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FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [Fee required]
For the fiscal year ended December 31, 1997
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OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [No fee required]
For the transition period from to
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COMMISSION FILE NUMBER 0-20800
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STERLING FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Washington 91-1572822
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
111 North Wall Street, Spokane, Washington 99201
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including
area code: (509) 458-2711
Securities registered pursuant to Section 12(b) of the Act:
None None
---------------- -------------------------------------------
(Title of class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock ($1.00 par value)
8.75% Subordinated Notes Due 2000
9.50% Cumulative Capital Securities Due 2027
(Title of class)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes X No
--- ---
As of February 27, 1998, the aggregate market value of the common
equity held by non-affiliates of the registrant, computed by reference
to the average of the bid and asked prices on such date as reported by
the Nasdaq National Market, was $174,627,031.
The number of shares outstanding of the Registrant's Common Stock, par
value $1.00 per share, as of February 27, 1998 was 7,578,552.
DOCUMENTS INCORPORATED BY REFERENCE
Specific portions of the Registrant's Proxy Statement dated April 2,
1998 are incorporated by reference into Part III hereof.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. [X]
STERLING FINANCIAL CORPORATION
DECEMBER 31, 1997 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business
General
Recent Developments
Growth and Acquisition Strategies
Lending Activities
Investments and Mortgage-Backed Securities
Sources of Funds
Subsidiaries
Competition
Personnel
Regulation
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for the Registrant's Stock and Related Shareholder
Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
General
Net Interest Income
Asset and Liability Management
Results of Operations for the Twelve Months Ended
December 31, 1997 and 1996
Results of Operations for the Six Months Ended
December 31, 1996 and 1995
Results of Operations for Fiscal Years Ended June 30, 1996
and 1995
Liquidity and Sources of Funds
Capital Resources
New Accounting Standards
Year 2000 Issues
Effects of Inflation and Changing Prices
Item 7.A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Item 13. Certain Relationships and Related Transactions
PART IV 56
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
SIGNATURES
Consolidated Financial Statements
Any trend or forward-looking information discussed in this report is
subject to numerous possible risks and uncertainties. These include
but are not limited to: the possibility of adverse economic
developments which may, among other things, increase default and
delinquency risks in Sterling's loan portfolios; shifts in interest
rates which may result in lower interest rate margins; changes in
accounting policies; changes in the monetary and fiscal policies of
the federal government; changes in the regulatory and competitive
environment, and other risks. Sterling's future results may differ
materially from historical results as well as from any trend or
forward-looking information included in this report.
PART I
Item 1. Business
------------------
GENERAL
Sterling Financial Corporation ("Sterling") is a unitary savings and
loan holding company, the significant operating subsidiary of which is
Sterling Savings Association ("Sterling Savings"). The significant
operating subsidiaries of Sterling Savings are Action Mortgage Company
("Action Mortgage"), INTERVEST-Mortgage Investment Company
("INTERVEST") and Harbor Financial Services, Inc. ("Harbor
Financial"). Sterling Savings commenced operations in 1983 as a State
of Washington-chartered, federally insured stock savings and loan
association headquartered in Spokane, Washington.
Sterling endeavors to provide personalized, quality financial services
to its customers as exemplified by its "Hometown Helpful" philosophy.
Sterling believes that this dedication to personalized service has
enabled it to maintain a stable retail deposit base. Sterling, with
approximately $1.9 billion in total assets at December 31, 1997,
attracts Federal Deposit Insurance Corporation ("FDIC") insured
deposits from the general public through 41 retail branches located
primarily in rural and suburban communities in Washington and Oregon.
Sterling originates loans through its branch offices as well as eight
Action Mortgage residential loan production offices in the Spokane and
Seattle, Washington; Portland, Oregon and Boise, Idaho metropolitan
areas and four INTERVEST commercial real estate lending offices
located in the metropolitan areas of Seattle and Spokane, Washington
and Portland, Oregon. Sterling also markets tax-deferred annuities,
mutual funds and other financial products through Harbor Financial.
Recently, Sterling has focused its efforts on becoming more like a
community bank by increasing its construction, business banking and
consumer lending while increasing its retail deposits. Sterling's
revenues are derived primarily from interest earned on loans and
mortgage-backed securities ("MBS"), from fees and service charges and
from mortgage banking operations. The operations of Sterling Savings,
and savings institutions generally, are influenced significantly by
general economic conditions and by policies of its primary regulatory
authorities, the Office of Thrift Supervision ("OTS"), the FDIC and
the State of Washington Department of Financial Institutions
("Washington Supervisor"). See "Regulation."
Sterling changed its fiscal year-end from June 30 to December 31,
effective December 31, 1996. Accordingly, results of operations
included herein have been presented for the twelve months ended
December 31, 1997 and 1996, six months ended December 31, 1996 and
1995 and the fiscal years ended June 30, 1996 and 1995.
RECENT DEVELOPMENTS
To further enhance its presence in the Pacific Northwest market,
Sterling has been working to expand its community bank delivery
system, focusing primarily on deposit gathering and lending. On
February 2, 1998, Sterling signed an agreement to acquire 33 branch
offices in Washington, Idaho and Oregon from KeyBank National
Association ("KeyBank"). The purchase includes approximately $585
million of deposit balances, the owned branch facilities, branch
furniture, fixtures and certain equipment and approximately $133
million of loan balances. To acquire these branches, Sterling will
pay approximately $72 million based upon a premium on deposits plus
the value of the assets related to these branches. Sterling
anticipates using the net proceeds of approximately $380 million from
this transaction to reduce its borrowings and wholesale liabilities.
As a result of this transaction, Sterling's total assets are expected
to increase by approximately $150 million.
In order to finance this transaction, Sterling will use its existing
cash resources and borrowing capacities supplemented with additional
borrowings of approximately $25 million. Sterling may also increase
its capital resources through an offering of debt or equity
securities, the proceeds of which offering will likely be issued to
retire certain borrowings.
The strategic advantages of the branch acquisition to Sterling are
expected to include (i) a reduction in its cost of funds which should
contribute to an improvement in net interest margin, (ii) an expanded
branch network through which to generate additional loans and retail
deposits, and (iii) an increased presence with Sterling's existing
markets of Washington and Oregon, as well as expansion into certain
markets in Idaho. Sterling's operating costs will increase as a
result of adding these branches and amortizing the core deposit
premium and other intangible assets over time. Sterling anticipates
the amortization period to be 10 to 15 years.
The acquisition is subject to regulatory approvals and other
conditions of closing and is scheduled to close in mid-year 1998.
Management anticipates securing regulatory approvals, meeting other
conditions of closing and obtaining appropriate financing, although
there can be no assurance in this regard.
GROWTH AND ACQUISITION STRATEGIES
Sterling intends to continue to pursue an aggressive growth strategy.
In addition, Sterling has grown and may seek to grow by acquiring
other financial institutions or branches thereof or other substantial
assets or deposit liabilities. Sterling may not be successful in
identifying further acquisition candidates, integrating acquired
institutions or preventing deposit erosion or loan quality
deterioration at acquired institutions. There is significant
competition for acquisitions in Sterling's market area, and Sterling
may not be able to acquire other institutions on attractive terms.
Furthermore, the success of Sterling's growth strategy will depend on
increasing and maintaining sufficient levels of regulatory capital,
obtaining necessary regulatory approvals, generating appropriate
internal growth and favorable economic and market conditions. There
can be no assurance that Sterling will be successful in implementing
its internal growth strategy.
LENDING ACTIVITIES
FOCUS ON COMMUNITY LENDING. In recent years, Sterling has focused its
efforts on becoming more like a community retail bank. Sterling is
increasing its business banking, consumer and construction lending.
Business banking, consumer and construction loans generally produce
higher yields than residential mortgage loans. Such loans, however,
generally involve a higher degree of risk than the financing of
residential real estate.
BUSINESS BANKING LENDING. Sterling offers business banking loans
primarily collateralized by various types of property including
accounts receivable, inventory and equipment. Business lending is
generally considered to involve a higher degree of risk than the
financing of real estate, primarily because security interests in the
collateral are more difficult to perfect and the collateral may be
difficult to obtain or liquidate following an uncured default.
Business banking loans typically offer relatively higher yields and
variable interest rates. The availability of such loans enables
potential depositors to establish a full-service banking relationship
with Sterling. Sterling attempts to reduce the risk of loss
associated with business lending by closely monitoring the financial
condition and performance of its customers. Sterling's Private
Banking Group provides services to higher net worth and higher income
borrowers by originating a variety of consumer and business banking
loans to meet their needs. Such loans generally meet the same
underwriting requirements as similar loans of the same type but
typically involve larger balances and may have nonstandard terms.
Sterling is permitted to hold 20% of its assets as business banking
loans. At December 31, 1997, business banking loans were 12.9% of
assets.
CONSUMER LENDING. Sterling's consumer lending program provides loans
for home improvements, automobiles, personal lines of credit, boats
and certain other purposes. Generally, consumer loans are originated
for terms ranging from six months to ten years. Interest rates are
either fixed or adjustable monthly, quarterly or semiannually, based
on a contractual formula at a margin over an established external
index. Sterling also makes loans collateralized by savings accounts
and second mortgage loans collateralized by real estate. Fixed rate
secured financing is available with amortization terms up to 15 years.
The consumer loan portfolio also includes dealer-generated installment
contracts for consumer goods, including automobiles and boats. The
majority of these indirect loans are installment loans with fixed
interest rates. Consumer loans, especially those originated through
dealers, generally have greater inherent risks than other types of
loans.
ONE- TO FOUR-FAMILY RESIDENTIAL LENDING. Sterling originates fixed
rate and adjustable rate mortgages ("ARMs"), which have interest rates
that adjust annually or every three, five and seven years and are
indexed to the weekly average yield on one-year U.S. Treasury
securities. Sterling also originates one- to four-family residential
construction loans.
Sterling continues to originate conventional and government-insured
residential loans for sale into the secondary mortgage market. Within
the secondary mortgage market for conventional loans, Sterling sells
its residential loans primarily on a servicing-released basis to
others. Sterling also sells loans to the Federal Home Loan Mortgage
Corporation (the "FHLMC") and the Federal National Mortgage
Association (the "FNMA"). Sterling endeavors to underwrite residential
loans in compliance with FHLMC and FNMA underwriting standards. Loans
sold into the secondary market are all sold without recourse to
Sterling, except that Sterling may be obligated to repurchase any
loans which are not underwritten in accordance with FHLMC and FNMA or
applicable investor underwriting guidelines.
Conventional residential mortgage loans are originated for up to 95%
of the appraised value or selling price of the mortgaged property,
whichever is less. All loans with loan-to-value ratios in excess of
80% carry a requirement that the customer purchase private mortgage
insurance from approved third parties so that Sterling's risk is
limited to approximately 80% of the appraised value. Sterling's
residential lending programs are designed to comply with all
applicable regulatory requirements. For a discussion of Sterling's
management of interest rate risk ("IRR") on conventional loans, see
"- Secondary Market Activities."
Sterling makes residential construction loans on custom homes, pre-
sold homes and homes that are not pre-sold. Construction financing is
generally considered to involve a higher degree of risk than long-term
financing on improved, occupied real estate. Sterling's risk of loss
on construction loans depends largely upon the accuracy of the initial
estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of
construction. If the estimate of construction costs proves to be
inaccurate, Sterling might have to advance funds beyond the amount
originally committed to permit completion of the development and to
protect its security position. Sterling also might be confronted, at
or prior to maturity of the loan, with a project with insufficient
value to ensure full repayment. Sterling's underwriting, monitoring
and disbursement practices with respect to construction financing are
intended to ensure that sufficient funds are available to complete
construction projects. Sterling endeavors to limit its risk through
its underwriting procedures by using only approved, qualified
appraisers and by dealing only with qualified builders/borrowers.
Since fiscal year 1994, there has been a significant decrease in the
volume of Sterling's permanent residential mortgage lending. During
the twelve months ended December 31, 1997 and 1996, the six months
ended December 31, 1996 and 1995 and the fiscal years ended June 30,
1996 and 1995, Sterling's residential lending arm, Action Mortgage,
increased its residential construction lending in an effort to offset
this decline in permanent residential lending and to improve its
operating margins.
At December 31, 1997, approximately 15% of Sterling's total loan
portfolio consisted of one- to four-family residential construction
loans, approximately 85% of which were for properties that were not
custom built or pre-sold. Further, approximately 72% of Sterling's
one- to four-family residential construction loan portfolio was
concentrated in the Portland, Oregon market which is served by one
loan production office. A reduction in the demand for residential
housing could have a negative impact on Sterling. In addition, at
December 31, 1997, another 11% of Sterling's loan portfolio consisted
of multifamily residential construction and commercial property
construction loans.
MULTIFAMILY RESIDENTIAL AND COMMERCIAL PROPERTY LENDING. Sterling
offers multifamily residential and commercial real estate loans as
both construction and permanent loans collateralized by real property
in the Pacific Northwest. Construction loans on such properties
typically have terms of 12 to 18 months and provide for variable
interest rates. Permanent loans on existing properties typically have
maturities of three to ten years. Multifamily residential and
commercial property loans generally involve a higher degree of risk
than the financing of one- to four-family residential real estate
because they typically involve large loan balances to single borrowers
or groups of related borrowers. The payment experience on such loans
typically is dependent on the successful operation of the real estate
project and is subject to certain risks not present in one- to four-
family residential mortgage lending. These risks include excessive
vacancy rates or inadequate operating cash flows. Construction
lending is subject to risks such as construction delays, cost
overruns, insufficient values and an inability to obtain permanent
financing in a timely manner. Sterling attempts to reduce its
exposure to these risks, typically by investigating the borrowers'
finances, and, depending on the circumstances, requiring annual
financial statements from the borrowers, requiring operating
statements on the properties and acquiring personal guarantees from
the borrowers.
The following table sets forth information on loan origination and
sale activities for the periods indicated.
Twelve Months Ended Six Months Ended
December 31, December 31,
----------------------------------- ----------------------------------
1997 1996 1996 1995
----------------- ---------------- ---------------- ----------------
Amount % Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------ -------- ------
(Dollars in thousands)
Mortgage--permanent:
One- to four-family residential $174,285 21.8% $165,246 25.5% $ 72,524 23.0% $124,246 35.2%
Multifamily residential 28,515 3.6 3,419 0.5 2,200 0.7 9,875 2.8
Commercial property 36,410 4.5 19,690 3.0 16,790 5.3 25,861 7.3
Mortgage--construction:
One- to four-family residential 215,758 26.9 195,800 30.3 94,331 29.9 76,137 21.6
Multifamily residential 62,356 7.8 51,601 8.0 12,735 4.0 29,303 8.3
Commercial property 10,825 1.4 28,704 4.4 10,925 3.5 17,455 4.9
Non-mortgage:
Consumer 99,641 12.4 56,163 8.7 33,333 10.6 25,934 7.4
Business banking 173,014 21.6 126,483 19.6 72,676 23.0 44,015 12.5
-------- ----- -------- ----- -------- ----- -------- -----
Total loans originated $800,804 100.0% $647,106 100.0% $315,514 100.0% $352,826 100.0%
======== ===== ======== ===== ======== ===== ======== =====
Residential mortgage loans sold $108,004 $187,121 $ 77,856 $122,797
Twelve Months Ended
December 31,
-----------------------------------
1997 1996
----------------- ----------------
Amount % Amount %
-------- ------ -------- ------
(Dollars in thousands)
Mortgage--permanent:
One- to four-family residential $216,968 31.7% $286,033 43.7%
Multifamily residential 11,094 1.6 19,398 3.0
Commercial property 28,761 4.2 11,460 1.7
Mortgage--construction:
One- to four-family residential 177,606 26.0 144,136 22.0
Multifamily residential 68,169 10.0 29,945 4.6
Commercial property 35,234 5.1 21,850 3.3
Non-mortgage:
Consumer 48,764 7.1 61,769 9.4
Business banking 97,822 14.3 80,330 12.3
-------- ----- -------- -----
Total loans originated $684,418 100.0% $654,921 100.0%
======== ===== ======== =====
Residential mortgage loans sold $232,061 $ 98,192
LOAN PORTFOLIO ANALYSIS. The following table sets forth the
composition of Sterling's loan portfolio by type of loan at the dates
indicated.
December 31, June 30,
-------------------------------------- --------------------------------------
1997 1996 1996 1995
------------------ ------------------ ------------------ ------------------
Amount % Amount % Amount % Amount %
---------- ------ ---------- ------ ---------- ------ ---------- ------
(Dollars in thousands)
Mortgage-permanent:
One- to four-family residential $ 282,894 24.2% $ 274,757 26.6% $ 302,526 30.0% $ 600,438 53.0%
Multifamily residential 65,621 5.6 69,728 6.8 64,305 6.4 59,776 5.3
Commercial property 118,270 10.1 102,279 9.9 101,243 10.1 85,511 7.5
Land and other 352 0.0 361 0.0 374 0.0 2,271 0.2
---------- ----- ---------- ----- ---------- ----- ---------- -----
467,137 39.9 447,125 43.3 468,448 46.5 747,996 66.0
---------- ----- ---------- ----- ---------- ----- ---------- -----
Mortgage-construction:
One- to four-family residential 178,834 15.3 148,252 14.3 137,930 13.7 113,531 10.0
Multifamily residential 97,059 8.3 77,743 7.5 79,048 7.8 42,158 3.7
Commercial property 26,386 2.3 37,875 3.7 40,003 4.0 22,630 2.0
---------- ----- ---------- ----- ---------- ----- ---------- -----
302,279 25.9 263,870 25.5 256,981 25.5 178,319 15.7
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total mortgage loans 769,416 65.8 710,995 68.8 725,429 72.0 926,315 81.7
Consumer 157,277 13.5 123,340 11.9 111,507 11.1 108,182 9.5
Business banking 241,808 20.7 199,848 19.3 169,830 16.9 99,528 8.8
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total loans receivable 1,168,501 100.0% 1,034,183 100.0% 1,006,766 100.0% 1,134,025 100.0%
===== ===== ===== =====
Undisbursed portion of loans in
process (90,111) (91,791) (112,325) (73,584)
Deferred loan origination costs
(fees) 540 468 891 3,153
Discount on loans acquired pursuant
to purchase transactions (380) (629) (776) (1,122)
Allowance for loan losses (8,959) (7,891) (7,889) (7,361)
---------- ---------- ---------- ----------
Loans receivable $1,069,591 $ 934,340 $ 886,667 $1,055,111
========== ========== ========== ==========
June 30,
--------------------------------------
1994 1993
------------------ ------------------
Amount % Amount %
---------- ------ ---------- ------
(Dollars in thousands)
Mortgage-permanent:
One- to four-family residential $ 575,363 64.3% 389,177 63.4%
Multifamily residential 45,188 5.1 50,543 8.3
Commercial property 78,822 8.8 76,125 12.4
Land and other 2,702 0.3 4,406 0.7
---------- ----- ---------- -----
702,075 78.5 520,251 84.8
---------- ----- ---------- -----
Mortgage-construction:
One- to four-family residential 37,054 4.1 14,014 2.3
Multifamily residential 31,856 3.6 6,500 1.0
Commercial property 833 0.1 375 0.1
---------- ----- ---------- -----
69,743 7.8 20,889 3.4
---------- ----- ---------- -----
Total mortgage loans 771,818 86.3 541,140 88.2
Consumer 69,316 7.8 43,870 7.2
Business banking 52,700 5.9 28,507 4.6
---------- ----- ---------- -----
Total loans receivable 893,834 100.0% 613,517 100.0%
===== =====
Undisbursed portion of loans in
process (44,148) (13,009)
Deferred loan origination costs
(fees) 2,082 (177)
Discount on loans acquired pursuant
to purchase transactions (1,508) (1,943)
Allowance for loan losses (5,740) (4,719)
---------- ----------
Loans receivable $ 844,520 $ 593,669
========== ==========
CONTRACTUAL PRINCIPAL PAYMENTS. The following table sets forth the
scheduled contractual principal repayments for Sterling's loan
portfolio at December 31, 1997. Demand loans, loans having no stated
repayment schedule and no stated maturity, and overdrafts are reported
as due in one year or less. Loan balances do not include undisbursed
loan proceeds, unearned discounts, deferred loan origination costs and
fees, or allowances for loan losses.
Principal Payments
Balance Contractually Due in Fiscal Years
Outstanding at ----------------------------------
December 31, 1997 1998 1999-2002 Thereafter
----------------- ---------- ---------- ----------
(Dollars in thousands)
Mortgage--permanent:
Fixed rate $ 173,431 $ 15,250 $ 49,821 $ 108,360
Variable rate 293,706 12,006 55,108 226,592
Mortgage--construction 302,279 197,117 84,452 20,710
Consumer 157,277 27,592 63,441 66,244
Business banking 241,808 65,757 51,302 124,749
---------- ---------- ---------- ----------
$1,168,501 $ 317,722 $ 304,124 $ 546,655
========== ========== ========== ==========
LOAN SERVICING. Sterling services its own loans as well as loans
owned by others. Loan servicing includes collecting and remitting
loan payments, accounting for principal and interest, holding escrow
funds for the payment of real estate taxes and insurance premiums,
contacting delinquent borrowers and supervising foreclosures in the
event of unremedied defaults.
For residential mortgage loans serviced for other investors, Sterling
receives a fee, generally ranging from 0.25% to 0.375% of the unpaid
principal balance of each loan, to compensate for the costs of
performing the servicing function. At December 31, 1997 and 1996 and
June 30, 1996, Sterling serviced for itself and for other investors
residential mortgage loans totaling $1.6 billion, $1.5 billion and
$1.5 billion, respectively. Of such mortgage loans, Sterling serviced
$378.9 million, $530.5 million and $574.6 million, respectively, at
these dates for the FHLMC and the FNMA. Sterling's ability to
continue as a seller/servicer for the FHLMC and the FNMA is dependent
upon meeting the qualifications of these agencies. Sterling currently
meets all applicable requirements.
From time to time, Sterling has sold portfolios of servicing rights
primarily to improve earnings and to increase its regulatory capital
ratios. During the twelve months ended December 31, 1997 and the six
months ended December 31, 1996, Sterling did not transfer any
portfolio of servicing rights. During the fiscal years ended
June 30, 1996 and 1995, Sterling sold in bulk rights to service
conventional loans for others of approximately $172.2 million and
$437.8 million, respectively. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" (hereafter
referred to as "Management's Discussion and Analysis") - Results of
Operations - Other Income."
SECONDARY MARKET ACTIVITIES. Sterling has developed correspondent
relationships with a number of mortgage companies and financial
institutions to facilitate the origination or purchase and sale of
mortgage loans in the secondary market on either a participation or
whole loan basis. Substantially all of such purchased loans or
participations are secured by real estate. Those agents who present
loans to Sterling for purchase are required to provide a processed
loan package prior to commitment. Sterling then underwrites the loan
in accordance with its established lending standards.
In originating one- to four-family residential mortgage loans for sale
in the secondary market, Sterling incurs market risk from the time of
the loan commitments until such time as the loans are sold. To help
minimize this risk, Sterling typically obtains simultaneous
commitments from investors to purchase such loans at specified yields.
In recent years, the majority of conventional, Federal Housing
Administration-("FHA") and Veteran's Administration-("VA") insured
loans have been sold into the secondary market on a loan-by-loan
servicing-released basis. Sterling generally receives a fee of
approximately 1.0% to 2.0% of the principal balance of such loans for
releasing the servicing.
LOAN COMMITMENTS. Sterling uses written commitments to individual
borrowers and mortgage brokers for the purposes of originating and
purchasing loans. These commitments establish the terms and
conditions under which Sterling will fund the loans. Sterling had
outstanding commitments to originate or purchase loans aggregating
$141.2 million at December 31, 1997. Sterling also had secured and
unsecured commercial and personal lines of credit totaling
approximately $124.6 million, of which the undisbursed portion was
approximately $58.1 million at December 31, 1997. See Note 17 of
"Notes to Consolidated Financial Statements" included herein.
CLASSIFIED ASSETS, REAL ESTATE OWNED AND DELINQUENT LOANS. To measure
the quality of assets, including loans and real estate owned ("REO"),
Sterling has established guidelines for classifying assets and
determining provisions for anticipated loan and REO losses. Under
these guidelines, an allowance for anticipated loan and REO losses is
established when certain conditions exist. This system for
classifying and reserving for loans and REO is administered by
Sterling's Special Assets Department, which is responsible for
minimizing loan deficiencies and losses therefrom. An oversight
committee, comprised of senior management, monitors the activities and
progress of the Special Assets Department and reports results to
Sterling's Board of Directors.
Under this system, Sterling classifies loans and other assets it
considers of questionable quality. Sterling's system employs the
classification categories of "substandard," "doubtful" and "loss."
Substandard assets have deficiencies which give rise to the distinct
possibility that Sterling will sustain some loss if the deficiencies
are not corrected. Doubtful assets have the weaknesses of substandard
assets and on the basis of currently existing facts, there is a high
probability of loss. An asset classified as loss is considered
uncollectible and of such little value that it should not be included
as an asset of Sterling. Total classified assets increased to
$19.4 million at December 31, 1997 from $16.1 million at December 31,
1996 and $8.1 million at June 30, 1996, respectively. As a
percentage of total assets, classified assets were 1.0%, 1.0% and
0.6%, respectively, for these periods. See "- Major Classified
Loans."
Assets classified as substandard or doubtful require the establishment
of general valuation allowances in amounts considered by management to
be adequate under generally accepted accounting principles ("GAAP").
Assets classified as loss require either a specific valuation
allowance of 100% of the amount classified or a write-off of such
amount. At December 31, 1997, Sterling's assets classified as loss
totaled $462,000. Judgments regarding the adequacy of a general
valuation allowance are based on on-going evaluations of the nature,
volume and quality of the loan portfolio, REO and other assets,
specific problem assets and current economic conditions that may
affect the recoverability of recorded amounts.
REO is recorded at the lower of estimated fair value, less estimated
selling expenses, or carrying value at foreclosure. Fair value is
defined as the amount in cash or other consideration that a real
estate asset would yield in a current sale between a willing buyer and
a willing seller. Development and improvement costs relating to the
property are capitalized to the extent they are deemed to be
recoverable upon disposal. The carrying value of REO is continuously
evaluated and, if necessary, an allowance is established to reduce the
carrying value to net realizable value (which considers, among other
things, estimated direct holding costs and selling expenses).
The following table sets forth the activity in Sterling's REO for the
periods indicated.
Fiscal Years Ended
June 30,
Twelve Months Ended Six Months Ended ------------------
December 31, 1997 December 31, 1996 1996 1995
------------------- ----------------- -------- --------
(Dollars in thousands)
Balance at beginning of period $ 3,974 $ 4,874 $ 5,298 $ 7,298
Loan foreclosures and other
additions 6,865 1,839 1,628 1,568
Capitalized expenses. 627 181 124 0
Sales and other reductions (2,476) (2,889) (2,108) (3,534)
Provisions for loss (173) (31) (68) (34)
------- ------- ------- -------
Balance at end of period $ 8,817 $ 3,974 $ 4,874 $ 5,298
======= ======= ======= =======
MAJOR CLASSIFIED LOANS. Each of Sterling's classified loans with a
net carrying value at December 31, 1997 of more than $400,000 is
described below. The following loans are classified at
December 31, 1997.
Sterling acquired a loan as part of an acquisition from an insolvent
savings association. This nonperforming loan is secured by an
office/warehouse building located in Garland, Texas. A foreclosure
sale is scheduled to occur in the first half of 1998. The carrying
value on this loan at December 31, 1997 was $1.5 million. Sterling
has established a general valuation allowance of approximately
$164,000 for this loan.
Sterling holds a loan secured by a deed of trust on a multifamily
apartment complex located in Tacoma, Washington. The loan matured in
January 1997. Sterling is proceeding against the borrowers with
judicial foreclosure action. The carrying value of this loan at
December 31, 1997 was $1.2 million. No specific allowance has been
established for this loan.
Sterling holds a loan secured by a commercial warehouse plus excess
land located in Beaverton, Oregon. The loan was current at
December 31, 1997, but is classified due to delinquent payment history
over the past year. The carrying value of this loan at December 31,
1997 was $1.1 million. No specific allowance has been established for
this loan.
Sterling holds several loans to a business based in Spokane,
Washington. These loans, secured by accounts receivable, equipment
and inventory, were current at December 31, 1997, although there has
been a history of delinquent payments on the loans. The aggregate
carrying value of these loans at December 31, 1997 was $548,000. No
specific allowance has been established for these loans.
Sterling holds a commercial construction loan secured by two 2-story
office buildings in Richland, Washington. The borrower has filed for
Chapter 11 bankruptcy, and Sterling is preparing a motion for relief
from stay in order to foreclose. The carrying value on this loan at
December 31, 1997 was approximately $1.6 million. No specific
allowance has been established for this loan.
Sterling holds a loan secured by a deed of trust on a pyrolysis (tire
recycling) plant located in Chehalis, Washington and by deeds of trust
on residential properties and assignments of real estate contracts.
This nonperforming loan was acquired through Sterling's past
acquisition of an insolvent savings association. The carrying value
on the loan at December 31, 1997 was $1.0 million. No specific
allowance has been established for this loan.
MAJOR REAL ESTATE OWNED. Each of Sterling's REO properties with a net
carrying value at December 31, 1997 of more than $400,000 is described
below.
Sterling acquired through foreclosure in November 1997 commercial
property in Spokane and Kennewick, Washington, as well as certain
accounts receivable, inventory, equipment and fixtures. The carrying
value on this property at December 31, 1997 was $3.6 million. No
specific loss allowance has been established for this property, as no
loss is expected. Sterling intends to liquidate this property in
1998.
Sterling is a 99.5% partner in a partnership which owns a commercial
office building in Renton, Washington acquired through an assignment
of interest from a bankrupt Spokane borrower. The carrying value at
December 31, 1997 was $2.7 million, net of a specific loss allowance
of $192,000. The project consists of a five-story office building
with 30,373 square feet of rentable area and adjoining undeveloped
property. The office building is currently 62.2% leased with
continued efforts to lease the remaining 11,553 square feet. Efforts
to sell the project have not been successful, but are on-going.
Sterling acquired a three-story office/retail/restaurant building
located in Olympia, Washington through foreclosure in August 1991.
The restaurant space has been converted to office space and is
currently leased. The carrying value on this property at December 31,
1997 was $656,000, net of a specific loss allowance of $202,000.
Sterling acquired a three-story office building located in Post Falls,
Idaho through foreclosure in October 1997. The office building is
currently vacant and efforts to sell the property are on-going. The
carrying value on this property at December 31, 1997 was $853,000, net
of a specific loss allowance of $116,000.
DELINQUENT LOAN PROCEDURES. Delinquent and problem loans are part of
any lending business. If a borrower fails to make a required payment
when due, Sterling institutes internal collection procedures. For
residential mortgage and consumer loans, Sterling's collection
procedures generally provide that an initial request for payment be
mailed to the borrower when the loan is 15 days past due. At 25 days
past due, the borrower is contacted by telephone and payment is
requested orally. In most cases, deficiencies are cured promptly. At
30 days past due, Sterling tracks the loan as a delinquency. In the
case of delinquent residential mortgage loans a notice of intent to
foreclose is mailed at 45 days past due. If the loan is still
delinquent 30 days following the mailing of the notice of intent to
foreclose, Sterling generally initiates foreclosure proceedings. In
certain instances, Sterling may modify the loan or grant a limited
moratorium on loan payments to enable the borrower to reorganize his
or her financial affairs.
The following table summarizes the principal balances of nonperforming
assets at the dates indicated.
December 31, June 30,
----------------- -------------------------------------
1997 1996 1996 1995 1994 1993
------- ------- ------- ------- ------- -------
(Dollars in thousands)
Nonaccrual loans $ 4,755 $ 2,329 $ 3,352 $ 3,395 $ 2,262 $ 5,065
Restructured loans 150 215 240 254 188 283
------- ------- ------- ------- ------- -------
Total nonperforming loans 4,905 2,544 3,592 3,649 2,450 5,348
Real estate owned (1) 8,817 3,974 4,874 5,298 7,298 6,979
------- ------- ------- ------- ------- -------
Total nonperforming assets $13,722 $ 6,518 $ 8,466 $ 8,947 $ 9,748 $12,327
======= ======= ======= ======= ======= =======
Ratio of total nonperforming
assets to total assets 0.73% 0.42% 0.57% 0.58% 0.71% 1.19%
Ratio of total nonperforming
loans to total loans 0.42% 0.25% 0.36% 0.32% 0.27% 0.87%
Ratio of allowance for
estimated losses on loans to
total nonperforming loans (2) 183.00% 305.28% 224.15% 205.70% 234.38% 85.95%
(1) Amount is net of the allowance for REO losses.
(2) Excludes loans classified as loss. Loans classified as loss
excluded from allowance for loan losses were $47,000, $262,000,
$213,000, $145,000, $7,000 and $314,000 at December 31, 1997 and
1996 and June 30, 1996, 1995, 1994 and 1993, respectively. Loans
classified as loss excluded from total nonperforming loans were
$35,000, $45,000, $167,000, $141,000, $4,000 and $223,000 at
December 31, 1997 and 1996 and June 30, 1996, 1995, 1994 and 1993,
respectively.
Sterling regularly reviews the collectibility of accrued interest
income and generally ceases to accrue interest on a loan when either
principal or interest is past due by 90 days or more. Any accrued and
uncollected interest is eliminated from income at that time. Loans may
be placed in nonaccrual status earlier if, in management's judgment,
the loan may be uncollectible. Interest on such a loan is then
recognized as income only if collected or if the loan is restored to
performing status. Additional interest income of $258,000, $135,000,
$86,000, $151,000, $224,000 and $231,000 would have been recorded
during the twelve months ended December 31, 1997 and 1996, the six
months ended December 31, 1996 and 1995 and the fiscal years ended
June 30, 1996 and 1995, respectively, if nonaccrual and restructured
loans had been current in accordance with their original contractual
terms. Sterling's quality control staff also reviews various aspects
of loans originated and acquired by Sterling to ensure compliance with
appropriate underwriting criteria. These reviews assist Sterling in
monitoring the performance of its personnel and independent
appraisers. Sterling's mortgage loan quality control function is
intended to conform to guidelines and standards established by the
FNMA, the FHLMC, and, as applicable, other private investors.
ALLOWANCE FOR LOAN AND REAL ESTATE OWNED LOSSES. Generally, Sterling
establishes specific allowances for the difference between the
anticipated fair value (market value less selling costs, foreclosure
costs and projected holding costs), adjusted for other possible
sources of repayment, and the book balance (loan principal and accrued
interest or carrying value of REO) of its loans classified as loss and
REO. Each classified loan and REO property is reviewed at least
monthly. Allowances are established or periodically increased, if
necessary, based on the review of information obtained through on-site
inspections, market analysis, appraisals and purchase offers.
Management believes that allowances for loan and REO losses are
adequate, although there can be no assurances in this regard. See
Note 6 of "Notes to Consolidated Financial Statements."
Sterling is currently evaluating its loan loss allowance in
conjunction with its review of so-called Year 2000 issues. This
review includes an evaluation of (i) Sterling's large borrower's
abilities to respond to their internal Year 2000 issues; (ii) the
effect, if any, this will have on such borrowers' ability to make
timely payments and ultimately, to repay their obligations; and (iii)
the potential effect of increased delinquencies and loan losses on
Sterling. The loan loss allowance may or may not increase, depending
upon Sterling's findings. See "Management's Discussion and Analysis -
Year 2000 Issues."
Management believes that the allowance for loan losses is adequate
given the composition and risks of the loan portfolio, although there
can be no assurance that the allowance will be adequate to cover all
contingencies. The following table sets forth information regarding
changes in Sterling's allowance for estimated losses on loans for the
periods indicated.
Fiscal Years Ended June 30,
Twelve Months Ended Six Months Ended -------------------------------------
December 31, 1997 December 31, 1996 1996 1995 1994 1993
------------------- ----------------- ------- ------- ------- -------
(Dollars in thousands)
Balance at beginning of period $ 7,891 $ 7,889 $ 7,361 $ 5,740 $ 4,719 $ 4,745
Charge-offs:
Mortgage--permanent (219) (767) (751) (795) (565) (1,575)
Mortgage--construction (202) (7) 0 0 0 0
Consumer (1,023) (382) (408) (216) (57) (4)
Business banking (119) (19) (5) (9) (3) (7)
------- ------- ------- ------- ------- -------
Total charge-offs (1,563) (1,175) (1,164) (1,020) (625) (1,586)
------- ------- ------- ------- ------- -------
Recoveries:
Mortgage--permanent 58 30 23 61 39 57
Consumer 100 39 45 23 7 2
Business banking 23 8 24 5 0 1
------- ------- ------- ------- ------- -------
Total recoveries 181 77 92 89 46 60
------- ------- ------- ------- ------- -------
Net charge-offs (1,382) (1,098) (1,072) (931) (579) (1,526)
Provisions for loan losses 2,450 1,100 1,600 1,600 1,600 1,500
Allowance for losses on assets
acquired 0 0 0 952 0 0
------- ------- ------- ------- ------- -------
Balance at end of period $ 8,959 $ 7,891 $ 7,889 $ 7,361 $ 5,740 $ 4,719
======= ======= ======= ======= ======= =======
Allowances allocated to loans
classified as loss $ 47 $ 262 $ 213 $ 145 $ 7 $ 314
Ratio of net charge-offs to
average loans outstanding
during the period 0.14% 0.12% 0.11% 0.09% 0.08% 0.29%
Allowances are provided for individual loans when management considers
ultimate collection to be questionable. Such allowances are based,
among other factors, upon the estimated net realizable value of the
security or the loan or guarantees, if applicable. The following
table sets forth the allowances for estimated losses on loans by loan
category and summarizes the percentage of gross loans in each category
to total gross loans.
December 31, June 30,
-------------------------------------------- --------------------------------------------
1997 1996 1996 1995
--------------------- --------------------- --------------------- ---------------------
Loans in Loans in Loans in Loans in
Category as a Category as a Category as a Category as a
Percentage Percentage Percentage Percentage
of Total of Total of Total of Total
Amount Gross Loans Amount Gross Loans Amount Gross Loans Amount Gross Loans
------ ------------- ------ ------------- ------ ------------- ------ -------------
(Dollars in thousands)
Mortgage-permanent $3,608 39.9% $3,156 43.3% $3,047 46.5% $3,375 66.0%
Mortgage-construction 3,108 25.9 2,380 25.5 1,969 25.5 1,369 15.7
Consumer 24 13.5 334 11.9 403 11.1 366 9.5
Business banking 1,394 20.7 1,196 19.3 1,075 16.9 856 8.8
Unallocated 825 N/A 825 N/A 1,395 N/A 1,395 N/A
------ ----- ------ ----- ------ ----- ------ -----
$8,959 100.0% $7,891 100.0% $7,889 100.0% $7,361 100.0%
====== ===== ====== ===== ====== ===== ====== =====
June 30,
--------------------------------------------
1994 1993
--------------------- ---------------------
Loans in Loans in
Category as a Category as a
Percentage Percentage
of Total of Total
Amount Gross Loans Amount Gross Loans
------ ------------- ------ -------------
(Dollars in thousands)
Mortgage-permanent $3,309 78.5% $3.035 84.7%
Mortgage-construction 969 7.8 569 3.5
Consumer 359 7.8 209 7.2
Business banking 660 5.9 463 4.6
Unallocated 443 N/A 443 N/A
------ ----- ------ -----
$5,740 100.0% $4,719 100.0%
====== ===== ====== =====
INVESTMENTS AND MORTGAGE-BACKED SECURITIES
Investments and MBS that management has the positive intent and
ability to hold to maturity are classified as held-to-maturity and
carried at amortized cost. Unrealized gains and losses on such
securities are not reported in the Consolidated Financial Statements
as these securities are held for investment purposes. See
"Management's Discussion and Analysis - Results of Operations - Other
Income" and Note 2 of "Notes to Consolidated Financial Statements."
Sterling classifies specific investments and MBS as available-for-
sale. Investments classified as available-for-sale are carried at
fair value. Unrealized gains and losses are excluded from earnings
and are reported net of deferred income tax as a separate component of
shareholders' equity until such securities mature or are actually
sold. These securities may be sold in response to changes in market
interest rates and related changes in the securities' prepayment risk,
needs for liquidity, changes in the availability of and the yield on
alternative investments, and changes in funding sources and terms.
At December 31, 1997 and 1996, investments and MBS classified as
available-for-sale were $656.2 million and $469.8 million,
respectively. The carrying value of these securities includes a net
unrealized loss of $1.0 million (net of a $540,000 related tax
benefit) and $6.0 million (net of a $3.2 million related tax benefit),
respectively. At June 30, 1996, investments and MBS classified as
available-for-sale were $460.1 million. The carrying value of these
securities included a net unrealized loss of $10.3 million (net of a
$5.5 million related tax benefit). The increase in fair value since
June 30, 1996 is due primarily to a decrease in long-term interest
rates.
Sterling invests primarily in MBS issued by the FHLMC and the FNMA and
agency obligations and stock in the Federal Home Loan Bank of Seattle
("FHLB Seattle"). Such investments provide Sterling with a relatively
liquid source of interest income and collateral which can be used to
secure borrowings. Sterling invests exclusively in investment-grade
securities.
The following table provides the carrying values, maturities and
weighted average yields of Sterling's investment and MBS portfolio at
December 31, 1997.
Maturity
---------------------------------------------------------
Less than One to Five to Over Ten
One Year Five Years Ten Years Years Total
--------- ---------- --------- --------- --------
(Dollars in thousands)
Mortgage-backed securities,
at fair value(1):
Balance $ 5,580 $ 57,219 $ 89,675 $316,779 $469,253
Weighted average yield 7.00% 5.71% 6.55% 6.70% 6.55%
U.S. government and agency
obligations, at fair
value(1):
Balance $ 6,966 $132,029 $ 20,013 $ 0 $159,008
Weighted average yield 5.90% 6.55% 6.82% 0.00% 6.56%
FHLB Seattle stock, at cost:
Balance $ 0 $ 0 $ 0 $ 27,975 $ 27,975
Weighted average yield(2) 0.00% 0.00% 0.00% 7.61% 7.61%
Municipal bonds(3):
Balance $ 1,032 $ 9,516 $ 2,200 $ 0 $ 12,748
Weighted average yield 3.91% 4.44% 4.78% 0.00% 4.46%
Other:
Balance $ 0 $ 0 $ 0 $ 2 $ 2
Weighted average yield 0.00% 0.00% 0.00% 1.15% 1.15%
Total carrying value $ 13,578 $198,764 $111,888 $344,756 $668,986
======== ======== ======== ======== ========
Weighted average yield 6.20% 6.21% 6.56% 6.77% 6.56%
(1) Based on contractual maturities.
(2) The weighted average yield on FHLB Seattle stock is based upon
the dividends received for the twelve months ended December 31,
1997.
(3) The weighted average yields on municipal bonds reflects the
actual yields on the bonds and is not tax effected.
The following table sets forth the carrying values and classifications
for financial statement reporting purposes of Sterling's investment
and MBS portfolio at the dates indicated.
December 31,
------------------ June 30,
1997 1996 1996
-------- -------- --------
(Dollars in thousands)
Mortgage-backed securities $469,253 $376,940 $399,893
U.S. government and agency obligations 159,008 66,919 35,244
FHLB Seattle stock 27,975 25,923 24,911
Municipal bonds 12,748 11,846 11,854
Other 2 33 38
-------- -------- --------
Total $668,986 $481,661 $471,940
======== ======== ========
Available-for-sale $656,236 $469,790 $460,061
Held-to-maturity 12,750 11,871 11,879
-------- -------- --------
Total $668,986 $481,661 $471,940
======== ======== ========
Weighted average yield 6.56% 6.42% 6.26%
SOURCES OF FUNDS
GENERAL. Sterling's primary sources of funds for use in lending and
for other general business purposes are loan repayments, FHLB Seattle
advances and secured lines of credit and other borrowings, deposits,
proceeds from sales of investments and MBS and proceeds from sales of
loans. Scheduled loan repayments are a relatively stable source of
funds, while other sources of funds are influenced significantly by
prevailing interest rates, interest rates available on other
investments and other economic conditions. Borrowings may be used on
a short-term basis to compensate for reductions in other sources of
funds (such as deposit inflows at less than projected levels).
Borrowings may also be used on a longer-term basis to support expanded
lending activities and to match repricing intervals of assets. See
"Lending Activities" and "Investments and Mortgage-Backed Securities."
DEPOSIT ACTIVITIES. Sterling offers a variety of accounts for
depositors designed to attract both short-term and long-term deposits
from the general public. These accounts include certificates of
deposit ("CDs"), regular savings accounts and checking accounts,
including negotiable order of withdrawal ("NOW") accounts. These
accounts earn interest at rates established by management and are
based on a competitive market analysis. The method of compounding
varies from simple interest credited at maturity to daily compounding,
depending on the type of account.
With the exception of certain promotional CDs and variable rate, 18-
month Individual Retirement Account ("IRA") certificates, all CDs
carry a fixed rate of interest for a defined term from the opening
date of the account. Substantial penalties are imposed if principal is
withdrawn from most CDs prior to maturity.
Sterling supplements its retail deposit gathering by soliciting funds
from public entities. Public funds were 9.1%, 5.7% and 6.2% of
deposits at December 31, 1997 and 1996 and June 30, 1996,
respectively. Public funds are generally obtained by competitive
bidding among qualifying financial institutions. Sterling had no
brokered deposits at December 31, 1997.
With the planned acquisition of KeyBank branches, Sterling anticipates
a significant increase in its checking account balances. Further,
Sterling is reviewing the pricing of all of its products and may
implement changes coinciding with the closing date of the transaction.
See "Recent Developments."
The primary retail deposit vehicles being utilized by Sterling's
customers are CDs with terms of one year or less, regular savings
accounts, money market accounts and NOW accounts. The following table
presents the average balance outstanding and weighted average interest
rate paid for each major category of deposits for the periods
indicated.
Twelve Months Ended December 31, Six Months Ended December 31,
------------------------------------------ -----------------------------------------
1997 1996 1996 1995
------------------- -------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Average Interest Average Interest Average Interest Average Interest
Balance Rate Balance Rate Balance Rate Balance Rate
-------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Certificates of deposit $620,561 5.70% $585,140 5.71% $578,738 5.64% $629,828 6.01%
Regular savings accounts and
money market accounts 236,057 3.92 216,336 3.83 222,223 3.82 175,479 3.68
Checking accounts:
NOW accounts 78,234 1.33 70,010 1.41 70,944 1.41 66,426 1.50
Non-interest-bearing
demand accounts 29,132 0.00 23,959 0.00 24,875 0.00 26,297 0.00
-------- -------- -------- -------- -------- -------- -------- --------
$963,984 4.74% $895,445 4.76% $896,780 4.70% $898,030 5.05%
======== ======== ======== ======== ========
Fiscal Years Ended June 30,
------------------------------------------
1996 1995
------------------- --------------------
Weighted Weighted
Average Average
Average Interest Average Interest
Balance Rate Balance Rate
-------- -------- -------- --------
(Dollars in thousands)
Certificates of deposit $610,297 5.90% $626,952 5.23%
Regular savings accounts and
money market accounts 194,346 3.72 163,490 3.56
Checking accounts:
NOW accounts 67,507 1.52 66,060 1.80
Non-interest-bearing
demand accounts 24,346 0.00 21,961 0.00
-------- -------- -------- --------
$896,496 4.94% $878,463 4.53%
======== ========
The following table shows the amounts and maturities of CDs that had
balances of $100,000 or more at December 31, 1997.
(Dollars in thousands)
Remaining maturity:
Less than three months $121,016
Three to six months 44,029
Six to 12 months 43,462
Over 12 months 16,442
--------
$224,949
========
The following table presents the types of deposit accounts offered by
Sterling Savings and the balance in such accounts:
Decemer 31, 1997
-------------------------------------------------
Percent Interest Rate
Minimum Minimum of Total Offered at
Term Category Balances Amount Deposits December 31, 1997
-------- --------------------------- -------- ---------- -------- -----------------
(Dollars in thousands, except minimum amounts)
Transaction Accounts:
None NOW checking $ 100 $ 88,305 8.5% 1.50%
None Commercial checking 100 31,054 3.0 0.00
None Regular savings 100 63,117 6.1 2.55
None Money market demand 2,500 183,795 17.7 3.46
---------- ------
366,271 35.3
---------- ------
Certificates of Deposit:
3 months Fixed term, fixed rate 500 968 0.1 3.92
6 months Fixed term, fixed rate 500 13,401 1.3 5.10
9 months Fixed term, adjustable rate 5,000 65,684 6.3 5.22
12 months Fixed term, fixed rate 500 123,729 12.0 5.32
12 months Fixed term, fixed rate 5,000 368 0.0 2.75
12 months Fixed term, adjustable rate 5,000 4,624 0.4 5.13
15 months Fixed term, adjustable rate 5,000 66,553 6.4 5.22
18 months Fixed term, fixed rate 500 129,783 12.6 5.51
24 months Fixed term, fixed rate 500 81,897 7.9 5.25
36 months Fixed term, fixed rate 500 13,211 1.3 5.26
36 months Zero coupon, fixed term(1) N/A 70 0.0 N/A
18 months Variable rate, IRA 100 5,448 0.5 5.91
18 months Fixed rate, IRA 500 1,914 0.2 5.41
36 months Variable rate, IRA 2,000 15,128 1.5 5.70
7 days Jumbos 100,000 147,359 14.2 5.00
---------- ------
670,137 64.7
---------- ------
Total deposits $1,036,408 100.0%
========== ======
(1) Not offered as of December 31, 1997.
The following table sets forth the composition of Sterling's deposit
accounts at the dates indicated.
December 31, 1997 December 31, 1996 June 30, 1996
-------------------- -------------------- --------------------
Percent Percent Percent
Total of Total of Total of
Amount Deposits Amount Deposits Amount Deposits
---------- -------- ---------- -------- ---------- --------
(Dollars in thousands)
NOW checking $ 88,305 8.5% $ 72,686 8.0% $ 69,125 7.7%
Commercial checking 31,054 3.0 24,180 2.7 20,468 2.3
Regular savings 63,117 6.1 72,243 8.0 74,413 8.3
Money market demand 183,795 17.7 148,696 16.5 152,874 17.0
Variable rate certificates:
18 months 5,448 0.5 5,582 0.6 5,478 0.6
Fixed rate certificates:
1-11 months 299,106 28.9 208,976 23.2 201,481 22.4
12-35 months 270,620 26.1 269,606 29.9 270,120 30.1
36-240 months 94,963 9.2 100,309 11.1 104,428 11.6
---------- ------ ---------- ------ ---------- ------
1,036,408 100.0 902,278 100.0 898,387 100.0
Deposit premium 0 0.0 0 0.0 7 0.0
---------- ------ ---------- ------ ---------- ------
Total deposits $1,036,408 100.0% $ 902,278 100.0% $ 898,394 100.0%
========== ====== ========== ====== ========== ======
Substantially all of Sterling's depositors are residents of the States
of Washington or Oregon. Upon successful completion of the
acquisition of the KeyBank branches, Sterling will add deposits in the
State of Idaho. See "Recent Developments."
Sterling is a member of The Exchange, an automated teller machine
("ATM") system that allows participating customers to deposit or
withdraw from NOW accounts, money market demand accounts and savings
accounts at over 18,000 Exchange system machines located throughout
the United States and Canada. Sterling is also a member of the Plus
System ATM network, with numerous locations in the United States and
internationally. Sterling has installed ATMs in 20 of its branches to
better serve customers in those markets. Customers in these areas can
also access the system through ATMs operated by other financial
institutions.
BORROWINGS. Deposit accounts are Sterling's primary source of funds.
Sterling does, however, rely upon advances from the FHLB Seattle and
reverse repurchase agreements to supplement its funding and to meet
deposit withdrawal requirements. See "Management's Discussion and
Analysis - Liquidity and Sources of Funds."
The FHLB Seattle is part of a system, which consists of 12 regional
Federal Home Loan Banks (the "FHL Banks") each subject to Federal
Housing Finance Board supervision and regulation, that functions as a
central reserve bank providing credit to savings institutions. As a
member, Sterling is required to own stock of the FHLB Seattle in an
amount determined by a formula based upon Sterling's loans outstanding
and advances from the FHLB Seattle. At December 31, 1997, Sterling
exceeded its FHLB Seattle stock ownership requirement of $12.6 million
by $15.3 million. The stock of the FHLB Seattle has always been
redeemable at par value, but there can be no assurance that this will
always be the case.
As a member of the FHLB Seattle, Sterling is authorized to apply for
advances on the security of its FHLB Seattle stock and certain of its
mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the United States or its agencies),
provided certain standards related to creditworthiness are met. Each
credit program has its own interest rate and range of maturities. At
December 31, 1997, Sterling had advances totaling $455.1 million from
the FHLB Seattle which mature from fiscal years 1998 through 2015 at
interest rates ranging from 5.15% to 8.40%. See "Recent
Developments," "Management's Discussion and Analysis - Liquidity and
Sources of Funds" and Note 9 of "Notes to Consolidated Financial
Statements."
Sterling also borrows funds under reverse repurchase agreements
pursuant to which it sells securities (generally U.S. agency and MBS)
under an agreement to buy them back at a specified price at a later
date. These agreements to repurchase are deemed to be borrowings
collateralized by the securities sold. Sterling uses these borrowings
to supplement deposit gathering for funding the origination of loans.
Sterling had $180.1 million, $229.8 million and $195.8 million in
reverse repurchase agreements outstanding at December 31, 1997 and
1996 and June 30, 1996, respectively. The use of reverse repurchase
agreements may expose Sterling to certain risks not associated with
other borrowings, including IRR and the possibility that additional
collateral may have to be provided if the market value of the pledged
collateral declines. For additional information regarding reverse
repurchase agreements, see "Management's Discussion and Analysis -
Asset and Liability Management," "Management's Discussion and Analysis
- Liquidity and Sources of Funds" and Note 10 of "Notes to
Consolidated Financial Statements."
On June 4, 1997, Sterling issued $41.2 million of 9.50% junior
subordinated deferrable interest debentures (The "Junior Subordinated
Debentures") to Sterling Capital Trust I (the "Trust"), a Delaware
business trust, of which Sterling owns all of the common equity. The
sole asset of the Trust is the Junior Subordinated Debentures. The
Trust issued $40.0 million of 9.50% Cumulative Capital Securities (the
"Trust Preferred Securities") to investors. The indenture governing
the Junior Subordinated Debentures limits the ability of Sterling
under certain circumstances to pay dividends or make other capital
distributions. The Trust Preferred Securities are treated as debt of
Sterling. The Trust Preferred Securities mature on June 30, 2027 and
are redeemable at the option of Sterling on June 30, 2002, or earlier
in the event the deduction of related interest for federal income
taxes is prohibited, treatment as Tier 1 capital is no longer
permitted, or certain other contingencies arise.
Sterling has outstanding $17.2 million of 8.75% Subordinated Notes
which are due on January 31, 2000 ("the Subordinated Notes"). The
Subordinated Notes are unsecured general obligations of Sterling and
are subordinated to certain other existing and future indebtedness.
Under the terms of the Subordinated Notes, Sterling is limited by the
amount of certain long-term debt that it may incur. Sterling is
limited and is restricted, under certain circumstances, from paying
cash dividends and from making other capital distributions.
At December 31, 1997, Sterling had the authority to incur
approximately $50.1 million of additional long-term debt
notwithstanding such restriction. Interest on the Subordinated Notes
is due the first day of each month. Sterling may, at its option,
redeem the Subordinated Notes in whole or in part at par plus accrued
interest. See Note 11 of "Notes to Consolidated Financial
Statements."
In addition to the borrowings described above, Sterling has a $15.0
million five-year variable rate loan with KeyBank of Washington.
Interest is payable quarterly on this loan. The interest rate at
December 31, 1997 was 7.33%. Principal is repayable in five annual
payments of $3.0 million each, commencing September 1998. Sterling
also has a $5.0 million line of credit agreement with KeyBank of
Washington. Advances under the line of credit accrue interest at
KeyBank of Washington's prime interest rate plus 0.50% (9.00% at
December 31, 1997) and the line of credit matures in 1999. Management
expects that the line of credit will be renewed at that time on
substantially the same terms, although there can be no assurance in
this regard. Borrowings under this line of credit are secured by a
pledge of certain shares of Sterling Savings Preferred Stock which are
owned by Sterling. No amounts were outstanding on this line of credit
at December 31, 1997 and 1996 and June 30, 1996. See "Management's
Discussion and Analysis Liquidity and Sources of Funds."
Sterling Savings has an unsecured $10.0 million line of credit
agreement with KeyBank of Washington. Advances under the line of
credit accrue interest at KeyBank of Washington's federal funds rate
plus an incremental negotiated rate (5.84% at December 31, 1997) and
the line matures in 1999. Management expects that the line of credit
will be renewed at that time on substantially the same terms, although
there can be no assurance in this regard. No amounts were outstanding
on this line of credit at December 31, 1997 and 1996 and June 30,
1996.
The following table sets forth certain information regarding
Sterling's short-term borrowings as of and for the periods indicated.
Fiscal Years Ended
Twelve Months June 30,
Ended Six Months Ended ------------------
December 31, 1997 December 31, 1996 1996 1995
----------------- ----------------- -------- --------
(Dollars in thousands)
Maximum amount outstanding at
any month-end during the period:
Reverse repurchase agreements $273,573 $232,885 $195,785 $148,055
Short-term advances 353,847 95,000 171,000 223,000
Average amount outstanding during
the period:
Reverse repurchase agreements 185,698 213,560 156,578 118,064
Short-term advances 207,931 90,833 140,917 201,250
Weighted average interest rate paid
during the period:
Reverse repurchase agreements 5.68% 5.60% 5.91% 6.02%
Short-term advances 5.90% 5.79% 5.88% 5.13%
Weighted average interest rate paid
at end of period:
Reverse repurchase agreements 5.71% 5.62% 5.57% 6.67%
Short-term advances 5.99% 5.75% 6.42% 5.41%
The following table sets forth certain information concerning
Sterling's outstanding borrowings.
December 31,
---------------------------------- June 30, 1996
1997 1996 ----------------
Amount % Amount % Amount %
-------- ------ -------- ------ -------- ------
(Dollars in thousands)
FHLB Seattle advances:
Short-term $353,847 50.0% $ 90,000 17.3% $ 90,000 19.1%
Long-term 101,238 14.3 169,626 32.5 169,410 35.9
Securities sold subject to reverse
repurchase agreements 180,077 25.5 229,797 44.0 195,785 41.4
Subordinated Notes 17,240 2.4 17,240 3.3 17,240 3.6
Trust Preferred Securities 40,000 5.7 0 0.0 0 0.0
Term note payable 15,000 2.1 15,000 2.9 0 0.0
-------- ----- -------- ----- -------- -----
Total borrowings $707,402 100.0% $521,663 100.0% $472,435 100.0%
======== ===== ======== ===== ======== =====
Weighted average interest rate 6.09% 6.21% 6.25%
SUBSIDIARIES
Sterling's principal subsidiary is Sterling Savings Association.
Sterling Savings has three principal subsidiaries which have been
previously described: Action Mortgage, Harbor Financial and INTERVEST.
Additionally, Sterling Financial Corporation and Sterling Savings have
the following wholly owned subsidiaries that are either inactive or
exist solely for the purpose of holding and owning specific assets or
properties:
STERLING FINANCIAL CORPORATION.
(1) Tri-Cities Mortgage Corporation was obtained as part of an
acquisition in April 1988. The corporation's principal asset is
a 99.5% partnership interest in Renton Plaza Investors (a
partnership which owns a five-story office building near Renton,
Washington). See "Lending Activities - Major Real Estate
Owned."
(2) Sterling Capital Trust I was organized in May 1997 as a Delaware
business trust. Sterling owns all the common equity of the
Trust. The sole asset of the Trust is the Junior Subordinated
Debentures issued by Sterling.
STERLING SAVINGS ASSOCIATION.
(1) Fidelity Service Corporation was organized in 1983 to acquire and
sell real and personal property in eastern Washington and Idaho.
The corporation's assets consist principally of office furniture
and equipment used by Sterling Savings.
(2) Evergreen Environmental Development Corporation was organized to
engage in real estate development and was obtained as part of an
acquisition in December 1988. This corporation's assets include
a 33% interest in the Grapetree Partnership, which owns a parcel
of raw land in Spokane, Washington that it intends to develop
into single-family residential lots. Sterling Savings'
investment in the Grapetree Partnership has been deemed by its
primary federal regulators to be an impermissible investment.
Accordingly, Sterling Savings' investment has been deducted from
tangible, core and risk-based capital.
(3) Tri-West Mortgage, Inc. was obtained as part of an acquisition in
1988 and was originally engaged in mortgage banking. The
corporation's sole assets consist of commercial property in
Spokane and Kennewick, Washington acquired through foreclosure,
as well as accounts receivable, inventory, equipment and
fixtures. See "Lending Activities - Major Real Estate Owned."
(4) Evergreen First Service Corporation was obtained as part of an
acquisition in 1988 and owns all of the outstanding capital stock
of Harbor Financial, through which Sterling offers tax-deferred
annuities, mutual funds and other financial products.
COMPETITION
Sterling faces strong competition, both in attracting deposits and in
originating, purchasing and selling real estate and other loans, from
savings and loan associations, mutual savings banks, credit unions and
commercial banks and other institutions, many of which have greater
resources than Sterling. Sterling also faces strong competition in
marketing financial products such as annuities, mutual funds and other
financial products and in pursuing acquisition opportunities. Some or
all of these competitive institutions operate in Sterling's market
areas.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994 (the "Interstate Banking Act") allows adequately capitalized and
well-managed bank holding companies to acquire banks in any state,
subject to certain conditions, regardless of whether such acquisitions
would be prohibited by applicable state law. The Interstate Banking
Act also allows interstate merger transactions beginning June 1, 1997.
Each state was entitled to enact a law before June 1, 1997, expressly
prohibiting merger transactions with out-of-state banks. If a state
"opted out" in this manner, no bank in any other state may establish a
branch in that state. As of June 1, 1997 only the states of Montana
and Texas had opted out of interstate merger transactions. As a
result of the Interstate Banking Act, Sterling's bank competitors may
be able to conduct extensive interstate banking operations and thereby
gain competitive advantages over Sterling.
PERSONNEL
As of December 31, 1997, Sterling, including its subsidiaries, had 510
full-time equivalent employees. Employees are not represented by a
collective bargaining unit. Sterling believes its relationship with
its employees is excellent. As a condition of the acquisition of
KeyBank branches Sterling agreed to hire approximately 190 employees
who work in the new branches. See "Recent Developments."
REGULATION
INTRODUCTION. THE FOLLOWING IS NOT INTENDED TO BE A COMPLETE
DISCUSSION BUT IS INTENDED TO BE A SUMMARY OF SOME OF THE MOST
SIGNIFICANT PROVISIONS OF LAWS APPLICABLE TO STERLING AND ITS
SUBSIDIARIES.
Sterling is a savings and loan holding company and as such is subject
to OTS regulations, examinations and reporting requirements. Sterling
Savings is chartered by the State of Washington and its savings
deposits are insured by the FDIC. Sterling Savings is subject to
comprehensive regulation, examination and supervision by the OTS, the
FDIC and the Washington Supervisor. Furthermore, certain transactions
and savings deposits are subject to regulations and controls
promulgated by the Federal Reserve Board (the "Fed").
SAVINGS AND LOAN HOLDING COMPANY REGULATION. Sterling is registered
as a savings and loan holding company under the Home Owners' Loan Act
(the "HOLA"). The HOLA generally permits a savings and loan holding
company to engage in activities which are unrelated to the operation
of a savings and loan association, provided the holding company
controls only one savings and loan association and such savings and
loan association meets the Qualified Thrift Lender Test (the "QTL
Test"). Sterling presently controls only one savings and loan
association, Sterling Savings, which at December 31, 1997 met the QTL
Test.
If Sterling Savings fails to meet the QTL Test in the future, Sterling
will become subject to restrictions on the activities in which it may
engage. Such activities would generally be limited to any activity
that the Fed by regulation has determined is permissible for bank
holding companies pursuant to Section 4(c) of the Bank Holding Company
Act of 1956, as amended (unless limited or prohibited by the OTS by
regulation), and certain other limited services and activities.
Sterling currently has no plans to engage in any new activity that
would be restricted if Sterling Savings were to fail to meet the QTL
Test in the future. Although Sterling Savings expects to remain in
compliance with the QTL Test in the future, there can be no assurance
in this regard.
Under the HOLA, no person may acquire control of a savings association
or a savings and loan holding company without the prior approval of
the OTS. As a savings and loan holding company, Sterling is
prohibited from acquiring (i) control of another savings association
or a savings and loan holding company without the prior approval of
the OTS, (ii) the assets of another savings association, or savings
and loan holding company by merger, consolidation or purchase, without
the prior approval of the OTS, (iii) more than 5% of the voting shares
of a savings association or a savings and loan holding company which
is not a subsidiary of Sterling; or (iv) control of a depository
institution, the accounts of which are not insured by the FDIC.
The HOLA authorizes the OTS to issue a directive to a savings and loan
holding company and any of its subsidiaries if the OTS determines that
there is reasonable cause to believe that the continuation by the
holding company of any activity constitutes a serious risk to the
financial safety, soundness or stability of the holding company's
subsidiary savings association. The OTS may impose restrictions
through such directive to limit such risk, including limiting (i) the
payment of dividends by the savings association, (ii) transactions
between the savings association, the holding company and the
subsidiaries or affiliates of either and (iii) any activities of the
savings association that might create a serious risk that the
liabilities of the holding company and its other affiliates may be
imposed on the savings association. Such a directive has the same
effect as a final cease and desist order. The issuance of the
directive can be appealed to the Director of the OTS.
THE FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") provides for expanded regulation of depository institutions
and their affiliates, including parent holding companies. FDICIA
further provides the OTS with broad powers to take "prompt corrective
action" to resolve problems of insured depository institutions. The
extent of these powers depends upon whether the institution in
question is "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized."
Under OTS regulations which implement the "prompt corrective action"
system mandated by FDICIA, an institution is "well capitalized" if its
total risk-based capital ratio (the ratio of qualifying total capital
to risk-weighted assets) is 10% or more, its Tier 1 risked-based
capital ratio (the ratio of Tier 1 core capital to risk-weighted
assets) is 6% or more, its leverage ratio (the ratio of core capital
to total assets) is 5% or more and it is not subject to any written
agreement, order or directive to meet a specified capital level. At
December 31, 1997, Sterling Savings met the standards for a "well
capitalized" institution.
An institution which is "undercapitalized" must submit a capital
restoration plan to the OTS. The plan may be approved only if the OTS
determines it is likely to succeed in restoring the institution's
capital and will not appreciably increase the risks to which the
institution is exposed. The institution's performance under the plan
must be guaranteed by any company which controls the institution, up
to a maximum of 5% of the institution's assets. The OTS may also
require an undercapitalized institution to take various actions deemed
appropriate to minimize the potential losses to the deposit insurance
fund. Institutions that are "significantly undercapitalized" or
"critically undercapitalized" are subject to additional sanctions.
FDICIA directs each bank regulatory agency and the OTS to review its
capital standards every two years to determine whether those standards
require sufficient capital to facilitate prompt corrective action to
prevent or minimize loss to the deposit insurance funds. FDICIA, as
amended, also requires the OTS to prescribe minimum operational and
managerial standards and standards for asset quality, earnings and
stock valuation for savings institutions. Any savings institution
which fails to meet the standards may be required to submit a plan for
corrective action. If a savings institution fails to submit or
implement an acceptable plan, the OTS may require the institution to
take any action the OTS determines will best carry out the purpose of
prompt corrective action.
Under FDICIA, only a "well capitalized" depository institution may
accept brokered deposits without prior regulatory approval. FDICIA
also requires annual examinations of all insured depository
institutions by the appropriate federal banking agency, with some
exceptions for small, well capitalized institutions and state-
chartered institutions examined by state regulators. The federal
banking agencies are required to set compensation standards for
insured depository institutions that prohibit excessive compensation,
fees or benefits to officers, directors, employees and principal
Shareholders. FDICIA also contains a number of consumer banking
provisions, including disclosure requirements and substantive
contractual limitations with respect to deposit accounts. FDICIA also
greatly expanded the range of merger, purchase and assumption, and
deposit transfer transactions involving banks and savings associations
that are exempt from payment of exit and entry fees as transfers of
deposits between the FDIC's Bank Insurance Fund ("BIF") and its
Savings Association Insurance Fund ("SAIF"). Many of the provisions
of FDICIA have been implemented through the adoption of regulations by
the federal banking agencies.
REGULATORY CAPITAL REQUIREMENTS. Pursuant to the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"),
the OTS adopted regulations implementing new capital standards
applicable to all savings associations, including Sterling Savings.
Such capital standards require that savings associations maintain (i)
tangible capital of not less than 1.5% of adjusted total assets, (ii)
core capital of not less than 3.0% of adjusted total assets, and
(iii) risk-based capital of not less than 8.0% of risk-weighted
assets. As of December 31, 1997, Sterling Savings met all regulatory
capital requirements. For additional information, see "Management's
Discussion and Analysis - Liquidity and Sources of Funds" and
"Management's Discussion and Analysis - Capital Resources."
TANGIBLE CAPITAL. Tangible capital consists of common shareholders'
equity, including retained earnings; non-cumulative perpetual
preferred stock; certain non-withdrawable and pledged deposits; and
minority interests in equity accounts of fully consolidated
subsidiaries. In calculating tangible capital, certain items must be
deducted. These items are goodwill and other intangible assets,
nonqualifying purchased mortgage servicing rights and investments
(whether debt or equity) in subsidiaries engaged as of April 1989 in
activities which were permissible for national banks. With respect to
purchased mortgage servicing rights, the amount that qualifies to be
included in tangible capital is the lower of (a) 90% of fair market
value if determinable, (b) 90% of original cost or (c) the current
amortized book value. See "Lending Activities - Classified Assets,
Real Estate Owned and Delinquent Loans - Major Real Estate Owned" and
"Subsidiaries."
LEVERAGE (OR CORE) CAPITAL. Core capital generally consists of
tangible capital plus certain other qualifying intangible assets
(which may comprise up to 25% of core capital) which meet a three-part
test of separatability, marketability and market valuation.
RISK-BASED CAPITAL. The risk-based capital requirement is an amount
equal to 8% of risk-adjusted assets. A risk weight is assigned to
both the on-balance sheet assets and off-balance sheet commitments of
a savings association. Risk weights range from zero to 100% depending
on the type of asset.
Both core capital and "supplementary capital" may be used to meet the
risk-based capital requirement, although supplementary capital cannot
be used in an amount greater than 100% of core capital. For purposes
of the risk-based capital requirement, supplementary capital includes
permanent capital instruments such as cumulative perpetual preferred
stock, perpetual or mandatory convertible subordinated debt, maturing
capital instruments such as subordinated debt, intermediate-term
preferred stock, commitment notes and certain grandfathered mandatory
redeemable preferred stock (although the amount included declines as
the instrument approaches maturity), and general valuation loan and
lease loss allowances up to a maximum of 1.25% of risk-weighted
assets. The risk-based capital requirement was equal to 8.00% of
risk-weighted assets at December 31, 1997.
The following tables set forth Sterling Savings' tangible, core and
risk-based capital positions as reported to the OTS on the quarterly
Thrift Financial Report at December 31, 1997.
Tangible Capital
-------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total shareholders' equity: $148,403 7.96%
Adjustment:
Unrealized losses on certain available-
for-sale securities 1,003 0.06
Less:
Intangibles 7,882 0.42
Excess qualifying purchased mortgage
loan servicing 147 0.01
Investment in non-includable
subsidiaries 353 0.02
-------- ------
Total tangible capital 141,024 7.57
Tangible capital requirement 27,951 1.50
-------- ------
Tangible capital excess $113,073 6.07%
======== ======
Core Capital
-------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total tangible capital: $141,024 7.57%
Add:
Qualifying identified intangibles up
to 25% of other core capital 0 0.00
Total core capital 141,024 7.57
Core capital requirement 55,902 3.00
-------- ------
Core capital excess $ 85,122 4.57%
======== ======
Risk-based Capital
-------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total core capital: $141,024 12.94%
General valuation allowances 8,912 0.82
Assets required to be deducted (829) (0.08)
-------- ------
Total risk-based capital 149,107 13.68
Risk-based capital requirement 88,115 8.00
-------- ------
Risk-based capital excess $ 60,992 5.68%
======== ======
(1) Ratio of capital to adjusted total assets for tangible and core
capital and ratio of total capital to risk-weighted assets for
risk-based capital.
The OTS has adopted a regulation that adds an IRR component to the
risk-based capital requirement for savings institutions like Sterling
Savings. The OTS may waive or defer inclusion of the IRR component on
a case-by-case basis. Under the rule, institutions meeting or
exceeding a base level of interest rate exposure must deduct an IRR
component from the total capital available to meet their risk-based
capital requirement. That deduction is equal to one-half of the
difference between the institution's actual measured exposure and the
base level of exposure. The institution's actual measured IRR is
expressed as the change that occurs in its net present value ("NPV")
as a result of a hypothetical 200 basis point increase or decrease in
interest rates (whichever leads to the lower NPV) divided by the
estimated economic value of its assets. The base level of IRR which
would require inclusion of a capital component is defined as a decline
in NPV which exceeds 2.0% of an institution's assets expressed in
terms of economic value. Using a computer model, the OTS will
calculate changes in each institution's NPV based on financial data
the institution submits on its Thrift Financial Report. The OTS will
then advise each institution of its required IRR deduction. The OTS,
using December 31, 1997 financial information, has calculated that no
IRR component deduction was required to be added to Sterling Savings'
risk-based capital.
Savings associations that fail to meet the tangible, core or risk-
based capital requirements are subject to a number of sanctions or
restrictions. Under FIRREA, the OTS must prohibit any asset growth,
except that the OTS may permit growth in an amount not in excess of
net interest credited to the savings association's deposit
liabilities, if (i) the savings association obtains the prior approval
of the OTS; (ii) any increase in assets is accompanied by an increase
in tangible capital in an amount not less than 3.0% of the increase in
assets; (iii) any increase in assets is accompanied by an increase in
capital not less in percentage amount than required under the risk-
based capital standards then applicable; (iv) any increase in assets
is invested in low-risk assets; and (v) the savings association's
ratio of core capital to total assets is not less than the ratio
existing on January 1, 1991.
The OTS also may require any savings association not in compliance
with capital standards (including any individual minimum capital
requirement) to comply with a capital directive issued by the OTS.
Such capital directive may order the savings association to (a)
achieve its minimum capital requirements by a specified date; (b)
adhere to a compliance schedule for achieving its minimum capital
requirements; (c) submit and adhere to a capital plan acceptable to
the OTS; and/or (d) take other actions including reducing its assets
or rate of liability growth and/or restricting its payment of
dividends in order to reach the required capital levels. The OTS, by
such capital directive, enforcement proceedings or otherwise, may
require an association not in compliance with the capital requirements
to (i) increase the amount of its regulatory capital to a specified
level; (ii) convene a meeting with the OTS supervision staff for the
purpose of accomplishing the objectives of the regulations; (iii)
reduce or limit the rate of interest that may be paid on savings
accounts; (iv) limit the receipt of deposits to those made to existing
accounts; (v) cease or limit lending or the making of a particular
loan or category of loan; (vi) cease or limit the purchase of loans or
the making of specified other investments; (vii) limit operational
expenditures to specific levels; (viii) increase liquid assets and
maintain such increased liquidity at specified levels; or (ix) take
such other action or actions as the OTS may deem necessary or
appropriate for the safety and soundness of the sav