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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
For the year ended December 31, 1998
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 (IRS Employer Identification No.)
incorporation or organization)
111 North Wall Street, Spokane, Washington 99201
(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 26, 1999, 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
$130,735,508.
The number of shares outstanding of the Registrant's Common Stock, par value
$1.00 per share, as of February 26, 1999 was 8,072,021.
DOCUMENTS INCORPORATED BY REFERENCE
Specific portions of the Registrant's Proxy Statement dated March 26, 1999 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, 1998 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
----
PART I............................................................................................. 1
Item 1. Business............................................................................... 1
General.................................................................................... 1
Growth and Acquisition Strategies.......................................................... 2
Lending Activities......................................................................... 2
Investments and Mortgage-Backed Securities................................................. 13
Sources of Funds........................................................................... 14
Subsidiaries............................................................................... 20
Competition................................................................................ 20
Personnel.................................................................................. 21
Regulation................................................................................. 21
Item 2. Properties............................................................................. 29
Item 3. Legal Proceedings...................................................................... 29
Item 4. Submission of Matters to a Vote of Security Holders.................................... 29
PART II............................................................................................ 30
Item 5. Market for the Registrant's Stock and Related Shareholder Matters...................... 30
Item 6. Selected Financial Data................................................................ 31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 33
General.................................................................................... 33
Net Interest Income........................................................................ 33
Asset and Liability Management............................................................. 36
Financial Position......................................................................... 39
Results of Operations for the Years Ended December 31, 1998 and 1997....................... 40
Results of Operations for the Six Months Ended December 31, 1996 and 1995.................. 42
Results of Operations for Fiscal Years Ended June 30, 1996 and 1995........................ 45
Liquidity and Sources of Funds............................................................. 47
Capital Resources.......................................................................... 48
New Accounting Standards................................................................... 49
Year 2000 Issues........................................................................... 50
Effects of Inflation and Changing Prices................................................... 51
Item 7. A. Quantitative and Qualitative Disclosures About Market Risk.......................... 51
Item 8. Financial Statements and Supplementary Data............................................ 51
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 51
PART III........................................................................................... 51
Item 10. Directors and Executive Officers of the Registrant.................................... 51
Item 11. Executive Compensation................................................................ 51
Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 51
Item 13. Certain Relationships and Related Transactions........................................ 51
PART IV............................................................................................ 52
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................... 52
SIGNATURES......................................................................................... 54
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 Bank ("Sterling Savings Bank"), formerly Sterling Savings Association.
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 Savings Bank 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 $2.31 billion in total assets at
December 31, 1998, attracts Federal Deposit Insurance Corporation ("FDIC")
insured deposits from the general public through 77 retail branches located
primarily in rural and suburban communities in Washington, Oregon, Idaho and
Montana. Sterling originates loans through its branch offices as well as ten
Action Mortgage residential loan production offices in the metropolitan areas of
Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho; and four
INTERVEST commercial real estate lending offices located in the metropolitan
areas of Spokane and Seattle, Washington; and Portland, Oregon. Sterling also
markets tax-deferred annuities, mutual funds and other financial products
through Harbor Financial.
Recently, Sterling has focused its efforts on becoming more like a
community bank by increasing its business banking, consumer and construction
lending while increasing its retail deposits. Sterling's revenues are derived
primarily from interest earned on loans, investments and mortgage-backed
securities ("MBS"), from fees and service charges and from mortgage banking
operations. The operations of Sterling Savings 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"). See "Regulation."
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. Sterling completed the acquisition
of Big Sky Bancorp, Inc. ("Big Sky") and its subsidiary, First Federal Savings
and Loan Association of Montana ("First Federal"), on November 13, 1998. On
that date, First Federal had approximately $66 million in total assets and
deposits of approximately $50 million. The merger with Big Sky was accounted
for as a pooling of interests; and accordingly, all historical amounts have been
restated to include the results of Big Sky.
On June 15, 1998, Sterling acquired 33 branch offices in Washington,
Idaho and Oregon from KeyBank National Association ("KeyBank"). The purchase
included $518 million of deposit balances and $125 million of loan balances.
Upon acquisition, the weighted average interest rate on deposits assumed was
3.42%. Sterling incurred an approximate $57 million intangible asset associated
with the acquisition. Sterling is amortizing the intangible asset over a period
of 15 years using the straight-line method. With the net cash received from the
branch acquisition, Sterling repaid approximately $322 million of certain
reverse repurchase borrowings and Federal Home Loan Bank of Seattle ("FHLB
Seattle") advances.
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 years ended December 31, 1998 and 1997, six months
ended December 31, 1996 and 1995 and the fiscal year ended June 30, 1996. See
Note 1 of "Notes to Consolidated Financial Statements" included herein.
1
Growth and Acquisition Strategies
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.
Lending Activities
Focus on Community Lending. In recent years, Sterling has focused its
efforts on becoming more like a community retail bank. Accordingly, 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 has a Business Banking Group which
provides a full range of credit products to small- and medium-sized businesses,
including consumer, private banking and agriculture loans. Credit products
include lines of credit, receivables and inventory financing, equipment loans,
and permanent and construction real restate financing. Loans may be made on an
unsecured, partially-secured or fully-secured basis. The credit product line
for both businesses and individuals includes standardized products as well as
customized, individual accommodations.
Sterling has established minimum underwriting standards which
delineate criteria for sources of repayment, financial strength and credit
enhancements such as guarantees. Typically, the primary source of repayment is
recurring cash flow of the borrower or cash flow from the business or project
being financed. Depending on the type of loan, underwriting standards include
minimum financial requirements, maximum loan-to-collateral value ratios, minimum
cash flow coverage of debt service, debt-to-income ratios and minimum liquidity
requirements. Exceptions to the minimum underwriting standards may be made
depending upon the type of loan and financial strength of the borrower. All
exceptions are reported to the Sterling Senior Loan Committee and in some cases
are reported to Sterling's Board of Directors. Common forms of collateral
pledged to secure business banking loans include real estate, accounts
receivable, inventory, equipment, agricultural crops or livestock and marketable
securities. Most loans have maximum terms of one to seven years and loan-to-
value ratios in the range of 65% to 80%, based on an analysis of the collateral
pledged.
Sterling's Consumer Lending Group 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.
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. Such loans generally but do not always meet the same
underwriting requirements as general consumer loans of the same type. Private
banking loans typically involve larger balances and may have nonstandard terms.
Sterling's Agriculture Lending Group offers agriculture loans to a
variety of agricultural producers. In connection with such loans, Sterling
endeavors to appropriately evaluate the borrowers' financial, production,
marketing and management abilities. Such loans may include annual operating
loans and term loans to finance the purchase of machinery, equipment, production
livestock and real estate. Such loans also may be made to cover interim
operating and family living expenses.
2
Sterling actively participates in the transportation finance market,
primarily through consumer indirect auto loans (sales finance contracts).
Sterling also makes direct (branch originated) auto loans and marine and
recreational vehicle loans. Most applicants for these credit products are
assigned a credit score which is designed to indicate the relative probability
of repayment. The credit scoring models are validated as to their predictive
power on a periodic basis. The Consumer Lending Group includes in its credit
criteria other judgmental factors, such as the advance rate and debt-to-income
ratio, which are used to augment this credit score. However, all credit
decisions made contrary to an established cut-off score are required to be
supported and documented by a credit officer with the appropriate approval
authority. Consumer loans, especially those originated through dealers,
generally have greater inherent risks than other types of loans. At December
31, 1998, consumer direct and indirect loans were 14.0% and 4.0%, respectively,
of Sterling's total loan portfolio.
Business banking loans generally involve a higher degree of risk than
the financing of real estate, primarily because collateral is more difficult to
appraise, 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, however, typically offer relatively higher
yields and variable interest rates. The availability of such loans enables
potential depositors to establish full-service banking relationships with
Sterling. Sterling is permitted to hold 20% of its assets in certain business
banking loans. At December 31, 1998, certain business banking loans subject to
this limit were approximately 8% of total assets. At December 31, 1998, all
business banking loans were 19.6% of Sterling's total loan portfolio.
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 a
variety of market indices. 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. At December 31, 1998, 21.3% of Sterling's total loan
portfolio consisted of conventional one- to four-family residential loans.
Conventional residential mortgage loans are originated for up to 95%
of the appraised value or selling price of the mortgaged property, whichever is
less. Borrowers must purchase private mortgage insurance from approved third
parties so that Sterling's risk is limited to approximately 80% of the appraised
value on all loans with loan-to-value ratios in excess of 80%. 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, presold
homes and homes that are built for sale. 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.
3
At December 31, 1998, 12.8% of Sterling's total loan portfolio
consisted of one- to four-family residential construction loans, approximately
74% of which were for properties that were built for sale. Further,
approximately 63% 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, particularly in that market, could have a negative impact on Sterling.
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 primarily 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 or acquiring personal
guarantees from the borrowers. At December 31, 1998, 9.5% of Sterling's total
loan portfolio consisted of multifamily residential construction and commercial
property construction loans.
4
The following table sets forth information on loan origination
and sale activities for the periods indicated.
Years Ended December 31, Six Months Ended December 31,
---------------------------------- -------------------------------- Fiscal Year Ended
1998 1997 1996 1995 June 30, 1996
----------------- --------------- --------------- --------------- ---------------
Amount % Amount % Amount % Amount % Amount %
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
(Dollars in thousands)
Mortgage - permanent:
One- to four-family residential.. $ 241,725 24.0 $179,297 22.2 $ 75,036 23.5 $126,051 35.5 $221,110 32.0
Multifamily residential.......... 83,904 8.3 29,015 3.6 2,200 0.7 9,875 2.8 11,429 1.6
Commercial property.............. 34,735 3.5 36,410 4.5 16,865 5.3 25,861 7.3 28,861 4.2
Mortgage - construction:
One- to four-family residential.. 226,025 22.5 217,973 26.9 94,765 29.7 76,199 21.5 177,838 25.8
Multifamily residential.......... 47,809 4.8 62,356 7.7 12,735 4.0 29,303 8.2 68,169 9.9
Commercial property.............. 42,301 4.2 10,825 1.3 10,925 3.5 17,455 4.9 35,234 5.1
Non-mortgage:
Consumer - direct................ 99,449 9.8 79,448 9.8 33,535 10.5 26,226 7.4 49,473 7.2
Consumer - indirect.............. 51,958 5.2 20,955 2.6 0 0.0 0 0.0 0 0.0
Business banking................. 178,209 17.7 173,014 21.4 72,676 22.8 44,015 12.4 97,822 14.2
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans originated........... $1,006,115 100.0 $809,293 100.0 $318,737 100.0 $354,985 100.0 $689,936 100.0
========== ===== ======== ===== ======== ===== ======== ===== ======== =====
One- to four-family residential
mortgage loans sold............. $ 110,151 $108,004 $ 77,856 $122,797 $232,061
========== ======== ======== ======== ========
5
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,
---------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
Amount % Amount % Amount %
---------- ----- ---------- ----- ---------- -----
(Dollars in thousands)
Mortgage - permanent:
One- to four-family
residential............... $ 342,757 21.3 $ 313,792 26.0 $ 304,216 28.4
Multifamily residential.... 124,656 7.7 68,697 5.7 73,455 6.9
Commercial property........ 177,912 11.1 120,068 10.0 104,372 9.7
Land and other............. 0 0.0 434 0.0 385 0.0
---------- ----- ---------- ----- ---------- -----
645,325 40.1 502,991 41.7 482,428 45.0
---------- ----- ---------- ----- ---------- -----
Mortgage - construction:
One- to four-family
residential............... 206,139 12.8 179,495 14.9 148,786 13.9
Multifamily residential.... 98,934 6.2 97,059 8.0 77,743 7.3
Commercial property........ 53,641 3.3 26,386 2.2 37,875 3.5
---------- ----- ---------- ----- ---------- -----
358,714 22.3 302,940 25.1 264,404 24.7
---------- ----- ---------- ----- ---------- -----
Total mortgage loans....... 1,004,039 62.4 805,931 66.8 746,832 69.7
Consumer - direct.......... 224,651 14.0 139,666 11.6 124,529 11.6
Consumer - indirect........ 64,764 4.0 19,016 1.6 0 0.0
Business banking........... 315,614 19.6 241,808 20.0 199,848 18.7
---------- ----- ---------- ----- ---------- -----
Total loans receivable..... 1,609,068 100.0 1,206,421 100.0 1,071,209 100.0
---------- ===== ---------- ===== ---------- =====
Undisbursed portion of
loans in process......... (125,147) (91,048) (92,151)
Deferred loan origination
(fees) and costs.......... (2,309) 232 156
Premium (discount) on loans
acquired pursuant to
purchase transactions.... 1,545 (380) (629)
Allowance for loan losses.. (14,623) (9,486) (8,389)
---------- ---------- ----------
Loans receivable, net...... $1,468,534 $1,105,739 $ 970,196
========== ========== ==========
June 30,
---------------------------------------------------------
1996 1995 1994
----------------- ----------------- -----------------
Amount % Amount % Amount %
---------- ----- ---------- ----- ---------- -----
(Dollars in thousands)
Mortgage - permanent:
One- to four-family
residential............... $ 332,819 31.9 $ 632,062 53.8 $607,551 64.9
Multifamily residential.... 68,154 6.5 63,977 5.5 49,414 5.3
Commercial property........ 103,480 9.9 88,554 7.5 82,131 8.8
Land and other............. 398 0.0 2,301 0.2 2,734 0.3
---------- ----- ---------- ----- -------- -----
504,851 48.3 786,894 67.0 741,830 79.3
---------- ----- ---------- ----- -------- -----
Mortgage - construction:
One- to four-family
residential............... 138,030 13.2 113,761 9.7 37,760 4.0
Multifamily residential.... 79,048 7.6 42,158 3.6 31,856 3.4
Commercial property........ 40,003 3.8 22,630 1.9 833 0.1
---------- ----- ---------- ----- -------- -----
257,081 24.6 178,549 15.2 70,449 7.5
---------- ----- ---------- ----- -------- -----
Total mortgage loans....... 761,932 72.9 965,443 82.2 812,279 86.8
Consumer - direct.......... 112,811 10.8 109,373 9.3 70,429 7.5
Consumer - indirect........ 0 0.0 0 0.0 0 0.0
Business banking........... 169,830 16.3 99,528 8.5 52,700 5.7
---------- ----- ---------- ----- -------- -----
Total loans receivable..... 1,044,573 100.0 1,174,344 100.0 935,408 100.0
---------- ===== ---------- ===== -------- -----
Undisbursed portion of
loans in process......... (112,493) (73,761) (44,377)
Deferred loan origination
(fees) and costs.......... 556 2,803 1,748
Premium (discount) on loans
acquired pursuant to
purchase transactions.... (776) (1,122) (1,508)
Allowance for loan losses.. (8,366) (7,796) (6,133)
---------- ---------- --------
Loans receivable, net...... $ 923,494 $1,094,468 $885,138
========== ========== ========
6
Contractual Principal Payments. The following table sets forth the
scheduled contractual principal repayments for Sterling's loan portfolio at
December 31, 1998. 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 and
premiums, deferred loan origination costs and fees, or allowances for loan
losses.
Principal Payments
Contractually
Balance Due in Fiscal Years
Outstanding at ---------------------------
December 31, 1998 1999 2000-2003 Thereafter
----------------- ------ --------- ----------
(Dollars in thousands)
Mortgage - permanent:
Fixed rate............. $ 354,608 $ 14,442 $ 50,037 $290,129
Variable rate.......... 290,717 12,463 57,636 220,618
Mortgage - construction.. 358,714 302,008 46,218 10,488
Consumer - direct........ 224,651 39,373 82,822 102,456
Consumer - indirect...... 64,764 11,021 48,255 5,488
Business banking......... 315,614 98,443 77,698 139,473
---------- -------- -------- --------
$1,609,068 $477,750 $362,666 $768,652
========== ======== ======== ========
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, 1998 and 1997, Sterling serviced for itself and for
other investors residential mortgage loans totaling $985.6 million and $1.1
billion, respectively. Of such mortgage loans, Sterling serviced $193.2 million
and $379.4 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 sells portfolios of servicing rights
primarily to improve earnings and to increase its regulatory capital ratios.
During the year ended December 31, 1998 and the fiscal year ended June 30, 1996,
Sterling sold, in bulk, rights to service conventional loans for others of
approximately $117.6 million and $172.2 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.
7
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 $296.7 million at December 31, 1998. Sterling
also had secured and unsecured commercial and personal lines of credit totaling
approximately $166.0 million, of which the undisbursed portion was approximately
$86.5 million at December 31, 1998. See Note 17 of "Notes to Consolidated
Financial Statements."
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 decreased to $17.7 million at
December 31, 1998 from $19.4 million at December 31, 1997. As a percentage of
total assets, classified assets were 0.8% and 1.0%, 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, 1998,
Sterling's assets classified as loss totaled $711,000. 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.
Years Ended Six Months Fiscal Year
December 31, Ended Ended
-------------------- December 31, June 30,
1998 1997 1996 1996
------- ------- ------------ -----------
(Dollars in thousands)
Balance at beginning of period......... $ 8,817 $ 3,974 $ 4,874 $ 5,298
Loan foreclosures and other additions.. 2,394 6,865 1,839 1,628
Capitalized expenses................... 202 627 181 124
Sales and other reductions............. (5,110) (2,476) (2,889) (2,108)
Provisions for losses.................. (71) (173) (31) (68)
------- ------- ------- -------
Balance at end of period............... $ 6,232 $ 8,817 $ 3,974 $ 4,874
======= ======= ======= =======
8
Major Classified Loans. Each of Sterling's classified loans with a
net carrying value at December 31, 1998 of more than $400,000 is described
below.
Sterling holds a residential construction loan secured by 36
individual residential condominium units located in Vancouver, Washington. The
borrower was unable to pay off the loan when it matured in November 1998 and has
had to reduce the unit prices to generate sales. The carrying value of this loan
at December 31, 1998 was $2.5 million. Sterling has classified $300,000 of this
loan as doubtful and allocated $150,000 of its general valuation allowance
against this loan.
Sterling holds a line of credit and various permanent and construction
loans, secured by real estate owned by a Spokane, Washington-based developer.
The borrower filed for Chapter 11 bankruptcy in January 1998. Sterling is
proceeding to obtain a relief of stay from the bankruptcy court in order to
foreclose on these properties. The aggregate carrying value of these loans at
December 31, 1998 was $2.0 million. Sterling has allocated $63,000 of its
general valuation allowance against 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, 1998 was
approximately $1.5 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, 1998, although there has been a history
of delinquent payments on the loans. The aggregate carrying value of these loans
at December 31, 1998 was $481,000. No specific allowance has been established
for these loans.
Sterling holds several loans to a business located in Snohomish
County, Washington. These loans are secured by a first deed of trust on a
commercial property, a residential rental property and a security interest in
equipment. These loans were classified as substandard as a result of recent
operating losses. The aggregate carrying value on these loans at December 31,
1998 was $480,000. No specific allowance has been established for these loans.
Sterling holds three residential construction loans on properties
located in Portland, Oregon and Vancouver, Washington. Sterling is proceeding
against the borrower to foreclose on these properties. The aggregate carrying
value at December 31, 1998 was $452,000. No specific allowance has been
established for these loans.
Major Real Estate Owned. Each of Sterling's REO properties with a net
carrying value at December 31, 1998 of more than $400,000 is described below.
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, 1998 was
$2.8 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
substantially fully leased. Efforts to sell the property have not been
successful but are on-going.
Sterling acquired through foreclosure in April 1998 an
office/warehouse building located in Garland, Texas. The carrying value on this
property at December 31, 1998 was $1.2 million. No specific loss allowance has
been established for this property. Sterling is currently attempting to sell
this property.
Sterling acquired a three-story office building located in Post Falls,
Idaho through foreclosure in October 1997. The office/warehouse building is
currently vacant and efforts to sell the property are on-going. The carrying
value on this property at December 31, 1998 was $717,000, net of a specific loss
allowance of $252,000.
9
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, 1998 was $640,000, net of a
specific loss allowance of approximately $245,000. Efforts to sell the property
have not been successful but are on-going.
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 require 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 records 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.
For consumer loans, a demand letter is sent when the account becomes
delinquent for two payments. Additional collection work or repossession may
follow. 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. Similar collection procedures to those for consumer and
mortgage loans are followed for business loans with the exception that these
accounts are generally handled as a joint effort between the account loan
officer and the collection department during initial stages of delinquency. On
or before 75 days of delinquency, the collection effort is shifted from the
account loan officer to the collection department with legal action to follow.
The following table summarizes the principal balances of nonperforming
assets at the dates indicated.
December 31, June 30,
--------------------------- ---------------------------
1998 1997 1996 1996 1995 1994
------- ------- ------- ------- ------- -------
(Dollars in thousands)
Nonaccrual loans..................................... $ 3,050 $ 4,755 $ 2,329 $ 3,352 $ 3,395 $ 2,262
Restructured loans................................... 87 150 215 240 254 188
------- ------- ------- ------- ------- -------
Total nonperforming loans............................ 3,137 4,905 2,544 3,592 3,649 2,450
Real estate owned (1)................................ 6,232 8,817 3,974 4,874 5,298 7,298
------- ------- ------- ------- ------- -------
Total nonperforming assets........................... $ 9,369 $13,722 $ 6,518 $ 8,466 $ 8,947 $ 9,748
======= ======= ======= ======= ======= =======
Ratio of total nonperforming assets to total assets.. 0.40% 0.71% 0.41% 0.55% 0.56% 0.68%
Ratio of total nonperforming loans to total loans.... 0.19% 0.41% 0.24% 0.34% 0.31% 0.26%
Ratio of allowance for estimated losses on loans to
total nonperforming loans (2)...................... 462.48% 193.82% 325.21% 238.04% 218.10% 250.45%
- ---------------------
(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 $114,000, $47,000, $262,000, $213,000,
$145,000 and $7,000 at December 31, 1998, 1997 and 1996 and at June 30,
1996, 1995 and 1994, respectively. Loans classified as loss excluded from
total nonperforming loans were $0, $35,000, $45,000, $167,000, $141,000 and
$4,000 at December 31, 1998, 1997 and 1996 and at June 30, 1996, 1995 and
1994, 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 $159,000, $258,000,
$86,000, $151,000 and $224,000 would have been recorded during the years ended
December 31, 1998 and 1997, the six months ended December 31, 1996 and 1995 and
the fiscal year ended June 30, 1996, respectively, if nonaccrual and
10
restructured loans had been current in accordance with their original
contractual terms. Interest income of $194,000, $311,000, $8,000, $21,000 and
$62,000 was recorded on these loans during the years ended December 31, 1998 and
1997, the six months ended December 31, 1996 and 1995 and the year ended June
30, 1996, respectively. Sterling's quality control staff also reviews various
aspects of loans originated and acquired by Sterling in an effort 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 Year 2000 issues. This review includes an
evaluation of (i) Sterling's large borrowers' abilities to respond to their
internal Year 2000 issues; (ii) the effect, if any, this will have on such
borrowers' abilities 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.
Six Months
Years Ended Ended Fiscal Years Ended
December 31, December 31, June 30,
----------------- --------------- ---------------------------
1998 1997 1996 1996 1995 1994
------- ------- --------------- ------- ------- ------
(Dollars in thousands)
Balance at beginning of
period....................... $ 9,486 $ 8,389 $ 8,366 $ 7,796 $ 6,133 $5,070
Charge-offs:
Mortgage - permanent....... (252) (219) (767) (752) (795) (566)
Mortgage - construction.... (28) (202) (7) 0 0 0
Consumer - direct.......... (1,048) (999) (384) (412) (220) (61)
Consumer - indirect........ (738) (29) 0 0 0 0
Business banking........... (325) (119) (19) (5) (9) (3)
------- ------- ------- ------- ------- ------
Total charge-offs............. (2,391) (1,568) (1,177) (1,169) (1,024) (630)
------- ------- ------- ------- ------- ------
Recoveries:
Mortgage - permanent....... 34 58 30 23 61 39
Consumer - direct.......... 106 96 41 49 27 11
Consumer - indirect........ 42 6 0 0 0 0
Business banking........... 21 23 8 24 5 0
------- ------- ------- ------- ------- ------
Total recoveries.............. 203 183 79 96 93 50
------- ------- ------- ------- ------- ------
Net charge-offs............... (2,188) (1,385) (1,098) (1,073) (931) (580)
Provisions for loan losses.... 5,325 2,482 1,121 1,643 1,642 1,643
Allowance for losses on
assets acquired.............. 2,000 0 0 0 952 0
------- ------- ------- ------- ------- ------
Balance at end of period...... $14,623 $ 9,486 $ 8,389 $ 8,366 $ 7,796 $6,133
======= ======= ======= ======= ======= ======
Allowances allocated to
loans classified as loss..... $ 114 $ 47 $ 262 $ 213 $ 145 $ 7
Ratio of net charge-offs
to average loans
outstanding during the
period....................... 0.17% 0.13% 0.11% 0.10% 0.09% 0.08%
11
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 collateral of 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,
------------------------------------------------------- ---------------------------------------------------------
1998 1997 1996 1996 1995 1994
------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Loans in Loans in Loans in Loans in Loans in Loans in
Category Category Category Category Category Category
as a as a as a as a as a as a
Percentage Percentage Percentage Percentage Percentage Percentage
of Total of Total of Total of Total of Total of Total
Gross Gross Gross Gross Gross Gross
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ ----------
(Dollars in thousands)
Mortgage
- permanent..... $ 4,535 40.1% $3,800 41.7% $3,589 45.0% $3,462 48.3% $3,754 67.0% $3,652 79.3%
Mortgage
- construction.. 3,199 22.3 3,108 25.1 2,380 24.7 1,969 24.6 1,369 15.2 969 7.5
Consumer
- direct........ 3,113 14.0 400 11.6 399 11.6 465 10.8 422 9.3 409 7.5
Consumer
- indirect...... 650 4.0 153 1.6 0 0.0 0 0.0 0 0.0 0 0.0
Business
banking......... 2,626 19.6 1,200 20.0 1,196 18.7 1,075 16.3 856 8.5 660 5.7
Unallocated...... 500 N/A 825 N/A 825 N/A 1,395 N/A 1,395 N/A 443 N/A
------- ----- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$14,623 100.0% $9,486 100.0% $8,389 100.0% $8,366 100.0% $7,796 100.0% $6,133 100.0%
======= ===== ====== ===== ====== ===== ====== ===== ====== ===== ====== =====
12
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 investments and MBS are not
reported in the Consolidated Financial Statements as these investments and MBS
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
investments and MBS mature or are actually sold. These investments and MBS may
be sold in response to changes in market interest rates and related changes in
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, 1998 and 1997, investments and MBS classified as
available for sale were $566.4 million and $666.5 million, respectively. The
carrying value of these investments and MBS at December 31, 1998 includes an
unrealized gain of $788,000 (net of a $424,000 related income tax provision) and
an unrealized loss of $706,000 (net of a $351,000 related income tax benefit),
respectively. The improvement in fair value since December 31, 1997 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. Such investments provide Sterling with a relatively liquid
source of interest income and collateral which can be used to secure borrowings.
Sterling invests primarily in investment-grade investments and MBS.
The following table provides the carrying values, contractual
maturities and weighted average yields of Sterling's investment and MBS
portfolio at December 31, 1998.
Maturity
----------------------------------------------------
Less than One to Five to Over Ten
One Year Five Years Ten Years Years Total
-------- -------- -------- -------- --------
(Dollars in thousands)
MBS
Balance.............................. $ 836 $ 8,311 $52,915 $343,663 $405,725
Weighted average yield............... 7.87% 6.36% 6.00% 6.14% 6.13%
U.S. government and agency obligations
Balance.............................. $10,157 $102,154 $ 345 $ 250 $112,906
Weighted average yield............... 6.13% 6.06% 6.13% 7.05% 6.07%
FHLB Seattle stock
Balance.............................. $ 0 $ 0 $ 0 $ 32,318 $ 32,318
Weighted average yield (1)........... 0.00% 0.00% 0.00% 7.50% 7.50%
Municipal bonds (2)
Balance.............................. $ 2,538 $ 8,517 $ 1,992 $ 0 $ 13,047
Weighted average yield............... 4.07% 4.47% 4.39% 0.00% 4.38%
Other (3)
Balance.............................. $ 96 $ 95 $ 0 $ 22,218 $ 22,409
Weighted average yield............... 5.51% 6.13% 0.00% 6.38% 6.37%
Total carrying value.................... $13,627 $119,077 $55,252 $398,449 $586,405
======= ======== ======= ======== ========
Weighted average yield.................. 5.85% 5.97% 5.94% 6.26% 6.16%
- ----------------------
(1) The weighted average yield on FHLB Seattle stock is based upon the
dividends received for the year ended December 31, 1998.
(2) The weighted average yields on municipal bonds reflect the actual yields
on the bonds and are not presented on a tax-equivalent basis.
(3) Other investments relate primarily to trust-preferred securities.
13
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,
-------------------
1998 1997
-------- --------
(Dollars in thousands)
MBS..................................... $405,725 $477,513
U.S. government and agency obligations.. 112,906 169,749
FHLB Seattle stock...................... 32,318 29,949
Municipal bonds......................... 13,047 13,033
Other................................... 22,409 695
-------- --------
Total............................... $586,405 $690,939
======== ========
Available-for-sale...................... $566,372 $666,476
Held-to-maturity........................ 20,033 24,463
-------- --------
Total............................... $586,405 $690,939
======== ========
Weighted average yield.................. 6.16% 6.55%
Sources of Funds
General. Sterling's primary sources of funds for use in lending and
for other general business purposes are deposits, loan repayments, FHLB Seattle
advances, secured lines of credit and other borrowings, 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 borrowings and other economic conditions. Borrowings also 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 money market demand accounts ("MMDA") and
checking accounts in addition to more traditional savings accounts and
certificates of deposit ("CDs") accounts. Sterling offers both interest- and
noninterest-bearing checking accounts. The interest-bearing checking accounts
are subject to monthly service charges, unless a minimum balance is maintained.
MMDA, CDs and savings 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 6.4% and 8.7% of deposits at December
31, 1998 and 1997, respectively. Public funds are generally obtained by
competitive bidding among qualifying financial institutions. Sterling had no
brokered deposits at December 31, 1998.
14
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 negotiable order of withdrawal ("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.
Fiscal Year
Years Ended December 31, Six Months Ended December 31, Ended June 30,
--------------------------------------- ---------------------------------------- ------------------
1998 1997 1996 1995 1996
------------------- ------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
Average Interest Average Interest Average Interest Average Interest Average Interest
Balance Rate Balance Rate Balance Rate Balance Rate Balance Rate
---------- -------- ---------- -------- ---------- -------- ---------- -------- ---------- --------
(Dollars in thousands)
Certificates of deposit...... $ 791,311 5.46% $ 655,120 5.70% $614,734 5.64% $666,821 5.99% $647,555 5.88%
Regular savings accounts
and money market accounts... 351,759 3.62 246,218 3.89 233,144 3.78 187,235 3.66 205,698 3.69
Checking accounts:
NOW accounts............... 145,335 1.14 81,985 1.38 74,726 1.46 70,561 1.55 71,628 1.57
Noninterest-bearing
demand accounts............ 72,828 0.00 29,569 0.00 25,398 0.00 26,552 0.00 24,517 0.00
---------- ---------- -------- -------- --------
$1,361,233 4.23% $1,012,892 4.74% $948,002 4.70% $951,169 5.04% $949,398 4.93%
========== ========== ======== ======== ========
15
The following table shows the amounts and maturities of CDs that had
balances of $100,000 or more at December 31, 1998.
(Dollars in thousands)
Remaining maturity:
Less than three months................................................... $ 117,660
Three to six months...................................................... 40,700
Six to 12 months......................................................... 47,767
Over 12 months........................................................... 22,364
----------
$ 228,491
========
The following table presents the types of deposit accounts offered by
Sterling Savings Bank and the balance in such accounts:
December 31, 1998
----------------------------------------------------
Percentage
Minimum Minimum of Total Interest Rate
Term Category Balances Amount Deposits Offered
- ------- ---------------------- ---------- ------------ ------- -------------
(Dollars in thousands, except minimum amounts)
Transaction Accounts:
None NOW checking........................... $ 100 $ 193,114 12.5% 1.39%
None Commercial checking.................... 100 104,176 6.7 0.00
None Regular savings........................ 100 102,927 6.7 1.50
None Money market demand.................... 2,500 330,251 21.4 1.00
---------- -----
730,468 47.3
---------- -----
Certificates of Deposit:
3 months Fixed term, fixed rate................ 500 5,783 0.4 3.97
6 months Fixed term, fixed rate................ 500 87,086 5.6 4.35
9 months Fixed term, adjustable rate........... 5,000 38,725 2.5 4.41
12 months Fixed term, fixed rate................ 500 260,444 16.8 4.65
12 months Fixed term, fixed rate................ 5,000 257 0.0 2.75
12 months Fixed term, adjustable rate(1)........ 500 3 0.0 N/A
12 months Fixed term, adjustable rate........... 5,000 2,426 0.2 4.27
15 months Fixed term, adjustable rate........... 5,000 35,575 2.3 4.31
18 months Fixed term, fixed rate................ 500 67,239 4.3 4.51
24 months Fixed term, fixed rate................ 500 116,739 7.5 4.41
36 months Fixed term, fixed rate................ N/A 21,352 1.4 4.41
36 months Zero coupon, fixed term(1)............ N/A 19 0.0 N/A
18 months Variable rate, IRA.................... 100 7,454 0.5 5.20
18 months Fixed rate, IRA....................... 500 2,949 0.2 4.51
36 months Variable rate, IRA.................... 2,000 13,701 0.9 4.31
7 days Fixed term, fixed rate................ 500 1,841 0.1 3.15
7 days Mini-jumbos........................... N/A 5,369 0.4 4.70
7 days Jumbos................................ 100,000 147,995 9.6 4.60
---------- -----
814,957 52.7
---------- -----
Total deposits...................................... $1,545,425 100.0%
========== =====
(1) Not currently offered.
16
The following table sets forth the composition of Sterling's deposit
accounts at the dates indicated.
December 31,
----------------------------------------------
1998 1997
----------------------------------------------
Percentage Percentage
of Total of Total
Amount Deposits Amount Deposits
------- --------- ------ ----------
(Dollars in thousands)
NOW checking................. $ 193,114 12.5 $ 92,281 8.5
Commercial checking.......... 104,176 6.7 31,230 2.9
Regular savings.............. 102,927 6.7 71,484 6.6
Money market demand.......... 330,251 21.4 184,795 17.0
Variable-rate certificates:
9-36 months.................. 97,884 6.3 5,729 0.6
Fixed-rate certificates:
1-11 months.................. 248,074 16.1 314,513 29.0
12-35 months................. 447,628 28.9 284,559 26.2
36-240 months................ 21,371 1.4 99,854 9.2
---------- ----- ---------- -----
Total deposits............... $1,545,425 100.0 $1,084,445 100.0
========== ===== ========== =====
Substantially all of Sterling's depositors are residents of the states
of Washington, Idaho, Montana and Oregon.
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 52 ATMs to
better serve customers in those markets. Customers also can 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, 1998, Sterling exceeded its FHLB Seattle stock ownership
requirement of $22.3 million by $10.0 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, 1998, Sterling had advances
totaling $319.5 million from the FHLB Seattle which mature from fiscal years
1999 through 2015 at interest rates ranging from 4.34% to 8.40%. See
"Management's Discussion and Analysis Liquidity and Sources of Funds" and Note
9 "Notes to Consolidated Financial Statements."
17
Sterling also borrows funds under reverse repurchase agreements
pursuant to which it sells investments (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
investments and MBS sold. Sterling uses these borrowings to supplement deposit
gathering for funding the origination of loans. Sterling had $195.1 million and
$180.1 million in reverse repurchase agreements outstanding at December 31, 1998
and 1997, respectively. Sterling enters into short-term repurchase agreements
with selected retail customers. The balance of such short-term repurchase
agreements was $6.8 million at December 31, 1998. 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, 1998, Sterling had the authority to incur
approximately $78.0 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, at December 31, 1998
Sterling had a $40.0 million one-year variable-rate line of credit outstanding
with KeyBank. This line of credit matures June 1, 1999, but may be renewed for
an additional six months. Interest is payable quarterly on this loan. The
interest rate is adjustable monthly and accrues at the London InterBank Offering
Rate ("LIBOR") plus 2% (7.6875% at December 31, 1998). Sterling also had a $5.0
million line-of-credit agreement with KeyBank. Advances under the line of
credit accrue interest at KeyBank's prime interest rate plus 0.50% (8.25% at
December 31, 1998) and the line of credit matures in June 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 Bank Preferred and Common Stock which are owned by Sterling. No amounts
were outstanding on this line of credit at December 31, 1998 and 1997.
Sterling Savings Bank has an unsecured $10.0 million line-of-credit
agreement with KeyBank. Advances under the line of credit accrue interest at
KeyBank's federal funds rate plus an incremental negotiated rate (5.875% at
December 31, 1998) and the line matures in June 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, 1998 and 1997.
18
The following table sets forth certain information regarding
Sterling's short-term borrowings as of and for the periods indicated.
Years Ended
December 31, Six Months Fiscal Year
-------------- Ended Ended
1998 1997 December 31, 1996 June 30, 1996
---- ---- ----------------- -------------
(Dollars in thousands)
Maximum amount outstanding at any month-end during the period:
Short-term reverse repurchase agreements....................... $336,734 $273,573 $232,885 $195,785
Short-term advances............................................ 353,879 353,847 95,000 171,000
Average amount outstanding during the period:
Short-term reverse repurchase agreements....................... 123,659 185,698 213,560 156,578
Short-term advances............................................ 198,042 207,931 90,833 140,917
Weighted average interest rate paid during the period:
Short-term reverse repurchase agreements....................... 5.56% 5.68% 5.60% 5.91%
Short-term advances............................................ 6.08% 5.90% 5.79% 5.88%
Weighted average interest rate paid at end of period:
Short-term reverse repurchase agreements....................... 5.58% 5.71% 5.62% 5.57%
Short-term advances............................................ 5.96% 5.99% 5.75% 6.42%
The following table sets forth certain information concerning
Sterling's outstanding borrowings.
December 31,
----------------------------------
1998 1997
--------------- ---------------
Amount % Amount %
-------- ---- -------- ----
(Dollars in thousands)
FHLB Seattle advances:
Short-term........................ $ 95,000 15.6 $353,847 49.7
Long-term......................... 224,540 36.7 106,238 14.9
Securities sold subject to reverse
repurchase agreements:
Short-term........................ 49,274 8.1 180,077 25.3
Long-term......................... 145,800 23.8 0 0.0
Subordinated Notes payable.......... 17,240 2.8 17,240 2.4
Advances under line of credit....... 40,000 6.5 0 0.0
Trust Preferred Securities.......... 40,000 6.5 40,000 5.6
Term note payable................... 0 0.0 15,000 2.1
-------- ----- -------- -----
Total borrowings.................... $611,854 100.0 $712,402 100.0
======== ===== ======== =====
Weighted average interest rate...... 5.71% 6.25%
19
Subsidiaries
Sterling's principal subsidiary is Sterling Savings Bank. Sterling
Savings Bank has three principal subsidiaries which have been previously
described: Action Mortgage, Harbor Financial and INTERVEST. Additionally,
Sterling and Sterling Savings Bank 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 Bank.
(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 Bank.
(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 Bank's investment in the Grapetree
Partnership has been deemed by its primary federal regulators to be an
impermissible investment. Accordingly, Sterling Savings Bank's
investment has been deducted from 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
asset consists of commercial property in Spokane, Washington acquired
through foreclosure. 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, 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.
Adequately capitalized and well-managed bank holding companies are
allowed by law to acquire banks in any state, subject to certain conditions,
regardless of whether such acquisitions would be prohibited by applicable state
law. Interstate merger transactions are allowed except in certain states which
have opted not to participate in interstate merger transactions. Sterling's
competitors may be able to conduct extensive interstate banking operations and
thereby gain competitive advantages over Sterling.
20
Personnel
As of December 31, 1998, Sterling, including its subsidiaries, had 746
full-time equivalent employees. Employees are not represented by a collective
bargaining unit. Sterling believes its relationship with its employees is
excellent.
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
Bank is chartered by the State of Washington and its savings deposits are
insured by the FDIC. Sterling Savings Bank 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 Bank, which at December 31, 1998 met the QTL
Test.
If Sterling Savings Bank 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 Bank were to fail to meet
the QTL Test in the future. Although Sterling Savings Bank 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.
21
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, 1998, Sterling Savings Bank 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 Bank. 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, 1998, Sterling Savings Bank 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."
22
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).
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 grand-
fathered 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, 1998.
The following tables set forth Sterling Savings Bank's core, Tier 1-
risk-based and total risk-based capital positions as reported on the quarterly
Thrift Financial Report at December 31, 1998.
Core Capital Ratio
----------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total shareholders' equity:................ $206,008 9.17%
Adjustment:
Unrealized gains on securities............. (788) (0.04)
Less:
Intangibles................................ 61,180 2.72
Excess qualifying purchased mortgage loan
servicing................................ 18 0.00
Investment in non-includable subsidiaries.. 353 0.02
-------- -----
Total core capital......................... 143,669 6.39
Core capital requirement................... 89,900 4.00
-------- -----
Core capital excess........................ $ 53,769 2.39%
======== =====
Core (Tier 1)
Risk-based
Capital Ratio
----------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total core (Tier 1) capital:.................. $143,669 9.40%
Core (Tier 1) risk-based capital requirement.. 61,127 4.00
-------- ----
Core (Tier 1) risk-based capital excess....... $ 82,542 5.40%
======== ====
23
Total Risk-based Capital
------------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total core (Tier 1) capital:.... $143,669 9.40%
General valuation allowances.... 14,508 0.95
Assets required to be deducted.. (804) (0.05)
-------- -----
Total risk-based capital........ 157,373 10.30
Risk-based capital requirement.. 122,254 8.00
-------- -----
Risk-based capital excess....... $ 35,119 2.30%
======== =====
- --------------------
(1) Ratio of core capital to adjusted total assets for core capital ratio and
ratio of core and total capital to risk-weighted assets for Tier 1 risk-
based and total 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
Bank. 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 then will advise
each institution of its required IRR deduction. The OTS, using December 31,
1998 financial information, has calculated that no IRR component deduction is
required to be added to Sterling Savings Bank's risk-based capital.
Savings associations that fail to meet the tangible, core or risk-
based capital requirements are subject to a number of sanctions or restrictions.
Under FIRREA, the OTS must prohibit any asset growth, except that the OTS may
permit growth in an amount not in excess of net interest credited to the savings
association's deposit liabilities, if (i) the savings association obtains the
prior approval of the OTS; (ii) any increase in assets is accompanied by an
increase in tangible capital in an amount not less than 3.0% of the increase in
assets; (iii) any increase in assets is accompanied by an increase in capital
not less in percentage amount than required under the risk-based capital
standards then applicable; (iv) any increase in assets is invested in low-risk
assets and (v) the savings association's ratio of core capital to total assets
is not less than the ratio existing on January 1, 1991.
The OTS also may require any savings association not in compliance
with capital standards (including any individual minimum capital requirement) to
comply with a capital directive issued by the OTS. Such capital directive may
order the savings association to (a) achieve its minimum capital requirements by
a specified date; (b) adhere to a compliance schedule for achieving its minimum
capital requirements; (c) submit and adhere to a capital plan acceptable to the
OTS and/or (d) take other actions including reducing its assets or rate of
liability growth and/or restricting its payment of dividends in order to reach
the required capital levels. The OTS, by such capital directive, enforcement
proceedings or otherwise, may require an association not in compliance with the
capital requirements to (i) increase the amount of its regulatory capital to a
specified level; (ii) convene a meeting with the OTS supervision staff for the
purpose of accomplishing the objectives of the regulations; (iii) reduce or
limit the rate of interest that may be paid on savings accounts; (iv) limit the
receipt of deposits to those made to existing accounts; (v) cease or limit
lending or the making of a particular loan or category of loan; (vi) cease or
limit the purchase of loans or the making of specified other investments; (vii)
limit operational expenditures to specific levels; (viii) increase liquid assets
and maintain such increased liquidity at specified levels or (ix) take such
other action or actions as the OTS may deem necessary or appropriate for the
safety and soundness of the savings
24
association or the protection of its depositors. The material failure of a
savings asso