UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
March 31, 1999
--------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
__________________ TO ____________________.
Commission file number.....0-20800
STERLING FINANCIAL CORPORATION
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Washington 91-1572822
--------------------------------- -------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
111 North Wall Street, Spokane, Washington 99201
----------------------------------------------------
(Address of principal executive offices) (Zip Code)
(509) 458-2711
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Sections 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date:
Class Outstanding as of April 30, 1999
------------------------------ --------------------------------
Common Stock ($1.00 par value) 8,091,655
<PAGE>
STERLING FINANCIAL CORPORATION
FORM 10-Q
For the Quarter Ended March 31, 1999
TABLE OF CONTENTS
PART I - Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Consolidated Statements of Comprehensive Income
Notes to Consolidated Financial Statements
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3 - Quantitative and Qualitative Disclosures About
Market Risk
PART II - Other Information
Item 1 - Legal Proceedings
Item 2 - Changes in Securities and Use of Proceeds
Item 3 - Defaults Upon Senior Securities
Item 4 - Submission of Matters to a Vote of Security Holders
Item 5 - Other Information
Item 6 - Exhibits and Reports on Form 8-K
Signature
<PAGE>
PART I - Financial Information
Item 1 - Financial Statements
------------------------------
STERLING FINANCIAL CORPORATION
Consolidated Balance Sheets
(Unaudited)
March 31, December 31,
1999 1998
---------- ------------
(Dollars in thousands)
ASSETS
Cash and cash equivalents:
Interest bearing $ 948 $ 26,977
Non-interest bearing and vault 51,162 61,354
Restricted 2,658 8,775
Loans receivable, net 1,629,296 1,468,534
Loans held for sale 6,886 15,881
Investments and mortgage-backed
securities ("MBS"):
Available for sale 502,411 566,372
Held to maturity 14,662 20,033
Accrued interest receivable (including
$3,504 and $4,954 on investments
and MBS) 14,355 14,938
Real estate owned, net 5,532 6,232
Office properties and equipment, net 52,633 51,771
Other intangible assets, net 59,732 61,180
Prepaid expenses and other assets, net 13,660 12,540
---------- ----------
Total assets $2,353,935 $2,314,587
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $1,563,748 $1,545,425
Advances from Federal Home Loan Bank
Seattle ("FHLB Seattle") 335,441 319,540
Securities sold subject to repurchase
agreements and federal funds purchased 198,224 195,074
Other borrowings (Note 3) 102,240 97,240
Cashiers checks issued and payable 14,332 17,512
Borrowers' reserves for taxes and insurance 2,988 1,826
Accrued interest payable 5,533 5,639
Accrued expenses and other liabilities 11,641 13,314
---------- ----------
Total liabilities 2,234,147 2,195,570
---------- ----------
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Balance Sheets, Continued
(Unaudited)
March 31, December 31,
1999 1998
---------- ------------
(Dollars in thousands)
Preferred stock, $1 par value; 10,000,000
shares authorized; 0 shares issued and
outstanding $ 0 $ 0
Common stock, $1 par value; 20,000,000
shares authorized; 8,072,021 and 8,056,072
shares issued and outstanding 8,072 8,056
Additional paid-in capital 70,276 70,229
Accumulated other comprehensive income
(loss):
Unrealized gains (losses) on invest-
ments and MBS available for sale,
net of deferred income tax provision
(benefit) of $(723) and $424 (1,342) 788
Retained earnings 42,782 39,944
---------- ----------
Total shareholders' equity 119,788 119,017
---------- ----------
Total liabilities and shareholders'
equity $2,353,935 $2,314,587
========== ==========
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Income
(Unaudited)
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands,
except per share data)
Interest income:
Loans $ 32,746 $ 25,415
MBS 5,934 7,164
Investments and cash equivalents 2,826 3,377
---------- ----------
Total interest income 41,506 35,956
---------- ----------
Interest expense:
Deposits 14,669 12,503
Short-term borrowings 2,856 8,292
Long-term borrowings 6,238 2,749
---------- ----------
Total interest expense 23,763 23,544
---------- ----------
Net interest income 17,743 12,412
Provision for losses on loans (900) (808)
---------- ----------
Net interest income after provision for
losses on loans 16,843 11,604
---------- ----------
Other income:
Fees and service charges 2,468 1,408
Mortgage banking operations 353 668
Loan servicing fees 197 248
Net gains on sales of securities 593 711
Real estate owned operations (92) (68)
---------- ----------
Total other income 3,519 2,967
---------- ----------
Operating expenses 15,862 10,165
---------- ----------
Income before income taxes 4,500 4,406
Income tax provision (1,662) (1,580)
---------- ----------
Net income $ 2,838 $ 2,826
========== ==========
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Income, Continued
(Unaudited)
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands,
except per share data)
Income per common share - basic $ 0.35 $ 0.35
========== ==========
Income per common share - diluted $ 0.35 $ 0.34
========== ==========
Weighted average common shares
outstanding - basic 8,063,756 8,004,135
========== ==========
Weighted average common shares
outstanding - diluted 8,184,690 8,207,691
========== ==========
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands)
Cash flows from operating activities:
Net income $ 2,838 $ 2,826
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Provisions for loan and real estate
owned losses 1,105 814
Stock dividends on FHLB Seattle stock (618) (573)
Net gain on sales of loans, securities
and mortgage servicing rights (911) (1,300)
Net gain on sales of real estate owned (136) (23)
Depreciation and amortization 1,829 1,885
Deferred income tax provision 0 (101)
Compensation expense associated with
stock grants 0 18
Change in:
Accrued interest receivable 583 1,578
Prepaid expenses and other assets (49) (251)
Cashiers checks issued and payable (3,180) (3,068)
Accrued interest payable (106) (797)
Accrued expenses and other
liabilities (1,673) 2,068
Proceeds from sales of loans 30,026 26,693
Loans originated for sale (29,700) (34,844)
---------- ----------
Net cash provided by (used in)
operating activities 8 (5,075)
---------- ----------
Cash flows from investing activities:
Change in restricted cash 6,117 (1,692)
Loans disbursed (371,817) (237,730)
Loan principal received 218,825 205,952
Purchase of investments (29,823) (64,874)
Proceeds from maturities of investments 34,285 68,569
Proceeds from sales of available-for-sale
investments 542 0
Purchase of MBS 0 (190,217)
Principal payments on MBS 32,904 27,368
Proceeds from sales of MBS 29,104 174,107
Purchase of office properties and
equipment (862) (170)
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows, Continued
(Unaudited)
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands)
Cash flows from investing activities
Continued:
Improvements and other changes to real
estate owned (12) 263
Proceeds from sales and liquidation of
real estate owned 959 300
Proceeds from sales of mortgage
servicing rights 0 449
---------- ----------
Net cash used in investing
activities (79,778) (17,675)
---------- ----------
Cash flows from financing activities:
Net change in checking, passbook and money
market deposits $ (9,593) $ 15,106
Proceeds from issuance of certificates
of deposit 199,873 316,987
Payments for maturing certificates of
deposit (186,452) (355,312)
Interest credited to deposits 14,495 12,645
Advances from FHLB Seattle 35,877 30,000
Repayment of FHLB Seattle advances (20,026) (55,021)
Net change in securities sold subject to
repurchase agreements and funds purchased 3,150 59,806
Proceeds from other borrowings 5,000 0
Repayment of other borrowings 0 (15,000)
Proceeds from exercise of stock options,
net of repurchases 63 281
Other 1,162 1,407
---------- ----------
Net cash provided by financing
activities 43,549 10,899
---------- ----------
Net change in cash and cash equivalents (36,221) (11,851)
Cash and cash equivalents, beginning of
period 88,331 52,439
---------- ----------
Cash and cash equivalents, end of period $ 52,110 $ 40,588
========== ==========
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows, Continued
(Unaudited)
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands)
Supplemental disclosures:
Cash paid during the period for:
Interest $ 23,869 $ 23,697
Income taxes 719 1,235
Noncash financing and investing activities:
Loans converted into real estate owned 317 1,137
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Comprehensive Income
(Unaudited)
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands)
Net income $ 2,838 $ 2,826
Other comprehensive income (loss):
Change in unrealized gains or losses
on investments and MBS available for
sale (3,277) 48
Less deferred income tax (provision)
benefit 1,147 (17)
---------- ----------
Net other comprehensive income (loss) (2,130) 31
---------- ----------
Comprehensive income $ 708 $ 2,857
========== ==========
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
1. GENERAL:
Notes to the December 31, 1998 consolidated financial statements,
as set forth in Sterling Financial Corporation's ("Sterling's")
December 31, 1998 Annual Report on Form 10-K, substantially apply
to these interim consolidated financial statements as of and for
the three months ended March 31, 1999 and are not repeated here.
All financial statements presented are unaudited. However, the
December 31, 1998 consolidated balance sheet was derived from the
audited balance sheet as of that date.
2. INTERIM FINANCIAL STATEMENTS:
The financial information set forth in the unaudited interim
consolidated financial statements reflects the adjustments, all of
which are of a normal and recurring nature, which, in the opinion
of management, are necessary for a fair presentation of the
periods reported. The unaudited interim consolidated financial
statements for the three months ended March 31, 1998 have been
restated to reflect the November 1998 acquisition of Big Sky
Bancorp, Inc. ("Big Sky"), which was accounted for as a pooling of
interests.
3. OTHER BORROWINGS:
The following table details Sterling's other borrowings.
March 31, December 31,
1999 1998
---------- ------------
(Dollars in thousands)
Advances on line of credit(1) $ 40,000 $ 40,000
Advances on line of credit(2) 5,000 0
8.75% Subordinated Notes Due 2000 17,240 17,240
Sterling obligated mandatorily
redeemable preferred securities
of subsidiary trust holding solely
junior subordinated deferrable
interest debentures of Sterling(3) 40,000 40,000
---------- -----------
$ 102,240 $ 97,240
========== ===========
(1) In June 1998, Sterling entered into a one-year variable rate
line-of-credit agreement with KeyBank National Association
("KeyBank"). Interest accrues at the London Interbank
Offering Rate Index plus 2.0% (7.0% at March 31, 1999) and is
payable monthly. This line of credit is for twelve months
and may be renewed for an additional six months. Subsequent
to quarter end, Sterling obtained a commitment to extend this
borrowing to May 31, 2001 and to increase the balance to
$50.0 million. The commitment is subject to several material
conditions. Therefore, there can be no assurance that the
borrowing will be extended.
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements, Continued
3. OTHER BORROWINGS, CONTINUED:
(2) At March 31, 1999, Sterling borrowed $5.0 million on a line
of credit from KeyBank which matures on April 1, 2000. All
of the proceeds of this loan were contributed to Sterling
Savings Bank to enhance its regulatory capital ratios.
Interest accrues at KeyBank's prime rate (7.75% at March 31,
1999) and is payable monthly.
(3) Sterling has outstanding $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 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. The Trust Preferred Securities must be
redeemed upon maturity of the Junior Subordinated Debentures
in 2027.
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements, Continued
4. INCOME PER SHARE:
The following table presents the basic and diluted income per
share computations.
<TABLE>
<CAPTION>
Three Months Ended March 31,
---------------------------------------------------------------------------
1999 1998
------------------------------------ ------------------------------------
Weighted Per Share Weighted Per Share
Net Income Avg. Shares Amount Net Income Avg. Shares Amount
---------- ----------- --------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic computations $2,838,000 8,063,756 $ 0.35 $2,826,000 8,004,135 $ 0.35
Effect of dilutive securities:
Common stock options 0 120,934 0 203,556
---------- ----------- --------- ---------- ----------- ---------
Diluted computations $2,838,000 8,184,690 $ 0.35 $2,826,000 8,207,691 $ 0.34
========== =========== ========= ========== =========== =========
Antidilutive options not included
in diluted income per share 71,500 0
</TABLE>
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements, Continued
5. OPERATING EXPENSES:
The following table details Sterling's components of total
operating expenses:
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands)
Employee compensation and benefits $ 6,941 $ 4,736
Occupancy and equipment 2,362 1,582
Depreciation 1,004 762
Amortization of intangibles 1,448 537
Advertising 619 279
Data processing 1,279 747
Insurance 274 248
Legal and accounting 391 396
Travel and entertainment 380 295
Other 1,164 583
---------- ----------
Total operating expenses $ 15,862 $ 10,165
========== ==========
6. OTHER ACCOUNTING POLICIES:
In June 1998, the Financial Accounting Standards Board (the
"FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 133, Accounting for Derivative Instruments and
Hedging Activities. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively
referred to as derivatives), and for hedging activities. It
requires that an entity recognize all derivatives as either assets
or liabilities in the statement of financial position and measure
those instruments at fair value. SFAS No. 133 is effective for
all fiscal quarters of fiscal years beginning after June 15, 1999;
however, earlier application of all of the provisions of this
Statement is encouraged as of the beginning of any fiscal quarter.
Sterling has not yet determined the effect, if any, of
implementing SFAS No. 133 on its consolidated financial
statements.
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements, Continued
7. MORTGAGE BANKING OPERATIONS:
Sterling operates ten residential loan production offices
primarily in the Spokane and Seattle, Washington; Portland,
Oregon; and Boise, Idaho metropolitan areas through its subsidiary
Action Mortgage. Mortgage banking operations include revenues
from servicing released and servicing retained sales of originated
residential loans, bulk sales of loan servicing rights and other
fees.
The following table summarizes information related to Sterling's
mortgage banking operations:
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands)
Revenues:
Gains on sales of originated
residential loans $ 318 $ 382
Other fees and income 1,239 1,037
---------- ----------
Total revenues 1,557 1,419
Identifiable expenses 809 735
---------- ----------
Income before adjustments, elimina-
tions and income taxes 748 684
Adjustments and eliminations 0 0
---------- ----------
Income before income taxes $ 748 $ 684
========== ==========
Identifiable assets $ 9,511 $ 5,883
========== ==========
Depreciation and amortization expense $ 33 $ 34
========== ==========
Capital expenditures for office
properties and equipment $ 28 $ 4
========== ==========
The following is a reconciliation of certain mortgage banking
operations to the amounts reported in the consolidated financial
statements:
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements, Continued
7. MORTGAGE BANKING OPERATIONS, CONTINUED:
<TABLE>
<CAPTION>
Mortgage
Banking Banking
Operations Operations Total
---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C>
As of and for the three months
ended March 31, 1999:
Other income $ 3,166 $ 353 $ 3,519
Income before income taxes 3,752 748 4,500
Total assets 2,344,424 9,511 2,353,935
As of and for the three months
ended March 31, 1998:
Other income $ 2,299 $ 668 $ 2,967
Income before income taxes 3,722 684 4,406
Total assets 1,944,599 5,883 1,950,482
</TABLE>
<PAGE>
PART I - Financial Information (continued)
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations
--------------------------------------------------------------------
STERLING FINANCIAL CORPORATION
Comparison of the Three Months Ended March 31, 1999 and 1998
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; SHIFTS IN THE
DEMAND FOR STERLING'S LOAN AND OTHER PRODUCTS; LOWER THAN EXPECTED
REVENUE OR COST SAVINGS IN CONNECTION WITH ACQUISITIONS; CHANGES IN
ACCOUNTING POLICIES; CHANGES IN THE MONETARY AND FISCAL POLICIES OF
THE FEDERAL GOVERNMENT; CHANGES IN LAWS, REGULATIONS AND THE
COMPETITIVE ENVIRONMENT. STERLING'S FUTURE RESULTS MAY DIFFER
MATERIALLY FROM HISTORICAL RESULTS AS WELL AS FROM ANY TREND OR
FORWARD-LOOKING INFORMATION INCLUDED IN THIS REPORT.
GENERAL
-------
Sterling Financial Corporation ("Sterling") is a unitary savings and
loan holding company, the significant operating subsidiary of which is
Sterling Savings Bank ("Sterling Savings Bank"). The significant
operating subsidiaries of Sterling Savings Bank are Action Mortgage
Company ("Action Mortgage"), INTERVEST-Mortgage Investment Company
("INTERVEST") and Harbor Financial Services, Inc. ("Harbor
Financial").
Sterling endeavors to provide personalized, quality financial services
to its customers as exemplified by its "Hometown Helpful" philosophy.
Sterling believes that this dedication to personalized service has
enabled it to maintain a stable retail deposit base. Sterling, with
$2.35 billion in total assets at March 31, 1999, attracts Federal
Deposit Insurance Corporation ("FDIC") insured deposits from the
general public through 77 retail branches located primarily in rural
and suburban communities in Washington, Oregon, Idaho and Montana.
Sterling originates loans through its branch offices as well as ten
Action Mortgage residential loan production offices in the
metropolitan areas of Spokane and Seattle, Washington; Portland,
Oregon; and Boise, Idaho; and four INTERVEST commercial real estate
lending offices located in the metropolitan areas of Spokane and
Seattle, Washington; and Portland, Oregon. Sterling also markets
tax-deferred annuities, mutual funds and other financial products
through Harbor Financial.
<PAGE>
Recently, Sterling has focused its efforts on becoming more like a
community bank by increasing its commercial real estate, business
banking, consumer and construction lending while increasing its retail
deposits, particularly transaction accounts. Commercial real estate,
business banking, consumer and construction loans generally produce
higher yields than residential loans. Such loans, however, generally
involve a higher degree of risk than financing residential real
estate. Sterling's revenues are derived primarily from interest
earned on loans, investments and mortgage-backed securities ("MBS"),
from fees and service charges and from mortgage banking operations.
The operations of Sterling Savings Bank, and savings institutions
generally, are influenced significantly by general economic conditions
and by policies of its primary regulatory authorities, the Office of
Thrift Supervision ("OTS"), the FDIC and the State of Washington
Department of Financial Institutions ("Washington Supervisor").
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. In June
1998, Sterling acquired 33 branch offices in Washington, Idaho and
Oregon from KeyBank National Association ("KeyBank"). Sterling
completed the acquisition of Big Sky Bancorp, Inc. ("Big Sky") and its
subsidiary, First Federal Savings and Loan Association of Montana
("First Federal"), in November 1998. The merger with Big Sky was
accounted for as a pooling of interests; and accordingly, all
historical amounts have been restated to include the results of Big
Sky.
Management believes that by changing the mix of its assets and
liabilities to be more like a community bank, its net interest income
(the difference between the interest earned on loans and investments
and the interest paid on liabilities) and other fee income will
increase, although there can be no assurances in this regard.
Sterling intends to continue to pursue an aggressive growth strategy,
which may include acquiring other financial institutions or branches
thereof or other substantial assets or deposit liabilities. Sterling
may not be successful in identifying further acquisition candidates,
integrating acquired institutions or preventing deposit erosion or
loan quality deterioration at acquired institutions. There is
significant competition for acquisitions in Sterling's market area,
and Sterling may not be able to acquire other institutions on
attractive terms. Furthermore, the success of Sterling's growth
strategy will depend on increasing and maintaining sufficient levels
of regulatory capital, obtaining necessary regulatory approvals,
generating appropriate growth and favorable economic and market
conditions. There can be no assurance that Sterling will be
successful in implementing its growth strategy.
<PAGE>
RESULTS OF OPERATIONS
---------------------
OVERVIEW. Sterling recorded net income of $2.8 million, or $0.35 per
diluted share, for the three months ended March 31, 1999. This
compares with net income of $2.8 million, or $0.34 per diluted share,
for the prior year's comparable period.
The annualized return on average assets was 0.49% and 0.60% for the
three months ended March 31, 1999 and 1998, respectively. The
decrease was due primarily to an increase in average assets relative
to net income. The annualized return on average equity was 9.55% and
10.24% for the three months ended March 31, 1999 and 1998,
respectively. The decrease was due primarily to the increase in
average common equity.
NET INTEREST INCOME. The most significant component of earnings for a
financial institution typically is net interest income ("NII"), which
is the difference between interest income, primarily from loan,
mortgage-backed securities ("MBS") and investment portfolios, and
interest expense, primarily on deposits and borrowings. During the
three months ended March 31, 1999 and 1998, NII was $17.7 million and
$12.4 million, respectively, an increase of 43.0%.
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. The
increase in NII during the quarter ended March 31, 1999 was due
primarily to the increase in average interest-earning assets and a
lower cost of funds.
During the three months ended March 31, 1999 and 1998, the volume of
average interest-earning assets was $2.15 billion and $1.79 billion,
respectively. Net interest spread during these periods was 3.21% and
2.59%, respectively. The net interest margin for the three months
ended March 31, 1999 and 1998 was 3.35% and 2.81%, respectively. Net
interest spread and net interest margin increased significantly from a
year ago, due primarily to a lower cost of funds. Net interest margin
increased due primarily to the wider spreads, which more than offset
the increase in average interest-bearing liabilities.
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.
<PAGE>
Sterling recorded provisions for loan losses of $900,000 and $808,000
for the three months ended March 31, 1999 and 1998, respectively.
Management anticipates that its provisions for loan losses will
continue to increase in the future as Sterling originates more
construction, business banking and consumer loans. At March 31, 1999,
Sterling's total classified assets were $19.4 million, compared with
$17.7 million at December 31, 1998. At March 31, 1999, Sterling's
loan delinquency rate as a percentage of total loans was 0.44%,
compared with 0.43% at December 31, 1998 and 0.53% at March 31, 1998.
Total nonperforming loans were $5.5 million at March 31, 1999,
compared with $4.2 million at March 31, 1998.
Management believes the loan loss provision for the three months ended
March 31, 1999 represents an appropriate allowance 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 as well as 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.
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in thousands)
Fees and service charges $ 2,468 $ 1,408
Mortgage banking operations 353 668
Loan servicing fees 197 248
Net gain on sales of securities 593 711
Real estate owned operations (92) (68)
---------- ----------
$ 3,519 $ 2,967
========== ==========
Fees and service charges consist primarily of service charges on
deposit accounts, fees for certain customer services, commissions on
sales of credit life insurance, commissions on sales of mutual funds
and annuity products and late charges on loans. The increases in such
fees and service charges for the three months ended March 31, 1999,
compared with the three months ended March 31, 1998, were due
primarily to the increase in fee-related transaction accounts
resulting from the KeyBank branch acquisition.
The following table summarizes loan originations and sales of loans
for the periods indicated.
<PAGE>
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in millions)
Originations of one-to-four family
permanent mortgage loans $ 64.6 $ 47.6
Sales of residential loans 29.7 26.3
Principal balances of mortgage loans
serviced for others 200.9 362.8
Sterling anticipates increasing its mortgage servicing portfolio over
the next twelve months by generating a greater volume of loan sales
through its mortgage banking subsidiary, Action Mortgage.
Loan servicing fees decreased for the three months ended March 31,
1999 compared with the prior year's comparable period, reflecting the
$161.9 million decrease in the balance of mortgage loans serviced for
others since March 1998. Sterling's average loan servicing portfolios
for the three months ended March 31, 1999 and 1998 were approximately
$205.3 million and $376.3 million, respectively.
During the three months ended March 31, 1999, Sterling sold
approximately $29.1 million of investments and MBS, resulting in net
gains of $593,000. In an effort to reposition the portfolio, Sterling
sold approximately $173.4 million of investments and MBS in the prior
year's comparable period, resulting in net gains of $711,000.
OPERATING EXPENSES. Operating expenses were $15.9 million and $10.2
million for the three months ended March 31, 1999 and 1998,
respectively. The increase was due primarily to increased staffing
levels, increased intangible amortization and increased data
processing and occupancy costs resulting from the KeyBank branch
acquisition.
Employee compensation and benefits were $6.9 million and $4.7 million
for the three months ended March 31, 1999 and 1998, respectively. The
increase was due primarily to increased staff hired in connection with
the new branches and increased community bank lending staff.
Amortization of intangibles was $1.4 million and $537,000 for the
three months ended March 31, 1999 and 1998, respectively. The
increase was due primarily to the amortization of the KeyBank
intangible asset.
Data processing expense was $1.3 million and $747,000 for the three
months ended March 31, 1999 and 1998, respectively. The increase was
due primarily to the costs incurred to process the substantial
increase in deposit and loan transactions.
<PAGE>
Occupancy and equipment expenses increased as a result of building
maintenance, property taxes and utility costs associated with the
addition of 33 branches. As a result, occupancy and equipment costs
were $2.4 million compared with $1.6 million for the quarters ended
March 31, 1999 and 1998, respectively.
INCOME TAX PROVISION. Sterling recorded federal and state income tax
provisions of $1.7 million and $1.6 million for the three months ended
March 31, 1999 and 1998, respectively. The effective tax rates during
these periods approximated the applicable statutory rates.
FINANCIAL POSITION
------------------
ASSETS. At March 31, 1999, Sterling's assets were $2.35 billion, up
1.7% from $2.31 billion at December 31, 1998.
INVESTMENTS AND MBS. Sterling's investment and MBS portfolio at
March 31, 1999 was $517.1 million, down $69.3 million from the
December 31, 1998 balance of $586.4 million. The decrease was due
primarily to net sales of MBS during the period.
LOANS RECEIVABLE. At March 31, 1999, net loans receivable were $1.63
billion, up $160.8 million from $1.47 billion at December 31, 1998.
The increase was due primarily to strong loan origination activity.
During the three months ended March 31, 1999, total loan originations
were $340.7 million compared with $207.7 million for the prior year's
comparable quarter. The most significant area of increase in loan
originations was in commercial real estate lending. See the loan
origination table below.
The following table sets forth the composition of Sterling's loan
portfolio at the dates indicated. Loan balances do not include
unearned discounts, deferred loan origination costs and fees or
allowances for loan losses.
March 31, 1999 December 31, 1998
----------------- -----------------
Amount % Amount %
---------- ----- ---------- -----
(Dollars in thousands)
Residential $ 367,868 22.4 $ 342,757 23.1
Multifamily 140,834 8.6 124,656 8.4
Commercial real estate 265,821 16.1 177,912 12.0
Construction 247,249 15.0 233,567 15.7
Consumer - direct 224,603 13.7 224,651 15.1
Consumer - indirect 75,805 4.6 64,764 4.4
Business banking 323,173 19.6 315,614 21.3
---------- ----- ---------- -----
Total loans receivable $1,645,353 100.0 $1,483,921 100.0
========== ===== ========== =====
<PAGE>
The following table sets forth Sterling's loan originations for the
periods indicated.
Three Months Ended
March 31,
---------------------- %
1999 1998 Change
---------- ---------- ------
(Dollars in thousands)
Residential $ 64,577 $ 47,579 35.7
Multifamily 29,580 13,245 123.3
Commercial real estate 64,128 10,585 505.8
Construction 77,690 61,277 26.8
Consumer - direct 29,789 15,654 90.3
Consumer - indirect 14,002 12,227 14.5
Business banking 60,951 47,144 29.3
---------- ---------- ------
Total loans originated $ 340,717 $ 207,711 64.0
========== ========== ======
Management believes its increase in loan originations is due primarily
to the increase in lending staff in its income property and business
banking departments over the last twelve months.
DEPOSITS. Total deposits increased $18.3 million to $1.56 billion at
March 31, 1999 from $1.55 billion at December 31, 1998. For the
quarter ended March 31, 1999, the average cost of total deposits was
3.83%, compared with 4.74% for the quarter ended March 31, 1998. The
decrease in the average cost of deposits was due primarily to the
increase in transaction accounts and the implementation of bank-like
pricing of certificates of deposit.
The following table sets forth the composition of Sterling's deposits
at the dates indicated.
March 31, 1999 December 31, 1998
----------------- -----------------
Amount % Amount %
---------- ----- ---------- -----
(Dollars in thousands)
Certificates of deposit $ 838,653 53.6 $ 814,957 52.8
Checking 288,286 18.4 297,290 19.2
Savings and money market 436,809 28.0 433,178 28.0
---------- ----- ---------- -----
Total deposits $1,563,748 100.0 $1,545,425 100.0
========== ===== ========== =====
<PAGE>
BORROWINGS. Deposit accounts are Sterling's primary source of funds.
Sterling does, however, rely upon advances from the Federal Home Loan
Bank Seattle ("FHLB Seattle") and reverse repurchase agreements to
supplement its funding and to meet deposit withdrawal requirements.
At March 31, 1999, total borrowings were $635.9 million, compared with
$611.9 million at December 31, 1998, an increase of $24.0 million.
See "Liquidity and Sources of Funds."
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, some of Sterling's
adjustable-rate mortgages 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.
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
<PAGE>
value of each major category of financial instruments is calculated
using estimated cash flows based on weighted-average contractual rates
and terms, then discounted at the estimated current market interest
rate for similar financial instruments. The present value of longer
term fixed-rate financial instruments is more difficult to estimate
because such instruments are susceptible to changes in market interest
rates. Present value estimates of adjustable-rate financial
instruments are more reliable since they represent the difference
between the contractual and discounted rates until the next interest
rate repricing date.
The calculations of present value have certain shortcomings. The
discount rates utilized for loans 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.
Sterling is continuing to pursue strategies to manage the level of its
IRR while increasing its NII and NPV through the origination and
retention of variable-rate consumer, business banking, construction
and commercial real estate loans, which generally have higher yields
than residential permanent loans, by the sale of certain long-term
fixed rate loans and investments and by increasing the level of its
core deposits, which are generally a lower-cost funding source than
borrowings. There can be no assurance that Sterling will be
successful implementing any of these strategies or that, if these
strategies are implemented, they will have the intended effect of
reducing IRR or increasing NII.
The following table presents Sterling's estimates of changes in NPV
for the periods indicated. The results indicate the impact of
instantaneous, parallel shifts in the market yield curve. These
calculations are highly subjective and technical and are relative
measurements of IRR which do not necessarily reflect any expected rate
movement.
<PAGE>
<TABLE>
<CAPTION>
At March 31, 1999 At December 31, 1998
--------------------------------- ---------------------------------
Change in Ratio of NPV Ratio of NPV
Interest Rate to the Present % to the Present %
in Basis Points Value of Change Value of Change
(Rate Shock) NPV Total Assets in NPV NPV Total Assets in NPV
--------------- ------- -------------- ------ ------- -------------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
+300 $12,338 0.56% (85.5) $11,384 0.53% (86.5)
+200 40,402 1.81 (52.7) 37,950 1.72 (55.1)
+100 62,728 2.75 (26.5) 59,814 2.66 (29.3)
Static 85,334 3.68 N/A 84,568 3.70 N/A
-100 85,811 3.67 0.6 71,197 3.10 (15.8)
-200 65,510 2.79 (23.2) 50,677 2.20 (40.1)
-300 58,910 2.49 (31.0) 40,966 1.77 (51.6)
</TABLE>
At March 31, 1999, Sterling calculated that its NPV was $85.3 million
and that its NPV would decrease by 52.7% and 85.5% if interest rate
levels generally were to increase by 2% and 3%, respectively. This
compares with an NPV of $84.6 million at December 31, 1998, which
would decline by 55.1% and 86.5% if interest rates generally were to
increase by 2% and 3%, respectively.
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 positions to be a negative 13.0% and
negative 14.6% at March 31, 1999 and 1998, respectively. Sterling
calculated its three-year gap positions to be a negative 16.0% and
negative 12.0% at March 31, 1999 and 1998, respectively. The increase
in the negative three-year gap position is largely due to increases in
fixed-rate loan originations funded by shorter-term deposits and
borrowings. Management attempts to maintain Sterling's gap position
between positive 5% and negative 20%. At March 31, 1999, 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.
LIQUIDITY AND SOURCES OF FUNDS
------------------------------
As a financial institution, Sterling's primary sources of funds are
operating, investing and financing activities, including the
collection of loan principal and interest payments. Financing
activities consist primarily of customer deposits, advances from the
FHLB Seattle and other borrowings. The level of advances from the
FHLB Seattle and other borrowings fluctuate with the level of assets.
Deposits increased to $1.56 billion at March 31, 1999, from $1.55
billion at December 31, 1998. Advances from the FHLB Seattle
increased to $335.4 million at March 31, 1999 from $319.5 million at
<PAGE>
December 31, 1998. At March 31, 1999 and December 31, 1998,
securities sold subject to repurchase agreements were $198.2 million
and $195.1 million, respectively. These borrowings are collateralized
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.
In connection with its Year 2000 compliance plan, Sterling is focusing
on identifying potential demand for funds from its loan and deposit
customers. See "Year 2000 Issues."
During the three months ended March 31, 1999, cash provided by
investing activities consisted of principal and interest payments on
loans and MBS, maturities of investments 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 three months ended March 31, 1999, net cash
was used in investing activities primarily to purchase $29.8 million
in investments and to fund loans.
Sterling Savings Bank's credit line with the FHLB Seattle provides for
borrowings of up to 30% of its total assets. At March 31, 1999, this
credit line represented a total borrowing capacity of $711.3 million,
of which $375.9 million was available. Sterling Savings Bank also
borrows on a secured basis from major broker/dealers and financial
entities by selling securities subject to repurchase agreements. At
March 31, 1999, Sterling Savings Bank had $198.2 million in
outstanding borrowings under reverse repurchase agreements and had
securities available for additional secured borrowings of
approximately $192.0 million. Sterling Savings Bank also had a
secured line-of-credit agreement from a commercial bank of
approximately $10.0 million as of March 31, 1999 but had no funds
drawn on this line of credit.
Excluding its subsidiaries, Sterling had cash and other resources of
approximately $1.7 million. Sterling borrowed $5.0 million on a line
of credit from a commercial bank at March 31, 1999. At March 31,
1999, Sterling had drawn all the funds on a $40.0 million twelve-month
line of credit from a commercial bank which matures in June 1999 but
may be renewed at Sterling's option for an additional six months.
Subsequent to quarter end, Sterling obtained a commitment to extend
this borrowing to May 31, 2001 and to increase the balance to $50.0
million. The commitment is subject to several material conditions.
Therefore, there can be no assurance that the borrowing will be
extended. All of the proceeds of these loans were contributed to
Sterling Savings Bank to enhance its regulatory capital ratios and to
substantially offset the intangible asset incurred in connection with
the KeyBank branch acquisition. These lines of credit are secured by
all of the stock of Sterling Savings Bank. At March 31, 1999,
Sterling had an investment of $91.1 million in the Preferred Stock of
Sterling Savings Bank, compared with $88.6 million at December 31,
<PAGE>
1998. Sterling received cash dividends on Sterling Savings Bank
Preferred Stock of $2.2 million during the three months ended
March 31, 1999. These resources were sufficient to meet the operating
needs of Sterling, including interest expense on its 8.75%
Subordinated Notes Due 2000 (the "Subordinated Notes") and other
borrowings. Sterling Savings Bank's ability to pay dividends is
limited by its earnings, financial condition and capital requirements,
as well as rules and regulations imposed by the OTS. See Note 3 of
"Notes to Consolidated Financial Statements."
OTS regulations require savings institutions such as Sterling Savings
Bank to maintain an average daily balance of liquid assets equal to or
greater than a specific percentage (currently 4%) of the average daily
balance of net withdrawable accounts and borrowings payable on demand
in one year or less during the preceding calendar month. At March 31,
1999 and December 31, 1998, Sterling Savings Bank's liquidity ratios
were 9.5% and 11.5%, respectively. The lower level of liquidity at
March 31, 1999 was due primarily to a decrease in the balance of
interest-bearing cash and federal funds purchased. Sterling Savings
Bank's strategy generally is to maintain its liquidity ratio at or
near the level necessary to support expected and potential loan
fundings and deposit withdrawals. Sterling Savings Bank tries to
minimize liquidity levels in order to maximize its yield on
alternative investments. The regulatory liquidity ratio does not take
into account certain other sources of liquidity, such as funds
invested through Sterling Savings Bank subsidiaries, potential
borrowings against investments and MBS and other potential financing
alternatives. The required minimum liquidity ratio may vary from time
to time, depending on economic conditions, savings flows and loan
funding needs.
CAPITAL RESOURCES
-----------------
Sterling's total shareholders' equity was $119.8 million at March 31,
1999 compared with $119.0 million at December 31, 1998. The increase
in total shareholders' equity was due primarily to an increase in
retained earnings for the three-month period, partially offset by a
decrease in the market value of available-for-sale investments and
MBS. At March 31, 1999 and December 31, 1998, shareholders' equity
was 5.1% of total assets.
At March 31, 1999, Sterling had an unrealized loss of $1.3 million,
net of related income taxes, on investments and MBS classified as
available for sale. At December 31, 1998, Sterling had an unrealized
gain of $788,000 on investments and MBS. Fluctuations in prevailing
interest rates could continue to cause volatility in this component of
shareholders' equity in future periods.
Sterling has issued and outstanding $40.0 million of Trust Preferred
Securities. The indenture governing the Trust Preferred Securities
limits the ability of Sterling under certain circumstances to pay
dividends or to make other capital distributions. The Trust Preferred
<PAGE>
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 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. Sterling may, subject to the
indenture governing the Subordinated Notes, incur additional
indebtedness from time to time to increase regulatory capital and for
general corporate purposes.
Sterling anticipates total capital expenditures of approximately $2.1
million for the remainder of the year ending December 31, 1999.
Sterling also anticipates spending approximately $430,000 during the
year in connection with the Year 2000 ("Year 2000") issues. Sterling
anticipates continuing to fund these expenditures from various
sources, including retained earnings and borrowings with various
arrangements. There can be no assurance that Sterling's estimates of
capital and Year 2000 expenditures or the funding thereof are
accurate. See "Year 2000 Issues."
Sterling Savings Bank is required by applicable regulations to
maintain certain minimum capital levels with respect to tangible
capital, core leverage capital and risk-based capital. Sterling
Savings Bank anticipates that it will continue to enhance its capital
resources and regulatory capital ratios of Sterling Savings Bank
through the retention of earnings, the amortization of intangible
assets and the management of the level and mix of assets, although
there can be no assurance in this regard. At March 31, 1999, Sterling
Savings Bank exceeded all applicable regulatory capital requirements.
Sterling continues to proactively manage its claim against the U.S.
government for breach of contract on three supervisory goodwill
acquisition contracts. In 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.
Recently, several similar cases have resulted in substantial judgments
against the government. Management believes the government will
appeal these judgments. Sterling is encouraged by these decisions,
although it is uncertain when a trial to determine Sterling's damages
will be held or when a judgment, if any, will be paid.
<PAGE>
REGULATION AND COMPLIANCE
-------------------------
Sterling, as a registered thrift holding company, is subject to
comprehensive examination and regulation by the OTS. Sterling Savings
Bank, as a State of Washington-chartered savings association, is
subject to comprehensive regulation and examination by the Washington
Supervisor as its chartering authority, the OTS as its primary federal
regulator, and by the FDIC, which administers the Savings Association
Insurance Fund, which insures Sterling Savings Bank's deposits to the
maximum extent permitted by law. Sterling Savings Bank is a member of
the FHLB Seattle, which is one of the 12 regional banks which comprise
the FHLB System. Sterling Savings Bank is further subject to
regulations of the Board of Governors of the Federal Reserve System
governing reserves required to be maintained against deposits and
certain other matters.
Sterling is subject to federal income taxation under the Internal
Revenue Code of 1986. Sterling's returns may therefore be audited
from time to time by the Internal Revenue Service, which has recently
commenced an audit of Sterling's returns for the periods ended
June 30, 1997, 1996 and 1995. Management believes Sterling's returns
will be confirmed. Due to the preliminary nature of the audit,
however, there can be no assurances in this regard.
One of the continuing challenges for Sterling, especially as it
transforms Sterling Savings Bank from a traditional thrift association
to a community bank, is to ensure compliance with the many laws and
regulations applicable to banking. These laws and regulations include
the federal Home Mortgage Disclosure Act, Expedited Funds Availability
Act, Flood Disaster Protection Act, Electronic Fund Transfers Act,
Real Settlement and Procedures Act, Bank Secrecy Act and many others.
Following the quarter ended March 31, 1999, Sterling entered into an
agreement with the OTS pursuant to which Sterling has agreed to
develop a comprehensive compliance program. As part of the compliance
program, Management and the Board of Directors will jointly work to
ensure that Sterling's policies and procedures regarding compliance
with pertinent laws are appropriate, compliance staffing is increased
and compliance staff members are adequately trained. Management is
committed to meeting and exceeding the requirements of the compliance
program.
YEAR 2000 ISSUES
----------------
The Year 2000 problem concerns the inability of information systems to
recognize properly and to process date-sensitive information beginning
on January 1, 2000. Systems that do not properly recognize such
information could generate erroneous data or fail. The potential
failure on January 1, 2000 of computer systems that use two-digit
calendar notations has developed into a major concern for financial
institutions and other entities.
<PAGE>
To address this concern, Sterling has created a Year 2000 Action Plan
that focuses on identifying, testing and implementing solutions for
Year 2000 processing. At March 31, 1999, Sterling had completed the
awareness and assessment phases and a majority of the testing phase of
its Year 2000 Action Plan. The awareness phase included gaining
understanding and support, committing resources to the plan,
establishing a project team consisting of senior managers and
department heads and developing a strategy to address all internal and
external systems.
The assessment phase involved attempting to identify all critical
business processes and determining the impact of the Year 2000 issues
on all computer systems throughout the organization. This assessment
included critical functions and systems not generally included in the
information systems category, such as fax machines, telephone
switches, elevators, vaults, ATMs and security systems. Certain
vendors were contacted and asked to submit certification letters
stating that they are adequately addressing Year 2000 conversion
issues. An assessment of our data service provider, The BISYS Group,
Inc. ("BISYS"), was conducted by federal regulatory agencies.
Sterling has completed an evaluation of its deposit base and
identified potential problems due to concentrations. Management will
assess whether those concentrations are at risk due to Year 2000
problems. All financial institutions are considering the possibility
of some level of reduction in deposits during the month of December
1999. Sterling has determined that alternative sources of funds
should be available so that adequate funding will not be a problem.
In conjunction with its review of Year 2000 issues, Sterling has
endeavored to assess the impact of the Year 2000 event on significant
borrowers and their ability to repay loans. Sterling is currently
evaluating and monitoring its allowances for loan losses with its
review of Year 2000 concerns in relation to its borrowers.
Sterling's Year 2000 testing, renovation and/or replacement of
hardware, proprietary programs, security systems, facility systems and
non-BISYS software was substantially completed by March 31, 1999.
Testing of BISYS-supported software and systems is scheduled to be
completed in the first half of 1999.
It is currently estimated that the aggregate cost of Sterling's Year
2000 readiness efforts will be approximately $870,000, of which
approximately $664,000 has been spent. The costs associated with the
replacement of computer hardware or equipment, currently estimated to
be approximately $305,000, are included in the estimate. Computer
hardware and equipment expenses will be capitalized, and all other
costs are being expensed as they are incurred and are being funded
through operating cash flow. The aggregate Year 2000 cost estimates
do not include any costs associated with the implementation of
contingency plans, which are in the process of being developed.
<PAGE>
Sterling is currently finalizing contingency plans to be implemented
as part of its efforts to identify and correct Year 2000 problems
affecting its internal operations. Year 2000 contingency plans are
designated to supplement Sterling's existing disaster recovery plan.
Depending on the systems affected, these plans could include short- to
medium-term use of backup equipment and software, increased work hours
for Sterling personnel, implementation of manual workarounds for
information systems or department functions or similar approaches.
Testing of the Year 2000 Contingency Plan is scheduled to be completed
by June 30, 1999. Final implementation is scheduled for September 30,
1999.
The discussion of Sterling's efforts and management's expectations
relating to Year 2000 readiness include forward-looking statements.
Although Sterling expects to identify and resolve all Year 2000 issues
that could materially adversely affect its business operations, it is
not possible to determine with complete certainty that all Year 2000
issues affecting the company will be identified or corrected. The
number of devices that could be affected and the interactions among
these devices are simply too numerous. In addition, no one can
accurately predict how many Year 2000-related failures will occur
generally or specifically with respect to Sterling and its customers
and suppliers. Nor can anyone accurately predict the severity,
duration or financial consequences of these perhaps inevitable
failures.
Sterling's Year 2000 Action Plan is expected to significantly reduce
Sterling's level of uncertainty about the Year 2000 event and, in
particular, about the Year 2000 compliance and readiness of its
external vendors and major customers. Sterling believes that, with
the implementation of its Action Plan as scheduled, the possibility of
significant interruptions of normal operations should be reduced.
There can, however, be no assurance in this regard.
PART I - Financial Information (continued)
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------
For a discussion of Sterling's market risks, see "Management's
Discussion and Analysis - Asset and Liability Management."
<PAGE>
PART II - Other Information
STERLING FINANCIAL CORPORATION
Item 1 - Legal Proceedings
Periodically various claims and lawsuits are brought against Sterling
and its subsidiaries, such as claims to enforce liens, condemnation
proceedings involving properties on which Sterling holds security
interests, claims involving the making and servicing of real property
loans and other issues incidental to Sterling's business. No material
loss is expected from any of such pending claims or lawsuits.
Item 2 - Changes in Securities and Use of Proceeds
--------------------------------------------------
None.
Item 3 - Defaults Upon Senior Securities
----------------------------------------
None.
Item 4 - Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
None.
Item 5 - Other Information
--------------------------
None.
Item 6 - Exhibits and Reports on Form 8-K
-----------------------------------------
(a) 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 S-4 dated
June 24, 1998 and incorporated by reference herein.
4.1 Reference is made to Exhibits 3.1 through 3.3.
<PAGE>
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.
27.1 Financial Data Schedule. Filed herewith.
(b) Reports on Form 8-K. No reports were filed during the three
months ended March 31, 1999.
<PAGE>
STERLING FINANCIAL CORPORATION
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
STERLING FINANCIAL CORPORATION
(Registrant)
May 10, 1999 By: /s/ Daniel G. Byrne
------------ -----------------------------------
Date Daniel G. Byrne
Senior Vice President - Finance;
Treasurer and Assistant Secretary;
Principal Financial Officer and
Chief Accounting Officer
<PAGE>
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