------------------------------
1997 1996 1996 1995 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Extraordinary item:
Early extinguishment of FHLB
Seattle advances, net of
income taxes 0 0 0 0 0 0 0 (425)
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) 9,636 2,483 (1,103) 3,206 6,792 9,288 8,526 7,238
--------- --------- --------- --------- --------- --------- --------- ---------
Preferred stock dividends
declared (940) (1,885) (942) (942) (1,885) (1,885) (272) 0
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) applicable
to common shares $ 8,696 $ 598 $ (2,045) $ 2,264 $ 4,907 $ 7,403 $ 8,254 $ 7,238
========= ========= ========= ========= ========= ========= ========= =========
Income (loss) per common share:
Basic $ 1.40 $ 0.11 $ (0.37) $ 0.42 $ 0.91 $ 1.42 $ 1.65 $ 1.51
Diluted $ 1.25 $ 0.11 $ (0.37) $ 0.42 $ 0.90 $ 1.27 $ 1.60 $ 1.49
Weighted average common shares
outstanding:
Basic 6,207,329 5,476,531 5,528,117 5,408,133 5,416,211 5,210,318 4,999,863 4,785,526
Diluted 7,707,333 7,573,622 7,625,208 7,526,882 7,552,330 7,296,687 5,335,657 4,845,409
Ratios:
Return on average assets 0.56% 0.16% (0.14)% 0.41% 0.45% 0.48% 0.72% 0.92%
Return on average common
shareholders' equity 11.36% 0.94% (6.57)% 6.80% 7.43% 13.09% 16.11% 17.36%
Shareholders' equity to assets
at end of period 5.48% 5.81% 5.81% 6.10% 5.80% 5.84% 5.57% 4.65%
Book value per common share
at end of period $ 13.59 $ 11.41 $ 11.41 $ 12.19 $ 11.01 $ 11.84 $ 10.07 $ 9.80
Net interest margin 2.81% 2.71% 2.80% 2.31% 2.46% 2.44% 2.90% 3.43%
Nonperforming assets to total
assets at end of period 0.73% 0.42% 0.42% 0.59% 0.57% 0.58% 0.71% 1.19%
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
December 31, June 30,
---------------------- ----------------------------------------------
1997 1996 1996 1995 1994 1993
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Financial Position Data:
Total assets $1,876,250 $1,536,344 $1,477,698 $1,540,784 $1,374,118 $1,038,962
Loans receivable 1,069,591 934,340 886,667 1,055,111 844,520 593,669
Mortgage-backed securities 469,253 376,940 399,893 280,776 360,789 325,969
Investments 199,733 104,721 72,047 76,576 77,565 43,531
Deposits 1,036,408 902,278 898,394 890,041 810,970 579,785
FHLB Seattle advances 455,085 259,626 259,410 352,073 364,985 295,996
Other borrowings 72,240 32,240 17,240 17,240 17,250 17,250
Shareholders' equity 102,863 89,220 85,745 89,907 76,529 48,272
Statistical Data:
Number of:
Employees (full-time equivalents) 510 495 490 499 494 379
Offices:
Full service 41 41 41 41 41 27
Loan production 8 10 10 11 20 17
Real estate loans 8,338 10,233 12,306 15,825 14,131 12,208
Deposit accounts 83,763 83,865 85,300 84,553 79,585 62,205
</TABLE>
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
--------------------------------------------------------------------
GENERAL
Sterling Financial Corporation ("Sterling") is a unitary savings and
loan holding company, the significant operating subsidiary of which is
Sterling Savings Association ("Sterling Savings"). The significant
operating subsidiaries of Sterling Savings are Action Mortgage Company
("Action Mortgage"), INTERVEST-Mortgage Investment Company
("INTERVEST") and Harbor Financial Services, Inc. ("Harbor
Financial"). Sterling Savings commenced operations in 1983 as a State
of Washington-chartered, federally insured stock savings and loan
association headquartered in Spokane, Washington. Sterling, with
$1.9 billion in total assets at December 31, 1997, attracts Federal
Deposit Insurance Corporation ("FDIC") insured deposits from the
general public through 41 retail branches located primarily in rural
and suburban communities in Washington and Oregon. Sterling
originates loans through its branch offices as well as eight Action
Mortgage residential loan production offices in the Spokane and
Seattle, Washington; Portland, Oregon and Boise, Idaho metropolitan
areas and four INTERVEST commercial real estate lending offices
located in the metropolitan areas of Seattle and Spokane, Washington
and Portland, Oregon. Sterling also markets tax-deferred annuities,
mutual funds and other financial products through Harbor Financial.
Recently, Sterling has focused its efforts on becoming more like a
community retail bank by increasing its construction, business banking
and consumer lending while increasing its retail deposits. Sterling's
revenues are derived primarily from interest earned on loans,
investments and mortgage-backed securities ("MBS"), from fees and
service charges and from mortgage banking operations. The operations
of Sterling Savings, and savings institutions generally, are
influenced significantly by general economic conditions and by
policies of its primary regulatory authorities, the Office of Thrift
Supervision ("OTS"), the FDIC and the State of Washington Department
of Financial Institutions ("Washington Supervisor"). See "Business -
Regulation."
Sterling changed its fiscal year-end from June 30 to December 31,
effective December 31, 1996. Accordingly, results of operations have
been presented for the twelve months ended December 31, 1997 and 1996,
the six months ended December 31, 1996 and 1995 and the fiscal years
ended June 30, 1996 and 1995.
Existing law contemplates a unification of the charters presently
available to banks and savings institutions. The Treasury Department
is required to make recommendations regarding unification of the
available charters and the merger of the insurance funds. The
legislation requires a merger of the SAIF with the BIF on
January 1, 1999 if all savings associations have converted to banks by
that date, but the legislation does not mandate such conversions.
<PAGE>
SAIF and BIF will continue to operate as separate funds, if this
unification of charters has not taken place, until such time as
additional federal legislation is passed requiring a merger of the
funds.
Sterling Savings may be required to convert its charter to either a
national bank charter, a state depository institution charter, or a
newly designed charter. Sterling may also become regulated at the
holding company level by the Federal Reserve Board (the "Fed") rather
than by the OTS. Regulation by the Fed could subject Sterling to
capital requirements that are not currently applicable to Sterling as
a thrift holding company under OTS regulation and may result in
statutory limitations on the type of business activities in which
Sterling may engage at the holding company level, which business
activities currently are not restricted. At this time, Sterling
Savings is unable to predict whether a charter change will be required
and, if it is, whether the charter change will significantly impact
Sterling Savings' operations. See "Business - Regulation."
Sterling intends to continue to pursue an aggressive growth strategy.
In addition, Sterling has grown and may seek to grow by acquiring
other financial institutions or branches thereof or other substantial
assets or deposit liabilities. Sterling may not be successful in
identifying further acquisition candidates, integrating acquired
institutions or preventing deposit erosion or loan quality
deterioration at acquired institutions. There is significant
competition for acquisitions in Sterling's market area, and Sterling
may not be able to acquire other institutions on attractive terms.
Furthermore, the success of Sterling's growth strategy will depend on
increasing and maintaining sufficient levels of regulatory capital,
obtaining necessary regulatory approvals, generating appropriate
internal growth and favorable economic and market conditions. There
can be no assurance that Sterling will be successful in implementing
its internal growth strategy.
To further enhance its presence in the Pacific Northwest market,
Sterling has been working to expand its community bank delivery
system, focusing primarily on deposit gathering and lending. On
February 2, 1998, Sterling signed an agreement to acquire 33 branch
offices in Washington, Idaho and Oregon from KeyBank National
Association ("KeyBank"). The purchase includes approximately $585
million of deposit balances, the owned branch facilities, branch
furniture, fixtures and certain equipment and approximately $133
million of loan balances. To acquire these branches, Sterling will
pay approximately $72 million based upon a premium on deposits plus
the value of the assets related to these branches. Sterling
anticipates using the net proceeds of approximately $380 million from
this transaction to reduce its borrowings and wholesale liabilities.
As a result of this transaction, Sterling's total assets are expected
to increase by approximately $150 million.
<PAGE>
In order to finance this transaction, Sterling will use its existing
cash resources and borrowing capacities supplemented with additional
borrowings of approximately $25 million. Sterling may also increase
its capital resources through an offering of debt or equity
securities, the proceeds of which offering will likely be issued to
retire certain borrowings.
The strategic advantages of the branch acquisition to Sterling are
expected to include (i) a reduction in its cost of funds which should
contribute to an improvement in net interest margin, (ii) an expanded
branch network through which to generate additional loans and retail
deposits, and (iii) an increased presence with Sterling's existing
markets of Washington and Oregon, as well as expansion into certain
markets in Idaho. Sterling's operating costs will increase as a
result of adding these branches and amortizing the core deposit
premium and other intangible assets over time. Sterling anticipates
the amortization period to be 10 to 15 years.
The acquisition is subject to regulatory approvals and other
conditions of closing and is scheduled to close in mid-year 1998.
Management anticipates securing regulatory approvals, meeting other
conditions of closing and obtaining appropriate financing, although
there can be no assurance in this regard.
NET INTEREST INCOME
The most significant component of earnings for a financial institution
typically is net interest income, which is the difference between
interest income, primarily from loan, MBS and investment portfolios,
and interest expense, primarily on deposits and borrowings ("NII").
Changes in NII result from changes in volume, net interest spread and
net interest margin. Volume refers to the dollar level of interest-
earning assets and interest-bearing liabilities. Net interest spread
refers to the difference between the yield on interest-earning assets
and the rate paid on interest-bearing liabilities. Net interest
margin refers to NII divided by total interest-earning assets and is
influenced by the level and relative mix of interest-earning assets
and interest-bearing liabilities. During the twelve months ended
December 31, 1997 and the six months ended December 31, 1996, the
increase in NII was due primarily to an increase in the interest
earned on all interest-earning assets coupled with a decrease in the
cost of deposits and Federal Home Loan Bank of Seattle ("FHLB
Seattle") advances. During the fiscal year ended June 30, 1996, the
increase in NII was due to a mix change in the volume of interest-
earning assets towards higher yielding assets, which helped increase
the net interest margin.
The following table sets forth, for the periods indicated, information
with regard to the average balances of interest-earning assets and
interest-bearing liabilities, the total dollar amounts of interest
income from interest-earning assets and interest expense on interest-
bearing liabilities, resultant yields or costs, NII, net interest
spread, net interest margin and the ratio of average interest-earning
assets to average interest-bearing liabilities.
<PAGE>
<TABLE>
<CAPTION>
Twelve Months Ended December 31,
-----------------------------------------------------------------------------------------
1997 1996
------------------------------------------ --------------------------------------------
Average Interest Earned Average Yield Average Interest Earned Average Yield
Balances or Paid or Cost(1) Balances(2) or Paid or Cost(1)
---------- --------------- ------------- ----------- --------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $1,002,262 $ 91,733 9.15% $ 909,523 $ 81,338 8.94%
Mortgage-backed securities 436,935 28,528 6.53 406,226 26,182 6.45
Investments and cash
equivalents 184,091 10,888 5.91 111,494 5,657 5.07
---------- ---------- ----- ---------- ---------- -----
Interest-bearing liabilities:
Total interest-earning assets $1,623,288 $ 131,149 8.08% $1,427,243 $ 113,177 7.93%
========== ========== ===== ========== ========== =====
Deposits and checking accounts:
Certificates of deposit $ 620,560 $ 35,361 5.70% $ 585,140 $ 33,391 5.71%
Regular savings accounts
and money market accounts 236,057 9,261 3.92 216,335 8,288 3.83
Interest-bearing demand
accounts 78,234 1,044 1.33 70,010 984 1.41
--------- ---------- ----- ---------- ---------- -----
Total deposits and checking
accounts 934,851 45,666 4.88 871,485 42,663 4.90
FHLB Seattle advances 337,617 21,975 6.51 283,922 19,070 6.72
All other borrowings 243,757 13,985 5.74 197,602 11,137 5.64
Trust Preferred Securities 21,130 2,220 10.51 0 0 0.00
Subordinated Notes 17,240 1,666 9.66 17,240 1,666 9.66
---------- ---------- ----- ---------- ---------- -----
Total interest-bearing
liabilities $1,554,595 $ 85,512 5.50% $1,370,249 $ 74,536 5.44%
========== ========== ===== ========== ========== =====
Net interest income $ 45,637 $ 38,641
========== ==========
Net interest spread 2.58% 2.49%
===== =====
Net interest margin 2.81% 2.71%
Ratio of average interest-
earning assets to average
interest-bearing liabilities 104.4% 104.2%
</TABLE>
<PAGE>
<TABLE>
<captions>
Six Months Ended December 31,
----------------------------------------------------------------------------------------
1996 1995
------------------------------------------- -------------------------------------------
Average Interest Earned Average Yield Average Interest Earned Average Yield
Balances(2) or Paid or Cost(1) Balances(2) or Paid or Cost(1)
----------- --------------- ------------- ----------- --------------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $ 925,494 $ 41,702 8.94% $1,069,712 $ 46,599 8.64%
Mortgage-backed securities 386,019 12,574 6.46 296,761 8,436 5.64
Investments and cash
equivalents 122,926 3,338 5.39 98,131 2,483 5.02
---------- ---------- ----- ---------- ---------- -----
Interest-bearing liabilities:
Total interest-earning assets $1,434,439 $ 57,614 7.97% $1,464,604 $ 57,518 7.79%
========== ========== ===== ========== ========== =====
Deposits and checking accounts:
Certificates of deposit $ 578,738 $ 16,329 5.60% $ 629,828 $ 18,934 5.96%
Regular savings accounts
and money market accounts 222,223 4,243 3.79 175,479 3,233 3.65
Interest-bearing demand
accounts 70,959 499 1.39 66,426 499 1.49
---------- ---------- ----- ---------- ---------- -----
Total deposits and checking
accounts 871,920 21,071 4.79 871,733 22,666 5.16
FHLB Seattle advances 258,089 8,849 6.80 348,108 11,577 6.60
All other borrowings 229,593 6,659 5.75 164,573 5,411 6.52
Trust Preferred Securities 0 0 0.00 0 0 0.00
Subordinated Notes 17,240 1,666 9.66 17,240 832 9.57
---------- ---------- ----- ---------- ---------- -----
Total interest-bearing
liabilities $1,376,842 $ 37,411 5.39% $1,401,654 $ 40,486 5.73%
========== ========== ===== ========== ========== =====
Net interest income $ 20,203 $ 17,032
========== ==========
Net interest spread 2.58% 2.06%
===== =====
Net interest margin 2.79% 2.31%
Ratio of average interest-
earning assets to average
interest-bearing liabilities 104.2% 104.5%
</TABLE>
<PAGE>
<TABLE>
<captions>
Fiscal Years Ended June 30,
----------------------------------------------------------------------------------------
1996 1995
------------------------------------------- -------------------------------------------
Average Interest Earned Average Yield Average Interest Earned Average Yield
Balances(2) or Paid or Cost(1) Balances(2) or Paid or Cost(1)
----------- --------------- ------------- ----------- --------------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $ 988,077 $ 86,235 8.73% $1,004,297 $ 79,858 7.95%
Mortgage-backed securities 354,596 22,044 6.22 347,949 22,386 6.43
Investments and cash
equivalents 98,215 4,802 4.89 100,237 5,011 5.00
---------- ---------- ----- ---------- ---------- -----
Interest-bearing liabilities:
Total interest-earning assets $1,440,888 $ 113,081 7.85% $1,452,483 $ 107,255 7.38%
========== ========== ===== ========== ========== =====
Deposits and checking accounts:
Certificates of deposit $ 610,297 $ 35,996 5.90% $ 626,952 $ 32,800 5.23%
Regular savings accounts
and money market accounts 194,346 7,233 3.72 163,490 5,826 3.56
Interest-bearing demand
accounts 67,507 1,029 1.52 66,060 1,189 1.80
---------- ---------- ----- ---------- ---------- -----
Total deposits and checking
accounts 872,150 44,258 5.07 856,502 39,815 4.65
FHLB Seattle advances 325,804 21,679 6.65 396,829 22,509 5.67
All other borrowings 167,087 9,994 5.98 133,075 7,866 5.91
Trust Preferred Securities 0 0 0.00 0 0 0.00
Subordinated Notes 17,240 1,680 9.74 17,246 1,674 9.71
---------- ---------- ----- ---------- ---------- -----
Total interest-bearing
liabilities $1,382,281 $ 77,611 5.61% $1,403,652 $ 71,864 5.12%
========== ========== ===== ========== ========== =====
Net interest income $ 35,470 $ 35,391
========== ==========
Net interest spread 2.24% 2.26%
===== =====
Net interest margin 2.46% 2.44%
Ratio of average interest-
earning assets to average
interest-bearing liabilities 104.2% 103.5%
</TABLE>
(1) The yield information for the available-for-sale portfolio does
not give effect to changes in fair value that are reflected as a
component of shareholders' equity.
(2) Average balances are computed on a monthly basis.
<PAGE>
The following table illustrates the changes in Sterling's NII due to
changes in volume (change in volume multiplied by initial rate),
changes in interest rate (change in rate multiplied by initial volume)
and changes in rate/volume (change in rate multiplied by change in
average volume) for the periods indicated.
<TABLE>
<CAPTION>
Twelve Months Ended Six Months Ended
December 31, 1997 vs. December 31, 1996 vs.
Twelve Months Ended Six Months Ended
December 31, 1996 December 31, 1995
Increase (Decrease) Due to: Increase (Decrease) Due to:
------------------------------------- -------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income on:
Loans $ 8,294 $ 1,907 $ 194 $10,395 $(6,300) $ 1,474 $ (71) $(4,897)
Mortgage-backed securities 1,979 341 26 2,346 2,544 1,207 387 4,138
Investments and cash equivalents 3,683 937 611 5,231 629 175 51 855
------- ------- ------- ------- ------- ------- ------- -------
Total interest income 13,956 3,185 831 17,972 (3,127) 2,856 367 96
------- ------- ------- ------- ------- ------- ------- -------
Deposits and checking accounts:
Certificates of deposit 2,021 (48) (3) 1,970 (1,540) (1,215) 150 (2,605)
Regular savings accounts and
money market accounts 756 199 18 973 864 109 37 1,010
Interest-bearing demand accounts 116 (50) (6) 60 34 (33) (1) 0
------- ------- ------- ------- ------- ------- ------- -------
Total deposits and checking accounts 2,893 101 9 3,003 (642) (1,139) 186 (1,595)
FHLB Seattle advances 3,606 (590) (111) 2,905 (3,002) 327 (53) (2,728)
Other borrowings 2,601 200 47 2,848 2,144 (653) (243) 1,248
Trust Preferred Securities 2,220 0 0 2,220 0 0 0 0
Subordinated Notes 0 0 0 0 0 0 0 0
------- ------- ------- ------- ------- ------- ------- -------
Total interest expense 11,320 (289) (55) 10,976 (1,500) (1,465) (110) (3,075)
------- ------- ------- ------- ------- ------- ------- -------
Net interest income $ 2,636 $ 3,474 $ 886 $ 6,996 $(1,627) $ 4,321 $ 477 $ 3,171
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year Ended
June 30, 1996 vs.
Fiscal Year Ended
June 30, 1995
Increase (Decrease) Due to:
-------------------------------------
Rate/
Volume Rate Volume Total
------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Interest income on:
Loans $(1,290) $ 7,793 $ (127) $ 6,376
Mortgage-backed securities 428 (755) (15) (342)
Investments and cash equivalents (101) (110) 2 (209)
------- ------- ------- -------
Total interest income (963) 6,928 (140) 5,825
------- ------- ------- -------
Deposits and checking accounts:
Certificates of deposit (871) 4,178 (111) 3,196
Regular savings accounts and
money market accounts 1,100 259 48 1,407
Interest-bearing demand accounts 26 (182) (4) (160)
------- ------- ------- -------
Total deposits and checking accounts 255 4,255 (67) 4,443
FHLB Seattle advances (4,029) 3,896 (697) (830)
Other borrowings 2,010 94 24 2,128
Trust Preferred Securities 0 0 0 0
Subordinated Notes (1) 7 0 6
------- ------- ------- -------
Total interest expense (1,765) 8,252 (740) 5,747
------- ------- ------- -------
Net interest income $ 802 $(1,324) $ 600 $ 78
======= ======= ======= =======
</TABLE>
<PAGE>
ASSET AND LIABILITY MANAGEMENT
The results of operations for savings institutions may be materially
and adversely affected by changes in prevailing economic conditions,
including rapid changes in interest rates, declines in real estate
market values and the monetary and fiscal policies of the federal
government. Like all financial institutions, Sterling's NII and the
net present value of assets, liabilities and off-balance sheet
contracts ("NPV") or estimated fair value, are subject to fluctuations
in interest rates. For example, Sterling's adjustable rate mortgages
("ARMs") are indexed to the weekly average yield on one-year U.S.
Treasury securities. When interest-earning assets such as loans are
funded by interest-bearing liabilities such as deposits, FHLB Seattle
advances and other borrowings, a changing interest rate environment
may have a dramatic effect on Sterling's results of operations.
Currently, Sterling's interest-bearing liabilities, consisting
primarily of savings deposits, FHLB Seattle advances and other
borrowings, mature or reprice more rapidly, or on different terms,
than do its interest-earning assets. The fact that liabilities mature
or reprice more frequently on average than assets may be beneficial in
times of declining interest rates; however, such an asset/liability
structure may result in declining NII during periods of rising
interest rates. See "Business - Lending Activities."
Additionally, the extent to which borrowers prepay loans is affected
by prevailing interest rates. When interest rates increase, borrowers
are less likely to prepay loans; whereas when interest rates decrease,
borrowers are more likely to prepay loans. Prepayments may affect the
levels of loans retained in an institution's portfolio as well as its
NII.
Sterling maintains an asset and liability management program intended
to manage NII through interest rate cycles and to protect its NPV by
controlling its exposure to changing interest rates. Sterling uses a
simulation model designed to measure the sensitivity of NII and NPV to
changes in interest rates. This simulation model is designed to
enable Sterling to generate a forecast of NII and NPV given various
interest rate forecasts and alternative strategies. The model is also
designed to measure the anticipated impact that prepayment risk, basis
risk, customer maturity preferences, volumes of new business and
changes in the relationship between long- and short-term interest
rates have on the performance of Sterling. The model calculates the
present value of assets, liabilities, off-balance sheet financial
instruments, and equity at current interest rates and at hypothetical
higher and lower interest rates at various intervals. The present
value of each major category of financial instruments is calculated
using estimated cash flows based on weighted-average contractual rates
and terms, then discounted at the estimated current market interest
rate for similar financial instruments. The present value of longer
term fixed rate financial instruments is more difficult to estimate
because such instruments are susceptible to changes in market interest
rates. Present value estimates of adjustable rate financial
instruments are more reliable since they represent the difference
between the contractual and discounted rates until the next interest
rate repricing date.
<PAGE>
The calculations of present value have certain shortcomings. The
discount rates utilized for loans and MBS are based on estimated
nationwide market interest rate levels for similar loans and
securities, with prepayment assumptions based on historical experience
and market forecasts. The unique characteristics of Sterling's loans
and MBS may not necessarily parallel those in the model. The discount
rates utilized for deposits and borrowings are based upon available
alternative types and sources of funds which are not necessarily
indicative of the market value of deposits and FHLB Seattle advances
since such deposits and advances are unique to, and have certain price
and customer relationship advantages for, depository institutions.
The present values are determined based on the discounted cash flows
over the remaining estimated lives of the financial instruments on the
assumption that the resulting cash flows are reinvested in financial
instruments with virtually identical terms. The total measurement of
Sterling's exposure to interest rate risk ("IRR") as presented in the
following table may not be representative of the actual values which
might result from a higher or lower interest rate environment. A
higher or lower interest rate environment will most likely result in
different investment and borrowing strategies by Sterling designed to
further mitigate the effect on the value of, and the net earnings
generated from, Sterling's net assets from any change in interest
rates.
During the twelve months ended December 31, 1997, short-term interest
rates were relatively stable, although in March 26, 1997, the Fed
implemented a policy to tighten credit by increasing the Federal Funds
rate to 5.50%. Longer term interest rates were somewhat more volatile
with 30-year treasury bond yields ranging between approximately 5.89%
and 7.17%. During the first half of the fiscal year ended June 30,
1996, prevailing short- and long-term interest rates declined,
primarily in response to a shift in policies of the Fed toward easing
of short-term interest rates. During this period, the Fed lowered the
Federal Funds rate from 6.00% to 5.25%. In the second half of fiscal
year 1996, prevailing long-term interest rates rose by approximately
0.50% to 0.75%. This increase resulted in a higher cost of funds than
anticipated by management. Also, as a consequence of this rising
interest rate environment, the market value of longer-term assets
significantly declined.
During the twelve months ended December 31, 1997, the six months ended
December 31, 1996 and the fiscal years ended June 30, 1996 and 1995,
management pursued strategies to increase NII and NPV and to reduce
the impact of changes in interest rates on the NPV. In mid-1997,
Sterling increased its capital resources with the issuance of Trust
Preferred Securities. Sterling then increased the level of long-term,
fixed rate investments and MBS funded with short-term borrowings,
which resulted in a moderate increase in IRR. NPV increased during
1997 as a result of these strategies and as a result of a decrease in
long-term interest rates. During the six months ended December 31,
1996 and the fiscal years ended June 30, 1996 and 1995, management
pursued strategies to increase NPV and to reduce the impact of changes
<PAGE>
in interest rates on NPV. During the six months ended December 31,
1996, NPV increased due primarily to an increase in the value of long-
term assets and a change in the loan mix. During the fiscal year
ended June 30, 1996, NPV declined due primarily to a decrease in the
value of long-term assets resulting from an increase in long-term
interest rates.
Sterling is continuing to pursue strategies to manage the level of its
IRR while increasing its NII through the origination and retention of
variable rate consumer, business banking, construction and commercial
real estate loans which generally have higher yields than residential
permanent loans. There can be no assurance that Sterling will be
successful implementing any of these strategies or that, if these
strategies are implemented, they will have the intended effect of
reducing IRR or increasing NII.
The following table presents Sterling's estimates of changes in NPV
as of December 31, 1997. The results indicate the impact of
instantaneous, parallel shifts in the market yield curve. These
calculations are relative measurements of IRR and do not reflect any
expected rate movement.
<TABLE>
<CAPTION>
Change in Interest Ratio of NPV to
Rates in Basis Points the Present Value
(Rate Shock) NPV of Total Assets Change in Ratio
--------------------- -------- ----------------- ---------------
(Dollars in thousands)
<S> <C> <C> <C>
+400 $ 33,974 1.96% (4.13)%
+200 80,857 4.47 (1.62)
+100 104,439 5.65 (0.44)
Static 114,503 6.09 N/A
-100 107,104 5.64 (0.45)
-200 90,190 4.72 (1.37)
-400 45,917 2.37 (3.72)
</TABLE>
At December 31, 1997, Sterling calculated that its NPV was
$114.5 million, as compared with $97.4 million at December 31, 1996
and $80.7 million at June 30, 1996, and that its NPV would decrease by
29.4% and 70.3% if interest rate levels generally were to increase by
2% and 4%, respectively. These calculations, which are highly
subjective and technical, may differ materially from regulatory
calculations. See "Business - Regulation - Regulatory Capital
Requirements - Risk-based Capital."
Sterling also uses gap analysis, a traditional analytical tool
designed to measure the difference between the amount of interest-
earning assets and the amount of interest-bearing liabilities expected
to mature or reprice in a given period. Sterling calculated its one-
year cumulative gap position to be a negative 13.6%, negative 4.4% and
<PAGE>
negative 14.9% at December 31, 1997 and 1996 and June 30, 1996,
respectively. Sterling calculated its three-year gap position to be a
negative 6.9%, negative 6.6% and negative 11.3% at December 31, 1997
and 1996 and June 30, 1996, respectively. The widening in the
negative one- and three-year gap positions during the twelve months
ended December 31, 1997 was due primarily to an increase in MBS and
other securities funded with short-term borrowings. Management
attempts to maintain Sterling's gap position between negative 5% and
negative 20%. At December 31, 1997, Sterling's gap positions were
within limits established by its Board of Directors. Management is
pursuing strategies to increase its NII without significantly
increasing its cumulative gap positions in future periods. See
"Results of Operations - Net Interest Income" and "Capital Resources."
The following table sets forth the estimated maturity/repricing and
the resulting gap between Sterling's interest-earning assets and
interest-bearing liabilities at December 31, 1997. Other than loans
which are in the available-for-sale portfolio, all of the financial
instruments of Sterling are intended to be held to maturity. The
estimated maturity/repricing amounts reflect contractual maturities
and amortizations, assumed loan prepayments based upon Sterling's
historical experience, estimates from secondary market sources such as
the Federal Home Loan Mortgage Corporation (the "FHLMC') and estimated
passbook deposit decay rates (the rate of withdrawals or transfers to
higher-yielding certificates of deposits ("CDs")). Management
believes these assumptions and estimates are reasonable, but there can
be no assurance in this regard. The classification of mortgage loans
and MBS is based upon regulatory reporting formats and, therefore, may
not be consistent with the financial information reported in
accordance with generally accepted accounting principles ("GAAP") and
contained elsewhere in this Report on Form 10-K.
<PAGE>
<TABLE>
<CAPTION>
Maturity or Repricing
---------------------------------------------------------------------------
Over Over Over
Zero to Three One Year Three
Three Months to to Three Years to Over
Months One Year Years Five Years Five Years Total
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans and mortgage-backed
securities:
ARM and balloon mortgage loans $ 333,320 $ 172,681 $ 89,153 $ 42,155 $ 18 $ 637,327
Fixed rate mortgage loans 19,561 53,647 148,932 109,322 171,574 503,036
Loans held-for-sale 5,225 0 0 0 0 5,225
---------- ---------- ---------- ---------- ---------- ----------
Total mortgage loans and mortgage-
backed securities 358,106 226,328 238,085 151,477 171,592 1,145,588
Non-mortgage loans:
Consumer 38,918 41,218 48,324 17,239 11,049 156,748
Commercial 224,743 4,922 7,685 2,816 1,567 241,733
---------- ---------- ---------- ---------- ---------- ----------
Total loans and mortgage-backed securities 621,767 272,468 294,094 171,532 184,208 1,544,069
Cash and investment securities 43,836 134,721 28,743 5,791 2,500 215,591
---------- ---------- ---------- ---------- ---------- ----------
Total rate-sensitive assets 665,603 407,189 322,837 177,323 186,708 1,759,660
---------- ---------- ---------- ---------- ---------- ----------
Cash on hand and in banks 36,552 36,552
Other non-interest-earning assets 80,038 80,038
---------- ---------- ---------- ---------- ---------- ----------
Total assets $ 303,298 $1,876,250
========== ==========
Interest-bearing liabilities:
Deposits:
Certificates of deposit $ 272,979 $ 299,163 $ 52,799 $ 25,325 $ 19,871 $ 670,137
Checking accounts 2,959 8,445 19,718 16,178 72,059 119,359
Money market accounts 183,795 0 0 0 0 183,795
Passbook accounts 3,863 10,228 16,387 10,988 21,651 63,117
---------- ---------- ---------- ---------- ---------- ----------
Total deposits 463,596 317,836 88,904 52,491 113,581 1,036,408
FHLB Seattle advances 95,000 299,000 49,000 693 11,392 455,085
Repurchase agreements 136,997 0 43,080 0 0 180,077
Other borrowings 15,000 0 17,240 0 40,000 72,240
---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities 710,593 616,836 198,224 53,184 164,973 1,743,810
Impact of liability commitments and
hedging 0 0 0 0 0 0
---------- ---------- ---------- ---------- ---------- ----------
Total rate-sensitive liabilities $ 710,593 $ 616,836 $ 198,224 $ 53,184 $ 164,973 $1,743,810
========== ========== ========== ========== ========== ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Maturity or Repricing
---------------------------------------------------------------------------
Over Over Over
Zero to Three One Year Three
Three Months to to Three Years to Over
Months One Year Years Five Years Five Years Total
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Other non-interest-bearing liabilities $ 29,577 $ 29,577
Shareholders' equity 102,863 102,863
---------- ----------
Total liabilities and shareholders' equity $ 297,413 $1,876,250
========== ==========
Net gap $ (44,990) $ (209,647) $ 124,613 $ 124,139 $ 5,885 $ 0
========== ========== ========== ========== ========== ==========
Cumulative gap $ (44,990) $ (254,637) $ (130,024) $ (5,885) $ 0 $ 0
========== ========== ========== ========== ========== ==========
Cumulative gap to total assets (2.4)% (13.6)% (6.9)% (0.3)% 0.0% 0.0%
</TABLE>
RESULTS OF OPERATIONS FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1997
AND 1996
OVERVIEW. For the twelve months ended December 31, 1997, net income
was $9.6 million, or $1.25 per diluted share. Primarily as a result
of the SAIF assessment which resulted in a pre-tax charge to earnings
of $5.8 million and an increase in other operating expenses, Sterling
reported a reduced net income of $2.5 million, or $0.11 per diluted
share, for the twelve months ended December 31, 1996. Excluding the
SAIF assessment, Sterling would have reported net income of $7.6
million, or $1.01 per diluted share, for the twelve months ended
December 31, 1996. The increase in net income is due primarily to an
increase in net interest income.
The return on average assets was 0.56% and 0.16% for the twelve months
ended December 31, 1997 and 1996, respectively. The return on common
shareholders' equity was 11.36% and 0.94% for the twelve months ended
December 31, 1997 and 1996, respectively. These increases were due
primarily to increases in NII, the impact of the 1996 SAIF assessment
and higher operating expenses.
<PAGE>
NET INTEREST INCOME. Net interest income for the twelve months ended
December 31, 1997 was $45.6 million, compared with $38.6 million for
the twelve months ended December 31, 1996. During these same periods,
the net interest margins were 2.81% and 2.71%, respectively, and the
volumes of interest-earning assets were $1.62 billion and $1.43
billion, respectively. The increase in NII was due primarily to an
increase in the volume of average interest-earning assets which were
primarily loans, and an increase in the net interest margin. The
increase in the net interest margin was due to an increase in the
rates earned on interest-earning assets coupled with a decrease in the
cost of deposits.
PROVISION FOR LOAN LOSSES. Management's policy is to establish
valuation allowances for estimated losses by charging corresponding
provisions against income. The evaluation of the adequacy of specific
and general valuation allowances is an ongoing process. Sterling
recorded provisions for loan losses of $2.5 million and $1.9 million
for the twelve months ended December 31, 1997 and 1996, respectively.
Sterling increased its provision for loan losses in anticipation of
potentially higher levels of loss from its expanded construction,
business banking and consumer lending activities. Management
anticipates that its provisions for loan losses will increase in the
future as Sterling continues to expand into these higher yielding,
higher risk loans.
At December 31, 1997, Sterling's loan delinquency rate as a percentage
of total loans was 0.71%, compared with 0.53% at December 31, 1996.
Total nonperforming loans were $4.9 million at December 31, 1997,
compared with $2.5 million at December 31, 1996. As a percentage of
total loans, nonperforming loans were 0.42% at December 31, 1997,
compared with 0.25% at December 31, 1996. Management believes the
loan loss provisions represent appropriate allowances for loan losses
based upon its evaluation of factors affecting the adequacy of
valuation allowances, although there can be no assurance in this
regard. Such factors include concentrations of the types of loans and
associated risks within the loan portfolio and economic factors
affecting the Pacific Northwest economy.
OTHER INCOME. The following table summarizes the components of other
income for the periods indicated:
Twelve Months Ended
December 31,
---------------------
1997 1996
------ ------
(Dollars in thousands)
Fees and service charges $4,978 $4,553
Mortgage banking operations 1,922 3,488
Loan servicing fees 1,291 1,095
Net gain on sales of securities 1,197 7
Net loss on sales and operations of
real estate owned ("REO") (84) (159)
------ ------
$9,304 $8,984
====== ======
<PAGE>
Fees and service charges consist primarily of service charges on
deposit accounts, fees for certain customer services, commissions on
sales of credit life insurance and late charges on loans, as well as
escrow fees, commissions on sales of mutual funds and annuity
products. The increase for the twelve months ended December 31, 1997,
compared with the twelve months ended December 31, 1996, was due
primarily to an increase in service charges on deposit accounts, fees
for certain customer services and commissions on sales of credit life
insurance. This increase in service charges on deposit accounts and
fees for certain customer services was due primarily to an increase
in the fee structure for most services.
The decrease in income from mortgage banking operations for the twelve
months ended December 31, 1997, compared with the twelve months ended
December 31, 1996, was due primarily to a shift away from loans
originated and sold in the secondary market to loans originated for
the permanent portfolio.
The following table summarizes loan originations and sales of loans
for the periods indicated:
Twelve Months Ended
December 31,
---------------------
1997 1996
------ ------
(Dollars in thousands)
Originations of one- to four-family permanent
mortgage loans $174.3 $165.2
Sales of residential loans 108.0 187.1
Principal balances at end of period of
mortgage loans serviced for others 452.2 542.2
The increase in loan servicing fees for the twelve months ended
December 31, 1997, compared with the twelve months ended December 31,
1996, was due primarily to a decrease in the balance of loans serviced
that have amortization of a related acquisition premium which offsets
the loan servicing income. Sterling's average loan servicing
portfolios for the twelve months ended December 31, 1997 and 1996,
were approximately $503.8 million and $645.8 million, respectively.
During the twelve months ended December 31, 1997, Sterling sold
approximately $263.2 million of investments and MBS, resulting in a
net gain of $1.2 million. No such sales were made in the same period
in 1996.
OPERATING EXPENSES. Operating expenses were $37.1 million and $40.9
million for the twelve months ended December 31, 1997 and 1996,
respectively. The decrease was due primarily to the one-time
$5.8 million SAIF assessment and other one-time charges of $1.8
million in 1996. Exclusive of these items, operating expenses
increased $3.8 million from 1996 to 1997.
<PAGE>
Employee compensation and benefits were $15.9 million and $13.0
million for the twelve months ended December 31, 1997 and 1996,
respectively. The increase was due primarily to an increase in
lending staff related to Sterling's efforts to increase its commercial
real estate, business banking and consumer lending areas. It was also
due to a reduction of approximately $1.4 million in the amount of
personnel cost deferred as the mix of loan originations was shifting
away from residential permanent mortgage to construction, business
banking and consumer loans. Amortization of intangibles amounted to
$2.2 million and $3.3 million for the twelve months ended December 31,
1997 and 1996, respectively. The decrease was due primarily to core
deposit premium balances for specific acquisitions becoming fully
amortized during the year. Occupancy and equipment expenses were $6.0
million and $5.6 million for the twelve months ended December 31, 1997
and 1996, respectively. This increase resulted from increasing
personnel levels. Insurance expenses were $1.2 million and $2.4
million for the twelve months ended December 31, 1997 and 1996,
respectively. The decrease was due primarily to the reduction in the
SAIF assessment rate on deposits during 1997. Legal and accounting
expenses were $1.4 million and $1.9 million during the twelve months
ended December 31, 1997 and 1996, respectively. The decrease was due
primarily to a decrease in legal fees. Other expenses were $2.1
million and $1.3 million for the twelve months ended December 31, 1997
and 1996, respectively. The increase in other expenses was due
primarily to a reduction in the deferral of loan origination costs, as
well as a increase in loan processing expense. See "General,"
"Capital Resources," "Year 2000 Issues" and Note 19 of "Notes to
Consolidated Financial Statements."
Sterling measures the efficiency of its operations by its operating
efficiency ratio (the ratio of total operating expenses to total
revenues, which includes NII and total other income). Sterling's
operating efficiency ratio was 67.5% and 85.9% for the twelve months
ended December 31, 1997 and 1996, respectively. Management is
striving to reduce its operating efficiency ratio below 65%, but there
can be no assurance that it will be able to achieve this goal.
INCOME TAX PROVISION. For the twelve months ended December 31, 1997,
Sterling's federal and state income tax provision of $5.7 million
represented 37.4% of income before income taxes, which approximated
the applicable statutory tax rates. For the twelve months ended
December 31, 1996, Sterling's income tax provision of $2.3 million
consisted of the provision on the operating income which approximates
the statutory tax rates plus a provision related to a change in the
estimate of prior period income taxes.
<PAGE>
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED DECEMBER 31, 1996 AND
1995
OVERVIEW. Sterling's SAIF assessment resulted in a pre-tax charge to
earnings of $5.8 million during the six months ended December 31,
1996. Primarily as a result of this charge and an increase in other
operating expenses, Sterling reported a net loss of $1.1 million, or
$0.37 per diluted share, for the six months ended December 31, 1996,
compared with net income of $3.2 million, or $0.42 per diluted share,
for the six months ended December 31, 1995.
The annualized return on average assets was (0.14)% and 0.41% for the
six months ended December 31, 1996 and 1995, respectively. The return
on common shareholders' equity was (6.6)% and 6.8% for the six months
ended December 31, 1996 and 1995, respectively. This decrease was due
primarily to the SAIF assessment and the increase in other operating
expenses.
NET INTEREST INCOME. Net interest income for the six months ended
December 31, 1996 was $20.2 million, compared to $17.0 million for the
six months ended December 31, 1995. During these same periods, the
net interest margins were 2.80% and 2.31%, respectively, and the
volumes of interest-earning assets were $1.43 billion and $1.46
billion, respectively. The increase in NII was due primarily to an
increase in the rates earned on interest-earning assets coupled with a
decrease in the cost of deposits and other borrowings. See "Net
Interest Income."
PROVISION FOR LOAN LOSSES. Management's policy is to establish
valuation allowances for estimated losses by charging corresponding
provisions against income. The evaluation of the adequacy of specific
and general valuation allowances is an ongoing process. Sterling
recorded provisions for loan losses of $1.1 million and $800,000 for
the six months ended December 31, 1996 and 1995, respectively.
At December 31, 1996, Sterling's loan delinquency rate as a percentage
of total loans was 0.53%, compared with 0.58% at December 31, 1995.
Total nonperforming loans were $2.5 million at December 31, 1996,
compared with $4.5 million at December 31, 1995. As a percentage of
total loans, nonperforming loans were 0.25% at December 31, 1996,
compared with 0.47% at December 31, 1995. Management believes the
loan loss provisions represent appropriate allowances for loan losses
based upon its evaluation of factors affecting the adequacy of
valuation allowances, although there can be no assurance in this
regard. Such factors include concentrations of the types of loans and
associated risks within the loan portfolio and economic factors
affecting the Pacific Northwest economy.
<PAGE>
OTHER INCOME. The following table summarizes the components of other
income for the periods indicated:
Six Months Ended
December 31,
---------------------
1996 1995
------ ------
(Dollars in thousands)
Fees and service charges $2,431 $1,777
Mortgage banking operations 1,686 1,761
Loan servicing fees 633 459
Net gain on sales of securities 0 451
Net loss on sales and operations of REO (102) (114)
------ ------
$4,648 $4,334
====== ======
Fees and service charges consist primarily of service charges on
deposit accounts, fees for certain customer services, commissions on
sales of credit life insurance and late charges on loans, as well as
escrow fees, commissions on sales of mutual funds and annuity
products. The increase for the six months ended December 31, 1996,
compared with the six months ended December 31, 1995 was due primarily
to an increase in service charges on deposit accounts, fees for
certain customer services and commissions on sales of credit life
insurance. This increase in service charges on deposit accounts and
fees for certain customer services was due primarily to the change in
the mix of Sterling's deposit accounts.
The decrease in income from mortgage banking operations for the six
months ended December 31, 1996, compared with the six months ended
December 31, 1995 primarily resulted from a decrease in the volume of
loans sold during the six months ended December 31, 1996, as compared
with the six months ended December 31, 1995.
The following table summarizes loan originations and sales of loans
for the periods indicated:
Six Months Ended
December 31,
---------------------
1997 1996
------ ------
(Dollars in millions)
Originations of one- to four-family permanent
mortgage loans $ 72.5 $124.2
Sales of residential loans 77.8 122.8
Principal balances at end of period of
mortgage loans serviced for others 542.2 837.1
<PAGE>
The increase in loan servicing fees for the six months ended
December 31, 1996, compared with the six months ended December 31,
1995, was due primarily to a decrease in the balance of loans serviced
that have amortization of a related acquisition premium, offsetting
the loan servicing income.
Sterling's average loan servicing portfolios for the six months ended
December 31, 1996 and 1995, were approximately $562.3 million and
$625.2 million, respectively. Sterling anticipates retaining a
significant portion of the current balance of loans serviced for
others, although there can be no assurances in this regard.
During the six months ended December 31, 1995, Sterling sold
approximately $55.6 million of investments and MBS. No such sales
were made in the same period in 1996. Sterling used the majority of
the proceeds from the 1995 sales to invest in one- to four-family
loans and intermediate-term MBS.
OPERATING EXPENSES. Operating expenses were $24.7 million and $15.5
million for the six months ended December 31, 1996 and 1995,
respectively. The significant increase is due primarily to the one-
time SAIF assessment and increases in employee compensation and
benefits, legal and accounting costs, and other expenses.
Employee compensation and benefits were $6.9 million and $6.1 million
for the six months ended December 31, 1996 and 1995, respectively.
The increase was due primarily to an increase in the number of
employees. Occupancy and equipment expenses were $2.9 million and $2.6
million for the six months ended December 31, 1996 and 1995,
respectively. Depreciation expense was $1.5 million and $1.3 million
for the six months ended December 31, 1996 and 1995, respectively.
The increases in occupancy and equipment and depreciation expenses
were due primarily to higher computer and data processing costs
following a conversion to a new data processing system in October
1995. Insurance expenses were $1.3 million and $1.1 million for the
six months ended December 31, 1996 and 1995, respectively. The
increase was due primarily to the initiation of liability coverage for
directors and officers and to increased premiums on property and
casualty policies. Legal and accounting expenses were $1.2 million
and $507,000 during the six months ended December 31, 1996 and 1995,
respectively. The increase was due primarily to costs incurred to
pursue Sterling's breach of contract claim against the U.S. government
and higher levels of accounting and regulatory examination costs.
Other expenses were $1.6 million and $835,000 for the six months ended
December 31, 1996 and 1995, respectively. The increase in other
expenses was due primarily to a reduction in the deferral of loan
origination costs, increased business and occupation taxes, and
increased provisions for various other expense items. See "General,"
"Capital Resources" and Note 19 of "Notes to Consolidated Financial
Statements."
<PAGE>
Sterling measures the efficiency of its operations by its operating
efficiency ratio (the ratio of total operating expenses to total
revenues, which includes NII and total other income). Sterling's
operating efficiency ratio was 99.6% and 72.6% for the six months
ended December 31, 1996 and 1995, respectively. The increase was due
primarily to the significant increase in operating expenses described
above.
INCOME TAX PROVISION. For the six months ended December 31, 1996,
Sterling's federal and state income tax provision of $112,000 resulted
from a change in the estimated prior period income taxes which
exceeded the benefit from the current operating loss related to a
change in the estimate of prior period income taxes. For the six
months ended December 31, 1995, Sterling's income tax provision of
$1.8 million represented 36.5% of income before income taxes, which
approximated the statutory tax rate.
RESULTS OF OPERATIONS FOR FISCAL YEARS ENDED JUNE 30, 1996 AND 1995
OVERVIEW. Sterling reported net income of $6.8 million, or $0.90 per
diluted share, for the fiscal year ended June 30, 1996, compared with
the fiscal year ended June 30, 1995, when net income was $9.3 million
or $1.27 per diluted share. In the fiscal year ended June 30, 1996,
the decrease in net income was due primarily to a decrease in income
from mortgage banking operations. All per share amounts have been
adjusted for all Common Stock dividends declared and/or paid. See "-
Other Income" and "- Operating Expenses."
For fiscal years ended June 30, 1996 and 1995, the annualized return
on average assets was 0.45% and 0.48%, respectively. The decrease was
due primarily to the decline in net interest margin and the increased
levels of average assets. The return on common shareholders' equity
was 7.4% for the fiscal year ended June 30, 1996, compared with 13.1%
for the fiscal year ended June 30, 1995. This decrease was due
primarily to a decline in income from mortgage banking operations.
NET INTEREST INCOME. NII was $35.5 million for the fiscal year ended
June 30, 1996, compared with NII of $35.4 million for the fiscal year
ended June 30, 1995. During this same period, the net interest
margins were 2.46% and 2.44%, respectively, and the volumes of
interest-earning assets were $1.44 billion and $1.45 billion,
respectively. The increase in NII was due primarily to a change in
the mix of interest-earning assets as the net interest margin
increased to 2.46% from 2.44% for the fiscal year ended June 30, 1995.
See "Net Interest Income."
PROVISION FOR LOAN LOSSES. Management's policy is to establish
valuation allowances for estimated losses by charging corresponding
provisions against income. The evaluation of the adequacy of specific
and general valuation allowances is an ongoing process. Sterling
recorded provisions for loan losses of $1.6 million for each of the
fiscal years ended June 30, 1996 and 1995.
<PAGE>
At June 30, 1996, Sterling's loan delinquency rate was 0.36%, compared
with 0.34% at June 30, 1995. Total nonperforming loans were
$3.6 million at June 30, 1996 and June 30, 1995. As a percentage of
total loans, nonperforming loans were 0.36% at June 30, 1996, compared
with 0.32% at June 30, 1995. Management believes the loan loss
provisions represent appropriate allowances for loan losses based upon
its evaluation of the factors affecting the adequacy of valuation
allowances, although there can be no assurance in this regard. Such
factors include concentrations of the types of loans and associated
risks within the loan portfolio and economic factors affecting the
Pacific Northwest economy.
OTHER INCOME. The following table summarizes the components of other
income for the periods indicated.
Fiscal Years Ended
December 31,
---------------------
1996 1995
------- --------
(Dollars in thousands)
Fees and service charges $ 4,408 $ 3,945
Mortgage banking operations 3,054 6,416
Loan servicing fees 921 1,271
Net gain on sales of securities 458 246
Net loss on sales and operations of REO (171) (491)
------- -------
$ 8,670 $11,387
======= =======
Fees and service charges consist primarily of service charges on
deposit accounts, fees for certain customer services, commissions on
sales of credit life insurance and late charges on loans, as well as
escrow fees, commissions on sales of mutual funds and annuity
products. The increase for the fiscal year ended June 30, 1996 was
due primarily to an increase in service charges on deposit accounts,
fees for certain customer services, and commissions on sales of credit
life insurance.
The decrease in income from mortgage banking operations for the fiscal
year ended June 30, 1996 was due primarily to from lower levels of
bulk sales of servicing rights. During the fiscal year ended
June 30, 1996 there were no gains on bulk sales of loan servicing
rights compared with a gain of $5.6 million for the fiscal year ended
June 30, 1995. Sterling sold bulk servicing during the fiscal year
ended June 30, 1995 primarily to offset the reduction in residential
loan originations and related gains on sales of loans. Residential
loan originations declined in response to a reduction in refinance
activities and increases in short-term interest rates. See "Asset and
Liability Management."
<PAGE>
The following table summarizes loan originations and sales of loans
and bulk servicing rights for the periods indicated:
Fiscal Years Ended
June 30,
---------------------
1997 1996
------ ------
(Dollars in millions)
Originations of one- to four-family permanent
mortgage loans $217.0 $286.0
Sales of residential loans 232.1 98.2
Principal balances of servicing portfolios
sold in bulk during the period 172.2 437.8
Principal balances of servicing portfolios
acquired 0.0 451.4
Principal balances at end of period of
mortgage loans serviced for others 587.8 647.0
The decrease in loan servicing fees for the fiscal year ended June 30,
1996, compared with the fiscal year ended June 30, 1995, was due
primarily to a decrease in the average size of the loan servicing
portfolios. During the fiscal years ended June 30, 1996 and 1995,
Sterling sold in bulk rights to service conventional loans for others
with principal balances of $172.2 million and $437.8 million,
respectively. Gains on these sales were included in income from
mortgage banking operations. Sterling's average loan servicing
portfolios for the fiscal years ended June 30, 1996 and 1995 was
approximately $677.4 million and $671.4 million, respectively.
During the fiscal years ended June 30, 1996 and 1995, Sterling sold
approximately $55.6 million and $166.2 million, respectively, of
investments and MBS. In the fiscal years ended June 30, 1996 and
1995, Sterling used the majority of the sales proceeds to repay
maturing borrowings and jumbo deposits. See "Asset and Liability
Management."
The decrease in net losses from sales and operation of REO was due
primarily to a higher level of income from the operations of REO.
OPERATING EXPENSES. Operating expenses were $31.7 million and $31.3
million for the fiscal years ended June 30, 1996 and 1995,
respectively. The increase in operating expenses of 1.3% was due
primarily to increases in depreciation, employee compensation and
benefits, insurance, and occupancy and equipment, offset by decreases
in advertising, data processing and amortization of intangibles. See
Note 19 of "Notes to Consolidated Financial Statements."
<PAGE>
Sterling measures the efficiency of its operations by its operating
efficiency ratio (the ratio of total operating expenses to total
revenues, which includes NII and total other income.) Sterling's
operating efficiency ratio was 71.8% and 66.9% for the fiscal years
ended June 30, 1996 and 1995, respectively. The increase was due
primarily to lower levels of NII and income from mortgage banking
operations. In addition, the operating efficiency ratio reflected a
decrease in cost efficiency of the residential lending operations due
primarily to a decrease in loan originations.
INCOME TAX PROVISION. Income tax provisions were $4.1 million and
$4.6 million for the fiscal years ended June 30, 1996 and 1995,
respectively. For the fiscal years ended June 30, 1996 and 1995, the
effective tax rates on income before income taxes were 37.4% and
33.2%, respectively. The effective tax rate for the fiscal year ended
June 30, 1996 was influenced by higher sources of income being derived
from states with state income taxes.
LIQUIDITY AND SOURCES OF FUNDS
As a financial institution, Sterling's primary sources of funds are
derived from financing and operating activities. Financing activities
consist primarily of customer deposits, advances from the FHLB Seattle
and other borrowings. Deposits increased to $1.04 billion at December
31, 1997, from $902.3 million at December 31, 1996 and $898.4 million
at June 30, 1996. Retail deposits, which exclude public funds,
increased to $941.9 million at December 31, 1997, from $851.0 million
at December 31, 1996 and $842.5 million at June 30, 1996. At December
31, 1997, approximately $94.5 million of deposits consisted of public
funds that generally had maturities of 60 days or less. Advances from
the FHLB Seattle increased to $455.1 million at December 31, 1997 from
$259.6 million at December 31, 1996 and $259.4 million at June 30,
1996. At December 31, 1997 and 1996, securities sold subject to
repurchase agreements were $180.1 million and $229.8 million,
respectively, compared with $195.8 million at June 30, 1996. These
borrowings are secured by investments and MBS with a market value
exceeding the face value of the borrowings. Under certain
circumstances, Sterling could be required to pledge additional
securities or reduce the borrowings. The maturities of reverse
repurchase agreements are generally less than twelve months and are
subject to more frequent repricing than are other types of borrowings.
During 1997, Sterling instituted a program of repurchase agreements
with selected retail customers. These borrowings are generally
overnight borrowings. The balance of $2.0 million at
December 31, 1997 is included in the reverse repurchase agreements.
Management plans to continue to rely upon the FHLB Seattle advances
and reverse repurchase agreements to help fund its operations. See
"Business - Recent Developments" and "- Sources of Funds -
Borrowings."
<PAGE>
With the planned acquisition of KeyBank branches, Sterling anticipates
substantially reducing its FHLB Seattle advances and reverse
repurchase agreements. Additionally, in order to finance this
transaction, Sterling will use its existing cash resources and
borrowing capacities supplemented with additional borrowings of
approximately $25 million. The acquisition is subject to regulatory
approvals and other conditions of closing and is scheduled to close
mid-year 1998. See "Business - Recent Developments."
Cash provided or used by investing activities consists primarily of
principal and interest payments on loans and MBS and sales of MBS.
The levels of these payments and sales increase or decrease depending
on the size of the loan and MBS portfolios and the general trend and
level of interest rates, which influences the level of refinancing and
mortgage prepayments. During the twelve months ended December 31,
1997, net cash was used in investing activities primarily to purchase
$594.6 million in investments and MBS and to fund loans. The increase
in investments and MBS coincided with Sterling's sale of Trust
Preferred Securities.
Cash provided or used by operating activities is determined largely by
changes in the level of loan sales. Proceeds from sales of loans
decreased in the twelve months ended December 31, 1997 due primarily
to a reduction in residential loan sales. The level of loans held for
sale depends on the level of loan originations and the time within
which investors fund the purchase of loans from Sterling. A majority
of conventional loans held for sale are sold within 10 days of the
closing while the sale of certain Federal Housing Administration-
("FHA") and Veteran's Administration-("VA") insured loans may take up
to 60 days. Sterling typically offsets fluctuations in the level of
loans held for sale by changing the level of advances from the FHLB
Seattle, using reverse repurchase agreements or cash. Management
believes that proceeds from loans sold, advances from the FHLB Seattle
and reverse repurchase agreements will be sufficient to fund loan
commitments in the future.
Sterling Savings' credit line with the FHLB Seattle provides for
borrowings up to 35% of its total assets. At December 31, 1997, this
credit line represented a total borrowing capacity of approximately
$658.3 million, of which $203.2 million was available. Sterling
Savings also borrows on a secured basis from major broker/dealers and
financial entities by selling securities subject to repurchase
agreements. At December 31, 1997, Sterling Savings had $180.1 million
in outstanding borrowings under reverse repurchase agreements and
securities available for additional secured borrowings of
approximately $296.1 million. Sterling Savings also had a secured
line of credit agreement from a commercial bank of approximately $10.0
million as of December 31, 1997. At December 31, 1997, Sterling
Savings had no funds drawn on this line of credit.
<PAGE>
Excluding its subsidiaries, Sterling Financial had cash and other
resources of approximately $21.3 million and a line of credit from a
commercial bank of approximately $5.0 million at December 31, 1997.
At December 31, 1997, Sterling Financial had no funds drawn on this
line of credit. At September 30, 1996, Sterling Financial also
secured a $15.0 million six-year term variable rate loan from a
commercial bank. Certain proceeds of $10.0 million of this term loan
were contributed to Sterling Savings to enhance its capital. At
December 31, 1997, Sterling Financial had an investment of $66.1
million in the Preferred Stock of Sterling Savings, all of which has
been pledged to secure the $15.0 million loan. Sterling Financial
received cash dividends on Sterling Savings Preferred Stock of $6.1
million during the twelve months ended December 31, 1997. These
resources were sufficient to meet the operating needs of Sterling
Financial, including interest expense on its 8.75% Subordinated Notes
(the "Subordinated Notes"), other borrowings and dividends on its
$1.8125 Cumulative Convertible Preferred Stock (the "Preferred
Stock"). Sterling Savings' ability to pay dividends is limited by its
earnings, financial condition and capital requirements, as well as
rules and regulations imposed by the OTS. See "Business - Regulation
- Restrictions on Capital Distributions by Savings Associations,"
"Capital Resources" and Note 16 of "Notes to Consolidated Financial
Statements."
OTS regulations require savings institutions such as Sterling Savings
to maintain an average daily balance of liquid assets equal to or
greater than a specific percentage (currently 4%) of the average daily
balance of net withdrawable accounts and borrowings payable on demand
in one year or less during the preceding calendar month. At December
31, 1997 and 1996 and June 30, 1996, Sterling Savings' liquidity ratio
was 13.01%, 10.91% and 7.31%, respectively. The higher level of
liquidity at December 31, 1997 was due primarily to the purchase and
retention of qualifying securities. Sterling Savings' strategy
generally is to maintain its liquidity ratio at or near the required
minimum in order to maximize its yield on alternative investments. The
regulatory liquidity ratio does not take into account certain other
sources of liquidity, such as funds invested through Sterling Savings'
subsidiaries, potential borrowings against MBS or investment
securities and other potential financing alternatives. The required
minimum liquidity ratio may vary from time to time, depending on
economic conditions, savings flows and loan funding needs. See
"Business - Regulation."
CAPITAL RESOURCES
Sterling's total shareholders' equity was $102.9 million at
December 31, 1997, compared with $89.2 million at December 31, 1996
and $85.7 million at June 30, 1996. At December 31, 1997 and 1996 and
June 30, 1996, shareholders' equity was 5.5% and 5.8% of total assets,
respectively. The increase in total shareholders' equity was due
primarily to the higher market value of Sterling's available-for-sale
securities and the increase in retained earnings. See "General."
<PAGE>
At December 31, 1997, Sterling had an unrealized loss of $1.0 million,
net of related income taxes, on investments and MBS classified as
available-for-sale. The decrease in the unrealized loss from
$6.0 million at December 31, 1996 and $10.3 million at June 30, 1996
was due primarily to an increase in the market valuation of MBS and
U.S. Treasury securities due to the decline in long-term interest
rates over the past eighteen months. Fluctuations in prevailing
interest rates could continue to cause volatility in this component of
shareholders' equity in future periods. See "Business - Investments
and Mortgage-Backed Securities."
In connection with an acquisition in 1994, Sterling issued warrants to
purchase 99,985 shares of Sterling's Common Stock at $11.82 per share.
All of such warrants were exercised in July 1996, thereby increasing
Sterling's shareholders' equity by approximately $1.2 million.
During the year ended December 31, 1997, the Preferred Stock was
called for redemption at $26.07 per share plus accrued but unpaid
dividends. As a result of the call for redemption, 1,035,700 shares
of Preferred Stock were converted into 2,021,190 shares of common
stock. During the same period, 4,300 shares of Preferred Stock were
redeemed for $113,000.
In June 1997, Sterling issued and has outstanding $40.0 million of
Trust Preferred Securities. The indenture governing the Trust
Preferred Securities limits the ability of Sterling under certain
circumstances to pay dividends or make other capital distributions.
The Trust Preferred Securities are treated as debt of Sterling. The
Trust Preferred Securities mature on June 30, 2027, and are redeemable
at the option of Sterling, or earlier in the event the deduction of
related interest for federal income taxes is prohibited, treatment as
Tier 1 capital is no longer permitted, or certain other contingencies
arise.
Sterling has issued and outstanding $17.2 million of 8.75%
Subordinated Notes due on January 31, 2000. These notes are unsecured
general obligations of Sterling and are subordinated to certain other
existing and future indebtedness. The indenture governing the
Subordinated Notes limits the ability of Sterling under certain
circumstances to incur additional indebtedness, to pay cash dividends
or to make other capital distributions. See Note 11 of "Notes to
Consolidated Financial Statements."
In order to integrate the KeyBank branches and expand branch
locations, Sterling anticipates total capital expenditures of
approximately $13.0 million to $15.0 million for the year ended
December 31, 1998. Sterling also anticipates spending approximately
$500,000 during 1998 in connection with the Year 2000 ("Year 2000")
issues. Sterling anticipates continuing to fund these capital
expenditures from various sources, including retained earnings and
borrowings with various maturities. Sterling is exploring
opportunities to sell certain developed properties and enter into
lease arrangements. There can be no assurance that Sterling's
estimates of capital expenditures or the funding thereof are accurate.
See "- Recent Developments" and "- Year 2000 Issues."
<PAGE>
Sterling Savings is required by applicable regulations to maintain
certain minimum capital levels with respect to tangible capital, core
leverage capital and risk-based capital. Sterling Savings anticipates
that it will continue to enhance its capital resources and the
regulatory capital ratios of Sterling Savings through the retention of
earnings, the amortization of intangible assets and the management of
the level and mix of assets, although there can be no assurance in
this regard. At December 31, 1997, Sterling Savings exceeded all such
regulatory capital requirements. See Note 16 of "Notes to
Consolidated Financial Statements."
Sterling continues to proactively manage its claim against the U.S.
government for breach of contract on three supervisory goodwill
acquisition contracts. In July 1996, the U.S. Supreme Court ruled in
three similar cases that the U.S. government was liable for having
breached its acquisition contracts with certain savings associations.
Sterling is encouraged by the Supreme Court's decision, although it is
uncertain when a trial to determine Sterling's damages will be held or
when a judgment, if any, will be paid.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 131,
Disclosures about Segments for an Enterprise and Related Information
("SFAS 131"). This Statement will change the way public companies
report information about segments of their business in their annual
financial statements and requires them to report selected segment
information in their quarterly reports issued to Shareholders. It
also requires entity-wide disclosures about the products and services
an entity provides, and its major customers. This Statement is
effective for fiscal years beginning after December 15, 1997.
Sterling has not yet determined the effect, if any, of SFAS 131 on its
consolidated financial statements.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. This Statement requires that comprehensive income be reported
in a financial statement that is displayed with the same prominence as
other financial statements. This Statement does not require a
specific format for the financial statement, but requires that an
enterprise display net income as a component of comprehensive income
in the financial statement. Comprehensive income is defined as the
change in equity of a business enterprise arising from non-owner
sources. The classifications of comprehensive income under current
accounting standards include foreign currency items, minimum pension
liability adjustments, and unrealized gains and losses on certain
investments in debt and equity securities. This Statement will affect
Sterling's reporting of unrealized gains and losses on available-for-
sale investments and MBS, requiring reporting of these items on the
financial statement that reports comprehensive income. Management has
not yet determined which format it will choose to display
comprehensive income. This Statement is effective for fiscal years
beginning after December 15, 1997.
<PAGE>
In February 1997, the FASB issued SFAS No. 128, Earnings per Share
("SFAS 128"). SFAS 128 establishes standards for computing and
presenting earnings per share ("EPS") and simplifies the existing
standards. This standard replaces the presentation of primary EPS
with a presentation of basic EPS. It also requires the dual
presentation of basic and diluted EPS on the face of the income
statement for all entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the
basic EPS computation to the numerator and denominator of the diluted
EPS computation. SFAS 128 requires restatement of all prior-period
EPS data presented. Sterling adopted this standard effective December
31, 1997, and such adoption did not have a material effect on the
presentation of its EPS.
In March 1995, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 121,
Accounting for the Impairment of Long-lived Assets and for Long-lived
Assets to be Disposed of. SFAS No. 121 requires that long-lived
assets and certain identifiable intangibles being held and used by an
entity be reviewed for impairment by estimating future cash flows from
the use and disposition of the assets whenever circumstances indicate
that the carrying amount of such assets may not be recoverable.
Sterling adopted this new standard on July 1, 1996, and such adoption
did not have any effect on its consolidated financial statements.
In May 1995, the FASB issued SFAS No. 122 Accounting for Mortgage
Servicing Rights. This standard applies to transactions involving
sales or securitizations of mortgage loans with servicing rights
retained. This standard must also be applied to impairment
evaluations of all amounts capitalized as mortgage servicing rights,
including those purchased before adoption of this statement. Sterling
adopted this standard on July 1, 1996, and such adoption did not have
any effect on its consolidated financial statements.
In June 1996, the FASB issued SFAS No. 125 Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities.
This standard also applies to transactions involving sales or
securitizations of financial assets, such as mortgage loans. Sterling
adopted the provisions of this standard on January 1, 1997. The
adoption of this statement did not have a material effect on the
consolidated financial statements.
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-
Based Compensation. SFAS No. 123 establishes financial accounting and
reporting standards for stock-based employee compensation plans and
encourages all entities to adopt the fair value method of accounting
for all of their employee stock compensation plans. However, it also
allows an entity to continue to measure compensation costs for those
plans using the intrinsic value method of accounting. Entities
electing to retain the current accounting under the intrinsic method
must make pro forma disclosures of net income and earnings per share,
as if the fair value method of accounting under SFAS No. 123 had been
<PAGE>
applied. Sterling adopted the disclosure only provisions of this
standard on July 1, 1996 and continues using the intrinsic method of
accounting for employee stock options. See Note 13 of "Notes to
Consolidated Financial Statements."
YEAR 2000 ISSUES
Throughout the information technology industry, the use of two-digit
year fields was common practice in the design of hardware, system
software, proprietary applications and system interfaces. The Year
2000 problem is pervasive and complex as virtually every computer
operation will be affected in some way by the rollover of the two-
digit year value to 00. The issue is whether computer systems will
properly recognize date sensitive information when the year changes to
2000. Systems that do not properly recognize such information could
generate erroneous data or cause a system to fail. The potential
failure on January 1, 2000 of computer systems that use two-digit
calendar notations has developed into a major concern for financial
institutions. Sterling has created a Year 2000 compliance plan that
focuses on identifying, testing and implementing solutions for Year
2000 processing. A preliminary estimate of the total cost to complete
the Year 2000 compliance plan is $500,000. Maintenance or
modification costs will be expensed as incurred, while the costs of
new software will be capitalized and amortized over the software's
useful life.
As of December 31, 1997, Sterling had completed the awareness training
phase of its Year 2000 compliance plan and was into the issue
assessment phase. The awareness phase included gaining understanding
and support, committing resources to the plan, establishing a project
team consisting of senior managers and department heads, and
developing a strategy to address all internal and external systems.
The assessment phase involves identifying all critical business
processes and attempting to determine the impact of the Year 2000
issues on all computer systems throughout the organization. Vendors
are being contacted and asked to submit certification letters stating
that they are in compliance with Year 2000 conversion issues. To
ensure compliance, third-party reviews will be required of vendors
that provide critical services to Sterling.
Sterling estimates that testing programming changes (including
converting, replacing or eliminating all software and databases as
necessary) will be largely completed by December 31, 1998.
Contingency plans are being developed in the event modifications
cannot be completed in time.
Financial institutions must also consider the possibility of some
level of reduction in deposits during the month of December 1999.
Sterling has determined that several borrowing sources are and will be
available so that adequate funding in December 1999 will not be a
problem. Sterling is also evaluating its allowance for loan losses in
<PAGE>
conjunction with its review of Year 2000 issues. Management believes
that its Year 2000 plan will be effective in identifying and resolving
any Year 2000 problems although there can be no assurances in this
regard. See "Business - Lending Activities - Allowance for Loan and
Real Estate Owned Losses."
EFFECTS OF INFLATION AND CHANGING PRICES
A savings institution has an asset and liability structure that is
interest-rate sensitive. As a holder of monetary assets and
liabilities, a savings institution's performance may be significantly
influenced by changes in interest rates. Although changes in the
prices of goods and services do not necessarily move in the same
direction as interest rates, increases in inflation generally have
resulted in increased interest rates, which may have an adverse effect
on Sterling's business.
Item 7.A. Quantitative and Qualitative Disclosures About Market Risk
--------------------------------------------------------------------
For a discussion of Sterling's market risk, see "Management's
Discussion and Analysis - Asset and Liability Management."
Item 8. Financial Statements and Supplementary Data
----------------------------------------------------
The required information is contained on pages F-1 through F-38 of
this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
--------------------------------------------------------------------
During the year ended December 31, 1997, Sterling neither changed nor
had any disagreements with its independent accountants on accounting
and financial disclosures.
PART III
Item 10. Directors and Executive Officers of the Registrant
------------------------------------------------------------
The required information is contained under the captions "Board of
Directors of Sterling Financial Corporation" and "Executive Officers"
in Sterling's Proxy Statement dated April 2, 1998, for the annual
meeting of Shareholders on April 28, 1998, and is incorporated herein
by reference.
Item 11. Executive Compensation
-------------------------------
The required information is contained under the captions "Personnel
Committee Report on Executive Compensation" and "Executive
Compensation" in Sterling's Proxy Statement dated April 2, 1998, for
the annual meeting of Shareholders on April 28, 1998, and is
incorporated herein by reference.
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and
Management
-------------------------------------------------------------
The required information is contained under the caption "Security
Ownership of Certain Beneficial Owners and Management" in Sterling's
Proxy Statement dated April 2, 1998, for the annual meeting of
Shareholders on April 28, 1998, and is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions
--------------------------------------------------------
The required information is contained under the caption "Interest of
Directors, Officers and Others in Certain Transactions" in Sterling's
Proxy Statement dated April 2, 1998, for the annual meeting of
Shareholders on April 28, 1998, and is incorporated herein by
reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
-----------------------------------------------------------------
(a) Documents which are filed as a part of this report:
1. FINANCIAL STATEMENTS: The required financial statements
are contained in pages F-1 through F-38 of this Form 10-K.
2. FINANCIAL STATEMENT SCHEDULES: Financial statement
schedules have been omitted as they are not applicable or
the information is included in the Consolidated Financial
Statements.
EXHIBITS:
Exhibit No. Exhibit
----------- ---------------------------------------------------------
3.1 Restated Articles of Incorporation of Registrant. Filed
as Exhibit 3.1 to Registrant's Form S-4 dated November 7,
1994 and incorporated by reference herein.
3.2 Articles of Amendment of Restated Articles of
Incorporation of Registrant. Filed as Exhibit 3.2 to
Registrant's Form S-4 dated November 7, 1994 and
incorporated by reference herein.
3.3 Copy of Amended and Restated Bylaws of Registrant. Filed
as Exhibit 3.3 to Registrant's Form 10-Q dated March 31,
1997, and incorporated by reference herein.
4.1 Reference is made to Exhibits 3.1 and 3.2.
<PAGE>
Exhibit No. Exhibit
----------- ---------------------------------------------------------
4.2 The Registrant has outstanding certain long-term debt.
None of such debt exceeds ten percent of Registrant's
total assets; therefore, copies of the constituent
instruments defining the rights of the holders of such
debt are not included as exhibits. Copies of instruments
with respect to such long-term debt will be furnished to
the Securities and Exchange Commission upon request.
10.1 Copy of Sterling Savings Association Incentive Stock
Option Plan dated July 25, 1984, including a copy of Form
of Incentive Stock Option Plan Letter Agreement. Filed as
Exhibit 10.1 to Registrant's Form S-4 dated August 28,
1992 and incorporated by reference herein.
10.2 Copy of Sterling Savings Association 1992 Incentive Stock
Option Plan. Filed as Exhibit 10.2 to Registrant's Form
S-4 dated August 28, 1992 and incorporated by reference
herein.
10.3 Copy of Sterling Savings Association Deferred
Compensation Plan, effective July 1, 1984. Filed as
Exhibit 10.3 to Registrant's Form S-4 dated August 28,
1992 and incorporated by reference herein.
10.4 Copy of Sterling Savings Association Employment Savings
and Incentive Plan and Trust dated September 21, 1990.
Filed as Exhibit 10.4 to Registrant's Form S-4 dated
August 28, 1992 and incorporated by reference herein.
10.5 Copy of Employment Agreement, dated July 1, 1995, between
Sterling and Harold B. Gilkey. Filed as Exhibit 10.1 to
Registrant's Form 10-Q dated March 30, 1996 and
incorporated by reference herein.
10.6 Copy of Amendment to Employment Agreement, dated
June 30, 1996, between Registrant and Harold B. Gilkey.
Filed as Exhibit 10.6 to Registrant's Form 10-Q dated
March 31, 1997 and incorporated by reference herein.
10.7 Copy of Employment Agreement, dated July 1, 1995, between
Sterling and William W. Zuppe. Filed as Exhibit 10.2 to
Registrant's Form 10-Q dated March 30, 1996 and
incorporated by reference herein.
10.8 Copy of Amendment to Employment Agreement, dated June 30,
1996, between Registrant and William W. Zuppe. Filed as
Exhibit to Registrant's Form 10-Q dated March 31, 1997
and incorporated by reference herein.
11.1 Statement regarding Computation of Per Share Earnings.
<PAGE>
Exhibit No. Exhibit
----------- ---------------------------------------------------------
12.1 Statement regarding Computation of Return on Average
Common Shareholders' Equity.
12.2 Statement regarding Computation of Return on Average
Assets.
21.1 List of Subsidiaries of Registrant.
23.1 Consent of Coopers & Lybrand L.L.P.
27.1 Financial Data Schedule. Filed herewith.
(b) Reports on Form 8-K. No reports on Form 8-K were filed during
the last quarter of the period covered by this report.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
STERLING FINANCIAL CORPORATION
March 24, 1998 By /s/ Harold B. Gilkey
------------------------------------
Harold B. Gilkey, Chairman of the
Board, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the dates
indicated.
March 24, 1998 /s/ Harold B. Gilkey
---------------------------------------------
Harold B. Gilkey, Chairman of the Board,
Chief Executive Officer, Principal
Executive Officer
March 24, 1998 /s/ William W. Zuppe
---------------------------------------------
William W. Zuppe, President, Chief Operating
Officer, Director
March 24, 1998 /s/ Daniel G. Byrne
---------------------------------------------
Daniel G. Byrne, Senior Vice President, Chief
Financial Officer, Principal Financial
Officer, Principal Accounting Officer
March 24, 1998 /s/ Ned M. Barnes
---------------------------------------------
Ned M. Barnes, Secretary, Director
March 24, 1998 /s/ Rodney W. Barnett
------------------------------------
Rodney W. Barnett, Director
March 24, 1998 /s/ James P. Fugate
------------------------------------
James P. Fugate, Director
<PAGE>
SIGNATURES, CONTINUED
March 24, 1998 /s/ Robert D. Larrabee
--------------------------------------------
Robert D. Larrabee, Director
March 24, 1998 /s/ Robert E. Meyers
---------------------------------------------
Robert E. Meyers, Director
March 24, 1998 /s/ David O. Wallace
---------------------------------------------
David O. Wallace, Director
<PAGE>
Rreport of Independent Accountants
The Board of Directors and Shareholders
Sterling Financial Corporation
Spokane, Washington
We have audited the accompanying consolidated balance sheets of
Sterling Financial Corporation and subsidiaries ("Sterling") as of
December 31, 1997 and 1996 and June 30, 1996 and the related
consolidated statements of operations, changes in shareholders' equity
and cash flows for the year ended December 31, 1997, the six months
ended December 31, 1996 and the years ended June 30, 1996 and 1995.
These consolidated financial statements are the responsibility of
Sterling's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position
of Sterling Financial Corporation and subsidiaries at December 31,
1997 and 1996 and June 30, 1996 and the consolidated results of their
operations and their cash flows for the year ended December 31, 1997,
the six months ended December 31, 1996 and the years ended June 30,
1996 and 1995 in conformity with generally accepted accounting
principles.
As discussed in Note 1 to the consolidated financial statements,
Sterling changed its methods of accounting for the transfer and
servicing of financial assets and liabilities as of January 1, 1997,
mortgage servicing rights and impairment of long-lived assets as of
July 1, 1996 and impaired loans as of July 1, 1995.
/s/ Coopers & Lybrand L.L.P.
Spokane, Washington
January 28, 1998, except for Note 25 as to which the
date is February 4, 1998
<PAGE>
CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
December 31,
---------------------- June 30,
1997 1996 1996
---------- ---------- ----------
ASSETS
<S> <C> <C> <C>
Cash and cash equivalents:
Interest bearing $ 15,858 $ 6,253 $ 2,308
Non-interest bearing and vault 33,564 26,422 24,395
Restricted 2,988 3,230 2,225
Loans receivable (net of allowance for
losses of $8,959, $7,891 and $7,889) 1,069,591 934,340 886,667
Loans held-for-sale 5,225 6,116 7,456
Investments and mortgage-backed securities:
Available-for-sale 656,236 469,790 460,061
Held-to-maturity 12,750 11,871 11,879
Accrued interest receivable (including
$3,555, $1,394 and $711 on investments) 14,058 10,690 9,080
Office properties and equipment, net 37,956 39,861 40,471
Real estate owned, net 8,817 3,974 4,874
Core deposit premium, net 6,771 8,303 9,474
Other intangibles, net 1,018 1,728 2,131
Purchased mortgage servicing rights, net 1,170 1,474 1,642
Prepaid expenses and other assets 10,248 12,292 15,035
---------- ---------- ----------
Total assets $1,876,250 $1,536,344 $1,477,698
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $1,036,408 $ 902,278 $ 898,394
Advances from Federal Home Loan Bank
(FHLB) Seattle 455,085 259,626 259,410
Securities sold subject to repurchase
agreements 180,077 229,797 195,785
Other borrowings (Note 11) 72,240 32,240 17,240
Cashiers checks issued and payable 11,260 5,723 6,751
Borrowers' reserves for taxes and insurance 1,264 1,126 1,718
Accrued interest payable 5,855 5,095 3,578
Accrued expenses and other liabilities 11,198 11,239 9,077
---------- ---------- ----------
Total liabilities 1,773,387 1,447,124 1,391,953
---------- ---------- ----------
</TABLE>
<PAGE>
CONSOLIDATED BALANCE SHEETS, CONTINUED
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
December 31,
---------------------- June 30,
1997 1996 1996
---------- ---------- ----------
<S> <C> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY,
CONTINUED
Commitments and contingencies (Notes 17 and 25)
Capital stock:
Preferred stock, $1 par value; 10,000,000
shares authorized; 0, 1,040,000 and
1,040,000 shares issued and outstanding $ 0 $ 1,040 $ 1,040
Common stock, $1 par value; 20,000,000
shares authorized; 7,569,791, 5,539,178
and 5,426,398 shares issued and outstanding 7,570 5,539 5,426
Additional paid-in capital 69,412 70,462 69,325
Unrealized loss on investments and mortgage-
backed securities available-for-sale, net of
deferred income taxes of $540, $3,239 and
$5,542 (1,003) (6,020) (10,290)
Retained earnings 26,884 18,199 20,244
---------- ---------- ----------
Total shareholders' equity 102,863 89,220 85,745
---------- ---------- ----------
Total liabilities and shareholders'
equity $1,876,250 $1,536,344 $1,477,698
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLAR AMOUNTS IN THOUSANDS)<TABLE>
<CAPTION>
Year Ended Six Months Ended YearEnded
December 31, December 31, June 30,
------------------------- ------------------------- -------------------------
1997 1996 1996 1995 1996 1995
----------- ----------- ----------- ----------- ----------- -----------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Interest income:Loans $ 91,733 $ 81,338 $ 41,702 $ 46,599 $ 86,235 $ 79,859
Mortgage-backed securities 28,528 26,182 12,574 8,436 22,044 22,386
Investments and cash equivalents 10,888 5,657 3,338 2,483 4,802 5,011
----------- ----------- ----------- ----------- ----------- -----------
Total interest income 131,149 113,177 57,614 57,518 113,081 107,256
----------- ----------- ----------- ----------- ----------- -----------
Interest expense:
Deposits 45,666 42,663 21,071 22,666 44,258 39,815
Short-term borrowings 26,976 17,662 8,903 10,702 19,461 21,360
Long-term borrowings 12,870 14,211 7,437 7,118 13,892 10,689
----------- ----------- ----------- ----------- ----------- -----------
Total interest expense 85,512 74,536 37,411 40,486 77,611 71,864
----------- ----------- ----------- ----------- ----------- -----------
Net interest income 45,637 38,641 20,203 17,032 35,470 35,392
Provision for loan losses 2,450 1,900 1,100 800 1,600 1,600
----------- ----------- ----------- ----------- ----------- -----------
Net interest income after
provision for loan losses 43,187 36,741 19,103 16,232 33,870 33,792
----------- ----------- ----------- ----------- ----------- -----------
Other income:
Fees and service charges 4,978 4,553 2,431 1,777 4,408 3,945
Mortgage banking operations 1,922 3,488 1,686 1,761 3,054 6,416
Loan servicing fees 1,291 1,095 633 459 921 1,271
Net gain on sales of securities 1,197 7 0 451 458 246
Net loss on real estate owned (84) (159) (102) (114) (171) (491)
----------- ----------- ----------- ----------- ----------- -----------
Total other income 9,304 8,984 4,648 4,334 8,670 11,387
----------- ----------- ----------- ----------- ----------- -----------
Operating expenses (Note 19) 37,106 40,911 24,742 15,515 31,684 31,272
----------- ----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 15,385 4,814 (991) 5,051 10,856 13,907
----------- ----------- ----------- ----------- ----------- -----------
Income tax provision (benefit):
Current 5,747 3,612 123 923 4,395 3,397
Deferred 2 (1,281) (11) 922 (331) 1,222
----------- ----------- ----------- ----------- ----------- -----------
Total income tax provision 5,749 2,331 112 1,845 4,064 4,619
----------- ----------- ----------- ----------- ----------- -----------
Net income (loss) 9,636 2,483 (1,103) 3,206 6,792 9,288
Less preferred stock dividends
declared 940 1,885 942 942 1,885 1,885
----------- ----------- ----------- ----------- ----------- -----------
Income (loss) available to common
shares $ 8,696 $ 598 $ (2,045) $ 2,264 $ 4,907 $ 7,403
=========== =========== =========== =========== =========== ===========
</TABLE>
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS, CONTINUED
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION> Year Ended Six Months Ended Year Ended
December 31, December 31, June 30,
------------------------- ------------------------- -------------------------
1997 1996 1996 1995 1996 1995
----------- ----------- ----------- ----------- ----------- -----------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Income (loss) per common share -
basic $ 1.40 $ 0.11 $ (0.37) $ 0.42 $ 0.91 $ 1.42
=========== =========== =========== =========== =========== ===========
Weighted average common shares
outstanding - basic 6,207,329 5,476,531 5,528,117 5,408,133 5,416,211 5,210,318
=========== =========== =========== =========== =========== ===========
Income (loss) per common share -
diluted $ 1.25 $ 0.11 $ (0.37) $ 0.42 $ 0.90 $ 1.27
=========== =========== =========== =========== =========== ===========
Weighted average common shares
outstanding - diluted 7,707,333 7,573,622 7,625,208 7,526,882 7,552,330 7,296,687
=========== =========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1997, FOR THE SIX MONTHS ENDED
DECEMBER 31, 1996 AND FOR THE YEARS ENDED JUNE 30, 1996 AND 1995
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional Total
------------------ ------------------ Paid-in Unrealized Retained Shareholders'
Shares Amount Shares Amount Capital Loss Earnings Equity
--------- ------- --------- ------- ---------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1994 1,040,000 $ 1,040 4,563,717 $ 4,564 $ 60,648 $ (3,467) $ 13,744 $ 76,529
Shares issued upon exercise
of stock options 4,880 4 22 26
Shares acquired and retired
upon exercise of stock
options (384) (6) (6)
Shares issued in connection
with acquisition of
business 339,976 340 3,213 3,553
Adjustment of estimated
common stock dividend paid
to reflect final price and
cash paid for fractional
shares (135) (4) (4)
Dividends declared and paid
on preferred stock ($1.81
per share) (1,885) (1,885)
10% common stock dividend 490,805 491 5,307 (5,798)
Change in unrealized loss,
net of income taxes 2,406 2,406
Net income 9,288 9,288
--------- ------- --------- ------- ---------- ---------- ---------- ----------
Balance, June 30, 1995 1,040,000 1,040 5,398,859 5,399 69,184 (1,061) 15,345 89,907
Shares issued upon exercise
of stock options 28,172 28 154 182
Shares acquired and retired
upon exercise of stock
options (3,006) (3) (40) (43)
Shares issued upon exercise
of warrants, net of related
costs 1,949 2 20 22
Adjustment of estimated
common stock dividend paid
to reflect final price and
cash paid for fractional
shares 424 7 (8) (1)
Dividends declared and paid
on preferred stock ($1.81
per share) (1,885) (1,885)
Change in unrealized loss,
net of income taxes (9,229) (9,229)
Net income 6,792 6,792
--------- ------- --------- ------- ---------- ---------- ---------- ----------
</TABLE>
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY, CONTINUED
FOR THE YEAR ENDED DECEMBER 31, 1997, FOR THE SIX MONTHS ENDED
DECEMBER 31, 1996 AND FOR THE YEARS ENDED JUNE 30, 1996 AND 1995
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional Total
------------------ ------------------ Paid-in Unrealized Retained Shareholders'
Shares Amount Shares Amount Capital Earnings Loss Equity
--------- ------- --------- ------- ---------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1996 1,040,000 $ 1,040 5,426,398 $ 5,426 $ 69,325 $ (10,290) $ 20,244 $ 85,745
Shares issued upon exercise
of stock options 19,620 20 144 164
Shares acquired and retired
upon exercise of stock
options (4,875) (5) (68) (73)
Shares issued upon exercise
of warrants, net of related
costs 98,035 98 1,061 1,159
Dividends declared and paid
on preferred stock ($0.91
per share) (942) (942)
Change in unrealized loss,
net of income taxes 4,270 4,270
Net loss (1,103) (1,103)
--------- ------- --------- ------- ---------- ---------- ---------- ----------
Balance, December 31, 1996 1,040,000 1,040 5,539,178 5,539 70,462 (6,020) 18,199 89,220
Shares issued upon exercise
of stock options 14,632 15 130 145
Shares acquired and retired
upon exercise of stock
options (5,209) (5) (84) (89)
Preferred shares converted
to common stock (1,035,700) (1,036) 2,021,190 2,021 (998) (13)
Preferred shares redeemed (4,300) (4) (98) (11) (113)
Dividends declared and paid
on preferred stock ($0.45
per share) (940) (940)
Change in unrealized loss,
net of income taxes 5,017 5,017
Net income 9,636 9,636
--------- ------- --------- ------- ---------- ---------- ---------- ----------
Balance, December 31, 1997 0 $ 0 7,569,791 $ 7,570 $ 69,412 $ (1,003) $ 26,884 $ 102,863
========= ======= ========= ======= ========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended Six Months Ended Year Ended
December 31, December 31, June 30,
--------------------- --------------------- ---------------------
1997 1996 1996 1995 1996 1995
--------- --------- --------- --------- --------- ---------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 9,636 $ 2,483 $ (1,103) $ 3,206 $ 6,792 $ 9,288
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating
activities:
Provisions for loss on loans and real
estate owned 2,623 1,959 1,131 840 1,668 1,634
Stock dividends on FHLB Seattle stock (2,052) (1,933) (1,012) (839) (1,760) (1,377)
Net gain on sales of loans and securities (2,690) (3,012) (1,458) (1,958) (3,512) (1,052)
Net loss on sales of office properties and equipment 6 0 0 0 0 0
Net (gain) loss on sales of real estate
owned (218) (111) (110) 0 (1) 210
Depreciation and amortization 7,718 8,952 4,230 4,315 8,985 6,251
Deferred income tax provision (benefit) 2 (1,281) (11) 922 (331) 1,222
Change in:
Accrued interest receivable (3,368) (1,487) (1,610) (176) (53) (1,803)
Prepaid expenses and other assets (885) 1,787 349 433 1,906 (1,977)
Cashiers checks issued and payable 5,537 (3,074) (1,028) 1,108 (938) 1,578
Accrued interest payable 760 334 1,517 (3,295) (4,478) 4,897
Accrued expenses and other liabilities (191) 178 2,162 (256) (2,241) 132
Proceeds from sales of loans 109,497 190,126 79,314 124,304 235,115 98,987
Loans originated for sale (107,113) (171,309) (76,516) (117,361) (212,153) (122,182)
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
operating activities 19,262 23,612 5,855 11,243 28,999 (4,192)
--------- --------- --------- --------- --------- ---------
Cash flows from investing activities:
Loans disbursed (945,408) (673,294) (381,100) (271,183) (563,378) (516,679)
Loan principal received 801,193 596,861 331,679 219,608 484,790 214,637
Purchase of loans receivable 0 0 0 0 0 (4,971)
Purchase of investments (178,271) (41,119) (41,119) 0 0 (2,999)
Proceeds from maturities of investments 85,594 11,196 10,000 5,225 6,420 0
Proceeds from sales of available-for-sale
investments 0 0 0 0 0 6,919
Purchase of mortgage-backed securities (416,289) 0 0 0 0 (19,678)
Principal payments on mortgage-backed securities 66,876 61,907 28,368 20,008 53,547 37,338
</TABLE>
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended Six Months Ended Year Ended
December 31, December 31, June 30,
--------------------- --------------------- ---------------------
1997 1996 1996 1995 1996 1995
--------- --------- --------- --------- --------- ---------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Cash flows from investing activities, continued:
Proceeds from sales of mortgage-backed
securities 264,543 7 0 56,338 56,345 159,286
Purchase of office properties and equipment (1,203) (7,205) (905) (946) (7,245) (16,732)
Proceeds from sales of office properties and equipment 12 0 0 0 0 0
Improvements and other changes to real estate
owned (294) 8 0 (78) (70) 0
Proceeds from sales of real estate owned 2,011 2,009 1,627 1,332 1,714 2,313
Premiums paid for purchase of core deposits 0 0 0 0 0 (508)
Proceeds from sales of purchased mortgage
servicing rights 0 741 0 0 741 0
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
investing activities (321,236) (48,889) (51,450) 30,304 32,864 (141,074)
--------- --------- --------- --------- --------- ---------
Cash flows from financing activities:
Net change in checking, passbook and money
market deposits 48,466 37,361 925 23,763 67,532 (8,946)
Proceeds from issuance of certificates of
deposit 437,175 407,689 199,665 250,018 458,042 642,816
Payments for maturing certificates of deposit (397,134) (470,444) (218,055) (292,306) (552,028) (594,558)
Interest credited to deposits 45,623 39,019 21,349 17,163 34,833 39,815
Advances from FHLB Seattle 600,000 100,000 100,000 50,713 50,713 198,282
Repayment of FHLB Seattle advances (405,081) (186,076) (100,040) (58,031) (144,067) (209,049)
Net change in securities sold subject to
repurchase agreements and funds purchased (49,720) 92,469 34,012 (22,552) 35,905 78,031
Proceeds from other borrowings 40,000 15,000 15,000 0 0 0
Payments to redeem preferred stock and
fractional shares (126) 0 0 0 0 0
Proceeds from exercise of stock options and
warrants, net of repurchases 56 1,352 1,250 58 163 20
Cash dividends on preferred stock (940) (1,885) (942) (942) (1,885) (1,885)
Other 160 (455) (592) (3,000) (2,864) (2,174)
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
financing activities 318,479 34,030 52,572 (35,116) (53,656) 142,352
--------- --------- --------- --------- --------- ---------
</TABLE>
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended Six Months Ended Year Ended
December 31, December 31, June 30,
--------------------- --------------------- ---------------------
1997 1996 1996 1995 1996 1995
--------- --------- --------- --------- --------- ---------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Net change in cash and cash equivalents $ 16,505 $ 8,753 $ 6,977 $ 6,431 $ 8,207 $ (2,914)
Cash and cash equivalents, beginning of period 35,905 27,152 28,928 20,721 20,721 23,635
--------- --------- --------- --------- --------- ---------
Cash and cash equivalents, end of period $ 52,410 $ 35,905 $ 35,905 $ 27,152 $ 28,928 $ 20,721
========= ========= ========= ========= ========= =========
Supplemental disclosures:
Cash paid during the period for:
Interest $ 84,729 $ 74,202 $ 35,894 $ 43,781 $ 82,089 $ 66,967
Income taxes 6,708 3,315 934 1,827 4,208 2,752
Noncash financing and investing activities:
Loans converted into real estate owned $ 6,515 $ 1,631 $ 649 $ 393 $ 1,287 $ 968
Preferred stock converted to common stock 24,523 0 0 0 0 0
Loans exchanged for mortgage-backed
securities 0 1,116 0 243,030 244,146 94,723
Interest cost capitalized for constructed
assets 0 0 0 0 0 97
Stock issued for assets acquired 0 0 0 0 0 3,553
Common stock dividend 0 0 0 0 0 5,798
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:
BUSINESS
Sterling Financial Corporation ("Sterling") is a savings and
loan holding company for Sterling Savings Association
("Sterling Savings"). Sterling Savings is a Washington State-
chartered savings association headquartered in Spokane,
Washington, that conducts business from 41 offices located
throughout Washington and Oregon. Sterling Savings provides
full-service banking, including attracting FDIC-insured
deposits and originating consumer, business banking, commercial
real estate and residential construction loans. Action Mortgage
Company ("Action Mortgage"), a wholly owned subsidiary of
Sterling Savings, operates eight residential loan production
offices. Sterling Savings also owns Harbor Financial Services,
Inc. ("Harbor Financial"), which markets investment products to
clients through regional representatives in Spokane, Auburn,
Centralia, Chehalis and Clarkston, Washington. INTERVEST-
Mortgage Investment Company ("INTERVEST"), a wholly owned
subsidiary of Sterling Savings, provides commercial real estate
lending through its offices in the metropolitan areas of
Portland, Oregon, and Seattle and Spokane, Washington.
Effective December 31, 1996, Sterling changed its fiscal year
end from June 30 to December 31. Therefore, the consolidated
financial statements presented herein are audited for the six
months ended December 31, 1996 and the year ended December 31,
1997 with comparable unaudited consolidated financial
statements for the six months ended December 31, 1995 and the
year ended December 31, 1996.
ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets
and liabilities at the dates of the financial statements and
the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those
estimates.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the
accounts of Sterling and its wholly owned subsidiaries. Results
of operations of purchased companies are consolidated for all
periods after the date of acquisition. All significant
intercompany accounts and transactions have been eliminated in
consolidation. Certain prior period balances have been
reclassified to conform with the current period presentation.
These reclassifications had no effect on the net income (loss)
or retained earnings as previously reported.
CASH AND CASH EQUIVALENTS
Cash equivalents are any highly liquid instrument with a
remaining maturity of three months or less at the date of
purchase. At December 31, 1997 and 1996 and June 30, 1996,
Sterling had approximately $29.0 million, $22.4 million and
$20.7 million, respectively, of uninsured non-interest bearing
deposits. Restricted cash consists of non-interest bearing
deposits maintained as a reserve at the Federal Reserve Bank.
LOANS RECEIVABLE
Loans receivable that management of Sterling has the intent and
ability to hold for the foreseeable future or until maturity or
pay-off are reported at their outstanding principal less the
allowance for loan losses and any origination and commitment
fees, net of direct loan origination costs.
The accrual of interest on impaired loans is discontinued when,
in management's opinion, the borrower may be unable to make
payments as they become due. When interest accrual is
discontinued, all unpaid accrued interest is reversed. Interest
income is subsequently recognized only to the extent cash
payments are received.
ALLOWANCE FOR LOAN LOSSES
On July 1, 1995, Sterling adopted Statement of Financial
Accounting Standards ("SFAS") No. 114, "Accounting by Creditors
for Impairment of a Loan," and SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan - Income Recognition and
Disclosures," an amendment of SFAS No. 114. The adoption of
these statements had no material impact on Sterling's financial
condition or results of operations.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
ALLOWANCE FOR LOAN LOSSES, CONTINUED
Management of Sterling provides an allowance for loan losses
based upon estimates of the cash flows to be received from the
loans or the fair value of the underlying collateral, net of
selling costs. These estimates are affected by factors
including changes in the economic environment in the Pacific
Northwest region and the resultant effect on real estate
values. As a result of changing economic conditions, it is
reasonably possible that the amount of the allowance for loan
losses could change in the near term. A provision for loan
losses is charged to income based on management's evaluation of
the probable losses that may occur in the loan portfolio.
LOANS HELD-FOR-SALE
Loans held-for-sale are reported at the lower of amortized cost
or market value as determined on an aggregate basis. Any loan
that management determines will not be held to maturity is
classified as held-for-sale. Market value is determined for
loan pools of common interest rates using published quotes as
of the close of business. Unrealized losses on loans held-for-
sale are included in the consolidated statement of operations.
LOAN ORIGINATION AND COMMITMENT FEES
Loan origination fees, net of direct origination costs, are
deferred and recognized as interest income using the level
interest yield method over the contractual term of each loan
adjusted for actual loan prepayment experience. If the related
loan is sold, the remaining net amount deferred, which is part
of the basis of the loan, is considered in determining the gain
or loss on sale.
Loan commitment fees are deferred until the expiration of the
commitment period unless management believes there is a remote
likelihood that the underlying commitment will be exercised, in
which case the fees are amortized to fee income using the
straight-line method over the commitment period. If a loan
commitment is exercised, the deferred commitment fee is
accounted for in the same manner as a loan origination fee.
Deferred commitment fees associated with expired commitments
are recognized as fee income.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
INVESTMENTS AND MORTGAGE-BACKED SECURITIES
Sterling classifies debt and equity securities as follows:
-- AVAILABLE-FOR-SALE. Except for FHLB Seattle stock, debt
and equity securities that will be held for indefinite
periods of time are classified as available-for-sale and
are carried at market value. Market value is determined
using published quotes or other indicators of value as of
the close of business. Unrealized gains and losses are
reported, net of deferred income taxes, as a separate
component of shareholders' equity until realized. FHLB
Seattle stock may only be sold to FHLB Seattle or to
another member institution at par. Therefore, this
investment is restricted and is carried at cost.
-- HELD-TO-MATURITY. Debt securities that management has the
intent and ability to hold until maturity are classified as
held-to-maturity and are carried at their remaining unpaid
principal balance, net of unamortized premiums or
unaccreted discounts. Premiums are amortized and discounts
are accreted using the level interest yield method over the
estimated remaining term of the underlying security.
Realized gains and losses on sales of investments and mortgage-
backed securities are recognized based on specific
identification.
OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation and
amortization are computed using the straight-line method over
the lesser of the estimated useful lives or lease terms of the
assets. Expenditures for new properties and equipment and major
renewals or betterments are capitalized. Expenditures for
repairs and maintenance are charged to expense as incurred.
Upon sale or retirement, the cost and related accumulated
depreciation are removed from the respective property or
equipment accounts, and the resulting gains or losses are
reflected in operations.
REAL ESTATE OWNED
Property acquired in settlement of loans is carried at the
lower of cost or fair value less estimated costs to sell at
foreclosure. Development and improvement costs relating to the
property are capitalized to the extent they are deemed to be
recoverable upon disposition.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:
REAL ESTATE OWNED, CONTINUED
An allowance for losses on real estate owned is established to
include amounts for estimated losses as a result of an
impairment in value of the real property. Sterling reviews its
real estate owned for impairment in value whenever events or
circumstances indicate that the carrying value of the property
may not be recoverable. In performing the review, if expected
future undiscounted cash flow from the use of the property or
the fair value, less selling costs, from the disposition of the
property is less than its carrying value, an impairment loss is
recognized. As a result of changes in the real estate markets
in which these properties are located, it is reasonably
possible that the carrying values could be reduced in the near
term.
INTANGIBLE ASSETS
Net assets of organizations acquired in purchase transactions
are recorded at fair value at date of acquisition. Core deposit
premiums attributable to depositor relationships that existed
at the date of an acquisition are amortized on a straight-line
basis over the estimated life of the depositor relationships
acquired (generally 8 to 12 years). At December 31, 1997,
Sterling has $6.8 million of core deposit premiums which are
net of $11.7 million of accumulated amortization.
The cost of other intangibles is amortized using the level
interest yield method over the estimated remaining term
(assuming prepayments) of the long-term interest-bearing
assets, primarily loans receivable and mortgage-backed
securities, acquired (generally twelve years). At December 31,
1997, Sterling has $1.0 million of other intangibles, which is
net of $13.8 million of accumulated amortization.
In March 1995, SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
was issued. This standard requires a review for impairment of
long-lived assets and identifiable intangibles to be held and
used by an entity whenever events or changes in circumstances
indicate that the carrying amount of the assets may not be
recoverable. There was no effect on the consolidated financial
statements upon adoption of this standard on July 1, 1996.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
MORTGAGE BANKING OPERATIONS
Sterling, through Action Mortgage, originates or purchases and
sells loans and participating interests in loans to provide
additional funds for general corporate purposes. Loans and
participating interests therein are held-for-sale and are
carried at the lower of cost or market value. Sterling
recognizes a gain or loss on these loan sale transactions which
includes a component reflecting the differential between the
contractual interest rate of the loan and the interest rate
which will be received by the investor. The present value of
the estimated future profit for servicing the loans, together
with the normal servicing fee rate, is taken into account in
determining the amount of gain or loss on the sale of loans.
On January 1, 1997, Sterling adopted SFAS No. 125, "Accounting
for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities", which applies to transactions
involving sales or securitizations of financial assets, such as
mortgage loans, and the liquidation of financial liabilities.
SFAS No. 125 provides accounting and reporting standards based
on a consistent application of a FINANCIAL-COMPONENTS APPROACH
that focuses on control. Under this approach, after a transfer
of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has
incurred, derecognizes financial assets when control has been
surrendered and derecognizes liabilities when extinguished.
This statement provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers
that are secured borrowings. This statement also requires that
servicing assets and liabilities by measured by (a)
amortization in proportion to and over the period of estimated
net servicing income or loss, and (b) assessment for asset
impairment or increased obligation based on their fair values.
The application of the provisions of SFAS No. 125 did not have
a material effect on Sterling's financial condition, results of
operations or cash flows.
At December 31, 1997 and 1996 and June 30, 1996, purchased
mortgage servicing rights were $1.2 million, $1.5 million and
$1.6 million, respectively, net of accumulated amortization of
$1.1 million, $788,000 and $620,000, respectively. The cost of
mortgage servicing rights is amortized in proportion to, and
over the period of, estimated net servicing revenues.
Impairment of mortgage servicing rights is assessed based on
the fair value of those rights. Fair values are estimated using
discounted cash flows based on a current market interest rate.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
MORTGAGE BANKING OPERATIONS, CONTINUED
For purposes of measuring impairment, the rights are stratified
based primarily on prepayment and interest rate risks. The
amount of impairment recognized is the amount by which the
capitalized mortgage servicing rights for a stratum exceed
their fair value.
On July 1, 1996, Sterling adopted SFAS No. 122, "Accounting for
Mortgage Servicing Rights" which relates to transactions
involving sales or securitization of mortgage loans with
servicing rights retained and to impairment evaluations of all
amounts capitalized as mortgage servicing rights. There was no
effect on Sterling's consolidated financial statements upon
adoption of this standard.
INCOME TAXES
Sterling accounts for income taxes using the liability method,
which requires that deferred tax assets and liabilities be
determined based on the temporary differences between the
financial statement carrying amounts and tax bases of assets
and liabilities and tax attributes using enacted tax rates in
effect in the years in which the temporary differences are
expected to reverse.
Sterling files a consolidated federal income tax return with
its subsidiaries.
NET INCOME (LOSS) PER SHARE
Net income (loss) per share - basic is computed by dividing net
income (loss) available to common shareholders by the weighted-
average number of common shares outstanding during the period.
Net income (loss) per share - diluted is computed by dividing
net income (loss) by the weighted-average number of common
shares outstanding increased by the additional common shares
that would have been outstanding if the dilutive potential
common shares had been issued.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
NET INCOME (LOSS) PER SHARE, CONTINUED
The net income (loss) per share disclosures have been made in
accordance with SFAS No. 128, "Earnings per Share," which was
applied by Sterling in 1997. In accordance with SFAS No. 128,
all prior net income (loss) per share data has been restated to
conform to this presentation. Basic and diluted earnings per
share amounts for periods prior to 1997 are identical in amount
to primary and fully diluted earnings per share amounts that
were previously presented.
COMPREHENSIVE INCOME
In June 1997, SFAS No. 130, "Reporting Comprehensive Income,"
was issued. SFAS No. 130 establishes standards for reporting
and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. This Statement requires
that all items required to be recognized under accounting
standards as components of comprehensive income be reported in
a financial statement that is displayed with the same
prominence as other financial statements. This Statement does
not require a specific format for the financial statement, but
requires an enterprise to display an amount representing total
comprehensive income for the period in the financial statement.
This Statement requires an enterprise to classify items of
other comprehensive income by their nature in a financial
statement and display the accumulated balance of other
comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of a statement
of financial position. This Statement is effective for fiscal
years beginning after December 15, 1997. Sterling does not
believe that the application of this Statement will have a
material effect on the presentation of its financial
statements.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
2. INVESTMENTS AND MORTGAGE-BACKED SECURITIES:
A summary of carrying and fair values of investments and
mortgage-backed securities follows (in thousands):
<TABLE>
<CAPTION>
Held-to-Maturity Available-for-Sale
------------------------------------------- -------------------------------------------
Amortized
Cost/ Gross Gross Gross Gross Carrying/
Carrying Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Value Gains Losses Value Cost Gains Losses Value
--------- ---------- ---------- -------- --------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
December 31, 1997
U.S. government and
agency obligations $ 0 $ 0 $ 0 $ 0 $158,707 $ 301 $ 0 $159,008
FHLB Seattle stock
(restricted) 0 0 0 0 27,975 0 0 27,975
Municipal bonds 12,748 166 6 12,908 0 0 0 0
Mortgage-backed
securities 0 0 0 0 471,096 1,441 3,285 469,253
Other 2 1 0 3 0 0 0 0
-------- -------- -------- -------- -------- -------- -------- --------
$ 12,750 $ 167 $ 6 $ 12,911 $657,778 $ 1,742 $ 3,285 $656,236
======== ======== ======== ======== ======== ======== ======== ========
December 31, 1996
U.S. government and
agency obligations $ 0 $ 0 $ 0 $ 0 $ 66,760 $ 202 $ (43) $ 66,919
FHLB Seattle stock
(restricted) 0 0 0 0 25,923 0 0 25,923
Municipal bonds 11,846 48 (82) 11,812 0 0 0 0
Mortgage-backed
securities 0 0 0 0 386,365 368 (9,793) 376,940
Other 25 6 0 31 1 7 0 8
-------- -------- -------- -------- -------- -------- -------- --------
$ 11,871 $ 54 $ (82) $ 11,843 $479,049 $ 577 $ (9,836) $469,790
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
2. INVESTMENTS AND MORTGAGE-BACKED SECURITIES, CONTINUED:
<TABLE>
<CAPTION>
Held-to-Maturity Available-for-Sale
------------------------------------------- -------------------------------------------
Amortized
Cost/ Gross Gross Gross Gross Carrying/
Carrying Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Value Gains Losses Value Cost Gains Losses Value
--------- ---------- ---------- -------- --------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
June 30, 1996
U.S. government and
agency obligations $ 0 $ 0 $ 0 $ 0 $ 35,530 $ 0 $ (286) $ 35,244
FHLB Seattle stock
(restricted) 0 0 0 0 24,911 0 0 24,911
Municipal bonds 11,854 7 (242) 11,619 0 0 0 0
Mortgage-backed
securities 0 0 0 0 415,451 $ 104 (15,662) 399,893
Other 25 6 0 31 1 12 0 13
-------- -------- -------- -------- -------- -------- -------- --------
$ 11,879 $ 13 $ (242) $ 11,650 $475,893 $ 116 $(15,948) $460,061
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
2. INVESTMENTS AND MORTGAGE-BACKED SECURITIES, CONTINUED:
In accordance with a Special Report issued by the Financial
Accounting Standards Board in 1995, Sterling reassessed and
reclassified held-to-maturity debt securities with a carrying
value of approximately $214.1 million to the available-for-sale
classification. At the date of the transfer, the fair value of
such debt securities was approximately $211.4 million. The
difference between the carrying value and fair value of the
reclassified debt securities at the date of transfer of $2.7
million has been included in the unrealized loss on investment
securities component of shareholders' equity during the year
ended June 30, 1996.
During the years ended December 31, 1997 and 1996, the six months
ended December 31, 1996 and 1995 and the years ended June 30,
1996 and 1995, Sterling sold investments and mortgage-backed
securities which resulted in the following (in thousands):
Proceeds Gross Gross
from Realized Realized
Sales Gains Losses
-------- -------- --------
Year ended December 31, 1997 $264,543 $ 1,325 $ 128
Year ended December 31, 1996 7 7 0
Six months ended December 31,
1996 0 0 0
Six months ended December 31,
1995 56,338 569 118
Year ended June 30, 1996 56,345 576 118
Year ended June 30, 1995 166,205 703 457
At December 31, 1997, the amortized cost and fair value of
available-for-sale and held-to-maturity debt securities, by
contractual maturity (in thousands), are shown below. Expected
maturities may differ from contractual maturities because issuers
may have the right to call or prepay obligations with or without
call or prepayment penalties.
Amortized Fair
Cost Value
--------- --------
Available-for-sale mortgage-backed
securities:
Under one year $ 5,580 $ 5,580
After one year through five years 58,002 57,219
After five years through ten years 89,600 89,675
After ten years 317,914 316,779
-------- --------
$471,096 $469,253
======== ========
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
2. INVESTMENTS AND MORTGAGE-BACKED SECURITIES, CONTINUED:
Amortized Fair
Cost Value
--------- --------
Available-for-sale U.S. government and
agency obligations:
Under one year $ 6,960 $ 6,966
After one year through five years 131,747 132,029
After five years through ten years 20,000 20,013
-------- --------
$158,707 $159,008
======== ========
Held-to-maturity municipal bonds:
Under one year $ 1,032 $ 1,035
After one year through five years 9,516 9,618
After five years through ten years 2,200 2,255
-------- --------
$ 12,748 $ 12,908
======== ========
At December 31, 1997, U.S. government and agency obligations and
mortgage-backed securities with an aggregate fair value of $30.2
million were pledged as collateral for the treasury tax and loan
account in accordance with Federal Reserve Board regulations or
for wholesale public funds deposits in accordance with Washington
Public Deposit Protection Commission regulations. Additionally,
Sterling periodically utilizes mortgage-backed securities as
collateral for other borrowing transactions (see Notes 10
and 11).
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
3. LOANS RECEIVABLE:
The components of loans receivable are as follows (in thousands):
<TABLE>
<CAPTION> December 31, June 30,
----------------------- ----------
1997 1996 1996
---------- ---------- ----------
<S> <C> <C> <C>
Real estate loans:
Variable-rate:
1-4 unit residential $ 119,051 $ 154,158 $ 175,380
5 or more unit residential 59,939 64,812 59,088
Commercial 114,542 90,375 87,960
Land and other 174 180 183
Fixed-rate:
Conventional 1-4 unit
residential 115,234 44,359 41,937
5 and 7 year balloon or reset
1-4 unit residential 42,127 69,105 77,127
1-4 unit residential, insured by FHA/VA6,482 7,135 8,082
5 or more unit residential 5,682 4,916 5,217
Commercial 3,728 11,904 13,283
Land and other 178 181 191
Construction:
1-4 unit residential 178,834 148,252 137,930
5 or more unit residential 97,059 77,743 79,048
Commercial 26,386 37,875 40,003
---------- ---------- ----------
769,416 710,995 725,429
---------- ---------- ----------
Other loans:
Commercial loans 196,256 162,157 133,339
Commercial and personal lines
of credit 65,423 52,476 49,720
Consumer loans 132,482 104,212 93,892
Loans secured by deposits 4,924 4,343 4,386
---------- ---------- ----------
399,085 323,188 281,337
---------- ---------- ----------
Total loans receivable 1,168,501 1,034,183 1,006,766
Undisbursed portion of loans in
process (90,111) (91,791) (112,325)
Deferred direct origination costs,
net of loan fees 540 468 891
Discount on loans acquired pursuant
to purchase transactions (380) (629) (776)
Allowance for losses (8,959) (7,891) (7,889)
---------- ---------- ----------
Loans receivable $1,069,591 $ 934,340 $ 886,667
========== ========== ==========
Weighted average interest rate 8.58% 8.66% 8.65%
========== ========== ==========
</TABLE>
<PAGE>NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
3. LOANS RECEIVABLE, CONTINUED:
Sterling grants residential, commercial real estate, consumer and
commercial loans throughout the Pacific Northwest region. Loans
originated outside this area are primarily for immediate sale
into the secondary market. At December 31, 1997, approximately
61.1% and 30.2% of real estate loans are collateralized by
property in Washington and Oregon, respectively. The value of
real estate properties in these geographic regions will be
affected by changes in the economic environment of that region.
It is reasonably possible that these values could change in the
near term, which would affect Sterling's estimate of its
allowance for loan losses associated with these loans receivable.
4. LOAN SERVICING:
Loans serviced for others are not included in the consolidated
balance sheets. The unpaid principal balances of these loans as
of the dates indicated are summarized as follows (in thousands):
December 31,
------------------ June 30,
1997 1996 1996
-------- -------- --------
Loan portfolios serviced for:
FHLMC $317,213 $445,038 $488,731
FNMA 61,702 85,470 85,872
Others 73,280 11,674 13,215
-------- -------- --------
$452,195 $542,182 $587,818
======== ======== ========
Custodial escrow balances maintained in connection with the
foregoing loan servicing were approximately $1.8 million at
December 31, 1997 and 1996 and $2.3 million at June 30, 1996.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
4. LOAN SERVICING, CONTINUED:
Following is an analysis of the changes in purchased mortgage
servicing rights (in thousands):
Purchased Excess
Servicing Servicing
--------- ---------
Balance, June 30, 1994 $ 158 $ 80
Additions 3,440 0
Amortization (451) (30)
--------- --------
Balance, June 30, 1995 3,147 50
Sale of servicing portfolio (889) 0
Amortization (616) (50)
--------- --------
Balance, June 30, 1996 1,642 0
Amortization (168) 0
--------- --------
Balance, December 31, 1996 1,474 0
Amortization (304) 0
--------- --------
Balance, December 31, 1997 $ 1,170 $ 0
========= ========
5. REAL ESTATE OWNED:
The components of real estate owned are as follows (in
thousands):
December 31,
------------------ June 30,
1997 1996 1996
-------- -------- --------
Commercial real estate $ 6,174 $ 3,550 $ 3,575
Construction 283 413 310
Residential 616 447 690
Former branch building 0 0 607
Other 2,628 352 146
-------- -------- --------
9,701 4,762 5,328
Allowance for losses (884) (788) (454)
-------- -------- --------
$ 8,817 $ 3,974 $ 4,874
======== ======== ========
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
6. ALLOWANCES FOR LOAN AND REAL ESTATE OWNED LOSSES:
The following is an analysis of the changes in the allowances for
loan and real estate owned losses (in thousands):
Real
Estate
Loan Owned Total
-------- -------- --------
Balance, June 30, 1994 $ 5,740 $ 1,551 $ 7,291
Loss allowances acquired 952 98 1,050
Provision 1,600 34 1,634
Amounts written off (1,020) (969) (1,989)
Recoveries 89 0 89
-------- -------- --------
Balance, June 30, 1995 7,361 714 8,075
Provision 1,600 68 1,668
Amounts written off (1,164) (407) (1,571)
Recoveries 92 79 171
-------- -------- --------
Balance, June 30, 1996 7,889 454 8,343
Provision 1,100 31 1,131
Amounts written off (1,175) (61) (1,236)
Recoveries 77 364 441
-------- -------- --------
Balance, December 31, 1996 7,891 788 8,679
Provision 2,450 173 2,623
Amounts written off (1,563) (77) (1,640)
Recoveries 181 0 181
-------- -------- --------
Balance, December 31, 1997 $ 8,959 $ 884 $ 9,843
======== ======== ========
The following is a summary of loans that are not performing in
accordance with their original contractual terms (in thousands):
December 31,
------------------ June 30,
1997 1996 1996
-------- -------- --------
Nonaccrual loans (A) $ 4,755 $ 2,329 $ 3,352
Restructured loans (B) 150 215 240
-------- -------- --------
Total nonperforming loans $ 4,905 $ 2,544 $ 3,592
======== ======== ========
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
6. ALLOWANCES FOR LOAN AND REAL ESTATE OWNED LOSSES, CONTINUED:
(A) The accrual of interest and amortization of net deferred loan
fees are discontinued when either principal or interest
becomes 90 days past due, unless the loan meets specific
criteria. Any accrued and uncollected interest is reversed
from income at that time. A loan also may be put on
nonaccrual if, in management's judgment, the loan may be
uncollectible. Interest on nonaccrual loans is recognized as
collected. The total allowance for loan losses related to
these loans was $35,000, $45,000 and $167,000 at December 31,
1997 and 1996 and June 30, 1996, respectively.
For loans on nonaccrual status at period end, additional
gross interest income of $258,000, $135,000, $86,000,
$151,000, $224,000 and $231,000 would have been recorded
during the years ended December 31, 1997 and 1996, the six
months ended December 31, 1996 and 1995 and the years ended
June 30, 1996 and 1995, respectively, if nonaccrual and
restructured loans had been current in accordance with their
original contractual terms. Interest income of $311,000,
$79,000, $8,000, $21,000, $62,000 and $58,000 was recorded
during the years ended December 31, 1997 and 1996, the six
months ended December 31, 1996 and 1995 and the years ended
June 30, 1996 and 1995, respectively, in connection with such
loans.
The average recorded investment in impaired loans during the
years ended December 31, 1997 and 1996, the six months ended
December 31, 1996 and 1995 and the years ended June 30, 1996
and 1995 was $4.2 million, $3.6 million, $3.0 million, $4.8
million, $4.5 million and $3.3 million, respectively.
(B) Restructured loans occur when Sterling has agreed to
compromise the contractual loan terms to provide a reduction
in the rate of interest and, in most instances, an extension
of payments of principal or interest, or both, because of a
deterioration in the financial position of the borrower.
Restructured loans performing in accordance with their new
terms are not included in nonaccrual loans unless there is
uncertainty as to the ultimate collection of principal or
interest.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
7. OFFICE PROPERTIES AND EQUIPMENT:
The components of office properties and equipment are as follows
(in thousands):
<TABLE>
<CAPTION>
December 31,
------------------- June 30, Estimated
1997 1996 1996 Useful Life
-------- -------- -------- -----------
<S> <C> <C> <C> <C>
Buildings and improvements $ 29,541 $ 29,193 $ 26,309 20-40 years
Furniture, fixtures, equipment and
computer software 16,094 16,917 16,260 3-10 years
Automobiles 62 83 83 3-5 years
Leasehold improvements 2,571 2,560 2,528 5-20 years
-------- -------- --------
48,268 48,753 45,180
Less accumulated depreciation and
amortization (15,928) (14,508) (13,023)
-------- -------- --------
32,340 34,245 32,157
Land 5,616 5,616 5,239
Construction in progress 0 0 3,075
-------- -------- --------
$ 37,956 $ 39,861 $ 40,471
======== ======== ========
</TABLE>
8. DEPOSITS:
The components of deposits are as follows (in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
----------------------- ----------
1997 1996 1996
---------- ---------- ----------
<S> <C> <C> <C>
Commercial checking accounts (non-interest
bearing) $ 31,054 $ 24,180 $ 20,468
Checking accounts, 1.50% 88,305 72,686 69,125
Passbook accounts, 2.55% 63,117 72,243 74,413
Money market demand accounts, 1.50%
to 4.17% 183,795 148,696 152,874
---------- ---------- ---------
366,271 317,805 316,880
---------- ---------- ---------
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
8. DEPOSITS, CONTINUED:
<TABLE>
<CAPTION>
December 31, June 30,
----------------------- ----------
1997 1996 1996
---------- ---------- ----------
<S> <C> <C> <C>
Certificate accounts:
Up to 3.99% $ 1,633 $ 4,972 $ 6,596
4.00 to 4.99% 2,959 39,186 39,656
5.00 to 5.99% 543,283 429,505 352,891
6.00 to 6.99% 98,627 79,501 143,063
7.00 to 7.99% 12,984 19,664 25,993
8.00 to 8.99% 8,911 9,945 11,517
9.00 to 9.99% 1,177 1,172 1,241
10.00% and over 563 528 557
---------- ---------- ---------
670,137 584,473 581,514
---------- ---------- ---------
$1,036,408 $ 902,278 $ 898,394
========== ========== =========
</TABLE>
The weighted average interest rate paid on deposit accounts was
4.80%, 4.66% and 4.77% at December 31, 1997 and 1996 and June 30,
1996, respectively. At December 31, 1997, the scheduled
maturities of certificate accounts were as follows (in
thousands):
Year Ending Weighted-Average
December 31, Interest Rate Amount
------------ ---------------- --------
1998 5.71% $572,143
1999 6.06 29,649
2000 6.02 23,149
2001 6.67 8,910
2002 6.76 16,415
Thereafter 6.45 19,871
--------
5.80% $670,137
========
At December 31, 1997, the remaining maturities of certificate
accounts with a minimum balance of $100,000 were as follows (in
thousands):
Less than three months $121,016
Three to six months 44,029
Six to twelve months 43,462
Over twelve months 16,442
--------
$224,949
========
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
8. DEPOSITS, CONTINUED:
The components of interest expense associated with deposits are
as follows (in thousands):
<TABLE>
<CAPTION>
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
----------------- ----------------- -----------------
1997 1996 1996 1995 1996 1995
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Checking accounts $ 1,044 $ 984 $ 499 $ 499 $ 1,029 $ 1,189
Passbook accounts 1,703 1,978 954 1,213 2,237 3,148
Money market demand
accounts 7,558 6,310 3,289 2,020 4,996 2,678
Certificate accounts 35,361 33,391 16,329 18,934 35,996 32,800
------- ------- ------- ------- ------- -------
$45,666 $42,663 $21,071 $22,666 $44,258 $39,815
======= ======= ======= ======= ======= =======
</TABLE>
9. FEDERAL HOME LOAN BANK ADVANCES AND LINES OF CREDIT:
Advances from FHLB are collateralized by qualifying loans with a
carrying value of approximately $325.0 million at December 31,
1997. Sterling Savings' credit line with FHLB Seattle is limited
to 35% of total assets. At December 31, 1997, Sterling Savings
had the ability to borrow an additional $203.2 million from FHLB
Seattle.
The advances from FHLB Seattle at December 31, 1997 are repayable
as follows (in thousands):
Year Ending Weighted-Average
December 31, Interest Rate Amount
------------ ---------------- --------
1998 5.99% $353,847
1999 6.87 50,000
2000 6.54 38,498
2001 0.00 0
2002 6.34 693
Thereafter 8.59 12,047
--------
6.20% $455,085
========
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
9. FEDERAL HOME LOAN BANK ADVANCES AND LINES OF CREDIT, CONTINUED:
Sterling has a $5.0 million term line-of-credit agreement with a
bank. The term line of credit matures in 1999. These borrowings
are collateralized by all shares of Sterling Savings 10.75% and
10.25% preferred stock and common stock. At December 31, 1997, no
amounts were outstanding under this line-of-credit agreement.
Sterling Savings has an unsecured $10.0 million line-of-credit
agreement with a bank that bears interest at the Federal Funds
rate plus an incremental negotiated rate and matures in 1999. At
December 31, 1997, no amounts were outstanding under this line-
of-credit agreement.
10. SECURITIES SOLD SUBJECT TO REPURCHASE AGREEMENTS:
Sterling enters into sales of securities under agreements to
repurchase (reverse repurchase agreements). Fixed-coupon reverse
repurchase agreements are treated as financings, and the
obligations to repurchase securities sold are reflected as a
liability in the consolidated balance sheet. The dollar amount of
securities underlying the agreements remains in the applicable
asset accounts. These agreements had a weighted-average interest
rate of 5.71% at December 31, 1997. The reverse repurchase
agreements mature at various dates through December 2001.
Substantially all of Sterling's reverse repurchase agreements are
transacted with Donaldson, Lufkin and Jenerette (DLJ), Morgan
Stanley (MS) and Merrill Lynch (ML). The mortgage-backed
securities underlying these agreements were held by DLJ, MS and
ML. The risk of default under such agreements is limited by the
financial strength of these broker-dealers and the level of
borrowings relative to the market value of pledged securities. At
December 31, 1997, under the repurchase agreements, Sterling has
pledged as collateral investments and mortgage-backed securities
with aggregate amortized costs and market/carrying values of
$216.7 million and $215.9 million, respectively.
The average balances of securities sold subject to repurchase
agreements were $185.7 million, $183.7 million, $213.6 million,
$164.6 million, $156.6 million and $115.3 million during the
years ended December 31, 1997 and 1996, the six months ended
December 31, 1996 and 1995 and the years ended June 30, 1996 and
1995, respectively. The maximum amount outstanding at any month
end during these same periods was $273.6 million, $232.9 million,
$232.9 million, $184.5 million, $195.8 million and $148.1
million, respectively.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
11. OTHER BORROWINGS:
The components of other borrowings are as follows (in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
----------------------- ----------
1997 1996 1996
---------- ---------- ----------
<S> <C> <C> <C>
Term note payable(1) $ 15,000 $ 15,000 $ 0
8.75% Subordinated Notes due 2000(2) 17,240 17,240 17,240
Sterling obligated mandatorily redeemable
preferred capital securities of subsidiary
trust holding solely junior subordinated
deferrable interest debentures of
Sterling (3) 40,000 0 0
---------- ---------- ----------
$ 72,240 $ 32,240 $ 17,240
========== ========== ==========
</TABLE>
(1) Sterling has a five-year term variable rate loan from a
commercial bank. Interest is payable quarterly on this loan.
The interest rate at December 31, 1997 was 7.325%. Principal
is repayable in five annual installments of $3.0 million
each, commencing September 1998.
(2) Sterling's 8.75% Subordinated Notes are due on January 31,
2000. These notes are unsecured general obligations of
Sterling and are subordinated to certain other existing and
future indebtedness. Under the terms of the notes, Sterling
is limited in the amount of certain long-term debt that it
may incur and the notes restrict Sterling, under certain
circumstances, as to the amount of cash dividends on its
preferred or common stock and capital distributions which can
be made. At December 31, 1997, Sterling could incur
approximately $50.1 million of additional long-term debt, and
Sterling would have been limited to the payment of up to
approximately $47.9 million in additional dividends. Interest
on these notes is due the first day of each month. Sterling
may, at its option, redeem the notes, in whole or in part, at
par plus accrued interest.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
11. OTHER BORROWINGS, CONTINUED:
(3) On June 4, 1997, Sterling issued $41.2 million of 9.50%
junior subordinated deferrable interest debentures (the
"Junior Subordinated Debentures") to Sterling Capital Trust I
(the "Trust"), a Delaware business trust, in which Sterling
owns all of the common equity. The sole asset of the Trust is
the Junior Subordinated Debentures. The Trust issued $40.0
million of 9.50% Cumulative Capital Securities (the "Trust
Preferred Securities") to investors. Sterling's obligations
under the Junior Subordinated Debentures and related
documents, taken together, constitute a full and
unconditional guarantee by Sterling of the Trust's
obligations under the Trust Preferred Securities. The Trust
Preferred Securities are treated as debt of Sterling.
Although Sterling, as a savings and loan holding company, is
not subject to the Federal Reserve capital requirements for
bank holding companies, the Trust Preferred Securities have
been structured to qualify as Tier 1 capital, subject to
certain limitations, if Sterling were to become regulated as
a bank holding company. The Junior Subordinated Debentures
and related Trust Preferred Securities mature on June 30,
2027 and are redeemable at the option of Sterling in the
event the deduction of related interest for federal income
taxes is prohibited, treatment as Tier 1 capital is no longer
permitted, or certain other contingencies arise. The Trust
Preferred Securities must be redeemed upon maturity of the
Junior Subordinated Debentures in 2027.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
12. INCOME TAXES, CONTINUED:
The tax effects of the principal temporary differences giving
rise to deferred tax assets and liabilities were as follows (in
thousands):
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1997 1996 June30,1996
-------------------- -------------------- --------------------
Assets Liabilities Assets Liabilities Assets Liabilities
------ ----------- ------ ----------- ------ -----------
<S> <C> <C> <C> <C> <C> <C>
Allowance for loan losses $3,106 $2,688 $2,651
Office properties and equipment $ 595 $ 791 $ 651
Equity in losses of partnerships 473 459 461
FHLB dividends 3,936 3,238 2,894
Purchase accounting discount or premium 1,399 495 1,008 540 843 655
Deferred loan fees 3,330 3,030 3,315
Unrealized losses on available-for-sale
securities 540 3,239 5,542
Acquired mortgage servicing rights 576 662 710
Net operating loss carryforward 144 186 228
Other 273 357 472
------ ------ ------ ------- ------ ------
Total deferred income taxes $5,462 $9,405 $7,478 $ 8,720 $9,736 $8,686
====== ====== ====== ======= ====== ======
</TABLE>
A valuation allowance against deferred tax assets has not been
established as it is more likely than not that these assets will
be realized through the reversal of taxable temporary
differences.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
12. INCOME TAXES, CONTINUED:
A reconciliation of the income tax provision and the amount of
income taxes computed by applying the statutory federal corporate
income tax rate to income (loss) before income taxes follows
(dollars in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1997 1996
-------------- --------------
Amount % Amount %
------ ----- ------ -----
<S> <C> <C> <C> <C>
Income tax provision at federal
statutory rate $5,385 35.0% $1,685 35.0%
Tax effect of:
State taxes, net of federal benefit 233 1.5 0 0.0
Amortization of goodwill 255 1.7 276 5.7
Tax-exempt interest (140) (0.9) (160) (3.3)
Change in tax estimates of prior periods 0 0.0 430 8.9
Other, net 16 0.1 100 2.1
------ ---- ------ ----
$5,749 37.4% $2,331 48.4%
====== ==== ====== ====
<CAPTION>
Six Months Ended December 31,
-------------------------------
1996 1995
-------------- --------------
Amount % Amount %
------ ----- ------ -----
<S> <C> <C> <C> <C>
Income tax provision (benefit) at
federal statutory rate $ (347) (35.0)% $1,768 35.0%
Tax effect of:
Amortization of goodwill 138 13.9 185 3.7
Tax-exempt interest (69) (7.0) (70) (1.4)
Change in tax estimates of prior
periods 340 34.3 0 0.0
Other, net 50 5.1 (38) (0.8)
------ ---- ------ ----
$ 112 11.3% $1,845 36.5%
====== ==== ====== ====
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
12. INCOME TAXES, CONTINUED:
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------
1996 1995
-------------- --------------
Amount % Amount %
------ ----- ------ -----
<S> <C> <C> <C> <C>
Income tax provision at federal
statutory rate $3,800 35.0% $4,867 35.0%
Tax effect of:
State taxes, net of federal benefit 179 1.7 0 0.0
Amortization of goodwill 343 3.1 400 2.9
Tax-exempt interest (141) (1.3) (140) (1.0)
Rehabilitation credit 0 0.0 (455) (3.3)
Other, net (117) (1.1) (53) (0.4)
------ ---- ------ ----
$4,064 37.4% $4,619 33.2%
====== ==== ====== ====
</TABLE>
At December 31, 1997, Sterling had acquired net operating loss
carryforwards of approximately $425,000 which expire beginning in
2002. Sterling's utilization of tax net operating loss
carryforwards is currently limited to approximately $123,000
annually.
On August 20, 1996, the Small Business Job Protection Act of 1996
was signed into law, which included the repeal of the special
thrift bad debt provisions. Although the percentage of taxable
income method bad debt deduction is no longer be available to
Sterling, the tax requirement to invest in certain qualifying
types of investments and loans has been eliminated, thus
providing greater flexibility to Sterling in structuring its
balance sheet to maximize returns. These tax-related changes had
no significant impact on Sterling's financial position or results
of operations for the year ended December 31, 1997 or the six
months ended December 31, 1996.
13. STOCK OPTIONS AND WARRANTS:
Sterling has granted options to purchase shares of its common
stock at exercise prices equal to the fair market value of the
stock at the date of grant. The options vest over 1 to 4 years
and are exercisable from 4 to 10 years from the date of grant.
Sterling is authorized to grant 600,000 options under the plans.
At December 31, 1997, 12,000 options are available to be granted.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
13. STOCK OPTIONS AND WARRANTS, CONTINUED:
As permitted by SFAS No. 123, Sterling has chosen not to record
compensation expense using the measurement provisions of SFAS No.
123 in the statement of operations. Had compensation cost for
Sterling's plans been determined based on the fair value at the
grant dates for awards under the plans consistent with the method
of SFAS No. 123, Sterling's reported net income (loss) and income
(loss) per common share would have been changed to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------
1997 1996
------------------------- --------------------------
As Pro As Pro
Reported Forma Reported Forma
----------- ----------- ------------- ----------
<S> <C> <C> <C> <C>
Net income $ 9,636,000 $ 8,992,000 $ 2,483,000 $ 1,817,000
=========== =========== =========== ===========
Income (loss) per common
share - basic $ 1.40 $ 1.30 $ 0.11 $ (0.12)
=========== =========== =========== ===========
Income (loss) per common
share - diluted $ 1.25 $ 1.17 $ 0.11 $ (0.12)
=========== =========== =========== ===========
<CAPTION>
Six Months Ended Year Ended
December 31, 1996 June 30, 1996
------------------------- -------------------------
As Pro As Pro
Reported Forma Reported Forma
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income (loss) $(1,103,000) $(1,449,000) $ 6,792,000 $ 6,178,000
=========== =========== =========== ===========
Income (loss) per common
share - basic $ (0.37) $ (0.43) $ 0.91 $ 0.79
=========== =========== =========== ===========
Income (loss) per common
share - diluted $ (0.37) $ (0.43) $ 0.90 $ 0.78
</TABLE>
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants in the
periods above: dividend yield of 0% in each period, expected
stock price volatility of 75%-80% each period, risk-free interest
rates of 5.74% to 6.97%; and expected lives of 4.0 to 9.1 years,
respectively.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
13. STOCK OPTIONS AND WARRANTS, CONTINUED:
Stock option transactions are summarized as follows:
<TABLE>
<CAPTION>
Exercise
Number of Weighted-Average Price Expiration
Shares Exercise Price Per Share Date
--------- ---------------- ------------- ----------
<S> <C> <C> <C> <C>
Balance, June 30, 1994 150,344 $ 8.05 $3.65-$11.85 1994-2003
Options granted 56,000 10.48 $10.13-$10.53 1998-2004
Options exercised (4,880) 5.30 $4.05-$10.33 1995-1997
Options expired (500) 6.01 $6.01 1994
---------
Balance, June 30, 1995 200,964 8.73 $3.65-$11.85 1995-2004
Options granted 222,750 13.26 $11.93-$14.13 1999-2006
Options exercised (28,172) 6.51 $3.65-$10.33 1995-2002
Options canceled (500) 11.93 $11.93 1999
---------
Balance, June 30, 1996 395,042 $11.44 $3.65-$14.13 1996-2006
Options granted 48,000 14.00 $14.00 2001-2006
Options exercised (19,620) 8.23 $6.93-$11.85 1996-2004
Options canceled (1,000) 14.13 $14.13 2001
---------
Balance, December 31, 1996 422,422 11.87 $3.65-$14.13 2002-2007
Options granted 74,000 21.21 $18.25-$21.31 1998-2002
Options exercised (14,632) 9.90 $7.09-$14.13 1997-2006
Options canceled (1,000) 14.13 $14.13 2006
--------- ------
Balance, December 31, 1997 480,790 $13.37 $7.22-$21.31 1998-2007
========= ======
Exercisable, December 31,
1997 328,790 $11.45
========= ======
</TABLE>
The weighted-average fair value of options granted during the
years ended December 31, 1997 and 1996, the six months ended
December 31, 1996 and the year ended June 30, 1996 was $21.25,
$14.08, $10.74 and $10.15 per share, respectively.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
13. STOCK OPTIONS AND WARRANTS, CONTINUED:
The following table summarizes information about the Plan's
outstanding and exercisable stock options at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------- ------------------------------
Weighted-Average
Range of Number Remaining Weighted-Average Number Weighted-Average
Exercise Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price
-------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$3.65 2,000 2.5 years $ 3.65 2,000 $ 3.65
$6.00-$6.99 5,250 3.3 years 6.26 5,250 6.26
$7.00-$8.00 32,000 4.5 years 7.37 32,000 7.37
$9.00-$11.84 95,290 3.7 years 9.88 93,790 9.88
$11.85-$14.13 292,250 5.6 years 13.36 195,750 13.09
$18.25-$19.62 2,000 9.0 years 18.93 -- --
$21.31 72,000 6.1 years 21.31 -- --
------- -------
480,790 328,790
======= =======
</TABLE>
In connection with an acquisition in 1994, Sterling issued
warrants to purchase 99,985 shares of Sterling's Common Stock at
$11.82 per share. All such warrants were exercised in July 1996,
thereby increasing Sterling's shareholders' equity by
approximately $1.2 million.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
14. PREFERRED STOCK:
During the year ended December 31, 1997, the $1.8125 Series A
Cumulative Convertible Preferred Stock (the "Preferred Stock")
was called for redemption at $26.07 per share plus accrued but
unpaid dividends. As a result of the call for redemption, the
holders of 1,035,700 shares of Preferred Stock elected to convert
their interests into 2,021,190 shares of Sterling Common Stock.
The remaining 4,300 shares of Preferred Stock were redeemed for
$113,000 during 1997.
15. EARNINGS PER SHARE:
Effective December 31, 1997, Sterling adopted SFAS No. 128,
"Earnings Per Share" ("SFAS No. 128"). SFAS No. 128 establishes
standards for computing and presenting earnings per share ("EPS")
and simplifies the existing standards. This standard replaces the
presentation of primary EPS with a presentation of basic EPS. It
also requires the dual presentation of basic and diluted EPS on
the face of the income statement for all entities with complex
capital structures and requires a reconciliation of the numerator
and the denominator for the basic and diluted EPS computation.
SFAS No. 128 requires restatement of all prior-period EPS data
presented.
In accordance with SFAS No. 128, the following table presents a
reconciliation of the numerators and denominators used in the
basic and diluted EPS computations, which includes the number of
antidilutive securities (if any) that were not included in the
dilutive EPS computation. These antidilutive securities occurred
when options outstanding held an option price greater than the
average market price for the period. Also shown is the effect
that has been given to preferred dividends in computing basic
EPS.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
15. EARNINGS PER SHARE, CONTINUED:
<TABLE>
<CAPTION>
For the Year Ended December 31,
--------------------------------------------------------------------------------
1997 1996
--------------------------------------- ---------------------------------------
Weighted- Weighted-
Net Average Net Average
Income (Loss) Shares Per Share Income (Loss) Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
------------- ------------- --------- ------------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net income $ 9,636,000 $ 2,483,000
Less preferred stock
dividends (940,000) (1,885,000)
----------- -----------
Income per common
share - basic 8,696,000 6,207,329 $ 1.40 598,000 5,476,531 $ 0.11
Effect of dilutive
securities:
Convertible pre-
ferred stock 940,000 1,363,935 1,885,000 2,029,664
Common stock
options 136,069 67,427
----------- ----------- ----------- -----------
Income per common
share - diluted $ 9,636,000 7,707,333 $ 1.25 $ 2,483,000 7,573,622 $ 0.11
=========== =========== =========== ===========
Antidilutive options not
included in diluted
EPS 74,000 130,500
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
15. EARNINGS PER SHARE, CONTINUED:
<TABLE>
<CAPTION>
For the Six Months Ended December 31,
---------------------------------------------------------------------------------
1996 1995
---------------------------------------- ----------------------------------------
Weighted- Weighted-
Net Average Net Average
Income (Loss) Shares Per Share Income (Loss) Shares Per Share
(Numerator) (Denominator) Amount (A) (Numerator) (Denominator) Amount (A)
------------- ------------- ---------- ------------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C>
Net income (loss) $(1,103,000) $ 3,206,000
Less preferred stock
dividends (942,000) (942,000)
----------- -----------
Income (loss) per
common share -
basic (2,045,000) 5,528,117 $(0.37) 2,264,000 5,408,133 $ 0.42
Effect of dilutive
securities:
Convertible pre-
ferred stock 942,000 2,029,664 942,000 2,029,664
Common stock
options 67,427 89,085
----------- ----------- ----------- -----------
Income (loss) per
common share -
diluted $(1,103,000) 7,625,208 $(0.37) $ 3,206,000 7,526,882 $ 0.42
=========== =========== =========== ===========
Antidilutive options
not included in
diluted EPS 130,500
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
15. EARNINGS PER SHARE, CONTINUED:
<TABLE>
<CAPTION>
For the Year Ended December 31,
--------------------------------------------------------------------------------
1997 1996
--------------------------------------- ---------------------------------------
Weighted- Weighted-
Net Average Net Average
Income (Loss) Shares Per Share Income (Loss) Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
------------- ------------- --------- ------------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net income $ 6,792,000 $ 9,288,000
Less preferred stock
dividends (1,885,000) (1,885,000)
----------- -----------
Income per common
share - basic 4,907,000 5,416,211 $ 0.91 7,403,000 5,210,318 $ 1.42
Effect of dilutive
securities:
Convertible pre-
ferred stock 1,885,000 2,029,664 1,885,000 2,029,664
Common stock
options 106,455 56,705
----------- ----------- ----------- -----------
Income per common
share - diluted $ 6,792,000 7,552,330 $ 0.90 $ 9,288,000 7,296,687 $ 1.27
=========== =========== =========== ===========
</TABLE>
(A) During the six months ended December 31, 1996 and 1995, the
effect of convertible preferred stock of 2,029,664 shares was
antidilutive. Thus, the presentation of basic and diluted
income (loss) per common share is identical.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
16. REGULATORY MATTERS:
In connection with the insurance of its deposits by the Federal
Deposit Insurance Corporation ("FDIC") and general regulatory
oversight by the Office of Thrift Supervision ("OTS"), Sterling
Savings is required to maintain minimum levels of regulatory
capital, including tangible, core and risk-based capital. At
December 31, 1997, Sterling Savings was in compliance with all
regulatory capital requirements. The OTS is empowered to take
"prompt, corrective action" to resolve problems of insured
depository institutions. The extent of these powers depends on
whether an institution is classified as "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly
under capitalized," or "critically undercapitalized." At December
31, 1997, Sterling Savings was considered "well capitalized."
The following table sets forth the amounts and ratios regarding
actual and minimum tangible, core and risk-based capital
requirements, together with the amounts and ratios required in
order to meet the definition of a "well capitalized" institution.
<TABLE>
<CAPTION>
Minimum
Capital Well Capitalized
Requirements Requirements Actual
------------------ ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997:
Total Capital (to
Risk-Weighted
Assets) $ 88,115 8.00% $109,054 10.00% $149,107 13.68%
Core (Tier I)
Capital (to
Risk-Weighted
Assets) N/A 65,376 6.00 141,024 12.94
Core (Tier I)
Capital (to
Adjusted Assets) 55,902 3.00 93,170 5.00 141,024 7.57
Tangible Capital
(to Tangible
Assets) 27,951 1.50 N/A 141,024 7.57
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
16. REGULATORY MATTERS, CONTINUED:
<TABLE>
<CAPTION>
Minimum
Capital Well Capitalized
Requirements Requirements Actual
------------------ ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996:
Total Capital (to
Risk-Weighted
Assets) $ 74,870 8.00% $ 93,351 10.00% $109,034 11.80%
Core (Tier I)
Capital (to
Risk-Weighted
Assets) N/A 55,442 6.00 101,589 10.99
Core (Tier I)
Capital (to
Adjusted Assets) 45,868 3.00 76,446 5.00 101,589 6.64
Tangible Capital
(to Tangible
Assets) 22,934 1.50 N/A 101,589 6.64
As of June 30, 1996:
Total Capital (to
Risk- Weighted
Assets) $ 70,167 8.00% $ 86,703 10.00% $ 98,014 11.30%
Core (Tier I)
Capital (to
Risk-Weighted
Assets) N/A 52,021 6.00 91,062 10.50
Core (Tier I)
Capital (to
Adjusted
Assets) 44,225 3.00 73,708 5.00 91,062 6.18
Tangible Capital
(to Tangible
Assets) 22,106 1.50 N/A 90,622 6.15
</TABLE>
On September 30, 1996, federal legislation was enacted which
included provisions regarding the recapitalization of the Savings
Association Insurance Fund ("SAIF"), which is operated by the
FDIC and provides deposit insurance for thrift institutions. The
new legislation required SAIF-insured savings institutions, like
Sterling Savings, to pay a one-time special assessment.
Sterling's SAIF assessment resulted in a pre-tax charge to
earnings of $5.8 million during the six months ended December 31,
1996.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
16. REGULATORY MATTERS, CONTINUED:
Existing law contemplates a unification of the charters presently
available to banks and savings institutions. The Treasury
Department is required to make recommendations regarding
unification of the available charters and the merger of the
insurance funds. The law requires a merger of the SAIF with the
BIF on January 1, 1999 if all savings institutions have converted
to banks by that date, but the law does not mandate such
conversion. SAIF and BIF will continue to operate as separate
funds, if this unification of charters has not taken place, until
such time as additional federal legislation is passed requiring a
merger of the funds.
Sterling Savings may be required to convert its charter to either
a national bank charter, a state depository institution charter
or a newly designed charter. Sterling may also become regulated
at the holding company level by the Board of Governors of the
Federal Reserve System ("Federal Reserve") rather than by the
OTS. Regulation by the Federal Reserve could subject Sterling to
capital requirements that are not currently applicable to
Sterling as a holding company under OTS regulations and may
result in statutory limitations on the type of business
activities in which Sterling may engage at the holding company
level, which business activities currently are not restricted. At
this time, Sterling Savings is unable to predict whether a
charter change will be required and, if so, whether the charter
change would significantly impact Sterling Savings' operations.
17. COMMITMENTS AND CONTINGENT LIABILITIES:
At December 31, 1997, Sterling had loan commitments to borrowers
and brokers totaling $141.2 million, including $7.5 million for
fixed-rate loans and $133.7 million for variable-rate loans. At
December 31, 1997, commitments to secondary market institutions
to sell fixed-rate loans totaled $4.8 million. Commitments, which
are disbursed subject to certain limitations, extend over various
periods of time, with the majority of funds being disbursed
within a twelve-month period. Substantially all of the
commitments are for loans that have credit risk similar to
Sterling's existing portfolio.
At December 31, 1997, Sterling had made available various secured
and unsecured commercial and personal lines of credit totaling
approximately $124.6 million, of which the undisbursed portion is
approximately $58.1 million. These lines of credit provide for
periodic adjustment to market rates of interest and have credit
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
17. COMMITMENTS AND CONTINGENT LIABILITIES, CONTINUED:
risk similar to Sterling's existing portfolio. Sterling
historically has not realized credit losses due to these off-
balance sheet credits. Based on this fact and Sterling's analysis
of the undisbursed portion of these lines of credit, no specific
valuation allowances were recorded for these off-balance sheet
credits at December 31, 1997 and 1996 and June 30, 1996.
During the fiscal year ended June 30, 1995, Sterling converted
approximately $94.7 million of its adjustable-rate residential
loans into FHLMC participation certificates. At December 31,
1997, Sterling is contingently liable for up to $947,000 related
to this transaction.
Rent expense for office properties under operating leases was
$1.1 million, $1.0 million, $500,000, $431,000, $1.1 million and
$1.3 million for the years ended December 31, 1997 and 1996, the
six months ended December 31, 1996 and 1995 and the years ended
June 30, 1996 and 1995, respectively.
Future minimum rental commitments as of December 31, 1997, under
noncancelable operating leases with initial or remaining terms of
more than one year, are as follows (in thousands):
Year Ending
December 31,
------------
1998 $1,028
1999 875
2000 560
2001 476
2002 362
Thereafter 3,988
------
$7,289
======
18. EMPLOYEE SAVINGS PLAN:
Sterling maintains an employee savings plan under Section 401(k)
of the Internal Revenue Code. Substantially all employees are
eligible to participate in the plan subject to certain
requirements. Under the plan, employees may elect to contribute
up to 8% of their salary, and Sterling will make a matching
contribution equal to 35% of the employee's contribution. All
matching contributions are made exclusively in the form of
Sterling Common Stock. Each employee may make a supplemental
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
18. EMPLOYEE SAVINGS PLAN, CONTINUED:
contribution of an additional 7% of their salary. All
contributions vest immediately. Employees have the option of
investing their contributions among four selected mutual funds,
Sterling Savings' certificates of deposit and Sterling Common
Stock. During the years ended December 31, 1997 and 1996,
Sterling contributed $210,000 and $238,000, respectively, to the
employee savings plan. During the six months ended December 31,
1996 and 1995, Sterling contributed $129,500 and $48,000,
respectively. During the years ended June 30, 1996 and 1995,
Sterling contributed $156,000 and $147,000, respectively.
19. OPERATING EXPENSES:
The components of total operating expenses are as follows (in
thousands):
<TABLE>
<CAPTION>
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
---------------- ---------------- ----------------
1997 1996 1996 1995 1996 1995
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Employee compensation and
benefits $15,897 $12,951 $ 6,935 $ 6,107 $12,124 $11,773
Occupancy and equipment 6,043 5,583 2,879 2,566 5,269 5,043
Depreciation 3,090 2,999 1,515 1,321 2,805 2,200
Amortization of intangibles 2,242 3,254 1,590 1,669 3,332 3,487
Advertising 1,661 1,454 606 472 1,321 1,894
Data processing 2,354 2,188 1,344 899 1,743 2,056
Insurance 1,170 2,430 1,263 1,139 2,306 2,063
SAIF one-time assessment
(see Note 16) 0 5,800 5,800 0 0 0
Legal and accounting 1,409 1,878 1,220 507 1,165 1,118
Travel and entertainment 1,093 1,101 629 452 924 992
Other 2,147 1,273 961 383 695 646
------- ------- ------- ------- ------- -------
$37,106 $40,911 $24,742 $15,515 $31,684 $31,272
======= ======= ======= ======= ======= =======
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
20. MORTGAGE BANKING OPERATIONS:
Sterling operates eight residential loan production offices
primarily in the Spokane and Seattle, Washington; Portland,
Oregon; and Boise, Idaho metropolitan areas through its
subsidiary Action Mortgage. Mortgage banking operations include
revenues from servicing released and servicing retained sales of
originated residential loans, bulk sales of loan servicing rights
and other fees.
The following table summarizes information related to Sterling's
mortgage banking operations (in thousands):
<TABLE>
<CAPTION>
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
---------------- ---------------- ----------------
1997 1996 1996 1995 1996 1995
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Gains on sales of origi-
nated residential loans $ 1,494 $ 3,005 $ 1,087 $ 1,506 $ 3,054 $ 807
Gains on bulk sales of
servicing 0 0 0 0 0 5,609
Other fees and income 2,524 483 1,156 255 2,032 1,446
------- ------- ------- ------- ------- -------
Total revenues 4,018 3,488 2,243 1,761 5,086 7,862
Identifiable expenses 2,932 1,775 801 1,167 2,491 3,325
------- ------- ------- ------- ------- -------
Income before adjustments,
eliminations and income
taxes 1,086 1,713 1,442 594 2,595 4,537
Adjustments and elimi-
nations 836 1,775 244 1,167 459 1,879
------- ------- ------- ------- ------- -------
Income before income taxes $ 1,922 $ 3,488 $ 1,686 $ 1,761 $ 3,054 $ 6,416
======= ======= ======= ======= ======= =======
Identifiable assets $ 5,153 $ 3,643 $ 3,643 $ 2,404 $ 3,220 $ 2,261
======= ======= ======= ======= ======= =======
Depreciation and amortiza-
tion expense $ 177 $ 243 $ 108 $ 186 $ 327 $ 385
======= ======= ======= ======= ======= =======
Capital expenditures for
office properties and
equipment $ 15 $ 50 $ 15 $ 57 $ 93 $ 344
======= ======= ======= ======= ======= =======
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
20. MORTGAGE BANKING OPERATIONS, CONTINUED:
In June 1997, SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information" was issued. SFAS No. 131
establishes standards for the way that public business
enterprises report information about operating segments in annual
financial statements and requires that those enterprises report
selected information about operating segments in interim
financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services,
geographic areas and major customers. This Statement supersedes
SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise," but retains the requirement to report information
about major customers.
This Statement is effective for financial statements for periods
beginning after December 15, 1997. Sterling has not yet
determined the effect that the application of SFAS No. 131 will
have on its consolidated financial statements.
21. INTEREST RATE RISK:
The results of operations for savings institutions may be
materially and adversely affected by changes in prevailing
economic conditions, including rapid changes in interest rates,
declines in real estate market values and the monetary and fiscal
policies of the federal government. Like all financial
institutions, Sterling's net interest income and its NPV (the net
present value of financial assets, liabilities and off-balance
sheet contracts) are subject to fluctuations in interest rates.
Currently, Sterling's interest-bearing liabilities, consisting
primarily of savings deposits, FHLB Seattle advances and other
borrowings, mature or reprice more rapidly, or on different
terms, than do its interest-earning assets. The fact that
liabilities mature or reprice more frequently on average than
assets may be beneficial in times of declining interest rates;
however, such an asset/liability structure may result in
declining net interest income during periods of rising interest
rates.
Additionally, the extent to which borrowers prepay loans is
affected by prevailing interest rates. When interest rates
increase, borrowers are less likely to prepay loans; whereas when
interest rates decrease, borrowers are more likely to prepay
loans. Prepayments may affect the levels of loans retained in an
institution's portfolio, as well as its net interest income.
Sterling maintains an asset and liability management program
intended to manage net interest income through interest rate
cycles and to protect its NPV by controlling its exposure to
changing interest rates.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
21. INTEREST RATE RISK, CONTINUED:
Sterling uses a simulation model designed to measure the
sensitivity of net interest income and NPV to changes in interest
rates. This simulation model is designed to enable Sterling to
generate a forecast of net interest income and NPV given various
interest rate forecasts and alternative strategies. The model
also is designed to measure the anticipated impact that
prepayment risk, basis risk, customer maturity preferences,
volumes of new business and changes in the relationship between
long- and short-term interest rates have on the performance of
Sterling. Another monitoring tool used by Sterling to assess
interest rate risk is "gap analysis." The matching of repricing
characteristics of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities are
"interest sensitive" and by monitoring Sterling's interest
sensitivity "gap." Management is aware of the sources of interest
rate risk and endeavors to actively monitor and manage its
interest rate risk although there can be no assurance regarding
the management of interest rate risk in future periods.
22. QUARTERLY FINANCIAL DATA (UNAUDITED):
<TABLE>
<CAPTION>
Year Ended December 31, 1997
------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest income $ 29,648 $ 30,769 $ 34,801 $ 35,931
Interest expense (18,596) (19,732) (23,244) (23,940)
Provision for loan losses (550) (550) (675) (675)
--------- --------- --------- ---------
Net interest income after
provision for loan losses 10,502 10,487 10,882 11,316
Net gain on sales of
securities 85 487 582 43
Other income 1,969 2,180 2,050 1,908
Operating expenses (8,888) (9,463) (9,432) (9,323)
--------- --------- --------- ---------
Income before income taxes 3,668 3,691 4,082 3,944
Income tax provision (1,394) (1,403) (1,551) (1,401)
--------- --------- --------- ---------
Net income 2,274 2,288 2,531 2,543
Less preferred stock divi-
dends declared (471) (469) 0 0
--------- --------- --------- ---------
Income available to common
shares $ 1,803 $ 1,819 $ 2,531 $ 2,543
========= ========= ========= =========
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
22. QUARTERLY FINANCIAL DATA (UNAUDITED), CONTINUED:
<TABLE>
<CAPTION>
Year Ended December 31, 1997
------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Income per common share -
basic $ 0.33 $ 0.33 $ 0.42 $ 0.34
========= ========= ========= =========
Weighted average common
shares outstanding - basic 5,540,765 5,550,144 6,148,920 7,567,855
========= ========= ========= =========
Income per common share -
diluted $ 0.30 $ 0.30 $ 0.33 $ 0.33
========= ========= ========= =========
Weighted average common
shares outstanding -
diluted 7,696,996 7,707,818 7,712,628 7,730,366
========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
Quarter Ended Quarter Ended
September 30, 1996 December 31, 1996
------------------ -----------------
(Dollars in thousands, except per
share amounts)
<S> <C> <C>
Interest income $ 27,856 $ 29,758
Interest expense (18,340) (19,071)
Provision for loan losses (550) (550)
--------- ---------
Net interest income after
provision for loan losses 8,966 10,137
Other income 1,821 2,827
Operating expenses (see Note 19) (15,972) (8,770)
--------- ---------
Income (loss) before income taxes (5,185) 4,194
Income tax (provision) benefit 1,887 (1,999)
Net income (loss) (3,298) 2,195
Less preferred stock dividends
declared (471) (471)
--------- ---------
Income (loss) available to common
shares $ (3,769) $ 1,724
========= =========
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
22. QUARTERLY FINANCIAL DATA (UNAUDITED), CONTINUED:
<TABLE>
<CAPTION>
Quarter Ended Quarter Ended
September 30, 1996 December 31, 1996
------------------ -----------------
(Dollars in thousands, except per
share amounts)
<S> <C> <C>
Income (loss) per common share - basic $ (0.44) $ 0.31
========= =========
Weighted average common shares
outstanding - basic 5,518,724 5,537,509
========= =========
Income (loss) per common share -
diluted $ (0.68) $ 0.29
========= =========
Weighted average common shares
outstanding - diluted 7,613,869 7,634,600
========= =========
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31, 1997
------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest income $ 28,614 $ 28,904 $ 27,980 $ 27,583
Interest expense (20,314) (20,172) (18,783) (18,342)
Provision for loan losses (400) (400) (400) (400)
--------- --------- --------- ---------
Net interest income after
provision for loan losses 7,900 8,332 8,797 8,841
Net gain on sales of
securities 0 451 0 7
Other income 1,823 2,060 2,274 2,055
Operating expenses (7,619) (7,896) (8,124) (8,045)
--------- --------- --------- ---------
Income before income taxes 2,104 2,947 2,947 2,858
Income tax provision (768) (1,077) (1,076) (1,143)
--------- --------- --------- ---------
Net income 1,336 1,870 1,871 1,715
Less preferred stock
dividends declared (471) (471) (471) (472)
--------- --------- --------- ---------
Income available to common
shares $ 865 $ 1,399 $ 1,400 $ 1,243
========= ========= ========= =========
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
22. QUARTERLY FINANCIAL DATA (UNAUDITED), CONTINUED:
<TABLE>
<CAPTION>
Year Ended December 31, 1997
------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Income per common share -
basic $ 0.18 $ 0.26 $ 0.26 $ 0.23
========= ========= ========= =========
Weighted average common
shares outstanding - basic 5,406,037 5,410,229 5,422,854 5,425,903
========= ========= ========= =========
Income per common share -
diluted $ 0.16 $ 0.25 $ 0.25 $ 0.23
========= ========= ========= =========
Weighted average common
shares outstanding -
diluted 7,517,520 7,528,978 7,525,160 7,562,023
========= ========= ========= =========
</TABLE>
23. FAIR VALUES OF FINANCIAL INSTRUMENTS:
Fair value estimates are determined as of a specific date in time
utilizing quoted market prices, where available, or various
assumptions and estimates. As the assumptions underlying these
estimates change, the fair value of the financial instruments
will change. The use of assumptions and various valuation
techniques, as well as the absence of secondary markets for
certain financial instruments, will likely reduce the
comparability of fair value disclosures between financial
institutions. Additionally, Sterling has not disclosed highly
subjective values of core deposit intangibles or other non-
financial instruments. Accordingly, the aggregate fair value
amounts presented do not represent and should not be construed to
represent the full underlying value of Sterling.
The methods and assumptions used to estimate the fair values of
each class of financial instruments are as follows:
CASH AND CASH EQUIVALENTS
The carrying value of cash and cash equivalents approximates
fair value due to the relatively short-term nature of these
instruments.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
23. FAIR VALUES OF FINANCIAL INSTRUMENTS, CONTINUED:
INVESTMENTS AND MORTGAGE-BACKED SECURITIES
The fair value of investments and mortgage-backed securities is
based on quoted market prices. If quoted market prices are not
available, fair values are based on quoted market prices of
comparable instruments.
LOANS HELD-FOR-SALE
The fair values are based on the estimated value at which the
loans could be sold in the secondary market considering the
fair value of options and commitments to sell or issue mortgage
loans.
LOANS RECEIVABLE
The fair values of performing residential mortgage loans and
home equity loans are estimated using current market comparable
information for securitizable mortgages, adjusting for credit
and other relevant characteristics. The fair value of
performing commercial real estate construction and permanent
financing, consumer and business banking loans is estimated by
discounting the cash flows using interest rates that consider
the current credit and interest rate risk inherent in the loans
and current economic and lending conditions.
The fair value of nonperforming loans is estimated by
discounting management's current estimate of future cash flows
using a rate estimated to be commensurate with the risks
involved.
DEPOSITS
The fair values for deposits subject to immediate withdrawal
such as interest and non-interest bearing checking, passbook
savings, and money market deposit accounts, are equal to the
amounts payable on demand at the reporting date (i.e., their
carrying amount on the balance sheet). The carrying amounts for
variable-rate certificates of deposit and other time deposits
approximate their fair value at the reporting date. Fair values
for fixed-rate certificates of deposit are estimated by
discounting future cash flows using interest rates currently
offered on time deposits with similar remaining maturities.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
23. FAIR VALUES OF FINANCIAL INSTRUMENTS, CONTINUED:
BORROWINGS
The carrying amounts of short-term borrowings under repurchase
agreements, FHLB Seattle and Federal Funds overnight advances,
and other short-term borrowings approximate their fair values
due to the relatively short period of time between the
origination of the instruments and their expected payment. The
fair value of long-term debt is estimated using discounted cash
flow analyses based on Sterling's current incremental borrowing
rates for similar types of borrowing arrangements.
<TABLE>
<CAPTION>
December 31,
---------------------------------------------- June 30,
1997 1996 1996
---------------------- ---------------------- ----------------------
Carrying Fair Carrying Fair Carrying Fair
Amount Value Amount Value Amount Value
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 52,410 $ 52,410 $ 35,905 $ 35,905 $ 28,928 $ 28,928
Investments and mortgage-backed
securities:
Available-for-sale 656,236 656,236 469,790 469,790 460,061 460,061
Held-to-maturity 12,750 12,911 11,871 11,843 11,879 11,650
Loans held-for-sale 5,225 5,225 6,116 6,116 7,456 7,456
Loans receivable, net 1,069,591 1,078,336 934,340 937,392 886,667 887,017
Accrued interest receivable 14,058 14,058 10,690 10,690 9,080 9,080
Financial liabilities:
Non-maturity deposits 366,271 366,271 317,805 317,805 316,880 316,880
Deposits with stated maturities 670,137 674,651 584,473 587,966 581,514 584,268
Borrowings 707,402 715,281 521,663 527,734 472,435 478,535
Accrued interest payable 5,855 5,855 5,095 5,095 3,578 3,578
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
23. FAIR VALUES OF FINANCIAL INSTRUMENTS, CONTINUED:
The fair value estimates above do not include the value of
residential mortgage loan servicing rights on Sterling's
residential loan servicing portfolio which totaled approximately
$452.2, $542.2 million and $588.0 million at December 31, 1997
and 1996 and June 30, 1996, respectively. The gross fair value of
these rights is estimated to be $5.3 million, $5.4 million and
$5.3 million at December 31, 1997 and 1996 and June 30, 1996,
respectively.
24. RELATED-PARTY TRANSACTIONS:
One of Sterling's directors is a principal in the law firm that
provides legal services to Sterling. During the years ended
December 31, 1997 and 1996, the six months ended December 31,
1996 and 1995 and the years ended June 30, 1996 and 1995,
Sterling incurred approximately $794,000, $784,000, $389,000,
$207,000, $552,000 and $646,000, respectively, for legal services
provided by this firm.
25. SUBSEQUENT EVENT:
On February 2, 1998, Sterling signed an agreement to acquire 33
branch offices in Washington, Idaho and Oregon from KeyBank
National Association ("KeyBank"). The purchase includes
approximately $585 million of deposit balances, the owned branch
facilities, branch furniture, fixtures and certain equipment and
approximately $133 million of loan balances. To acquire these
branches, Sterling will pay approximately $72 million based upon
a premium on deposits plus the value of the assets related to
these branches. Sterling anticipates using the net proceeds of
approximately $380 million from this transaction to reduce
borrowings and wholesale liabilities. As a result of this
transaction, Sterling's total assets are expected to increase by
approximately $150 million.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
26. PARENT COMPANY ONLY FINANCIAL INFORMATION:
Sterling Financial Corporation became the holding company for
Sterling Savings on November 1, 1992. The following Sterling
Financial Corporation (parent company only) financial information
should be read in conjunction with the other notes to
consolidated financial statements. The accounting policies for
the parent company only financial statements are the same as
those used in the presentation of the consolidated financial
statements other than the parent company only financial
statements account for the parent company's investments in its
subsidiaries under the equity method.
December 31,
------------------ June 30,
1997 1996 1996
-------- -------- --------
(Dollars in thousands)
ASSETS
Cash and cash equivalents $ 21,301 $ 12,954 $ 5,029
Investments in subsidiaries:
Sterling Savings 148,403 107,250 92,818
INTERVEST-Mortgage Investment
Company 0 0 3,448
Tri-Cities Mortgage Company 1,033 804 731
Sterling Capital Trust I 1,237 0 0
Income taxes receivable from
subsidiaries 816 0 1,021
Other assets 2,980 611 640
Federal income taxes receivable 583 0 0
-------- -------- --------
Total assets $176,353 $121,619 $103,687
======== ======== ========
LIABILITIES AND SHAREHOLDERS'
EQUITY
Accrued expenses payable $ 13 $ 88 $ 0
Term note payable 15,000 15,000 0
8.75% Subordinated Notes due 2000 17,240 17,240 17,240
Junior Subordinated Debentures of
Sterling 41,237 0 0
Federal income taxes payable 0 71 702
Shareholders' equity 102,863 89,220 85,745
-------- -------- --------
Total liabilities and share-
holders' equity $176,353 $121,619 $103,687
======== ======== ========
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
26. PARENT COMPANY ONLY FINANCIAL INFORMATION, CONTINUED:
<TABLE>
<CAPTION>
Year Ended Six Months Ended Year Ended
December 31, December 31, June 30,
--------------------- --------------------- ---------------------
1997 1996 1996 1995 1996 1995
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
Interest income $ 967 $ 0 $ 0 $ 0 $ 0 $ 220
Interest expense (4,682) (2,050) (1,217) (847) (1,680) (1,674)
--------- --------- --------- --------- --------- ---------
Net interest expense (3,715) (2,050) (1,217) (847) (1,680) (1,454)
Other income - equity in net
earnings (loss) of subsidiaries 12,367 4,328 (221) 4,091 8,639 10,671
Miscellaneous income, net 0 279 219 38 99 201
Operating expenses (776) (356) (198) (166) (324) (331)
--------- --------- --------- --------- --------- ---------
Income (loss) before income taxes 7,876 2,201 (1,417) 3,116 6,734 9,087
Deferred income tax benefit 1,760 282 314 90 58 201
--------- --------- --------- --------- --------- ---------
Net income (loss) $ 9,636 $ 2,483 $ (1,103) $ 3,206 $ 6,792 $ 9,288
========= ========= ========= ========= ========= =========
STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Net income (loss) $ 9,636 $ 2,483 $ (1,103) $ 3,206 $ 6,792 $ 9,288
Adjustments to reconcile net
income (loss) to net cash used
in operating activities (16,281) (3,286) 727 (3,259) (7,271) (10,546)
--------- --------- --------- --------- --------- ---------
Net cash used in operating
activities (6,645) (803) (376) (53) (479) (1,258)
--------- --------- --------- --------- --------- ---------
Cash flows from investing activities:
Investment in subsidiaries, net (30,076) (9,800) (9,494) (82) (392) (3,207)
Dividends from subsidiary 6,078 4,803 2,487 2,317 4,633 6,078
Investment in partnership 0 0 0 0 0 1,403
--------- --------- --------- --------- --------- ---------
Net cash provided by (used
in) investing activities (23,998) (4,997) (7,007) 2,235 4,241 4,274
--------- --------- --------- --------- --------- ---------
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
26. PARENT COMPANY ONLY FINANCIAL INFORMATION, CONTINUED:
<TABLE>
<CAPTION>
Year Ended Six Months Ended Year Ended
December 31, December 31, June 30,
--------------------- --------------------- ---------------------
1997 1996 1996 1995 1996 1995
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF CASH FLOWS
Cash flows from financing activities:
Repayment of subordinated debt 0 0 0 0 0 (10)
Proceeds from other borrowings 40,000 15,000 15,000 0 0 0
Proceeds from exercise of stock
options and warrants, net of
repurchases 56 1,352 1,250 58 163 20
Payments to redeem preferred stock
and fractional shares (126) 0 0 0 0 0
Cash dividends on preferred stock (940) (1,885) (942) (942) (1,885) (1,885)
Other, net 0 (2) 0 0 0 0
--------- --------- --------- --------- --------- ---------
Net cash provided by (used in)
financing activities 38,990 14,465 15,308 (884) (1,722) (1,875)
--------- --------- --------- --------- --------- ---------
Net increase in cash and cash
equivalents 8,347 8,666 7,925 1,298 2,040 1,141
Cash and cash equivalents, beginning
of period 12,954 4,287 5,029 2,989 2.989 1,848
--------- --------- --------- --------- --------- ---------
Cash and cash equivalents, end of
period $ 21,301 $ 12,954 $ 12,954 $ 4,287 $ 5,029 $ 2,989
========= ========= ========= ========= ========= =========
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the year ended December 31, 1996
and the six months ended December 31, 1995 is unaudited)
26. PARENT COMPANY ONLY FINANCIAL INFORMATION, CONTINUED:
Federal law prohibits Sterling Financial Corporation from
borrowing from its subsidiary savings association unless the
loans are collateralized by specified assets and are generally
limited to 10% of the subsidiary savings association's capital
and surplus.
Effective September 1, 1996, Sterling Financial Corporation
transferred its ownership in INTERVEST to Sterling Savings at
carrying value which approximated its market value.
During the year ended December 31, 1997, Sterling purchased $30.0
million of Sterling Savings common and preferred stock.
Current income taxes are allocated to Sterling and its
subsidiaries as if they were separate taxpayers.
The payment of dividends to Sterling Financial Corporation by its
subsidiary savings association is subject to various federal and
state regulatory limitations. Under current regulations, at
December 31, 1997, the subsidiary savings association could have
declared approximately $47.9 million of aggregate dividends, in
addition to amounts previously paid. Sterling Financial
Corporation's non-regulated subsidiaries are not subject to the
dividend payment limitations applicable to savings associations.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 36522
<INT-BEARING-DEPOSITS> 15858
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 656236
<INVESTMENTS-CARRYING> 12750
<INVESTMENTS-MARKET> 12911
<LOANS> 1078550
<ALLOWANCE> 8959
<TOTAL-ASSETS> 1876250
<DEPOSITS> 1036408
<SHORT-TERM> 0
<LIABILITIES-OTHER> 664739
<LONG-TERM> 72240
0
0
<COMMON> 7570
<OTHER-SE> 95293
<TOTAL-LIABILITIES-AND-EQUITY> 1876250
<INTEREST-LOAN> 91733
<INTEREST-INVEST> 39416
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 131149
<INTEREST-DEPOSIT> 45666
<INTEREST-EXPENSE> 85512
<INTEREST-INCOME-NET> 45637
<LOAN-LOSSES> 2450
<SECURITIES-GAINS> 1197
<EXPENSE-OTHER> 37106
<INCOME-PRETAX> 15385
<INCOME-PRE-EXTRAORDINARY> 15385
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9636
<EPS-PRIMARY> 1.40
<EPS-DILUTED> 1.25
<YIELD-ACTUAL> 2.81
<LOANS-NON> 4755
<LOANS-PAST> 0
<LOANS-TROUBLED> 150
<LOANS-PROBLEM> 11964
<ALLOWANCE-OPEN> 7891
<CHARGE-OFFS> 1563
<RECOVERIES> 181
<ALLOWANCE-CLOSE> 8959
<ALLOWANCE-DOMESTIC> 8959
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
EXHIBIT 11.1
COMPUTATION OF NET INCOME PER SHARE
For the Three and Twelve Months Ending December 31,1997
<TABLE>
<CAPTION>
Three Months Daily Twelve Months Daily
Shares Outstanding Weighted Average Weighted Average
---------------------- ----------------------------- -----------------------------
Common Number
Common Equivalent of Days Basic Diluted Basic Diluted
--------- ---------- ------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
January 1, 1997 5,539,178 7,568,842 23 127,401,094 174,083,366
January 24, 1997 5,539,575 7,569,239 32 177,266,400 242,215,648
February 25, 1997 5,541,048 7,570,712 2 11,082,096 15,141,424
February 27, 1997 5,543,007 7,572,671 33 182,919,231 249,898,143
April 1, 1997 5,543,007 7,572,671 15 83,145,105 113,590,065
April 16, 1997 5,543,507 7,573,171 29 160,761,703 219,621,959
May 15, 1997 5,550,618 7,573,168 15 83,259,270 113,597,526
May 30, 1997 5,552,252 7,574,802 7 38,865,764 53,023,617
June 6, 1997 5,555,471 7,574,801 6 33,332,826 45,448,808
June 12, 1997 5,556,641 7,574,800 5 27,783,205 37,874,002
June 17, 1997 5,556,651 7,574,810 1 5,556,651 7,574,810
June 18, 1997 5,564,201 7,574,810 2 11,128,402 15,149,619
June 20, 1997 5,566,152 7,574,809 6 33,396,912 45,448,854
June 26, 1997 5,566,652 7,575,309 5 27,833,260 37,876,545
July 1, 1997 5,566,652 7,575,309 27 150,299,604 204,533,342
July 28, 1997 5,566,902 7,575,559 4 22,267,608 30,302,236
August 1, 1997 5,568,072 7,575,558 31 172,610,232 234,842,299
September 1, 1997 5,774,651 7,575,556 3 17,323,953 22,726,669
September 4, 1997 6,454,906 7,575,538 1 6,454,906 7,575,538
September 5, 1997 7,567,091 7,567,091 26 196,744,366 196,744,366
October 1, 1997 7,567,091 7,567,091 29 219,445,639 219,445,639 219,445,639 219,445,639
October 30, 1997 7,567,741 7,567,741 47 355,683,827 355,683,827 355,683,827 355,683,827
December 16,1997 7,568,541 7,568,541 2 15,137,082 15,137,082 15,137,082 15,137,082
December 18, 1997 7,568,791 7,568,791 1 7,568,791 7,568,791 7,568,791 7,568,791
December 19, 1997 7,569,791 7,569,791 13 98,407,283 98,407,283 98,407,283 98,407,283
------------- ------------- ------------- -------------
696,242,622 696,242,622 2,265,675,210 2,763,511,457
------------- ------------- ------------- -------------
Divide by Number of Days Included in Period 365 92 92 365 365
------------- ------------- ------------- -------------
Weighted Average Shares Outstanding 7,567,855 7,567,855 6,207,329 7,571,264
Adjustment for Common Stock Equivalents
(Stock Options) 162,511 136,069
------------- ------------- ------------- -------------
Total 7,567,855 7,730,366 6,207,329 7,707,333
============= ============= ============= =============
Net Income $ 2,543,000 $ 2,543,000 $ 9,636,000 $ 9,636,000
Dividends Declared on Preferred Shares 0 (940,000)
------------- ------------- ------------- -------------
Net Income Available to Common Shareholders $ 2,543,000 $ 2,543,000 $ 8,696,000 $ 9,636,000
Net Income Per Share $ 0.34 $ 0.33 $ 1.40 $ 1.25
</TABLE>
<PAGE>
COMPUTATION OF NET INCOME PER SHARE
For the Three and Twelve Months Ending December 31,1996
<TABLE>
<CAPTION>
Three Months Daily Twelve Months Daily
Shares Outstanding Weighted Average Weighted Average
---------------------- ----------------------------- -----------------------------
Common Number
Common Equivalent of Days Basic Diluted Basic Diluted
--------- ---------- ------- -------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
January 1, 1996 5,411,022 7,440,686 17 91,987,374 126,491,662
January 18, 1996 5,424,944 7,454,608 8 43,399,552 59,636,864
January 26, 1996 5,425,648 7,455,312 66 358,092,768 492,050,592
April 1, 1996 5,425,648 7,455,312 60 325,538,880 447,318,720
May 31, 1996 5,426,398 7,456,062 31 168,218,338 231,137,922
July 1, 1996 5,426,398 7,456,062 9 48,837,582 67,104,558
July10, 1996 5,462,054 7,491,718 1 5,462,054 7,491,718
July 11 1996 5,483,264 7,512,928 4 21,933,056 30,051,712
July 15, 1996 5,498,370 7,528,034 2 10,996,740 15,056,068
July 17 1996 5,502,836 7,532,500 5 27,514,180 37,662,500
July 22 1996 5,513,970 7,543,634 1 5,513,970 7,543,634
July 23, 1996 5,526,724 7,556,388 1 5,526,724 7,556,388
July 24, 1996 5,531,968 7,561,632 2 11,063,936 15,123,264
July 26, 1996 5,532,468 7,562,132 5 27,662,340 37,810,660
July 31, 1996 5,532,592 7,562,256 12 66,391,104 90,747,072
August 12, 1996 5,533,342 7,563,006 1 5,533,342 7,563,006
August 13, 1996 5,534,342 7,564,006 8 44,274,736 60,512,048
August 21, 1996 5,534,958 7,564,622 5 27,674,790 37,823,110
August 26, 1996 5,535,208 7,564,872 2 11,070,416 15,129,744
August 28, 1996 5,535,828 7,565,492 1 5,535,828 7,565,492
August 29, 1996 5,537,328 7,566,992 33 182,731,824 249,710,736
October 1, 1996 5,537,328 7,566,992 83 459,598,224 628,060,336 459,598,224 628,060,336
December 23, 1996 5,539,178 7,568,842 9 49,852,602 68,119,578 49,852,602 68,119,578
------------- ------------- ------------- -------------
509,450,826 696,179,914 2,004,410,360 2,747,267,384
------------- ------------- ------------- -------------
Divide by Number of Days Included in Period 366 92 92 366 366
------------- ------------- ------------- -------------
Weighted Average Shares Outstanding 5,537,509 7,567,173 5,476,531 7,506,195
Adjustment for Other Common Stock Equivalents
(Stock Options) 67,427 67,427
------------- ------------- ------------- -------------
Total 5,537,509 7,634,600 5,476,531 7,573,622
============= ============= ============= =============
Net Income $ 2,195,000 $ 2,195,000 $ 2,483,000 $ 2,483,000
Dividends Declared on Preferred Shares (471,000) (1,885,000)
------------- ------------- ------------- -------------
Net Income Available to Common Shareholders $ 1,724,000 $ 2,195,000 $ 598,000 $ 2,483,000
============= ============= ============= =============
Net Income Per Share $ 0.31 $ 0.29 $ 0.11 $ 0.11
</TABLE>
Note: Convertible Preferred Stock is antidilutive for the 12 months
ended December 31, 1996. Therefore, basic earnings per share is
used.
<PAGE>
EXHIBIT 12.1
COMPUTATION OF RETURN ON AVERAGE COMMON SHAREHOLDERS' EQUITY
For the Three and Twelve Months Ending December 31, 1997
<TABLE>
<CAPTION>
Three Months Daily Twelve Months Daily
Shareholders' Equity Number Weighted Average Weighted Average
------------------------ ------------------------------ ------------------------------
Total Common of Days Total Common Total Common
----------- ----------- ------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
January 1, 1997 89,220,449 64,595,576 14 1,249,086,286 904,338,064
January 15, 1997 89,861,130 65,236,257 9 808,750,170 587,126,313
January 24, 1997 89,863,767 65,238,894 22 1,977,002,874 1,435,255,668
February 15, 1997 90,682,794 66,057,921 12 1,088,193,528 792,695,052
February 27, 1997 90,696,354 66,071,481 16 1,451,141,664 1,057,143,696
March 15, 1997 91,510,773 66,885,900 16 1,464,172,368 1,070,174,400
March 31, 1997 86,834,771 62,209,898 1 86,834,771 62,209,898
April 1, 1997 86,834,771 62,209,898 14 1,215,686,794 870,938,572
April 15, 1997 87,495,496 62,870,623 1 87,495,496 62,870,623
April 16, 1997 87,500,451 62,875,578 29 2,537,513,079 1,823,391,762
May 15, 1997 88,086,837 63,548,269 15 1,321,302,555 953,224,035
May 30, 1997 88,086,838 63,548,270 7 616,607,866 444,837,890
June 6, 1997 88,086,824 63,587,324 6 528,520,944 381,523,944
June 12, 1997 88,086,811 63,601,518 3 264,260,433 190,804,554
June 15, 1997 89,128,022 64,642,729 2 178,256,044 129,285,458
June 17, 1997 89,128,106 64,642,813 1 89,128,106 64,642,813
June 18, 1997 89,128,097 64,734,413 2 178,256,194 129,468,826
June 20, 1997 89,128,089 64,758,083 6 534,768,534 388,548,498
June 26, 1997 89,135,151 64,765,145 4 356,540,604 259,060,580
June 30, 1997 93,479,273 69,109,267 1 93,479,273 69,109,267
July 1, 1997 93,479,273 69,109,267 14 1,308,709,822 967,529,738
July 15, 1997 94,267,987 69,897,981 14 1,319,751,818 978,571,734
July 28, 1997 94,267,993 69,897,987 4 377,071,972 279,591,948
August 1, 1997 94,267,980 69,912,181 14 1,319,751,720 978,770,534
August 15, 1997 95,065,284 70,709,485 17 1,616,109,828 1,202,061,245
September 1, 1997 95,065,284 73,215,823 3 285,195,852 219,647,469
September 4, 1997 95,064,955 81,468,899 1 95,064,955 81,468,899
September 5, 1997 94,952,229 94,952,229 10 949,522,290 949,522,290
September 15, 1997 95,897,113 95,897,113 14 1,342,559,582 1,342,559,582
September 30, 1997 98,250,168 98,250,168 1 98,250,168 98,250,168
October 1, 1997 98,250,168 98,250,168 14 1,375,502,352 1,375,502,352 1,375,502,352 1,375,502,352
October 15, 1997 99,058,532 99,058,532 15 1,485,877,980 1,485,877,980 1,485,877,980 1,485,877,980
October 30, 1997 99,064,570 99,064,570 2 198,129,140 198,129,140 198,129,140 198,129,140
November 1, 1997 99,064,131 99,064,131 14 1,386,897,834 1,386,897,834 1,386,897,834 1,386,897,834
November 15, 1997 99,810,856 99,810,856 30 2,994,325,680 2,994,325,680 2,994,325,680 2,994,325,680
</TABLE>
<PAGE>
COMPUTATION OF RETURN ON AVERAGE COMMON SHAREHOLDERS' EQUITY, CONTINUED
For the Three and Twelve Months Ending December 31, 1997
<TABLE>
<CAPTION>
Three Months Daily Twelve Months Daily
Shareholders' Equity Number Weighted Average Weighted Average
------------------------ ------------------------------ ------------------------------
Total Common of Days Total Common Total Common
----------- ----------- ------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
December 15,1997 100,798,006 100,798,006 1 100,798,006 100,798,006 100,798,006 100,798,006
December 16,1997 100,805,438 100,805,438 2 201,610,876 201,610,876 201,610,876 201,610,876
December 18,1997 100,807,760 100,807,760 1 100,807,760 100,807,760 100,807,760 100,807,760
December 19,1997 100,818,990 100,818,990 5 504,094,950 504,094,950 504,094,950 504,094,950
December 24,1997 100,808,046 100,808,046 7 705,656,322 705,656,322 705,656,322 705,656,322
December 31, 1997 102,862,739 102,862,739 1 102,862,739 102,862,739 102,862,739 102,862,739
-------------- -------------- -------------- --------------
Total 365 9,156,563,639 9,156,563,639 33,995,549,229 27,931,187,159
-------------- -------------- -------------- --------------
Divide by Number of Days 92 92 365 365
-------------- -------------- -------------- --------------
Average 99,527,866 99,527,866 93,138,491 76,523,800
-------------- -------------- -------------- --------------
Net Income Available to Common Shares $ 2,542,000 $ 8,696,000
Divide by Average Common Shareholders' Equity 99,527,866 76,523,800
Return on Average Common Shareholders' Equity 10.13% 11.36%
</TABLE>
<PAGE>
COMPUTATION OF RETURN ON AVERAGE COMMON SHAREHOLDERS' EQUITY
For the Three and Twelve Months Ending December 31, 1996
<TABLE>
<CAPTION>
Three Months Daily Twelve Months Daily
Shareholders' Equity Weighted Average Weighted Average
------------------------ Number ------------------------------ ------------------------------
Total Common of Days Total Common Total Common
----------- ----------- ------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
January 1, 1996 91,961,974 67,335,189 14 1,287,467,636 942,692,646
January 15, 1996 92,497,199 67,870,414 3 277,491,597 203,611,242
January 18, 1996 92,585,618 67,958,833 8 740,684,944 543,670,664
January 26, 1996 92,593,938 67,967,153 20 1,851,878,760 1,359,343,060
February 14, 1996 93,383,848 68,757,063 29 2,708,131,592 1,993,954,827
March 15, 1996 93,930,143 69,303,358 16 1,502,882,288 1,108,853,728
March 31, 1996 87,313,985 62,687,200 1 87,313,985 62,687,200
April 1, 1996 87,313,985 62,687,200 14 1,222,395,790 877,620,800
April 15,1996 87,962,409 63,335,624 30 2,638,872,270 1,900,068,720
May 15, 1996 88,449,990 63,823,205 16 1,415,199,840 1,021,171,280
May 31, 1996 88,454,476 63,827,691 15 1,326,817,140 957,415,365
June 15, 1996 89,033,073 64,406,288 15 1,335,496,095 966,094,320
June 30, 1996 85,745,299 61,118,514 1 85,745,299 61,118,514
July 1, 1996 85,745,299 61,118,514 9 771,707,691 550,066,626
July 10, 1996 86,142,936 61,516,151 1 86,142,936 61,516,151
July 11, 1996 86,393,594 61,766,809 4 345,574,376 247,067,236
July 15, 1996 87,083,794 62,457,009 2 174,167,588 124,914,018
July 17, 1996 87,136,582 62,509,797 5 435,682,910 312,548,985
July 22, 1996 87,261,875 62,635,090 1 87,261,875 62,635,090
July 23, 1996 87,412,627 62,785,842 1 87,412,627 62,785,842
July 24, 1996 87,474,611 62,847,826 2 174,949,222 125,695,652
July 26, 1996 87,479,876 62,853,091 5 437,399,380 314,265,455
July 31, 1996 87,479,876 62,853,091 12 1,049,758,512 754,237,092
August 12, 1996 87,486,564 62,859,779 1 87,486,564 62,859,779
August 13, 1996 87,493,494 62,866,709 2 174,986,988 125,733,418
August 15, 1996 88,043,732 63,416,947 6 528,262,392 380,501,682
August 21, 1996 88,044,563 63,417,778 5 440,222,815 317,088,890
August 26, 1996 88,046,295 63,419,510 2 176,092,590 126,839,020
August 28, 1996 88,046,295 63,419,510 1 88,046,295 63,419,510
August 29, 1996 88,056,691 63,429,906 17 1,496,963,747 1,078,308,402
September 15, 1996 87,296,323 62,669,538 15 1,309,444,845 940,043,070
September 30, 1996 84,319,754 59,692,969 1 84,319,754 59,692,969
October 1, 1996 84,319,754 59,694,881 14 1,180,476,556 835,728,334 1,180,476,556 835,728,334
October 15, 1996 85,066,505 60,441,632 31 2,637,061,655 1,873,690,592 2,637,061,655 1,873,690,592
November 15, 1996 85,797,964 61,173,091 30 2,573,938,920 1,835,192,730 2,573,938,920 1,835,192,730
</tabe>
<PAGE>
COMPUTATION OF RETURN ON AVERAGE COMMON SHAREHOLDERS' EQUITY, CONTINUED
For the Three and Twelve Months Ending December 31, 1996
</TABLE>
<TABLE>
<CAPTION>
Three Months Daily Twelve Months Daily
Shareholders' Equity Weighted Average Weighted Average
------------------------ Number ------------------------------ ------------------------------
Total Common of Days Total Common Total Common
----------- ----------- ------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
December 15, 1996 86,515,160 61,890,287 8 692,121,280 495,122,296 692,121,280 495,122,296
December 23, 1996 86,515,160 61,890,287 8 692,121,280 495,122,296 692,121,280 495,122,296
December 31, 1996 89,220,449 64,595,576 1 89,220,449 64,595,576 89,220,449 64,595,576
-------------- -------------- -------------- --------------
Total 7,864,940,140 5,599,451,824 32,381,200,483 23,367,973,077
-------------- -------------- -------------- --------------
Divide by Number of Days 92 92 366 366
-------------- -------------- -------------- --------------
Average 85,488,480 60,863,607 88,473,225 63,846,921
Net Income Available to Common Shares $ 1,724,000 $ 598,000
Divide by Average Common Shareholders' Equity 60,863,607 63,846,921
Return on Average Common Shareholders' Equity 11.24% 0.94%
<PAGE>
</TABLE>
EXHIBIT 12.2
COMPUTATION OF RETURN ON AVERAGE ASSETS
Three and Twelve Months Ending December 31, 1997
Total Assets
--------------------------------
Three Months Twelve Months
--------------- ---------------
December 31, 1996 1,536,344,000
January 31, 1997 1,547,807,000
February 28, 1997 1,555,935,000
March 31, 1997 1,557,216,000
April 30, 1997 1,557,181,000
May 31, 1997 1,608,377,000
June 30, 1997 1,686,395,000
July 31, 1997 1,804,267,000
August 31, 1997 1,849,172,000
September 30, 1997 1,870,513,000 1,870,513,000
October 31, 1997 1,855,893,000 1,855,893,000
November 30, 1997 1,880,378,000 1,880,378,000
December 31, 1997 1,876,250,000 1,876,250,000
--------------- ---------------
7,483,034,000 22,185,728,000
Divide by Number of Months 4 13
--------------- ---------------
Average $ 1,870,758,500 $ 1,706,594,462
=============== ===============
Net Income $ 2,543,000 $ 9,636,000
Divide by Average Assets 1,870,758,500 1,706,594,462
--------------- ---------------
Return on Average Assets 0.54% 0.56%
=============== ===============
<PAGE>
COMPUTATION OF RETURN ON AVERAGE ASSETS
For the Three and Twelve Months Ended December 31, 1996
Total Assets
--------------------------------
Three Months Twelve Months
--------------- ---------------
December 31, 1995 1,506,496,000
January 31, 1996 1,512,583,000
February 29, 1996 1,502,502,000
March 31, 1996 1,497,617,000
April 30, 1996 1,491,384,000
May 31, 1996 1,485,967,000
June 30, 1996 1,477,698,000
July 31, 1996 1,480,342,000
August 31, 1996 1,487,950,000
September 30, 1996 1,531,295,000 1,531,295,000
October 31, 1996 1,547,601,000 1,547,601,000
November 30, 1996 1,552,864,000 1,552,864,000
December 31, 1996 1,536,344,000 1,536,344,000
--------------- ---------------
6,168,104,000 19,610,643,000
Divide by Number of Months 4 13
--------------- ---------------
Average 1,542,026,000 1,508,511,000
=============== ===============
Net Income $ 2,195,000 $ 2,483,000
Divide by Average Assets 1,542,026,000 1,508,511,000
--------------- ---------------
Return on Average Assets 0.56% 0.16%
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE REGISTRANT
State of Percent
Incorporation Owned
------------- -------
Sterling Savings Association Washington 100%
Tri-Cities Mortgage Corporation Washington 100%
Sterling Capital Trust I Delaware 100%
Subsidiaries of Sterling Savings
Association:
Action Mortgage Company Washington 100%
Harbor Financial Services, Inc. Washington 100%
(A subsidiary of Evergreen First Service
Corporation)
INTERVEST-Mortgage Investment Company Washington 100%
Evergreen Environmental Development
Corporation Washington 100%
Evergreen First Service Corporation Washington 100%
Fidelity Service Corporation Washington 100%
Tri-West Mortgage Company Washington 100%
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration
statements of Sterling Financial Corporation on Form S-8 (File
No. 33-55754 and 33-55756) of our report, which includes an
explanatory paragraph describing the changes in the methods of
accounting for the transfer and servicing of financial assets and
liabilities as of January 1, 1997, impairment of long-lived
assets and mortgage servicing rights as of July 1, 1996 and
impaired loans as of July 1, 1995, dated January 28, 1998, on our
audits of the consolidated financial statements of Sterling
Financial Corporation as of December 31, 1997 and 1996 and
June 30, 1996, and for the year ended December 31, 1997, the six
months ended December 31, 1996 and the years ended June 30, 1996
and 1995, which report is included in this Annual Report on
Form 10-K.
/s/ Coopers & Lybrand, L.L.P.
Spokane, Washington
January 28, 1998
<PAGE>
