<PAGE>
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/ X / QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD
FROM ________________ TO ________________.
Commission file number.....0-20800
STERLING FINANCIAL CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1572822
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
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 OCTOBER 31, 2000
------------------------------ ----------------------------------
Common Stock ($1.00 par value) 8,101,341
===============================================================================
<PAGE>
STERLING FINANCIAL CORPORATION
FORM 10-Q
For the Quarter Ended September 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I - Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets 1
Consolidated Statements of Income 2
Consolidated Statements of Cash Flows 3
Consolidated Statements of Comprehensive Income (Loss) 5
Notes to Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 21
PART II - Other Information
Item 1 - Legal Proceedings 22
Item 2 - Changes in Securities and Use of Proceeds 22
Item 3 - Defaults Upon Senior Securities 22
Item 4 - Submission of Matters to a Vote of Security Holders 22
Item 5 - Other Information 22
Item 6 - Exhibits and Reports on Form 8-K 22
Signature 23
</TABLE>
<PAGE>
PART I - Financial Information
ITEM 1 - FINANCIAL STATEMENTS
STERLING FINANCIAL CORPORATION
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(Dollars in Thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents:
Interest bearing $ 1,133 $ 23,365
Non-interest bearing and vault 57,584 72,221
Restricted 3,789 1,018
Loans receivable, net 1,997,319 1,787,771
Loans held for sale 2,074 985
Investments and mortgage-backed securities ("MBS"):
Available for sale 465,046 494,483
Held to maturity 10,893 11,247
Accrued interest receivable (including $3,479 and $3,504 on investments
and MBS) 17,369 16,720
Real estate owned, net 6,573 7,299
Office properties and equipment, net 50,331 52,649
Other intangibles, net 51,347 55,488
Mortgage servicing rights, net 332 222
Prepaid expenses and other assets, net 21,395 23,457
----------- -----------
Total assets $ 2,685,185 $ 2,546,925
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 1,685,258 $ 1,617,368
Advances from Federal Home Loan Bank of Seattle ("FHLB Seattle") 521,503 490,503
Securities sold subject to repurchase agreements and federal funds
purchased 198,304 179,515
Other borrowings (Note 3) 113,000 110,000
Cashiers checks issued and payable 10,532 11,967
Borrowers' reserves for taxes and insurance 3,275 1,369
Accrued interest payable 9,753 7,539
Accrued expenses and other liabilities 13,639 11,025
----------- -----------
Total liabilities 2,555,264 2,429,286
----------- -----------
Preferred stock, $1 par value; 10,000,000 shares authorized;
no shares issued and outstanding 0 0
Common stock, $1 par value; 20,000,000 shares authorized;
8,100,470 and 8,089,844 shares issued and outstanding 8,100 8,090
Additional paid-in capital 70,385 70,339
Accumulated other comprehensive loss:
Unrealized losses on investments and MBS available for sale,
net of deferred income tax benefit of $6,182 and $7,298 (11,482) (13,553)
Retained earnings 62,918 52,763
----------- -----------
Total shareholders' equity 129,921 117,639
----------- -----------
Total liabilities and shareholders' equity $ 2,685,185 $ 2,546,925
=========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
1
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Income
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2000 1999 2000 1999
------------- ------------- ------------- ------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Interest income:
Loans $ 44,954 $ 36,903 $ 126,895 $ 105,008
MBS 5,300 5,844 16,478 17,104
Investments and cash equivalents 2,634 2,497 8,099 8,121
----------- ----------- ------------ -----------
Total interest income 52,888 45,244 151,472 130,233
----------- ----------- ------------ -----------
Interest expense:
Deposits 19,248 15,352 53,705 44,958
Short-term borrowings 9,004 2,585 20,725 8,128
Long-term borrowings 4,273 7,994 17,187 21,306
----------- ----------- ------------ -----------
Total interest expense 32,525 25,931 91,617 74,392
----------- ----------- ------------ -----------
Net interest income 20,363 19,313 59,855 55,841
Provision for losses on loans (1,100) (1,000) (3,300) (2,900)
----------- ----------- ------------ -----------
Net interest income after provision for losses on loans 19,263 18,313 56,555 52,941
----------- ----------- ------------ -----------
Other income:
Fees and service charges 3,200 2,885 9,375 7,958
Mortgage banking operations 135 271 465 862
Loan servicing fees 215 194 657 608
Net gains on sales of securities 0 0 1 593
Real estate owned operations 9 (27) 97 (117)
----------- ----------- ------------ -----------
Total other income 3,559 3,323 10,595 9,904
----------- ----------- ------------ -----------
Operating expenses (Note 5) 17,307 16,352 51,016 47,928
----------- ----------- ------------ -----------
Income before income taxes 5,515 5,284 16,134 14,917
Income tax provision 2,050 1,955 5,979 5,516
----------- ----------- ------------ -----------
Net income $ 3,465 $ 3,329 $ 10,155 $ 9,401
=========== =========== ============ ===========
Income per share - basic $ 0.43 $ 0.41 $ 1.25 $ 1.16
=========== =========== ============ ===========
Income per share - diluted $ 0.43 $ 0.41 $ 1.25 $ 1.15
=========== =========== ============ ===========
Weighted average shares outstanding - basic 8,100,470 8,089,844 8,098,183 8,080,729
Weighted average shares outstanding - diluted 8,122,400 8,158,607 8,117,221 8,166,483
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
2
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
2000 1999
--------- ---------
(Dollars in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 10,155 $ 9,401
Adjustments to reconcile net income to net cash provided by
operating activities:
Provisions for losses on loans and real estate owned 3,300 3,105
Stock dividends on FHLB Seattle stock (1,719) (1,826)
Net gain on sales of loans, investments and MBS (407) (1,267)
Net gain on sales of real estate owned (180) (172)
Depreciation and amortization 8,015 8,485
Change in:
Accrued interest receivable (649) (374)
Prepaid expenses and other assets 634 (3,700)
Cashiers checks issued and payable (1,435) (8,324)
Accrued interest payable 2,214 599
Accrued expenses and other liabilities 2,614 1,382
Proceeds from sales of loans 47,305 63,238
Loans originated for sale (46,901) (62,908)
--------- ---------
Net cash provided by operating activities 22,946 7,639
--------- ---------
Cash flows from investing activities:
Change in restricted cash (2,771) 7,844
Loans disbursed (892,191) (984,169)
Loan principal received 674,449 691,393
Purchase of investments (19,912) (29,823)
Proceeds from maturities of investments 20,237 48,906
Proceeds from sales of available-for-sale investments 2,138 542
Purchase of MBS 0 (60,128)
Principal payments on MBS 32,065 65,999
Proceeds from sales of MBS 0 29,104
Purchase of office properties and equipment (1,083) (4,733)
Improvements and other changes to real estate owned (904) 43
Proceeds from sales and liquidation of real estate owned 5,616 1,599
--------- ---------
Net cash used in investing activities (182,356) (233,423)
--------- ---------
</TABLE>
3
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows (continued)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
2000 1999
--------- ---------
(Dollars in thousands)
<S> <C> <C>
Cash flows from financing activities:
Net change in checking, passbook and money market deposits $ (12,427) $ (15,157)
Proceeds from issuance of certificates of deposit 425,852 649,692
Payments for maturing certificates of deposit (398,313) (609,393)
Interest credited to deposits 52,778 44,745
Advances from FHLB Seattle 285,000 205,877
Repayment of FHLB Seattle advances (254,100) (95,090)
Net change in securities sold subject to repurchase agreements
and funds purchased 18,789 11,245
Proceeds from other borrowings 7,000 35,000
Repayment of other borrowings (4,000) (22,240)
Proceeds from exercise of stock options, net of repurchases 56 144
Deferred financing costs 0 (1,113)
Other 1,906 1,601
--------- ---------
Net cash provided by financing activities 122,541 205,311
--------- ---------
Net change in cash and cash equivalents (36,869) (20,473)
Cash and cash equivalents, beginning of period 95,586 88,331
--------- ---------
Cash and cash equivalents, end of period $ 58,717 $67,858
========= =========
Supplemental disclosures:
Cash paid during the period for:
Interest $ 89,404 $73,792
Income taxes 4,282 3,497
Noncash financing and investing activities:
Loans converted into real estate owned 3,807 1,364
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
4
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2000 1999 2000 1999
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Net income $ 3,465 $ 3,329 $ 10,155 $ 9,401
-------- -------- -------- --------
Other comprehensive income (loss):
Change in unrealized losses on investments and
MBS available for sale 4,560 (3,343) 3,188 (16,046)
Less deferred income taxes 1,597 (1,170) 1,117 (5,616)
-------- -------- -------- --------
Net other comprehensive income (loss) 2,963 (2,173) 2,071 (10,430)
-------- -------- -------- --------
Comprehensive income (loss) $ 6,428 $ 1,156 $ 12,226 $ (1,029)
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
1. GENERAL:
Notes to the December 31, 1999 consolidated financial statements, as
set forth in Sterling Financial Corporation's ("Sterling's") December
31, 1999 Annual Report on Form 10-K, substantially apply to these
interim consolidated financial statements as of and for the three and
nine months ended September 30, 2000 and are not repeated here. All
financial statements presented are unaudited. However, the December 31,
1999 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.
3. OTHER BORROWINGS:
The following table details Sterling's other borrowings:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(Dollars in thousands)
<S> <C> <C>
Advances on non-revolving line of credit(1) $40,000 $40,000
Advances on revolving line of credit(2) 3,000 0
Sterling obligated mandatorily redeemable preferred capital securities
of subsidiary trust holding solely junior subordinated
deferrable interest debentures of Sterling(3) 40,000 40,000
Floating Rate Notes Due 2006(4) 30,000 30,000
--------- ---------
Total other borrowings $ 113,000 $ 110,000
========= =========
</TABLE>
(1) Sterling has a $50.0 million non-revolving, variable-rate,
line-of-credit agreement with KeyBank National Association
("KeyBank"), of which $40.0 million was outstanding at September
30, 2000. In August 2000, the maturity on the line of credit was
extended to June 1, 2003. Through May 31, 2001, interest accrues at
the 30-day London Interbank Offering Rate ("LIBOR") plus 2.00%
(8.625% at September 30, 2000) and is payable monthly. On June 1,
2001, the interest rate adjusts to LIBOR plus 2.50%. On June 1,
2002, the interest rate adjusts to LIBOR plus 2.75%. This line of
credit, as well as the line of credit referred to in Note 2 below,
is collateralized by all of the stock of Sterling Savings Bank.
(2) Sterling has a $5.0 million revolving line-of-credit agreement with
KeyBank. The revolving line of credit matures on June 1, 2001. The
interest rate is adjustable monthly at KeyBank's prime interest
rate (9.50% at September 30, 2000). At September 30, 2000, $3.0
million was outstanding under this line-of-credit agreement. This
amount was repaid on October 2, 2000. At December 31, 1999, no
amount was outstanding under this agreement.
(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
6
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
the option of Sterling in the event the deduction of related
interest for federal income taxes is prohibited, treatment as
Tier 1 capital is no longer permitted, or certain other
contingencies arise. The Trust Preferred Securities must be
redeemed upon maturity of the Junior Subordinated Debentures in
2027.
(4) Sterling has outstanding $30.0 million of Floating Rate Notes Due
2006. 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 September 30, 2000, Sterling
could incur approximately $46.2 million of additional long-term
debt, and Sterling would have been limited to the payment of up to
approximately $7.7 million in additional dividends. Interest
accrues at the 90-day LIBOR plus 2.50% (9.16% until December 15,
2000) and is adjustable and payable quarterly. The notes mature on
June 15, 2006 and may be redeemed under certain conditions after
June 15, 2002.
4. INCOME PER SHARE:
The following table presents the basic and diluted income per share
computations:
<TABLE>
<CAPTION>
Three Months Ended September 30,
-------------------------------------------------------------------------
2000 1999
------------------------------------ -----------------------------------
Net Weighted Per Share Net Weighted Per Share
Income Avg. Shares Amount Income Avg. Shares Amount
------------ ----------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic computations $ 3,465,000 8,100,470 $ 0.43 $ 3,329,000 8,089,844 $ 0.41
Effect of dilutive securities:
Common stock options 0 21,930 0 68,763
------------ ----------- --------- ----------- ----------- ---------
Diluted computations $ 3,465,000 8,122,400 $ 0.43 $ 3,329,000 8,158,607 $ 0.41
============ =========== ========= =========== ============= ==========
Antidilutive options not
included in diluted
income per share 590,078 194,000
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------------------------------------------------
2000 1999
------------------------------------ -----------------------------------
Net Weighted Per Share Net Weighted Per Share
Income Avg. Shares Amount Income Avg. Shares Amount
------------ ----------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic computations $ 10,155,000 8,098,183 $ 1.25 $ 9,401,000 8,080,729 $ 1.16
Effect of dilutive securities:
Common stock options 0 19,038 0 85,754
------------ ----------- --------- ----------- ----------- ---------
Diluted computations $ 10,155,000 8,117,221 $ 1.25 $ 9,401,000 8,166,483 $ 1.15
============ =========== ========= =========== ============= ==========
Antidilutive options not
included in diluted
income per share 590,078 194,000
</TABLE>
7
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
5. OPERATING EXPENSES:
The following table details Sterling's components of total operating
expenses:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Employee compensation and benefits $8,096 $ 7,521 $ 24,228 $ 21,581
Occupancy and equipment 2,635 2,541 7,760 7,443
Depreciation 1,147 1,119 3,401 3,128
Amortization of intangible assets 1,346 1,398 4,141 4,294
Advertising 689 779 1,891 2,095
Data processing 1,321 1,405 4,183 4,026
Insurance 181 257 533 730
Legal and accounting 403 373 1,140 1,072
Travel and entertainment 351 373 1,125 1,177
Goodwill litigation costs 250 75 600 195
Other 888 511 2,014 2,187
-------- -------- -------- --------
Total operating expenses $ 17,307 $ 16,352 $ 51,016 $ 47,928
======== ======== ======== ========
</TABLE>
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, as amended by
SFAS No. 137, "Deferral of the Effective Date of FASB Statement No.
133," is effective for all fiscal quarters of fiscal years beginning
after June 15, 2000; however, earlier application of all of the
provisions of this Statement is encouraged as of the beginning of any
fiscal quarter. Sterling does not believe the effect of implementing
SFAS No. 133 will be material to its consolidated financial statements.
7. MORTGAGE BANKING OPERATIONS:
Sterling operates residential loan production offices primarily in the
Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho
metropolitan areas through its subsidiary Action Mortgage Company.
Residential 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.
8
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
The following table summarizes information related to Sterling's
residential mortgage banking operations:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Revenues:
Gains on sales of originated residential loans $ 108 $ 143 $ 292 $ 674
Other fees and income 1,722 1,344 5,094 3,871
-------- -------- -------- --------
Total revenues 1,830 1,487 5,386 4,545
Identifiable expenses (960) (875) (3,120) (2,483)
-------- -------- -------- --------
Income before income taxes $ 870 $ 612 $ 2,266 $ 2,062
======== ======== ========= ========
Identifiable assets $ 13,555 $ 10,793 $ 13,555 $ 10,793
======== ======== ======== ========
Depreciation and amortization expense $ 30 $ 30 $ 89 $ 95
======== ======== ======== ========
Capital expenditures for office properties and equipment $ 127 $ 20 $ 9 $ 62
======== ======== ======== ========
</TABLE>
Sterling also operates commercial real estate loan production offices
primarily in the Spokane and Seattle, Washington; and Portland, Oregon
metropolitan areas through its subsidiary INTERVEST-Mortgage Investment
Company. Commercial real estate lending operations include revenues
from sales of commercial real estate loans and participation interests
in commercial real estate loans, loan fees and servicing fees.
The following table summarizes information related to Sterling's
commercial real estate lending operations:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Revenues:
Gains on sales of originated commercial
real estate loans $ 8 $ 98 $ 114 $ 98
Other fees and income 1,101 917 3,083 2,606
-------- -------- -------- --------
Total revenues 1,109 1,015 3,197 2,704
Identifiable expenses (449) (352) (1,226) (927)
-------- -------- -------- --------
Income before income taxes $ 660 $ 663 $ 1,971 $ 1,777
======== ======== ======== ========
Identifiable assets $ 18,905 $ 15,297 $ 18,905 $ 15,297
======== ======== ======== ========
Depreciation and amortization expense $ 4 $ 4 $ 12 $ 10
======== ======== ======== ========
Capital expenditures for office properties
and equipment $ 2 $ 14 $ 35 $ 21
======== ======== ======== ========
</TABLE>
Sterling has determined that its reportable business segments are those
that are based on its method of disaggregated internal reporting.
9
<PAGE>
STERLING FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
The following is a reconciliation of certain mortgage banking
operations to the amounts reported in the consolidated financial
statements:
<TABLE>
<CAPTION>
Mortgage Banking
Operations
-------------------------
Banking Commercial
Operations Residential Real Estate Total
----------- ----------- ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
As of and for the three months ended September 30, 2000:
Interest income $ 50,537 $ 1,464 $ 887 $ 52,888
Other income 3,424 127 8 3,559
Income before taxes 3,985 870 660 5,515
Total assets 2,652,725 13,555 18,905 2,685,185
As of and for the three months ended September 30, 1999:
Interest income $ 43,117 $ 1,291 $ 836 $ 45,244
Other income 3,053 172 98 3,323
Income before taxes 4,009 612 663 5,284
Total assets 2,487,703 10,793 15,297 2,513,793
As of and for the nine months ended September 30, 2000:
Interest income $ 144,709 $ 4,308 $ 2,455 $ 151,472
Other income 10,130 351 114 10,595
Income before taxes 11,897 2,266 1,971 16,134
Total assets 2,652,725 13,555 18,905 2,685,185
As of and for the nine months ended September 30, 1999:
Interest income $ 124,122 $ 3,742 $ 2,369 $ 130,233
Other income 9,042 764 98 9,904
Income before taxes 11,078 2,062 1,777 14,917
Total assets 2,487,703 10,793 15,297 ` 2,513,793
</TABLE>
10
<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 and Nine Months Ended September 30, 2000 and 1999
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. 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 provides 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 $2.69 billion in total assets at September 30,
2000, 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 Action Mortgage
residential loan production offices in the metropolitan areas of Spokane and
Seattle, Washington; Portland, Oregon; and Boise, Idaho; and 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.
Sterling continues to enhance its presence as a community bank by
increasing its commercial real estate, business banking, consumer and
construction lending while increasing its retail deposits, particularly
transaction accounts. 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 assurance in this regard. 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").
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.
11
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
RESULTS OF OPERATIONS
OVERVIEW. Sterling recorded net income of $3.5 million, or $0.43 per
diluted share, for the three months ended September 30, 2000, compared with net
income of $3.3 million, or $0.41 per diluted share, for the three months ended
September 30, 1999. Sterling recorded net income of $10.2 million, or $1.25 per
diluted share, for the nine months ended September 30, 2000. This compares with
net income of $9.4 million, or $1.15 per diluted share, for the nine months
ended September 30, 1999. The increase in net income for both periods reflected
higher net interest income and other income.
The annualized return on average assets was 0.52% and 0.53% for the three
months ended September 30, 2000 and 1999, respectively. For the nine months
ended September 30, 2000 and 1999, the annualized return on average assets was
0.52%. The annualized return on average equity was 11.0% and 11.2% for the three
months ended September 30, 2000 and 1999, respectively. For the nine months
ended September 30, 2000 and 1999, the annualized return on average equity was
11.2% and 10.5%, respectively.
Operating cash earnings, operating cash earnings per common share and the
ratios given below exclude amortization of intangible assets of $848,000,
$881,000, $2.6 million and $2.7 million, which are net of related income taxes,
for the three months ended September 30, 2000 and 1999 and the nine months ended
September 30, 2000 and 1999, respectively.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ---------------------
2000 1999 2000 1999
------- ------- --------- --------
<S> <C> <C> <C> <C>
Operating cash earnings (dollars in thousands) $ 4,313 $ 4,210 $ 12,764 $ 12,107
Operating cash earnings per common share - diluted $ 0.53 $ 0.52 $ 1.57 $ 1.48
Operating cash return on average assets (annualized) 0.64% 0.67% 0.65% 0.67%
Operating cash return on average common
shareholders' equity (annualized) 13.7% 14.1% 14.0% 13.5%
</TABLE>
NET INTEREST INCOME. The most significant component of earnings for a
financial institution typically is net interest income ("NII"), which is the
difference between interest income, primarily from loan, MBS and investment
portfolios, and interest expense, primarily on deposits and borrowings. During
the three months ended September 30, 2000 and 1999, NII was $20.4 million and
$19.3 million, respectively, representing an increase of 5.4%. During the nine
months ended September 30, 2000 and 1999, NII was $59.9 million and $55.8
million, respectively, an increase of 7.2%.
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 increases in NII
during the three and nine months ended September 30, 2000, compared to the same
periods in 1999, were primarily due to the increase in the average volume of
loans and a change in the mix of loans and deposits.
During the three months ended September 30, 2000 and 1999, the volume of
average interest-earning assets was $2.49 billion and $2.30 billion,
respectively. For the three months ended September 30, 2000, average loans
increased by $227.8 million, while investments and MBS decreased by $38.7
million over the same period in 1999. Net interest spread during these periods
was 3.02% and 3.18%, respectively. The net interest margin for the three months
ended September 30, 2000 and 1999 was 3.25% and 3.33%, respectively. Net
interest margin and net
12
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
interest spread decreased primarily due to higher costs for deposits and
borrowings which increased faster than the yield on interest-earning assets,
primarily the yield on loans.
During the nine months ended September 30, 2000 and 1999, the volume of
average interest-earning assets was $2.44 billion and $2.22 billion,
respectively. For the nine months ended September 30, 2000, average loans
increased $251.9 million, while investments and MBS decreased $32.5 million over
the same period in 1999. Net interest spread during these periods was 3.09% and
3.22%, respectively. The net interest margin for the nine months ended September
30, 2000 and 1999 was 3.28% and 3.36%, respectively. The reasons for the
decreases in net interest spread and net interest margin were the same as those
for the related quarterly periods.
PROVISION FOR LOSSES ON LOANS. 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 losses on loans of $1.1 million and $1.0
million for the three months ended September 30, 2000 and 1999, respectively.
Sterling recorded provisions for losses on loans of $3.3 million and $2.9
million for the nine months ended September 30, 2000 and 1999, respectively.
Management anticipates that its provisions for losses on loans will continue to
increase in the future as Sterling originates more commercial real estate,
construction, business banking and consumer loans. At September 30, 2000,
Sterling's total classified assets were $25.8 million, compared with $19.4
million at September 30, 1999. At September 30, 2000, Sterling's loan
delinquency rate (60 days or more) as a percentage of total loans was 0.50%,
compared with 0.61% at September 30, 1999. Total nonperforming loans were $10.2
million at September 30, 2000, compared with $9.4 million at September 30, 1999.
Management believes that Sterling's asset quality remains at acceptable levels
and reflects the greater emphasis on higher-risk commercial real estate,
construction, business banking and consumer loans.
Management believes the provisions for losses on loans for the three and
nine months ended September 30, 2000 are appropriate based upon its evaluation
of factors affecting the adequacy of valuation allowances, although there can be
no assurance in this regard. Such factors include locations and concentrations
of loans, loan loss experience and economic factors affecting the Pacific
Northwest economy.
OTHER INCOME. The following table summarizes the components of other income
for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ---------------------
2000 1999 2000 1999
------- ------- --------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Fees and service charges $ 3,200 $ 2,885 $ 9,375 $ 7,958
Mortgage banking operations 135 271 465 862
Loan servicing fees 215 194 657 608
Net gains on sales of securities 0 0 1 593
Real estate owned operations 9 (27) 97 (117)
------- ------- --------- --------
Total other income $ 3,559 $ 3,323 $ 10,595 $ 9,904
======= ======= ========= =======
</TABLE>
Fees and service charges primarily consist 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 for the three and nine months ended
September 30, 2000, compared with the three and nine months ended September 30,
1999, were primarily due to the implementation of new service charges on
transaction accounts, improved efficiencies in assessing overdraft charges and
higher commissions on sales of mutual funds and annuity products.
13
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
The following table summarizes loan originations and sales of loans for the
periods indicated.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ---------------------
2000 1999 2000 1999
------- ------- --------- --------
(Dollars in millions)
<S> <C> <C> <C> <C>
Originations of one- to four-family permanent mortgage loans $ 25.8 $ 43.7 $ 79.5 $ 149.5
Sales of residential loans 12.4 14.5 32.5 62.9
Sales of commercial real estate loans 2.6 24.9 14.4 24.9
Principal balances of mortgage loans serviced for others 205.3 201.7 205.3 201.7
</TABLE>
The decreases in income from mortgage banking operations for the three and
nine months ended September 30, 2000 compared to the same periods in 1999, were
primarily due to a lower volume of commercial real estate and residential loan
sales.
During the nine months ended September 30, 2000, Sterling sold
approximately $2.1 million of investments, resulting in net gains of $1,000.
During the nine months ended September 30, 1999, Sterling sold approximately
$29.1 million of investments and MBS, resulting in net gains of $593,000.
OPERATING EXPENSES. Operating expenses were $17.3 million and $16.4 million
for the three months ended September 30, 2000 and 1999, respectively. During the
nine months ended September 30, 2000 and 1999, operating expenses were $51.0 and
$47.9 million, respectively. The higher level of operating expenses was
primarily a result of higher compensation costs, increased goodwill litigation
expenses and the full implementation of the item processing operations.
Employee compensation and benefits were $8.1 million and $7.5 million for
the three months ended September 2000 and 1999, respectively. During the nine
months ended September 30, 2000 and 1999, employee compensation and benefits
were $24.2 million and $21.6 million, respectively. The increases reflected
higher costs for personnel, lower loan origination cost deferrals, increased
employee benefit costs, and additional staff for the implementation of fee-based
business service operations. At September 30, 2000, full-time-equivalent
employees were 809, compared with 804 at September 30, 1999.
Goodwill litigation expenses were $250,000 and $75,000 for the three months
ended September 30, 2000 and 1999, respectively. During the nine months ended
September 30, 2000 and 1999, goodwill litigation expenses were $600,000 and
$195,000, respectively. The increase in both periods reflected increased
activity related to the discovery phase of Sterling's goodwill litigation.
Because of the increased level of effort required to bring the case to
conclusion, Sterling will likely see an increase in these costs over the next
few years.
Occupancy and equipment expenses were $2.6 million and $2.5 million for the
three months ended September 30, 2000 and 1999, respectively. During the nine
months ended September 30, 2000 and 1999, occupancy and equipment expenses were
$7.8 million and $7.4 million, respectively. The increases reflected costs
associated with the item processing centers and higher maintenance costs.
During the nine months ended September 30, 2000 and 1999, data processing
expenses were $4.2 million and $4.0 million, respectively. The increase was
primarily attributable to costs associated with the item processing centers,
internal data processing upgrades and increased computer maintenance.
Other expenses were $888,000 and $511,000 for the three months ended
September 30, 2000 and 1999, respectively. The increase in other expenses was
primarily due to the receipt of state excise tax refunds in the quarter ended
September 30, 1999. During the nine months ended September 30, 2000 and 1999,
other expenses
14
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
were $2.0 million and $2.2 million, respectively. The decrease for the
nine-month period was primarily a result of cost savings realized from in-house
item processing.
INCOME TAX PROVISION. Sterling recorded federal and state income tax
provisions of $2.1 million and $2.0 million for the three months ended September
30, 2000 and 1999, respectively. Tax provisions were $6.0 million and $5.5
million for the nine months ended September 30, 2000 and 1999, respectively. The
effective tax rates during these periods approximated the applicable statutory
federal and state income tax rates.
FINANCIAL POSITION
ASSETS. At September 30, 2000, Sterling's assets were $2.69 billion, up
5.4% from $2.55 billion at December 31, 1999. The increase was primarily due to
growth in net loans receivable.
INVESTMENTS AND MBS. Sterling's investment and MBS portfolio at September
30, 2000 was $475.9 million, down $29.8 million from the December 31, 1999
balance of $505.7 million. The decrease was primarily due to principal
repayments.
CASH AND CASH EQUIVALENTS. At September 30, 2000, Sterling's cash and cash
equivalents were $62.5 million, compared with $96.6 million at December 31,
1999. The decrease primarily reflects a decrease in the level of cash held for
Year 2000 contingencies.
LOANS RECEIVABLE. At September 30, 2000, net loans receivable were $2.00
billion, up $209.5 million (or 11.7%) from $1.79 billion at December 31, 1999.
The increase was primarily due to strong growth in construction and business
banking loans. During the three months ended September 30, 2000, total loan
originations were $217.4 million compared with $265.9 million for the prior
year's comparable quarter. During the nine months ended September 30, 2000 and
1999, total loan originations were $771.9 million and $920.9 million,
respectively. The decreases in loan originations during both periods reflected
management's more cautious underwriting approach.
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:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
----------------------- -----------------------
Amount % Amount %
----------- ------ ----------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Residential $ 411,423 20.5 $ 396,565 22.0
Multifamily 164,329 8.1 137,835 7.6
Commercial real estate 337,177 16.7 317,565 17.6
Construction 353,809 17.5 287,123 15.9
Consumer - direct 230,898 11.5 223,286 12.4
Consumer - indirect 105,384 5.2 94,420 5.2
Business banking 413,813 20.5 348,941 19.3
----------- ------ ----------- ------
Total loans receivable $ 2,016,833 100.0 $ 1,805,735 100.0
=========== ====== =========== ======
Weighted average yield at end of period 8.82% 8.32%
</TABLE>
15
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
The following table sets forth Sterling's loan originations for the
periods indicated.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- ----------------------------------
2000 1999 % Change 2000 1999 % Change
--------- --------- -------- ----------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Residential $ 25,797 $ 43,715 (41.0) $ 79,453 $ 149,478 (46.8)
Multifamily 3,720 7,100 (47.6) 39,245 50,789 (22.7)
Commercial real estate 17,381 8,384 107.3 39,403 93,459 (57.8)
Construction 89,924 115,883 (22.4) 322,733 279,953 15.3
Consumer - direct 16,896 17,248 (2.0) 68,268 70,482 (3.1)
Consumer - indirect 11,898 15,221 (21.8) 38,304 42,103 (9.0)
Business banking 51,744 58,346 (11.3) 184,525 234,632 (21.4)
--------- --------- -------- ----------- --------- -------
Total loans originated $ 217,360 $ 265,897 (18.3) $ 771,931 $ 920,896 (16.2)
========= ========= =========== =========
</TABLE>
DEPOSITS. Total deposits increased $67.9 million to $1.69 billion at
September 30, 2000 from $1.62 billion at December 31, 1999. The increase in the
average cost of total deposits noted in the table below was primarily due to the
increase in the rates paid on certificates of deposit.
The following table sets forth the composition of Sterling's deposits at
the dates indicated.
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
----------------------- -----------------------
Amount % Amount %
----------- ------ ----------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Certificates of deposit $ 984,468 58.4 $ 916,692 56.7
Checking(1) 312,766 18.6 290,017 17.9
Savings and money market 388,024 23.0 410,659 25.4
----------- ------ ----------- ------
Total deposits $ 1,685,258 100.0 $ 1,617,368 100.0
=========== ====== =========== ======
Weighted average cost of deposits
at end of period 4.61% 4.04%
</TABLE>
(1) Includes noninterest-bearing checking accounts.
BORROWINGS. Deposit accounts are Sterling's primary source of funds.
Sterling does, however, rely upon advances from the Federal Home Loan Bank of
Seattle ("FHLB Seattle"), reverse repurchase agreements and other borrowings to
supplement its funding and to meet deposit withdrawal requirements. At September
30, 2000, the total of such borrowings was $832.8 million, compared with $780.0
million at December 31, 1999, an increase of $52.8 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
16
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
environment may have a dramatic effect on Sterling's results of operations.
Currently, Sterling's interest-bearing liabilities, consisting primarily of
savings and time 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-term and short-term interest rates have
on the performance of Sterling. The model calculates the present value of
assets, liabilities, off-balance sheet financial instruments and equity at
current interest rates and at hypothetical higher and lower interest rates at
various intervals. The present value of each major category of financial
instruments is calculated using estimated cash flows based on weighted-average
contractual rates and terms, then discounted at the estimated current market
interest rate for similar financial instruments. The present value of longer
term fixed-rate financial instruments is more difficult to estimate because such
instruments are susceptible to changes in market interest rates. Present value
estimates of adjustable-rate financial instruments are more reliable since they
represent the difference between the contractual and discounted rates until the
next interest rate repricing date.
The calculations of present value have certain shortcomings. The discount
rates utilized for loans, investments and MBS are based on estimated nationwide
market interest rate levels for similar loans and securities, with prepayment
assumptions based on historical experience and market forecasts. The unique
characteristics of Sterling's loans and MBS may not necessarily parallel those
in the model. The discount rates utilized for deposits and borrowings are based
upon available alternative types and sources of funds which are not necessarily
indicative of the market value of deposits and FHLB Seattle advances since such
deposits and advances are unique to and have certain price and customer
relationship advantages for depository institutions. The present values are
determined based on the discounted cash flows over the remaining estimated lives
of the financial instruments on the assumption that the resulting cash flows are
reinvested in financial instruments with virtually identical terms.
The total measurement of Sterling's exposure to 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.
17
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
The following table presents Sterling's estimates of changes in NPV for the
periods indicated. The results indicate the potential effects of instantaneous,
parallel shifts in the market yield curve. These calculations are highly
subjective and technical and are relative measurements of IRR which do not
necessarily reflect any expected rate movement.
<TABLE>
<CAPTION>
At September 30, 2000 At December 31, 1999
----------------------------------------- --------------------------------------
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>
+300 $ 29,271 1.16% (74.6) $ 2,712 0.12% (97.2)
+200 59,947 2.33 (48.0) 36,369 1.51 (62.5)
+100 84,514 3.24 (26.7) 63,177 2.57 (34.8)
Static 115,364 4.33 N/A 96,899 3.86 N/A
-100 125,079 4.65 8.4 112,812 4.43 16.4
-200 115,127 4.27 (0.2) 103,314 4.03 6.6
-300 90,671 3.37 (21.4) 73,835 2.89 (23.8)
</TABLE>
At September 30, 2000, Sterling calculated that its NPV was $115.4 million
and that its NPV would decrease by 48.0% and 74.6% if interest rate levels
generally were to increase by 2% and 3%, respectively. This compares with an NPV
of $96.9 million at December 31, 1999, which would decline by 62.5% and 97.2% 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 negative
15.1% and negative 15.7% at September 30, 2000 and 1999, respectively. Sterling
calculated its three-year gap positions to be negative 12.8% and negative 20.5%
at September 30, 2000 and 1999, respectively. The decrease in the negative
readings at both the one-year gap position and the three-year gap position was
primarily due to new and existing loans being funded with longer-term deposits
and borrowings. Management attempts to maintain Sterling's gap position between
positive 10% and negative 25%. At September 30, 2000, 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.
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.
LIQUIDITY AND SOURCES OF FUNDS
As a financial institution, Sterling's primary sources of funds are
investing and financing activities, including the collection of loan principal
and interest payments. Financing activities consist primarily of customer
deposits, advances from FHLB Seattle and other borrowings. Deposits increased to
$1.69 billion at September 30, 2000 from $1.62 billion at December 31, 1999.
Advances from FHLB Seattle increased to $521.5 million at
18
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
September 30, 2000 from $490.5 million at December 31, 1999. At September
30, 2000 and December 31, 1999, securities sold subject to repurchase agreements
were $178.8 million and $179.5 million, respectively. The net increase in these
borrowings was primarily used to fund loans. These borrowings are required to be
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.
During the nine months ended September 30, 2000, cash provided by investing
activities consisted primarily of principal and interest payments on loans and
MBS and maturities of investments. The levels of these payments 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 nine months ended September 30, 2000, net cash
was used in investing activities primarily to fund loans.
Sterling Savings Bank's credit line with FHLB Seattle provides for
borrowings of up to 30% of its total assets. At September 30, 2000, this credit
line represented a total borrowing capacity of $813.6 million, of which $292.1
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 September 30, 2000, Sterling Savings Bank had
$178.8 million in outstanding borrowings under reverse repurchase agreements and
had securities available for additional secured borrowings of approximately
$173.5 million. Sterling Savings Bank also had a secured line-of-credit
agreement from KeyBank of $10.0 million as of September 30, 2000. At September
30, 2000, Sterling Savings Bank had no funds drawn on this line of credit.
Sterling, on a parent company-only basis, had cash and other resources of
approximately $7.4 million and a revolving line of credit from KeyBank of $5.0
million at September 30, 2000. At September 30, 2000, Sterling also had $40.0
million outstanding on a $50.0 million non-revolving, variable-rate line of
credit from KeyBank. The KeyBank lines of credit are secured by all of the stock
of Sterling Savings Bank. See Note 3 of "Notes to Consolidated Financial
Statements."
At September 30, 2000 and December 31, 1999, Sterling had an investment of
$95.1 million in the Preferred Stock of Sterling Savings Bank. Sterling's right
to receive dividends is subordinate to its pledge of the stock to KeyBank.
Sterling received cash dividends on Sterling Savings Bank Preferred Stock of
$7.5 million during the nine months ended September 30, 2000. These resources
were sufficient to meet the operating needs of Sterling, including interest
expense on the Floating Rate Notes Due 2006 and other borrowings. Sterling
Savings Bank's ability to pay dividends is limited by its earnings, financial
condition and capital requirements, as well as rules and regulations imposed by
the OTS.
OTS regulations require savings institutions such as Sterling Savings Bank
to maintain an average daily balance of liquid assets equal to or greater than a
specific percentage (currently 4%) of the average daily balance of net
withdrawable accounts and borrowings payable on demand in one year or less
during the preceding calendar month. At September 30, 2000 and December 31,
1999, Sterling Savings Bank's liquidity ratio was 7.8% and 9.1%, respectively.
The lower level of liquidity at September 30, 2000 was primarily due to a
decrease in the average balance of cash and cash equivalents. 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.
19
<PAGE>
STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
CAPITAL RESOURCES
Sterling's total shareholders' equity was $129.9 million at September 30,
2000 compared with $117.6 million at December 31, 1999. The increase in total
shareholders' equity was primarily due to the increase in retained earnings.
Shareholders' equity was 4.8% of total assets at September 30, 2000 compared
with 4.6% at December 31, 1999.
On October 25, 2000, Sterling declared a 10% stock dividend payable
November 27, 2000 to shareholders of record on November 6, 2000.
At September 30, 2000, Sterling had an unrealized loss of $11.5 million,
net of related income taxes, on investments and MBS classified as available for
sale. At December 31, 1999, Sterling had an unrealized loss of $13.6 million,
net of related income taxes, on investments and MBS classified as available for
sale. Since the start of the year, long-term interest rates have declined,
decreasing the unrealized loss on investments and MBS. Fluctuations in
prevailing interest rates continue to cause volatility in this component of
accumulated comprehensive income or loss in shareholders' equity and may
continue to do so in future periods.
Sterling has outstanding $30.0 million of Floating Rate Notes Due 2006. The
notes mature on June 15, 2006 and may be redeemed subject to certain conditions
after June 15, 2002. These notes are general unsecured obligations of Sterling
and are subordinate to certain other existing and future indebtedness. The
indenture governing the 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 3 of "Notes to Consolidated Financial
Statements."
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 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 anticipates total capital expenditures of approximately $1.6
million for the remainder of the year ending December 31, 2000. Sterling
anticipates continuing to fund these expenditures from various sources,
including retained earnings and borrowings with various maturities. Sterling is
exploring opportunities to sell certain developed properties and enter into
lease arrangements. There can be no assurance that Sterling's estimates of
capital expenditures or the funding thereof are accurate.
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 September 30, 2000, Sterling
Savings Bank exceeded all such regulatory capital requirements.
In connection with Sterling Savings Bank's acquisition of three insolvent
savings institutions between 1985 and 1988, the U.S. government agreed that
Sterling could utilize $13.5 million of cash assistance and $38.0 million of
supervisory goodwill associated with the acquisitions to help meet its
regulatory capital and liquidity requirements. In 1989, Congress enacted FIRREA
which provided, among other things, that savings institutions such as Sterling
Savings Bank were no longer permitted to include supervisory goodwill in their
regulatory capital. Consequently, Sterling Savings Bank was required to write
off its supervisory goodwill, which resulted in Sterling Savings Bank's failing
to comply with its minimum regulatory capital requirements from 1989 through
1991.
In May 1990, Sterling sued the U.S. government with respect to the loss of
the goodwill treatment and other matters in a lawsuit entitled STERLING SAVINGS
ASSOCIATION AND STERLING FINANCIAL CORPORATION V. THE UNITED
20
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STERLING FINANCIAL CORPORATION
Comparison of the Three and Nine Months Ended September 30, 2000 and 1999
STATES, No.95 829 C (the "Goodwill Litigation"). In the Goodwill Litigation,
Sterling seeks damages for, among other things, breach of contract and for
deprivation of property without just compensation and without due process of
the law.
In 1996, the U.S. Supreme Court ruled in three cases similar to the
Goodwill Litigation 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.
Sterling's Goodwill Litigation, which had been stayed for almost ten years,
has completed the fact discovery phase and is proceeding with the expert witness
discovery phase of this case. Although it is impossible to accurately predict
when this effort will be concluded, management anticipates that the expert
witness discovery stage will carry in to 2001 and that Sterling's case will be
scheduled for trial by late 2001. Because of the increased level of effort
required to bring the case to conclusion, Sterling likely will see an increase
in legal expenses over the next few years.
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
Washington State-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 FHLB Seattle, which is one of the twelve 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.
In November 1999, the United States Congress passed and the President
signed the Gramm-Leach Bliley Act (the "GLBA"). The GLBA is also known as the
Financial Services Modernization Act due to its sweeping overhaul of the
financial services industry. Enactment of the GLBA allows banks, securities
firms and insurance companies to affiliate. Now financial institutions can act
as financial "supermarkets" offering customers "one-stop shopping" for bank
accounts, insurance policies and securities transactions.
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 Estate Settlement and Procedures Act, Bank Secrecy Act
and many others. During the quarter ended June 30, 1999, Sterling entered into
an agreement with the OTS pursuant to which Sterling has developed a
comprehensive compliance program. As part of the compliance program, management
and the Board of Directors are jointly working 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.
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."
21
<PAGE>
PART II - Other Information
STERLING FINANCIAL CORPORATION
PART II - OTHER INFORMATION
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
<TABLE>
<CAPTION>
(a) Exhibit No. Exhibit
----------- --------
<S> <C>
3.1 Restated Articles of Incorporation of Registrant and Articles of
Amendment of Restated Articles of Incorporation. Filed as
Exhibits 3.1 and 3.2, respectively, to Registrant's Form S-4 dated
November 7, 1994 and incorporated by reference herein.
3.2 Copy of Bylaws of Registrant (amended and restated as of May 24,
1999). Filed as Exhibit 3.3 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1999 and incorporated by
reference herein.
4.1 Reference is made to Exhibits 3.1 through 3.3.
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.
</TABLE>
(b) Reports on Form 8-K. During the quarter ended September 30, 2000,
there was one report on Form 8-K (Item 5) filed on July 28, 2000.
22
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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)
November 6, 2000 By: /s/ Daniel G. Byrne
---------------- ----------------------------------
Date DANIEL G. BYRNE
Senior Vice President - Finance,
Assistant Secretary,
and Principal Financial Officer
By: /s/ William R. Basom
----------------------------------
WILLIAM R. BASOM
Vice President, Treasurer, and
Principal Accounting Officer
23
