<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 MARCH 31, 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:
<TABLE>
<CAPTION>
Class Outstanding as of April 28, 2000
----- --------------------------------
<S> <C>
Common Stock ($1.00 par value) 8,099,028
</TABLE>
<PAGE>
STERLING FINANCIAL CORPORATION
FORM 10-Q
For the Quarter Ended March 31, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - Financial Information 1
Item 1 - Financial Statements 1
Consolidated Balance Sheets 1
Consolidated Statements of Income 2
Consolidated Statements of Cash Flows 3
Consolidated Statements of Comprehensive Income 5
Notes to Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 20
PART II - Other Information 20
Item 1 - Legal Proceedings 20
Item 2 - Changes in Securities and Use of Proceeds 20
Item 3 - Defaults Upon Senior Securities 20
Item 4 - Submission of Matters to a Vote of Security Holders 20
Item 5 - Other Information 20
Item 6 - Exhibits and Reports on Form 8-K 20
Signature 22
</TABLE>
<PAGE>
PART I - Financial Information
Item 1 - Financial Statements
-----------------------------
STERLING FINANCIAL CORPORATION
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
----------- -----------
(Dollars in thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents:
Interest bearing $ 28,404 $ 23,365
Non-interest bearing and vault 60,519 72,221
Restricted 1,151 1,018
Loans receivable, net 1,874,420 1,787,771
Loans held for sale 1,863 985
Investments and mortgage-backed securities ("MBS"):
Available for sale 480,498 494,483
Held to maturity 11,234 11,247
Accrued interest receivable (including $3,485 and $3,504 on investments
and MBS) 15,598 16,720
Real estate owned, net 9,266 7,299
Office properties and equipment, net 51,899 52,649
Other intangibles, net 54,091 55,488
Mortgage servicing rights, net 244 222
Prepaid expenses and other assets, net 22,420 23,457
----------- -----------
Total assets $ 2,611,607 $ 2,546,925
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ 1,670,397 $ 1,617,368
Advances from Federal Home Loan Bank of Seattle ("FHLB Seattle") 475,525 490,503
Securities sold subject to repurchase agreements and federal funds
purchased 200,539 179,515
Other borrowings (Note 3) 110,000 110,000
Cashiers checks issued and payable 10,332 11,967
Borrowers' reserves for taxes and insurance 2,959 1,369
Accrued interest payable 8,792 7,539
Accrued expenses and other liabilities 14,497 11,025
----------- -----------
Total liabilities 2,493,041 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;
8,099,028 and 8,089,844 shares issued and outstanding 8,099 8,090
Additional paid-in capital 70,386 70,339
Accumulated other comprehensive loss:
Unrealized losses on investments and MBS available for sale,
net of deferred income tax benefit of $8,613 and $7,298 (15,996) (13,553)
Retained earnings 56,077 52,763
----------- -----------
Total shareholders' equity 118,566 117,639
----------- -----------
Total liabilities and shareholders' equity $ 2,611,607 $ 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
March 31,
----------------------------------------
2000 1999
----------------- -----------------
(Dollars in thousands, except per share data)
<S> <C> <C>
Interest income:
Loans $ 39,354 $ 32,746
MBS 5,652 5,934
Investments and cash equivalents 2,879 2,826
----------------- -----------------
Total interest income 47,885 41,506
----------------- -----------------
Interest expense:
Deposits 16,727 14,669
Short-term borrowings 2,948 2,856
Long-term borrowings 8,819 6,238
----------------- -----------------
Total interest expense 28,494 23,763
----------------- -----------------
Net interest income 19,391 17,743
Provision for losses on loans (1,100) (900)
----------------- -----------------
Net interest income after provision for losses on loans 18,291 16,843
----------------- -----------------
Other income:
Fees and service charges 2,993 2,468
Mortgage banking operations 121 353
Loan servicing fees 221 197
Net gains on sales of securities 0 593
Real estate owned operations 28 (92)
----------------- -----------------
Total other income 3,363 3,519
----------------- -----------------
Operating expenses (Note 5) 16,394 15,862
----------------- -----------------
Income before income taxes 5,260 4,500
Income tax provision (1,946) (1,662)
----------------- -----------------
Net income $ 3,314 $ 2,838
================= =================
Income per share - basic $ 0.41 $ 0.35
================= =================
Income per share - diluted $ 0.41 $ 0.35
================= =================
Weighted average shares outstanding - basic 8,094,343 8,063,756
Weighted average shares outstanding - diluted 8,113,508 8,184,690
</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>
Three Months Ended
March 31,
--------------------------------------
2000 1999
------------------ ---------------
(Dollars in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,314 $ 2,838
Adjustments to reconcile net income to net cash provided by
operating activities:
Provisions for losses on loans and real estate owned 1,100 1,105
Stock dividends on FHLB Seattle stock (562) (618)
Net gain on sales of loans, investments and MBS (109) (911)
Net gain on sales of real estate owned (48) (136)
Depreciation and amortization 2,717 2,833
Change in:
Accrued interest receivable 1,122 583
Prepaid expenses and other assets 2,260 (49)
Cashiers checks issued and payable (1,635) (3,180)
Accrued interest payable 1,253 (106)
Accrued expenses and other liabilities 3,472 (1,673)
Proceeds from sales of loans 9,938 30,026
Loans originated for sale (9,830) (29,700)
------------------ ---------------
Net cash provided by operating activities 12,992 1,012
------------------ ---------------
Cash flows from investing activities:
Change in restricted cash (133) 6,117
Loans disbursed (329,376) (371,817)
Loan principal received 238,702 218,825
Purchase of investments (19,912) (29,823)
Proceeds from maturities of investments 19,912 34,258
Proceeds from sales of available-for-sale investments 2,000 542
Principal payments on MBS 8,732 32,931
Proceeds from sales of MBS 0 29,104
Purchase of office properties and equipment (375) (1,866)
Improvements and other changes to real estate owned (343) (12)
Proceeds from sales and liquidation of real estate owned 472 959
------------------ ---------------
Net cash used in investing activities (80,321) (80,782)
------------------ ---------------
</TABLE>
3
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows (continued)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------------
2000 1999
----------------- ------------------
(Dollars in thousands)
<S> <C> <C>
Cash flows from financing activities:
Net change in checking, passbook and money market deposits $ 10,057 $ (9,593)
Proceeds from issuance of certificates of deposit 143,004 199,873
Payments for maturing certificates of deposit (115,763) (186,452)
Interest credited to deposits 15,731 14,495
Advances from FHLB Seattle 55,000 35,877
Repayment of FHLB Seattle advances (70,033) (20,026)
Net change in securities sold subject to repurchase agreements
and funds purchased 21,024 3,150
Proceeds from other borrowings 0 5,000
Proceeds from exercise of stock options, net of repurchases 56 63
Other 1,590 1,162
----------------- ------------------
Net cash provided by financing activities 60,666 43,549
----------------- ------------------
Net change in cash and cash equivalents (6,663) (36,221)
Cash and cash equivalents, beginning of period 95,586 88,331
----------------- ------------------
Cash and cash equivalents, end of period $ 88,923 $ 52,110
================= ==================
Supplemental disclosures:
Cash paid during the period for:
Interest $ 27,241 $ 23,869
Income taxes 4 719
Noncash financing and investing activities:
Loans converted into real estate owned 2,048 317
The accompanying notes are an integral part of the consolidated financial
statements.
</TABLE>
4
<PAGE>
STERLING FINANCIAL CORPORATION
Consolidated Statements of Comprehensive Income
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
2000 1999
--------- -----------
(Dollars in thousands)
<S> <C> <C>
Net income $ 3,314 $ 2,838
--------- -----------
Other comprehensive loss:
Change in unrealized losses on investments and
MBS available for sale (3,758) (3,277)
Less deferred income tax benefit (1,315) (1,147)
--------- -----------
Net other comprehensive loss (2,443) (2,130)
--------- -----------
Comprehensive income $ 871 $ 708
========= ===========
</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
months ended March 31, 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>
March 31, December 31,
------------ ------------
(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) 0 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 $ 110,000 $ 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 March 31,
2000. This line of credit matures on May 31, 2001. Interest accrues
at the 30-day London Interbank Offering Rate ("LIBOR") plus 2.00%
(8.06% at March 31, 2000) and is payable monthly. 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 in June 2000. The
interest rate is adjustable monthly at KeyBank's prime interest rate
(9.00% at March 31, 2000). At March 31, 2000 and December 31, 1999,
no amounts were outstanding under this line-of-credit 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 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.
6
<PAGE>
(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 March 31, 2000, Sterling could incur
approximately $35.6 million of additional long-term debt, and
Sterling would have been limited to the payment of up to
approximately $5.4 million in additional dividends. Interest accrues
at the 90-day LIBOR plus 2.50% (8.65% until June 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 March 31,
------------------------------------------------------------------------------
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 $ 3,314,000 8,094,343 $ 0.41 $ 2,838,000 8,063,756 $ 0.35
Effect of dilutive securities:
Common stock options 0 19,165 0 120,934
------------- ------------ --------- ------------- ------------ ---------
Diluted computations $ 3,314,000 8,113,508 $ 0.41 $ 2,838,000 8,184,690 $ 0.35
============= ============ ========= ============= ============ =========
Antidilutive options not
included in diluted
income per share 599,078 71,500
</TABLE>
5. OPERATING EXPENSES:
The following table details Sterling's components of total operating
expenses:
<TABLE>
<CAPTION> Three Months Ended
March 31,
---------------------------
2000 1999
---------- -----------
(Dollars in thousands)
<S> <C> <C>
Employee compensation and benefits $ 8,117 $ 6,941
Occupancy and equipment 2,530 2,362
Depreciation 1,125 1,004
Amortization of intangible assets 1,397 1,448
Advertising 549 619
Data processing 1,441 1,279
Insurance 175 274
Legal and accounting 354 331
Travel and entertainment 398 380
Goodwill litigation costs 100 60
Other 208 1,164
---------- -----------
Total operating expenses $ 16,394 $ 15,862
========== ===========
</TABLE>
7
<PAGE>
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 has not yet determined the effect, if any, of
implementing SFAS No. 133 on 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.
The following table summarizes information related to Sterling's
residential mortgage banking operations:
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------
2000 1999
----------- -----------
(Dollars in thousands)
<S> <C> <C>
Revenues:
Gains on sales of originated residential loans $ 85 $ 318
Other fees and income 1,634 1,239
----------- -----------
Total revenues 1,719 1,557
Identifiable expenses (1,089) (809)
----------- -----------
Income before income taxes $ 630 $ 748
=========== ===========
Identifiable assets $ 12,038 $ 9,511
=========== ===========
Depreciation and amortization expense $ 29 $ 33
=========== ===========
Capital expenditures for office properties and equipment $ 61 $ 28
=========== ===========
</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.
8
<PAGE>
The following table summarizes information related to Sterling's
commercial real estate lending operations:
<TABLE>
<CAPTION>
Three Months Ended March 31,
-------------------------------
2000 1999
----------- -----------
(Dollars in thousands)
<S> <C> <C>
Revenues:
Gains on sales of originated commercial real estate loans $ 24 $ 0
Other fees and income 817 719
----------- -----------
Total revenues 841 719
Identifiable expenses (403) (249)
----------- -----------
Income before income taxes $ 438 $ 470
=========== ===========
Identifiable assets $ 16,974 $ 13,685
=========== ===========
Depreciation and amortization expense $ 3 $ 3
=========== ===========
Capital expenditures for office properties and equipment $ 15 $ 7
=========== ===========
</TABLE>
Sterling has determined that its reportable business segments are those
that are based on its method of disaggregated internal reporting.
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 March 31, 2000:
Other income $ 3,242 $ 97 $ 24 $ 3,363
Income before income taxes 4,192 630 438 5,260
Total assets 2,582,595 12,038 16,974 2,611,607
As of and for the three months ended March 31, 1999:
Other income $ 3,166 $ 353 $ 0 $ 3,519
Income before income taxes 3,282 748 470 4,500
Total assets 2,330,739 9,511 13,685 2,353,935
</TABLE>
9
<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, 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 $2.61 billion in total assets at March 31,
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.
10
<PAGE>
RESULTS OF OPERATIONS
OVERVIEW. Sterling recorded net income of $3.3 million, or $0.41 per
diluted share, for the three months ended March 31, 2000, compared with net
income of $2.8 million, or $0.35 per diluted share, for the three months ended
March 31, 1999. The increase in net income reflected higher net interest income.
The annualized return on average total assets was 0.52% and 0.49% for
the three months ended March 31, 2000 and 1999, respectively. The annualized
return on average equity was 11.19% and 9.55% for the three months ended March
31, 2000 and 1999, respectively. The increases in these ratios were primarily
due to an increase in net income.
Operating cash earnings, operating cash earnings per common share, and
the ratios given below exclude amortization of intangible assets of $880,000 and
$913,000, which are net of related income taxes for the three months ended March
31, 2000 and 1999, respectively.
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------
2000 1999
------- -------
<S> <C> <C>
Operating cash earnings (dollars in thousands) $4,194 $3,751
Operating cash earnings per common share - diluted $ 0.52 $ 0.46
Operating cash return on average assets 0.66% 0.65%
Operating cash return on average common shareholders' equity 14.16% 12.62%
</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 March 31, 2000 and 1999, NII was $19.4 million and $17.7
million, respectively, representing an increase of 9.3%.
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 three months ended March 31, 2000, compared to the same period in the
prior year, was primarily due to the increase in the average volume of loans.
During the three months ended March 31, 2000 and 1999, the volume of
average interest-earning assets was $2.37 billion and $2.15 billion,
respectively. Net interest spread during these periods was 3.15% and 3.21%,
respectively. The net interest margin for the three months ended March 31, 2000
and 1999 was 3.29% and 3.35%, respectively. Net interest margin decreased
primarily due to the narrower interest rate spreads and an increase in the
average volumes of advances from the Federal Home Loan Bank of Seattle ("FHLB
Seattle") and other long-term borrowings. Net interest spread decreased
primarily due to a greater increase in the rates paid on interest-bearing
liabilities than the yield on the loan portfolio.
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
$900,000 for the three months ended March 31, 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
11
<PAGE>
consumer loans. At March 31, 2000, Sterling's total classified assets were
$22.4 million, compared with $19.9 million at December 31, 1999. At March 31,
2000, Sterling=s loan delinquency rate (60 days or more) as a percentage of
total loans was 0.58%, compared with 0.44% at March 31, 1999. Total
nonperforming loans were $8.5 million at March 31, 2000, compared with
$5.5 million at March 31, 1999. The increase in nonperforming loans was
primarily attributable to certain construction loans. 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 provision for losses on loans for the three
months ended March 31, 2000 is 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
March 31,
----------------------
2000 1999
------ ------
(Dollars in thousands)
<S> <C> <C>
Fees and service charges $2,993 $2,468
Mortgage banking operations 121 353
Loan servicing fees 221 197
Net gains on sales of securities 0 593
Real estate owned operations 28 (92)
------ ------
Total other income $3,363 $3,519
====== ======
</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 increase for the three months ended March 31,
2000, compared with the three months ended March 31, 1999, was primarily due to
the implementation of new service charges on transaction accounts and higher
commissions on sales of mutual funds and annuity products.
The following table summarizes loan originations and sales of loans for
the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------
2000 1999
------ ------
(Dollars in millions)
<S> <C> <C>
Originations of one- to four-family permanent mortgage loans $ 25.5 $ 64.6
Sales of residential loans 8.6 29.7
Sales of commercial real estate loans 1.3 0.0
Principal balances of mortgage loans serviced for others 202.8 200.9
</TABLE>
The decrease in income from mortgage banking operations for the three
months ended March 31, 2000 compared to the same period in 1999 was primarily
due to a lower volume of loan sales. Sterling anticipates increasing income from
its mortgage servicing portfolio over the next twelve months by generating a
greater volume of loan sales with the retention of servicing.
12
<PAGE>
During the three months ended March 31, 2000, Sterling did not realize
any gains on the sale of investments and MBS. Sterling sold approximately $29.1
million of investments and MBS in the prior year's comparable period, resulting
in net gains of $593,000.
OPERATING EXPENSES. Operating expenses were $16.4 million and $15.9
million for the three months ended March 31, 2000 and 1999, respectively. The
increase was primarily due to increased staffing levels.
Employee compensation and benefits were $8.1 million and $6.9 million
for the three months ended March 31, 2000 and 1999, respectively. The increase
reflected increased community bank lending staff and additional staff for
Sterling's item processing centers, which commenced operations in April 1999. At
March 31, 2000, full-time-equivalent employees were 830, compared with 801 at
March 31, 1999.
Occupancy and equipment expenses were $2.5 million and $2.4 million for
the three months ended March 31, 2000 and 1999, respectively. The increase
reflected costs associated with the item processing centers and higher
maintenance costs.
Data processing expense was $1.4 million and $1.3 million for the three
months ended March 31, 2000 and 1999, respectively. The increase was primarily
attributable to costs associated with the item processing centers, internal data
processing upgrades and increased out-sourcing of computer maintenance.
Other expenses were $208,000 and $1.2 million for three months ended
March 31, 2000 and 1999, respectively. The decrease was primarily due to cost
savings realized from in-house item processing and higher loan processing costs
in the quarter ended March 31, 1999.
INCOME TAX PROVISION. Sterling recorded a federal and state income tax
provision of $1.9 million and $1.7 million for the three months ended March 31,
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 March 31, 2000, Sterling's assets were $2.61 billion, up
2.5% 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 March
31, 2000 was $491.7 million, down $14.0 million from the December 31, 1999
balance of $505.7 million. The decrease was primarily due to principal
repayments and the reduction in market values of investments and MBS available
for sale.
LOANS RECEIVABLE. At March 31, 2000, net loans receivable were $1.87
billion, up $86.6 million (or 4.8%) from $1.79 billion at December 31, 1999. The
increase was primarily due to strong funding of construction and business
banking loans. During the three months ended March 31, 2000, total loan
originations were $248.7 million compared with $340.7 million for the prior
year's comparable quarter. The most significant increase in loan originations
was in construction lending, which was more than offset by decreases in
residential and commercial real estate lending. See the loan origination table
below.
13
<PAGE>
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>
March 31, 2000 December 31, 1999
---------------------- ----------------------
Amount % Amount %
---------- ----- ---------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Residential $ 399,332 21.1 $ 396,565 22.0
Multifamily 146,340 7.7 137,835 7.6
Commercial real estate 319,535 16.9 317,565 17.6
Construction 319,926 16.9 287,123 15.9
Consumer - direct 223,886 11.8 223,286 12.4
Consumer - indirect 100,473 5.3 94,420 5.2
Business banking 383,335 20.3 348,941 19.3
---------- ----- ---------- -----
Total loans receivable $1,892,827 100.0 $1,805,735 100.0
========== ===== ========== =====
Weighted average yield 8.49% 8.32%
</TABLE>
The following table sets forth Sterling's loan originations for the
periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------- %
2000 1999 Change
-------- -------- ------
(Dollars in thousands)
<S> <C> <C> <C>
Residential $ 25,512 $ 64,577 (60.5)
Multifamily 10,900 29,580 (63.2)
Commercial real estate 6,125 64,128 (90.5)
Construction 115,214 77,690 48.3
Consumer - direct 21,243 29,789 (28.7)
Consumer - indirect 12,336 14,002 (11.9)
Business banking 57,356 60,951 (5.9)
-------- -------- ------
Total loans originated $248,686 $340,717 (27.0)
======== ========
</TABLE>
The decrease in loan originations was primarily due to the increase in
long-term interest rates during the three months ended March 31, 2000.
DEPOSITS. Total deposits increased $53.0 million to $1.67 billion at
March 31, 2000 from $1.62 billion at December 31, 1999. For the quarter ended
March 31, 2000, the weighted average cost of total deposits was 4.14%, compared
with 3.83% for the quarter ended March 31, 1999. The increase in the average
cost of total deposits was primarily due to the increase in interest rates,
particularly on certificates of deposit.
14
<PAGE>
The following table sets forth the composition of Sterling's deposits
at the dates indicated.
<TABLE>
<CAPTION>
March 31, 2000 December 31, 1999
-------------------------- -------------------------
Amount % Amount %
-------------------------- -------------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Certificates of deposit $ 955,617 57.2 $ 916,692 56.7
Checking 307,206 18.4 290,017 17.9
Savings and money market 407,574 24.4 410,659 25.4
-------------- --------- -------------- --------
Total deposits $ 1,670,397 100.0 $ 1,617,368 100.0
============== ========= ============== ========
</TABLE>
BORROWINGS. Deposit accounts are Sterling's primary source of funds.
Sterling does, however, rely upon advances from FHLB Seattle and reverse
repurchase agreements to supplement its funding and to meet deposit withdrawal
requirements. At March 31, 2000, the total of such borrowings was $786.1
million, compared with $780.0 million at December 31, 1999, an increase of $6.1
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 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- 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.
15
<PAGE>
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.
Sterling is continuing to pursue strategies to manage the level of its
IRR while increasing its NII and NPV through the origination and retention of
variable-rate consumer, business banking, construction and commercial real
estate loans, which generally have higher yields than residential permanent
loans, and by increasing the level of its core deposits, which are generally a
lower-cost funding source than borrowings. There can be no assurance that
Sterling will be successful implementing any of these strategies or that, if
those strategies are implemented, they will have the intended effect of reducing
IRR or increasing NII.
The following table presents Sterling's estimates of changes in NPV for
the periods indicated. The results indicate the potential effects of
instantaneous, parallel shifts in the market yield curve. These calculations are
highly subjective and technical and are relative measurements of IRR which do
not necessarily reflect any expected rate movement.
<TABLE>
<CAPTION>
At March 31, 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> <C>
+300 $ (746) (0.03)% (100.8) $ 2,712 0.12% (97.2)
+200 34,759 1.40 (64.8) 36,369 1.51 (62.5)
+100 63,008 2.50 (36.1) 63,177 2.57 (34.8)
Static 98,638 3.83 N/A 96,899 3.86 N/A
-100 117,966 4.52 19.6 112,812 4.43 16.4
-200 121,442 4.61 23.1 103,314 4.03 6.6
-300 106,715 4.05 8.2 73,835 2.89 (23.8)
</TABLE>
At March 31, 2000, Sterling calculated that its NPV was $98.6 million
and that its NPV would decrease by 64.8% and 100.8% 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
21.4% and negative 13.0% at
16
<PAGE>
March 31, 2000 and 1999, respectively. Sterling calculated its three-year gap
positions to be negative 19.9% and negative 16.0% at March 31, 2000 and 1999,
respectively. The increase in the negative readings at both the one-year gap
position and the three-year gap position is due to a combination of
fixed-term loan originations funded with shorter-term liabilities, rising
interest rates shortening the projected maturities of callable liabilities,
and slower prepayments on loans and MBS also resulting from higher interest
rates. Management attempts to maintain Sterling's gap position between
positive 10% and negative 25%. At March 31, 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
$1.67 billion at March 31, 2000 from $1.62 billion at December 31, 1999.
Advances from FHLB Seattle decreased to $475.5 million at March 31, 2000 from
$490.5 million at December 31, 1999. At March 31, 2000 and December 31, 1999,
securities sold subject to repurchase agreements were $200.5 million and $179.5
million, respectively. The net increase in these borrowings was primarily used
to supplement loan growth during the quarter. 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.
During the three months ended March 31, 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 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,
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 March 31, 2000, this credit line
represented a total borrowing capacity of $789.9 million, of which $314.4
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, 2000, Sterling Savings Bank had $178.6
million in outstanding borrowings under reverse repurchase agreements and had
securities available for additional secured borrowings of approximately $179.7
million. Sterling Savings Bank also had a secured line-of-credit agreement from
KeyBank of $10.0 million as of March 31, 2000. At March 31, 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 $3.0 million and a revolving line of credit from KeyBank of
$5.0 million at March 31, 2000 with no funds drawn on this line of credit. At
March 31, 2000, Sterling 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 March 31, 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
$2.5 million during the
17
<PAGE>
three months ended March 31, 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 March 31, 2000 and December 31, 1999,
Sterling Savings Bank's liquidity ratio was 7.6% and 9.1%, respectively. The
lower level of liquidity at March 31, 2000 was primarily due to a decrease in
the balance of cash and cash equivalents and eligible securities. 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 $118.6 million at March 31,
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
partially offset by a decrease in the market value of available-for-sale
investments and MBS. Shareholders' equity at March 31, 2000 was 4.5% of total
assets compared with 4.6% at December 31, 1999.
At March 31, 2000, Sterling had an unrealized loss of $16.0 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. 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 $2.2
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
18
<PAGE>
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, 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 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 has been stayed for almost ten years;
and in November 1999, Sterling was finally authorized to begin taking discovery
related to its claim. Although it is impossible to accurately predict when this
effort will be concluded, it is anticipated that the discovery stage will take
most or all of 2000 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 will jointly work to
ensure that Sterling's
19
<PAGE>
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."
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
(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.
20
<PAGE>
PART II - Other Information
STERLING FINANCIAL CORPORATION
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.
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. There were no reports on Form 8-K (Item
5) filed during the quarter ended March 31, 2000.
21
<PAGE>
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 12, 2000 By: /s/ Daniel G. Byrne
- ---------------- ------------------------------------------
Date DANIEL G. BYRNE
Senior Vice President - Finance;
Treasurer and Assistant Secretary;
Principal Financial Officer and
Chief Accounting Officer
22
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0
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