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EX-32 - EXHIBIT 32 - Sterling Banks, Inc.ex32.htm
EX-15 - EXHIBIT 15 - Sterling Banks, Inc.ex15.htm
EX-31.1 - EXHIBIT 31.1 - Sterling Banks, Inc.ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - Sterling Banks, Inc.ex31-2.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q/A
(Amendment No.1)

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2009
or

[   ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________

Commission File No. 333-133649

STERLING  BANKS, INC.
(Exact name of registrant as specified in its charter)

New Jersey
20-4647587
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification Number)

3100 Route 38, Mount Laurel, New Jersey 08054
(Address of principal executive offices) (Zip Code)

856-273-5900
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

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 ___

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes_____No_____

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
x
(Do not check if a smaller reporting company)
 
 
 


 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):YES   NO   X  

Number of shares outstanding of the registrant’s common stock, par value $2.00 per share, outstanding as of November 24, 2009: 5,843,362


 

 


STERLING BANKS, INC.

FORM 10-Q/A

FOR THE QUARTER ENDED SEPTEMBER 30, 2009

INDEX


Part I
FINANCIAL INFORMATION
Page
     
Item 1.
Consolidated Financial Statements
 
 
  Balance Sheets
 
  Statements of Operations
 
  Statements of Shareholders’ Equity
 
  Statements of Cash Flows
 
  Notes to Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition
 
 
  and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4T.
Controls and Procedures
     
Part II
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Submission of Matters to a Vote of Security Holders
Item 5.
Other Information
Item 6.
Exhibits
     
SIGNATURES
 
 

EXHIBITS
 
 
3


 
EXPLANATORY NOTE

Sterling Banks, Inc. (the “Company”) is filing this Amendment No. 1 to its Quarterly Report on Form 10−Q for the quarter ended September 30, 2009, originally filed with the Securities and Exchange Commission (the “SEC”) on November 25, 2009 (the “Original Filing”), to amend and restate the Company’s unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2009.

The allowance for loan losses was increased and provision for loan losses was decreased from amounts previously reported to reflect changes to the qualitative reserve factors used to determine the general reserves and impairment amounts for specific reserves that the Company’s wholly owned subsidiary, Sterling Bank (the “Bank”), utilized in calculating its allowance for loan losses as of June 30, 2009.  The adjustment in the qualitative reserve factors and impaired amounts reflected second quarter trends in delinquent, classified and non-performing loans in the Bank’s loan portfolio, which were raised as part of the Bank’s recent regulatory examination by the Federal Reserve Bank of Philadelphia (the “FRB”) as was concluded by the issuance of a Report of Examination dated November 30, 2009.  This regulatory examination issue was raised but unresolved at the time of the Original Filing with the SEC.      As a result of subsequent discussions with the FRB, the Company concluded that the allowance for loan losses as of June 30, 2009 should be increased by $5.0 million and determined to establish a valuation allowance for deferred tax assets of $5.6 million as of and for the three months ended June 30, 2009.  These adjustments also impacted reported amounts in the Original Filing.  The decision to restate the second quarter and third quarter financial statements was approved by the Board of Directors of Sterling Banks, Inc. on January 14, 2010.

As a result of the changes noted above, the Bank’s September 30, 2009 capital ratios continue to be below the level considered “well capitalized” and the Bank continues to be considered “adequately capitalized” by established regulatory standards.
 
 
The Company also reassessed the effectiveness of the disclosure controls and procedures and of the design and operations of its internal controls over financial reporting.  Based on that evaluation and due to the restatement of the unaudited consolidated financial statements as of and for the three and six months ended June 30 and September 30, 2009, the Company concluded that its internal controls over financial reporting were not effective as of June 30 and September 30, 2009.  The Company’s conclusion was primarily related to the Company’s review and reassessment of management’s policies and procedures for the monitoring and timely evaluation of and revision to management’s approach for assessing credit risk inherent in the loan portfolio to reflect changes in the economic environment.

The information in this Amendment has been updated to give effect to the restatement.  The Company has not modified nor updated the information in the Original Filing, except as necessary to reflect the effects of the restatements described above.  This Amendment continues to speak as of the dates described herein, and the Company has not updated the disclosures contained in the Original Filing to reflect any events that occurred subsequent to such dates.  Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the Original Filing.

Based on the foregoing, only the following items have been amended:
· Part I – Financial Information:
· Item 1 – Financial Statements
· Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
· Item 3 – Quantitative and Qualitative Disclosures About Market Risk
· Item 4T – Controls and Procedures

For the convenience of the reader, this Form 10−Q/A sets forth the initial Form 10-Q in its entirety, although the Company is only amending those portions affected by the restatement described above.
 
 
 
4

 
 
In addition, as required by Rule 12b−15 under the Securities Exchange Act of 1934, as amended, new, currently-dated certifications of our principal executive officer and principal financial officer are filed herewith as Exhibits 31.1, 31.2, and 32.
 
 
 
5


 





Report of Independent Registered Public Accounting Firm



To the Board of Directors and Shareholders
Sterling Banks, Inc.

We have reviewed the accompanying consolidated balance sheet of Sterling Banks, Inc. and Subsidiary (the “Company”) as of September 30, 2009, the related consolidated statements of operations for the three-month and nine-month periods ended September 30, 2009 and 2008, and the related statements of shareholders' equity and cash flows for the nine-month periods ended September 30, 2009 and 2008.  These consolidated financial statements are the responsibility of the Company's management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board, the consolidated balance sheet of the Company as of December 31, 2008, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated April 15, 2009, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2008, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.


Blue Bell, Pennsylvania
March 8, 2010




McGladrey & Pullen, LLP is a member firm of RSM International –
an affiliation of separate and independent legal entities.

 
6

 
 

Part I.  Financial Information

Item 1.  Financial Statements


STERLING BANKS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2009 AND DECEMBER 31, 2008

   
September 30,
2009
(Unaudited and Restated)
(See Note 2)
   
December 31,
2008
 
ASSETS
           
Cash and cash due from banks
  $ 9,071,000     $ 13,054,000  
Federal funds sold
    19,498,000       472,000  
          Cash and cash equivalents
    28,569,000       13,526,000  
                 
Investment securities held-to-maturity, at cost (fair value of $12,174,000
    at September 30, 2009 and $19,992,000 at December 31, 2008)
    11,802,000        19,884,000  
Investment securities available-for-sale, at fair value
    35,340,000        24,097,000  
          Total investment securities
    47,142,000       43,981,000  
                 
Restricted stock, at cost
    2,014,000       2,448,000  
                 
Loans held for sale
    -       2,000  
                 
Loans
    296,914,000       305,626,000  
Less: allowance for loan losses
    (10,607,000 )      (8,531,000 )
          Total net loans
    286,307,000       297,095,000  
                 
Core deposit intangible asset, net
    2,077,000       2,374,000  
Bank premises and equipment, net
    8,297,000       8,526,000  
Branch Property Held for Sale
    505,000       596,000  
Accrued interest receivable and other assets
     8,176,000        10,557,000  
                 
          Total assets
  $ 383,087,000     $ 379,105,000  




See Notes to Consolidated Financial Statements

 
 
7

 
 

 
STERLING BANKS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2009 AND DECEMBER 31, 2008

   
September 30,
2009
(Unaudited and Restated)
(See Note 2)
   
December 31,
2008
 
LIABILITIES
 
Deposits
           
     Noninterest-bearing
  $ 31,367,000     $ 35,873,000  
     Interest-bearing
    311,836,000       292,721,000  
          Total deposits
    343,203,000       328,594,000  
                 
Federal Home Loan Bank advances
    15,250,000       16,000,000  
Subordinated debentures
    6,186,000       6,186,000  
Accrued interest payable and other accrued liabilities
    1,606,000       1,204,000  
                 
          Total liabilities
    366,245,000       351,984,000  
                 
COMMITMENTS AND CONTINGENCIES (Note 3)
               
                 
SHAREHOLDERS' EQUITY
               
  Preferred stock, no par value, 10,000,000 shares authorized, none issued
        or outstanding
    -       -  
  Common stock,
   $2 par value, 15,000,000 shares authorized; 5,843,362 issued and
        outstanding at September 30, 2009 and December 31, 2008
      11,687,000         11,687,000  
  Additional paid-in capital
    29,823,000       29,767,000  
  Accumulated deficit
    (24,997,000 )     (14,279,000 )
  Accumulated other comprehensive income (loss)
     329,000        (54,000 )
         Total shareholders' equity
    16,842,000       27,121,000  
          Total liabilities and shareholders' equity
  $ 383,087,000     $ 379,105,000  


See Notes to Consolidated Financial Statements



8

 
 

 
STERLING BANKS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
(Unaudited)

   
For the three months ended September 30,
2009
   
For the three months ended September 30,
2008
   
For the nine months ended September 30,
2009
   
For the nine months ended September 30,
2008
 
   
(Restated)
         
(Restated)
       
   
(See Note 2)
         
(See Note 2)
       
INTEREST INCOME
                       
  Interest and fees on loans
  $ 4,294,000     $ 5,125,000     $ 12,799,000     $ 15,839,000  
  Interest and dividends on securities
    465,000       318,000       1,450,000       1,093,000  
  Interest on due from banks and federal funds sold
    5,000       21,000       17,000       161,000  
          Total interest and dividend income
    4,764,000       5,464,000       14,266,000       17,093,000  
                                 
INTEREST EXPENSE
                               
  Interest on deposits
    1,632,000       1,985,000       5,442,000       6,994,000  
  Interest on Federal Home Loan Bank advances and
     overnight borrowings
    163,000       31,000       484,000       110,000  
  Interest on subordinated debentures
    107,000       105,000       316,000       313,000  
          Total interest expense
    1,902,000       2,121,000       6,242,000       7,417,000  
          Net interest income
    2,862,000       3,343,000       8,024,000       9,676,000  
                                 
PROVISION FOR LOAN LOSSES
     -        105,000       5,390,000        505,000  
  Net interest income after provision for loan losses
    2,862,000       3,238,000       2,634,000       9,171,000  
                                 
NONINTEREST INCOME
                               
  Service charges
    64,000       65,000       194,000       188,000  
  Gains on sales of available-for-sale securities
    -       -       5,000       95,000  
  Gains on sales of fixed assets
    -       1,000       -       5,000  
  Miscellaneous fees and other
    113,000       217,000       383,000       507,000  
          Total noninterest income
    177,000       283,000       582,000       795,000  
                                 
NONINTEREST EXPENSES
                               
  Compensation and benefits
    1,580,000       1,719,000       4,780,000       5,516,000  
  Occupancy, equipment and data processing
    887,000       923,000       2,714,000       2,751,000  
  Marketing and business development
    125,000       124,000       393,000       419,000  
  Professional services
    336,000       246,000       960,000       681,000  
  FDIC insurance
    371,000       90,000       870,000       303,000  
  Amortization of core deposit intangible asset
    99,000       86,000       297,000       261,000  
  Impairment or disposal of fixed assets
    -       -       84,000       -  
  Losses on sales and impairment of repossessed
      property
    -       -       77,000       -  
  Other operating expenses
    220,000       194,000       848,000       657,000  
          Total noninterest expenses
     3,618,000        3,382,000       11,023,000        10,588,000  
                                 
INCOME (LOSS) BEFORE INCOME TAX
   EXPENSE (BENEFIT)
    (579,000 )     139,000       (7,807,000 )     (622,000 )
                                 
INCOME TAX EXPENSE (BENEFIT)
     -        60,000        2,911,000        (217,000 )
                                 
NET INCOME (LOSS)
  $ (579,000 )   $ 79,000     $ (10,718,000 )   $ (405,000 )
                                 
NET INCOME (LOSS) PER COMMON SHARE
                               
      Basic and Diluted
  $ (0.09 )   $ 0.01     $ (1.83 )   $ (0.07 )
                                 
WEIGHTED AVERAGE SHARES OUTSTANDING
                               
      Basic
    5,843,362       5,843,362       5,843,362       5,843,362  
      Diluted
    5,843,362       5,849,335       5,843,362       5,843,362  

See Notes to Consolidated Financial Statements
 
 
9


 
STERLING BANKS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
(Unaudited)

                     
Retained
   
Accumulated
       
               
Additional
   
Earnings
   
Other
   
Total
 
   
Common Stock
   
Paid-In
   
(Accumulated
   
Comprehensive
   
Shareholders'
 
   
Shares
   
Amount
   
Capital
   
Deficit)
   
Income (Loss)
   
Equity
 
December 31, 2007
    5,843,362     $ 11,687,000     $ 29,708,000     $ 1,949,000     $ (36,000 )   $ 43,308,000  
Comprehensive loss:
                                               
   Net loss – 2008
    -       -       -       (405,000 )     -       (405,000 )
   Change in net unrealized loss on
                                               
       securities available-for-sale, net
                                               
       of reclassification adjustment
                                               
       and tax effects
    -       -       -       -       (80,000 )     (80,000 )
      Total comprehensive loss
                                            (485,000 )
Stock compensation
    -       -       40,000       -       -       40,000  
                                                 
September 30, 2008
    5,843,362     $ 11,687,000     $ 29,748,000     $ 1,544,000     $ (116,000 )   $ 42,863,000  
                                                 
                                                 
December 31, 2008
    5,843,362     $ 11,687,000     $ 29,767,000     $ (14,279,000 )   $ (54,000 )   $ 27,121,000  
Comprehensive loss:
                                               
   Net loss – 2009 (Restated – See Note 2)
    -       -       -       (10,718,000 )     -       (10,718,000 )
   Change in net unrealized gain (loss)
                                               
       on securities available-for-sale,
                                               
       net of reclassification adjustment
                                               
       and tax effects
    -       -       -       -       383,000       383,000  
      Total comprehensive loss
                                            (10,335,000 )
Stock compensation
    -       -       56,000       -       -       56,000  
                                                 
September 30, 2009 (Restated – See Note 2)
    5,843,362     $ 11,687,000     $ 29,823,000     $ (24,997,000 )   $ 329,000     $ 16,842,000  
                                                 
                                                 
                                                 

See Notes to Consolidated Financial Statements
 
 
 
10


 

STERLING BANKS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
(Unaudited)
 
   
2009
   
2008
 
   
(Restated)
       
   
(See Note 2)
       
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net loss
  $ (10,718,000 )   $ (405,000 )
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
               
      Depreciation and amortization of premises and equipment
    770,000       809,000  
      Provision for loan losses
    5,390,000       505,000  
      Net amortization of purchase premium on securities
    288,000       27,000  
      Net amortization of core deposit intangible
    297,000       261,000  
      Stock compensation
    56,000       40,000  
      Realized loss (gain) on sales, write down or retirement of buildings and equipment
    84,000       (5,000 )
      Realized loss on sales or write down of repossessed property
    77,000       -  
      Realized gain on sales of securities available-for-sale
    (5,000 )     (95,000 )
      Realized gain on sales of loans held for sale
    -       (12,000 )
      Proceeds from sale of loans held for sale
    2,000       1,058,000  
      Originations of loans held for sale
    -       (1,020,000 )
Changes in operating assets and liabilities:
               
   Decrease in accrued interest receivable and other assets
    1,613,000       135,000  
   Increase (Decrease) in accrued interest payable and other accrued liabilities
    403,000       (198,000 )
      Net cash (used in) provided by operating activities
    (1,743,000 )     1,100,000  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
   Purchases of securities available-for-sale
    (19,826,000 )     (3,995,000 )
   Purchases of securities held-to-maturity
    -       (15,322,000 )
   Proceeds from sales of securities available-for- sale
    -       5,470,000  
   Proceeds from maturities of securities available-for-sale
    4,005,000       25,900,000  
   Proceeds from maturities of securities held-to-maturity
    169,000       -  
   Proceeds from principal payments on mortgage-backed securities available-for-sale
    5,118,000       2,090,000  
   Proceeds from principal payments on mortgage-backed securities held-to-maturity
    7,728,000       1,550,000  
   Purchases of restricted stock
    (219,000 )     (2,465,000 )
   Proceeds from sale of restricted stock
    653,000       2,246,000  
   Net decrease in loans
    5,398,000       9,833,000  
   Proceeds from sales of other real estate owned
    435,000       -  
   Proceeds from sales of equipment
    -       46,000  
   Purchases of premises and equipment
    (534,000 )     (392,000 )
   Cash paid for acquisition
    -       (25,000 )
      Net cash provided by investing activities
    2,927,000       24,936,000  
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
   Net (decrease) increase in noninterest-bearing deposits
    (4,506,000 )     1,553,000  
   Net increase (decrease) in interest-bearing deposits
    19,115,000       (29,028,000 )
   Proceeds from Federal Home Loan Advances
    -       5,500,000  
   Repayments of Federal Home Loan Advances
    (750,000 )     -  
      Net cash provided by (used in) financing activities
    13,859,000       (21,975,000 )
                 
INCREASE IN CASH AND CASH EQUIVALENTS
    15,043,000       4,061,000  
                 
CASH AND CASH EQUIVALENTS, JANUARY 1,
    13,526,000        11,788,000  
                 
CASH AND CASH EQUIVALENTS, SEPTEMBER 30,
  $ 28,569,000     $ 15,849,000  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
               
   Cash:
               
     Interest on deposits and borrowed funds
  $ 6,121,000     $ 7,604,000  
     Income taxes
  $ -     $ 1,000  
   Noncash investing activities:
               
     Transfer of loans to other real estate owned
  $ 1,374,000     $ -  

See Notes to Consolidated Financial Statements
 
 
11

 

 
STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1.  DESCRIPTION OF BUSINESS

Sterling Banks, Inc. (the “Company”) is a bank holding company headquartered in Mount Laurel, NJ.  Through its subsidiary, Sterling Bank (the “Bank”), the Company provides individuals, businesses and institutions with commercial and retail banking services, principally in loans and deposits.  Sterling Banks, Inc. was incorporated under the laws of the State of New Jersey on February 28, 2006 for the sole purpose of becoming the holding company of the Bank.
 
The Bank is a commercial bank, which was incorporated on September 1, 1989, and commenced opera­tions on December 7, 1990.  The Bank is chartered by the New Jersey Department of Banking and Insurance and is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation.  The Bank maintains its principal office at 3100 Route 38 in Mount Laurel, New Jersey and has nine other full service branches.  The Bank’s primary deposit products are checking, savings and term certificate accounts, and its primary loan products are consumer, residential mortgage and commercial loans.
 
NOTE 2.  RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

The Company has restated the accompanying unaudited condensed consolidated financial statements as of and for the three and nine months ended September 30, 2009.  The allowance for loan losses was increased and provision for loan losses was decreased from amounts previously reported to reflect a correction of the qualitative reserve factors used to determine the general reserves and impairment amounts for specific reserves that the Bank utilized in calculating its allowance for loan losses as of June 30, 2009.  The adjustment in the qualitative reserve factors reflected second quarter trends in delinquent, classified and non-performing loans in the Bank’s loan portfolio, which were raised as part of the Bank’s regulatory examination by the FRB for the period ending June 30, 2009.  As a result, the Company concluded that the allowance for loan losses as of June 30, 2009 should be increased by $5,000,000 and determined to establish a valuation allowance for deferred tax assets of $5.6 million.  The correction was recorded in the three-month and six-month periods ended June 30, 2009 based upon the significant increase in the number of charge-offs experienced by the Company during the period, deterioration noted in the commercial real estate market, and changes in the various loss estimates on the Company’s nonperforming loan portfolio.  This correction also affected the amounts recorded as of and for the three and nine months ended September 30, 2009, including the valuation allowance for deferred tax assets that was initially reported during this period.

The effect of the restatement is as follows:

Consolidated Balance Sheets as of September 30, 2009

   
As Reported
   
Adjustment
   
Restated
 
Allowance for loan losses
  $ (6,682,000 )   $ (3,925,000 )   $ (10,607,000 )
Total net loans
  $ 290,232,000     $ (3,925,000 )   $ 286,307,000  
Accrued interest receivable and other assets
  $ 9,064,000     $ (888,000 )   $ 8,176,000  
Total assets
  $ 387,900,000     $ (4,813,000 )   $ 383,087,000  
Accumulated deficit
  $ (20,184,000 )   $ (4,813,000 )   $ (24,997,000 )
Total shareholders’ equity
  $ 21,655,000     $ (4,813,000 )   $ 16,842,000  

 
 
12


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 2.  RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS (continued)

Consolidated Statements of Operations

   
For the three months ended September 30, 2009
   
For the nine months ended September 30, 2009
 
   
As Reported
   
Adjustment
   
Restated
   
As Reported
   
Adjustment
   
Restated
 
Provision for loan losses
  $ 1,075,000     $ (1,075,000 )   $ -     $ 1,465,000     $ 3,925,000     $ 5,390,000  
  Net interest income
    after provision for
    loan losses
  $  1,787,000     $  1,075,000     $  2,862,000     $  6,559,000     $  (3,925,000 )   $  2,634,000  
Loss before income tax
   expense (benefit)
  $ (1,654,000 )   $ 1,075,000     $ (579,000 )   $ (3,882,000 )   $ (3,925,000 )   $ (7,807,000 )
Income tax expense
  (benefit)
  $ 2,856,000     $ (2,856,000 )   $ -     $ 2,023,000     $ 888,000     $ 2,911,000  
Net loss
  $ (4,510,000 )   $ 3,931,000     $ (579,000 )   $ (5,905,000 )   $ (4,813,000 )   $ (10,718,000 )
Net loss per common
   share
                                               
Basic and Diluted
  $ (0.77 )   $ 0.68     $ (0.09 )   $ (1.01 )   $ (0.82 )   $ (1.83 )

Consolidated Statements of Cash Flows

   
For the nine months ended September 30, 2009
 
   
As Reported
   
Adjustment
   
Restated
 
Net loss
  $ (5,905,000 )   $ (4,813,000 )   $ (10,718,000 )
Provision for loan losses
  $ 1,465,000     $ 3,925,000     $ 5,390,000  
Decrease in accrued interest receivable and other assets
  $ 725,000     $ 888,000     $ 1,613,000  

Certain amounts were also restated and additional disclosures are provided in the footnotes primarily in “Note 3 – Summary of Significant Accounting Policies, Income Taxes”, “Note 8 – Capital Ratios”, “Note 9 – Fair Value”, “Note 10 – Loans”, and “Note 11 – Allowance for Loan Losses.”

NOTE 3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Financial Statements and Basis of Presentation

The financial statements included herein have not been audited, except for the balance sheet at December 31, 2008, which was derived from the audited financial statements.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted; therefore, these financial statements should be read in conjunction with the audited financial statements and the notes thereto for the year ended December 31, 2008.  The accompanying financial statements reflect all adjustments which are, in the opinion of management, necessary to present a fair statement of the results for the interim periods presented.  Such adjustments are of a normal recurring nature.  The results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

The financial statements include the accounts of Sterling Banks, Inc. and its wholly-owned subsidiary, Sterling Bank.  Sterling Banks Capital Trust I is a wholly-owned subsidiary but is not consolidated because it does not meet the requirements.  All significant inter-company balances and transactions have been eliminated.

 
 
13


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Use of Estimates

 The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from such estimates.  Material estimates that are particularly susceptible to significant change in the near term are the determination of the allowance for loan losses, the valuation of deferred tax assets, the valuation of intangible assets and the fair value of financial instruments.

Accounting Standards Codification

 The Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) became effective on July 1, 2009.  At that date, the ASC became FASB’s officially recognized source of authoritative U.S. generally accepted accounting principles (“GAAP”) applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”) and related literature.  Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants.  All other accounting literature is considered non-authoritative.  The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies.  Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.
 
Commitments

In the normal course of business, there are various outstanding commitments to extend credit, such as letters of credit and unadvanced loan commitments, which are not reflected in the accompanying financial statements.  Management does not anticipate any material losses as a result of these commitments.

Contingencies

The Company, from time to time, is a party to routine litigation that arises in the normal course of business.  Management does not believe the resolution of this litigation, if any, would have a material adverse effect on the Company’s financial condition or results of operations.  However, the ultimate outcome of any such matter, as with litigation generally, is inherently uncertain and it is possible that some of these matters may be resolved adversely to the Company.

Investments

The Company has identified investment securities that it has the intent and ability to hold to maturity considering all reasonably foreseeable events or conditions.  The securities are classified as “held-to-maturity.”  The Company has also identified investment securities that will be held for indefinite periods of time, including securities that will be used as part of the Company’s asset/liability management strategy and that may be sold in response to changes in interest rates, prepayments and similar factors.  These securities are classified as “available-for-sale” and are carried at fair value, with any temporary unrealized gains or losses reported as other comprehensive income, net of the related income tax effect, a separate component of shareholders’ equity.

 

 
14


 
STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Allowance for Losses on Loans

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.  The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses in the balance of the loan portfolio, based on an evaluation of the collectibility of existing loans and prior loss experience.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of loans in light of changes in the nature and volume of the loan portfolio, overall portfolio quality and historical experience, review of specific problem loans, adverse situations which may affect borrowers’ ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and other factors which may warrant current recognition.  Such periodic assessments may, in management’s judgment, require the Company to recognize additions or reductions to the allowance.

Various regulatory agencies periodically review the adequacy of the Company’s allowance for loan losses as an integral part of their examination process.  Such agencies may require the Company to recognize additions or reductions to the allowance based on their judgments of information available to them at the time of their examination.  This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
 
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.
 
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual residential mortgage and consumer loans for impairment disclosures.

Impairment of Long-Lived Assets

The Company reviews long-lived assets, including property and equipment and definite lived intangibles, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable.  An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount.  Impairment, if any, is assessed using discounted cash flows.  During the nine months ended September 30, 2009, impairment was identified on our former Gaither Road location that is held for sale and a write down of $82,000 was recorded.  No impairments occurred during the nine months ended September 30, 2008.
 
 

 
15


 
STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Core Deposit Intangible

Core deposit intangibles arise from purchase business combinations.  On March 16, 2007, we completed our merger with the former Farnsworth Bancorp, Inc.  We were deemed to be the purchaser for accounting purposes and thus recognized a core deposit intangible asset in connection with the merger.  The establishment and subsequent amortization of this intangible asset requires several assumptions including, among other things, the estimated cost to service deposits acquired, discount rates, estimated attrition rates and useful lives.  If the value of the core deposit intangible or the customer relationship intangible is determined to be less than the carrying value in future periods, a write down would be taken through a charge to our earnings.  The most significant element in evaluation of these intangibles is the attrition rate of the acquired deposits.  If such attrition rate accelerates from that which we expected, the intangible is reduced by a charge to earnings.  The attrition rate related to deposit flows is influenced by many factors, the most significant of which are alternative yields for deposits available to customers and the level of competition from other financial institutions and financial services companies.  In connection with our annual impairment testing in the fourth quarter of 2008, we reassessed the carrying value of the core deposit intangible, determined that the value of the core deposit relationship had declined below its carrying value, and charged earnings for $475,000 in the fourth quarter of 2008.  We further reassessed the estimated useful life and determined that with changes in the marketplace, a remaining useful life of six years would be more appropriate.

Income Taxes

Deferred income taxes arise principally from the difference between the income tax basis of an asset or liability and its reported amount in the financial statements, at the statutory income tax rates expected to be in effect when the taxes are actually paid or recovered.  Deferred income tax assets are reduced by a valuation allowance when, based on the weight of evidence available, it is more likely than not that all or some portion of the net deferred tax assets may not be realized.
 
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained.  The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more-likely-than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions.  Tax positions that meet the more-likely-than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.  The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.  It is the Company’s policy to recognize interest and penalties related to the unrecognized tax liabilities within income tax expense in the statements of operations.
 
 
 
16


 

 
STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

As of the second quarter, on a restated basis, the Company updated its analysis of whether a valuation allowance should be recorded against its deferred tax assets.  Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized.  The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence.  In making such judgments, significant weight is given to evidence that can be objectively verified.  The impact of the correction of the allowance for loan loss and continued near-term losses represent significant negative evidence that caused the Company to conclude that a $5.6 million deferred tax valuation allowance was required at June 30, 2009 because the Company has determined it can no longer meet the more likely than not threshold for recognizing this asset.  Of this amount, approximately $2.9 million represents previously recognized deferred tax benefits where the Company has determined they can no longer meet the more likely than not threshold for recognizing this asset.

During the third quarter 2009, the Company recorded no income tax expense (benefit) as the increase in deferred tax assets was offset by a corresponding increase to the valuation allowance.  To the extent that the Company generates taxable income in a given quarter, the valuation allowance may be reduced to fully or partially offset the corresponding income tax expense.  Any remaining deferred tax asset valuation allowance will ultimately reverse through income tax expense when the Company can demonstrate a sustainable return to profitability that would lead management to conclude that it is more likely than not that the deferred tax asset will be utilized during the carryforward period.

The Worker, Homeownership, and Business Assistance Act of 2009 was passed during the fourth quarter of 2009 and will allow the Company to carry back its fiscal 2009 taxable loss up to five years.  This recently enacted legislation will enable the Company to record a federal income tax receivable of approximately $750,000 at December 31, 2009 and  reduce its’ recorded valuation allowance by the same amount in the fourth quarter 2009.

Recent Accounting Pronouncements

FASB ASC Topic 260, Earnings Per Share

On January 1, 2009, FASB ASC Topic 260, Earnings Per Share  became effective, which provides that unvested share based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are considered participating securities and should be included in the computation of basic Earnings per share using the two class method.  At September 30, 2009 the Company did not have any shares which were considered participating securities.


 
 
17


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

FASB ASC Topic 820, Fair Value Measurements and Disclosures (Accounting Standards Update No. 2009-5)
 
 
FASB ASC Topic 820 (Accounting Standards Update No. 2009-5) provides additional guidance on: a) determining when the volume and level of activity for the asset or liability has significantly decreased; b) identifying circumstances in which a transaction is not orderly; and c) understanding the fair value measurement implications of both (a) and (b).  This new guidance requires several new disclosures, including the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, in both interim and annual periods.  The Company adopted this new guidance on April 1, 2009.  Adoption of this new guidance did not have a significant impact on the Company’s financial position or results of operations.

FASB ASC Topic 320, Investments - Debt and Equity Securities

FASB ASC Topic 320 provides new guidance on the recognition and presentation of an other-than-temporary impairment (“OTTI”) and requires additional disclosures.  The recognition provisions within this new guidance apply only to our debt securities classified as available-for-sale and held-to-maturity, while the presentation and disclosure requirements within this new guidance apply to both our debt and equity securities.  An impaired debt security will be considered other-than-temporarily impaired if we have the intent to sell or it more likely than not we will be required to sell prior to recovery of the amortized cost.  In these situations the OTTI recognized in net income (loss) is equal to difference between amortized cost and fair value.  If we do not expect recovery of the entire cost basis, even if we have no intention to sell the security, it will be considered an OTTI as well.  In this situation the new guidance requires we recognize OTTI by separating the loss between the amount representing the credit loss and the amount relating to other factors.  Credit losses will be recognized in net income and losses relating to other factors will be recognized in other comprehensive income (“OCI”).  FASB ASC Topic 320 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  FASB ASC Topic 320 requires a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption with a corresponding adjustment to accumulated OCI for that portion representing losses related to factors other than credit quality.  We adopted FASB ASC Topic 320 effective April 1, 2009.  The change in accounting principle had no impact on the recorded amounts in the consolidated financial statements.  The adoption disclosure effects of this new guidance are depicted in Note 4 – Investment Securities.

FASB ASC Topic 825, Financial Instruments

FASB ASC Topic 825 requires disclosures about the fair value of financial instruments for interim periods of publicly traded companies as well as in annual financial statements.  Fair value information along with the significant assumptions used to estimate fair value must be disclosed.  The adoption effects of this new guidance are depicted in Note 9 – Fair Value.

FASB ASC Topic 855, Subsequent Events

New authoritative guidance under FASB ASC Topic 855, establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued (i.e., complete in a form and format that complies with GAAP and approved for issuance).  However, FASB ASC Topic 855 does not apply to subsequent events or transactions that are within the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions. 
 
 
 
18


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

There are two types of subsequent events to be evaluated under this Statement:

Recognized subsequent events - An entity must recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.

Non-recognized subsequent events - An entity must not recognize subsequent events that provide evidence about conditions that did not exist at the date of the balance sheet but that arose after the balance sheet date but before financial statements are issued or are available to be issued.  Some non-recognized subsequent events may be of such a nature that they must be disclosed to keep the financial statements from being misleading.  For such events, an entity must disclose the nature of the event and an estimate of its financial effect or a statement that such an estimate cannot be made.

FASB ASC Topic 855 also requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date - that is, whether that date represents the date the financial statements were issued or were available to be issued.

This guidance applies to both interim financial statements and annual financial statements.  FASB ASC Topic 855 is effective for interim and annual periods ending after June 15, 2009, and should be applied prospectively. 

Accordingly, management has evaluated subsequent events through the date of the Original Filing on November 25, 2009 and the date this amended interim financial information was issued and has determined that, other than those which have been reported in Note 2 and Note 11 to the consolidated financial statements, no other recognized or non-recognized subsequent events warranted inclusion or disclosure in the interim financial statements as of September 30, 2009.

NOTE 4.  INVESTMENT SECURITIES

The following is a summary of the Company's investment in available-for-sale and held-to-maturity securities as of September 30, 2009: 

                         
         
Gross
   
Gross
   
Estimated
 
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
Available-for-sale
                       
U.S. Government agencies and corporations
  $ 8,094,000     $ 138,000     $ (12,000 )   $ 8,220,000  
Residential mortgage-backed securities
    21,756,000       384,000       (58,000 )     22,082,000  
Municipal securities
    4,941,000       97,000       -       5,038,000  
Total securities available-for-sale
  $ 34,791,000     $ 619,000     $ (70,000 )   $ 35,340,000  
Held-to-maturity
                               
U.S. Government agencies and corporations
  $ 100,000     $ -     $ -     $ 100,000  
Residential mortgage-backed securities
    11,702,000       372,000       -       12,074,000  
Total securities held-to-maturity
  $ 11,802,000     $ 372,000     $ -     $ 12,174,000  

 
 
19


 

 
STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 4.  INVESTMENT SECURITIES (continued)
 
The Company’s investment securities as of December 31, 2008 were as follows:
 
                         
         
Gross
   
Gross
   
Estimated
 
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
Available-for-sale
                       
U.S. Government agencies and corporations
  $ 3,995,000     $ 33,000     $ -     $ 4,028,000  
Residential mortgage-backed securities
    15,250,000       76,000       (29,000 )     15,297,000  
Municipal securities
    4,941,000       -       (169,000 )     4,772,000  
Total securities available-for-sale
  $ 24,186,000     $ 109,000     $ (198,000 )   $ 24,097,000  
Held-to-maturity
                               
U.S. Government agencies and corporations
  $ 100,000     $ -     $ -     $ 100,000  
Residential mortgage-backed securities
    19,784,000       129,000       (21,000 )     19,892,000  
Total securities held-to-maturity
  $ 19,884,000     $ 129,000     $ (21,000 )   $ 19,992,000  

The amortized cost and estimated market value of debt securities classified as available-for-sale and held-to-maturity at September 30, 2009 by contractual maturities are shown below.  Expected maturities may differ from contractual maturities for mortgage-backed securities because the mortgages underlying the securities may be called or prepaid without any penalties; therefore, these securities are not included in the maturity categories in the following maturity schedule.
 
   
September 30, 2009
 
   
Available-for-sale
   
Held-to-maturity
 
   
Amortized
   
Estimated
   
Amortized
   
Estimated
 
   
Cost
   
Fair Value
   
Cost
   
Fair Value
 
Maturing within one year
  $ -     $ -     $ 100,000     $ 100,000  
Maturing after one year, but within five years
    637,000       645,000       -       -  
Maturing after five years, but within ten years
    9,489,000       9,621,000       -       -  
Maturing after ten years
    2,909,000       2,992,000       -       -  
Residential mortgage-backed securities
    21,756,000       22,082,000       11,702,000       12,074,000  
Total securities
  $ 34,791,000     $ 35,340,000     $ 11,802,000     $ 12,174,000  

 
 
20


 

 
STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 4.  INVESTMENT SECURITIES (continued)
 
The following table shows the gross unrealized losses and fair value of Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2009:

   
Continuous Unrealized Losses
   
Continuous Unrealized Losses
 
   
Existing for Less Than 12 Months
   
Existing for 12 Months or More
 
         
Unrealized
         
Unrealized
 
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
Available-for-sale:
                       
U.S. Government agencies and corporations
  $ 1,988,000     $ (12,000 )   $ -     $ -  
Residential mortgage-backed securities
    3,921,000       (58,000 )     -       -  
Municipal securities
    -       -       -       -  
      5,909,000       (70,000 )     -       -  
Held-to-maturity:
                               
Residential mortgage-backed securities
    -       -       -       -  
Total temporarily impaired securities
  $ 5,909,000     $ (70,000 )   $ -     $ -  

U.S. Government and Agency Obligations.  The unrealized losses on the Company’s investments in U.S. Treasury obligations and direct obligations of U.S. government agencies were caused by interest rate increases.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments.  Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2009.

Residential Federal Agency Mortgage-Backed Securities.  The unrealized losses on the Company’s investment in federal agency mortgage-backed securities were caused by interest rate increases.  The Company purchased those investments at a discount relative to their face amount, and the contractual cash flows of those investments are guaranteed by an agency of the U.S. government.  Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost bases of the Company’s investments.  Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2009.

 
 
21


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 5.  EARNINGS PER SHARE

Basic earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding.  Shares issued during the period are weighted for the portion of the period that they were outstanding during the year.  The weighted average number of common shares outstanding for the nine months ended September 30, 2009 and 2008 were 5,843,362, respectively.  Diluted earnings per common share consider common share equivalents (when dilutive) outstanding during each year.  Shares issuable upon the exercise of stock options were not considered in the calculation of net loss per share for the three and nine months ended September 30, 2009 and the nine months ended September 30, 2008, as their inclusion would be anti-dilutive.  The effect for the three months ended September 30, 2008 was an additional 5,973 shares for dilution.
 
NOTE 6.  STOCK-BASED EMPLOYEE COMPENSATION

The Company has a stock-based employee compensation plan.  The Company records compensation expense equal to the fair value of all equity-based compensation over the vesting period of each award.  The Company uses the Black-Scholes option pricing model to estimate the fair value of stock-based awards.
 
During the nine months ended September 30, 2009, the Company did not issue any options.  During the nine months ended September 30, 2008, the Company issued 175,200 options with an exercise price range of $3.80 to $4.05, to employees and directors that vest in equal annual installments over ten years.  The Company uses the Black-Scholes option pricing model to estimate the fair value of stock-based awards.  For options issued in 2008, the weighted average estimated value per option was $1.60.  The fair value of options granted in 2008 was estimated at the date of the grant based on the following assumptions: risk free interest rate of 4.1%, volatility of 22-23%, expected life of 8-10 years and no expected dividend yield.  Compensation cost charged to operations for the nine months ended September 30, 2009 and 2008 was $56,000 and $40,000, respectively.

As of September 30, 2009, there was approximately $577,000 of total unrecognized compensation cost related to share-based payments which is expected to be recognized over a weighted average period of 8.3 years.  Of the 296,984 unvested options at December 31, 2008, 20,331 options vested in 2009, 8,856 options expired and 267,797 options remain unvested at September 30, 2009.

NOTE 7.  COMMON STOCK

During the nine months of 2009 and 2008, no stock options were exercised.

During the nine months of 2009 and 2008, no cash dividends were declared or paid.

NOTE 8.  CAPITAL RATIOS

The Bank is subject to various regulatory capital requirements administered by state and federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
 

 
 
22

 

 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 8.  CAPITAL RATIOS (continued)

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined).

At September 30, 2009, management believes that the Bank is “adequately capitalized,” as defined by regulatory banking agencies.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank’s capital levels do not allow the Bank to accept brokered deposits without prior approval from regulators.  As of September 30, 2009, the Bank did not have any brokered deposits.  Further, the Bank is subject to certain interest rate restrictions that can be paid for its deposits without prior approval from regulators.

The Bank’s actual capital amounts and ratios are presented in the following tables (amounts in thousands, except percentages):


     
For Capital
To Be Well
 
Actual
Adequacy Purposes
Capitalized
 
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of September 30, 2009 (Restated):
           
             
Total Capital (to Risk-Weighted Assets)
$23,928
8.41%
>$22,768
>8.0%
>$28,460
>10.0%
Tier I Capital (to Risk-Weighted Assets)
$20,283
7.13%
>$11,384
>4.0%
>$17,076
>  6.0%
Tier I Capital (to Average Assets)
$20,283
5.37%
>$15,113
>4.0%
>$18,891
>  5.0%
           
     
For Capital
To Be Well
 
Actual
Adequacy Purposes
Capitalized
 
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2008:
           
             
Total Capital (to Risk-Weighted Assets)
$32,134
10.52%
>$24,428
>8.0%
>$30,535
>10.0%
Tier I Capital (to Risk-Weighted Assets)
$28,258
9.25%
>$12,214
>4.0%
>$18,321
>  6.0%
Tier I Capital (to Average Assets)
$28,258
7.21%
>$15,675
>4.0%
>$19,594
>  5.0%
 

NOTE 9.  FAIR VALUE

Effective January 1, 2008, the Company adopted FASB ASC Topic 820, Fair Value Measurement, which provides a framework for measuring fair value under generally accepted accounting principles.  FASB ASC Topic 820 applies to all financial instruments that are being measured and reported on a fair value basis.  Nonfinancial assets and nonfinancial liabilities that are recognized and disclosed at fair value on a nonrecurring basis under FASB ASC Topic 820 were delayed to fiscal years beginning after November 15, 2008.  Accordingly, effective January 1, 2009, the Company began disclosing the fair value of Other Real Estate Owned (OREO) previously deferred under the provisions of this guidance.

 
 
23


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 9.  FAIR VALUE (continued)

FASB ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  In determining fair value, the Company uses various methods including market, income and cost approaches.  Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or the risks inherent in the inputs to the valuation technique.  These inputs can be readily observable, market corroborated, or generally unobservable.  The Company utilizes techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.  Based on the observability of the inputs used in valuation techniques the Company is required to provide the following information according to the fair value hierarchy.  The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.

Financial assets and liabilities carried at fair value will be classified and disclosed as follows:

Level 1 Inputs
 
·
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
 
·
Generally, this includes debt and equity securities and derivative contracts that are traded in an active exchange market (e.g. New York Stock Exchange), as well as certain US Treasury and US Government and agency mortgage-backed securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2 Inputs
 
·
Quoted prices for similar assets or liabilities in active markets.
 
·
Quoted prices for identical or similar assets or liabilities in markets that are not active.
 
·
Inputs other than quoted prices that are observable, either directly or indirectly, for the term of the asset or liability (e.g., interest rates, yield curves, credit risks, prepayment speeds or volatilities) or “market corroborated inputs.”
 
·
Generally, this includes US Government and agency mortgage-backed securities, corporate debt securities, derivative contracts and loans held for sale.

Level 3 Inputs
 
·
Prices or valuation techniques that require inputs that are both unobservable (i.e. supported by little or no market activity) and that are significant to the fair value of the assets or liabilities.
 
·
These assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 
 
24


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 9.  FAIR VALUE (continued)

Fair Value on a Recurring Basis

Certain assets and liabilities are measured at fair value on a recurring basis.  The following table presents the assets and liabilities carried on the balance sheet by caption and by level within the FASB ASC Topic 820 hierarchy (as described above) as of the dates listed.

September 30, 2009
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Financial Assets
                       
Investment securities available-for-sale
                       
    U.S. Government agencies and
        corporations
  $ -     $ 8,220,000     $ -     $ 8,220,000  
    Mortgage-backed securities
  $ -     $ 22,082,000     $ -     $ 22,082,000  
    Municipal securities
  $ -     $ 5,038,000     $ -     $ 5,038,000  

December 31, 2008
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Financial Assets
                       
Investment securities available-for-sale
                       
    U.S. Government agencies and
        Corporations
  $ -     $ 4,028,000     $ -     $ 4,028,000  
    Mortgage-backed securities
  $ -     $ 15,297,000     $ -     $ 15,297,000  
    Municipal securities
  $ -     $ 4,772,000     $ -     $ 4,772,000  

Securities Portfolio

The fair value of securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers.  The fair value of securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1).  When listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or significant management judgment or estimation based upon unobservable inputs due to limited or no market activity of the instrument (Level 3).

Fair Value on a Nonrecurring Basis

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is impairment).  The following table presents the assets and liabilities carried on the balance sheet by caption and by level within the FASB ASC Topic 820 hierarchy (as described above) as of the dates listed.

September 30, 2009
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Financial Assets
                       
Impaired loans (Restated)
  $ -     $ -     $ 27,192,000     $ 27,192,000  

December 31, 2008
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Financial Assets
                       
Impaired loans
  $ -     $ -     $ 14,892,000     $ 14,892,000  


 
 
25


 

 
STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 9.  FAIR VALUE (continued)

September 30, 2009
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Non-Financial Assets
                       
Other real estate owned
  $ -     $ -     $ 1,786,000     $ 1,786,000  

Impaired Loans

The fair value of impaired loans is based on the loan’s fair value of the collateral for collateral dependent loans.  The valuation allowance for impaired loans is included in the allowance for loan losses in the consolidated balance sheets.  The valuation allowance for impaired loans at September 30, 2009 was $1,231,000.  During the nine months ended September 30, 2009, the valuation allowance for impaired loans decreased $1,571,000 from $2,802,000 at December 31, 2008 as a result of loans being collected or charged off in full or in part.

Other Real Estate Owned

Other real estate owned (OREO) fair value was determined using appraisals which may be discounted based on management’s review and changes in market conditions (Level 3).

Fair Value of Financial Instruments (FASB ASC Topic 825 Disclosure)
 
FASB ASC Topic 825, Disclosures About Fair Value of Financial Instruments, requires the disclosure of the estimated fair value of financial instruments, including those financial instruments for which the Company did not elect the fair value option.  The methodology for estimating the fair value of financial assets and liabilities that are measured on a recurring or nonrecurring basis are discussed above.
 
The following methods and assumptions were used to estimate the fair value under FASB ASC Topic 825 of each class of financial instruments not previously discussed.
 
Cash and Cash Equivalents:  The carrying amounts of cash and due from banks and federal funds sold approximate fair value.
 
Investment Securities Held-to-Maturity:  The fair value of securities held-to-maturity is based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.  These financial instruments are not carried at fair value.
 
Restricted Stock:  The carrying value of restricted stock approximates fair value based on redemption provisions.
 
Loans (except collateral dependent impaired loans):  Fair values are estimated for portfolios of loans with similar financial characteristics.  Loans are segregated by type such as commercial, residential mortgage and other consumer.  Each loan category is further segmented into groups by fixed and adjustable rate interest terms and by performing and non-performing categories.
 
The fair value of performing loans is typically calculated by discounting scheduled cash flows through their estimated maturity, using estimated market discount rates that reflect the credit and interest rate risk inherent in each group of loans.  The estimate of maturity is based on contractual maturities for loans within each group, or on the Company’s historical experience with repayments for each loan classification, modified as required by an estimate of the effect of current economic conditions.

 
 
 
26


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 9.  FAIR VALUE (continued)

Fair value for nonperforming loans that are not collateral dependent is based on the discounted value of expected future cash flows, discounted using a rate commensurate with the risk associated with the likelihood of repayment.
 
For all loans, assumptions regarding the characteristics and segregation of loans, maturities, credit risk, cash flows, and discount rates are judgmentally determined using specific borrower and other available information.
 
The carrying amounts reported for loans held for sale approximates fair value.
 
Accrued Interest Receivable and Payable:  The fair value of interest receivable and payable is estimated to approximate the carrying amounts.
 
Deposits:  The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW and money market accounts, is equal to the amount payable on demand.  The fair value of time deposits is based on the discounted value of contractual cash flows, where the discount rate is estimated using the market rates currently offered for deposits of similar remaining maturities.
 
Borrowed Funds:  The fair value of borrowings is calculated by discounting scheduled cash flows through the estimated maturity date using current market rates.
 
Estimated Fair Values:  The estimated fair values of the Company’s material financial instruments as of September 30, 2009 are as follows:

   
Carrying Value
   
Fair Value
 
   
(Restated)
   
(Restated)
 
Financial Assets:
           
Cash and due from banks
  $ 9,071,000     $ 9,071,000  
Federal funds sold
  $ 19,498,000     $ 19,498,000  
Investment securities, held-to-maturity
  $ 11,802,000     $ 12,174,000  
Investment securities, available-for-sale
  $ 35,340,000     $ 35,340,000  
Restricted stock
  $ 2,014,000     $ 2,014,000  
Loans, net of allowance for loan losses
  $ 286,307,000     $ 285,794,000  
Accrued interest receivable
  $ 1,379,000     $ 1,379,000  
Financial Liabilities:
               
Noninterest-bearing demand deposits
  $ 31,367,000     $ 31,367,000  
Interest-bearing deposits
  $ 311,836,000     $ 306,102,000  
Borrowed funds
  $ 21,436,000     $ 18,434,000  
Accrued interest payable
  $ 547,000     $ 547,000  


 
27

 

 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 9.  FAIR VALUE (continued)

The estimated fair values of the Company’s material financial instruments as of December 31, 2008 are as follows:
 
   
Carrying Value
   
Fair Value
 
Financial Assets:
           
Cash and due from banks
  $ 13,054,000     $ 13,054,000  
Federal funds sold
  $ 472,000     $ 472,000  
Investment securities, held-to-maturity
  $ 19,884,000     $ 19,992,000  
Investment securities, available-for-sale
  $ 24,097,000     $ 24,097,000  
Restricted stock
  $ 2,448,000     $ 2,448,000  
Loans held for sale
  $ 2,000     $ 2,000  
Loans, net of allowance for loan losses
  $ 297,095,000     $ 299,648,000  
Accrued interest receivable
  $ 1,740,000     $ 1,740,000  
Financial Liabilities:
               
Noninterest-bearing demand deposits
  $ 35,873,000     $ 35,873,000  
Interest-bearing deposits
  $ 292,721,000     $ 288,303,000  
Borrowed funds
  $ 22,186,000     $ 19,340,000  
Accrued interest payable
  $ 427,000     $ 427,000  

The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, and, as the fair value for these financial instruments is not material, these disclosures are not included above.
 
Limitations:  Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instruments.  These estimates do not reflect any premium or discount which could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.
 
Fair value estimates are provided for existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.  In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates, and have generally not been considered in the Company’s estimates.
 
 
 
28


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 10.  LOANS

The composition of net loans as of September 30, 2009 and December 31, 2008 are as follows:
 
   
September 30, 2009
   
December 31, 2008
 
Commercial, Financial and Agricultural
  $ 30,496,000     $ 32,115,000  
Real Estate - Construction
    46,499,000       68,278,000  
Real Estate – Mortgage
    165,049,000       147,435,000  
Installment loans to individuals
    49,865,000       53,827,000  
Lease Financing
    5,641,000       4,636,000  
Unrealized Loan Fees
    (636,000 )     (665,000 )
Total loans
    296,914,000       305,626,000  
Less:  allowance for loan losses
    (10,607,000 )     (8,531,000 )
Net loans
  $ 286,307,000     $ 297,095,000  

Summaries of information pertaining to impaired and nonaccrual loans are as follows:

   
September 30, 2009
   
December 31, 2008
 
Impaired loans without a valuation allowance
  $ 24,536,000     $ 5,813,000  
Impaired loans with a valuation allowance
    2,656,000       11,881,000  
Total impaired loans including troubled debt restructurings
    27,192,000       17,694,000  
Valuation allowance related to impaired loans
    1,231,000       2,802,000  
Average investment in impaired loans
    22,727,000       10,348,000  
Total non-accrual loans (included in impaired loans)
    14,056,000       9,898,000  

NOTE 11.  ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is calculated under FASB ASC Topic 310, Receivables and FASB ASC Topic 450, Contingencies.  Nonperforming and impaired loans are evaluated under FASB ASC Topic 310 using either the fair value of collateral or present value of future cash flow methods.  The Company evaluates all nonperforming and impaired loans using the fair value of collateral method since all non-performing and impaired loans are collateralized by real estate.  When a loan is evaluated using this method, a new appraisal of the primary and or secondary collateral is obtained and compared to the outstanding balance of the loans.  A specific reserve is added to the allowance for loan losses if a collateral shortfall exists.  On December 31, 2008, the amount of the specific reserve was $2,802,000 which was included in the total allowance for loan losses of $8,531,000.  During the nine months ended September 30, 2009, the Company charged off loans or portions of loans totaling $3,439,000 from the allowance for loan losses, made a provision of $5,390,000, including changes in qualitative factors, and had recoveries of $125,000, resulting in an allowance for loan losses balance of $10,607,000.


 
29

 

 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 11.  ALLOWANCE FOR LOAN LOSSES (continued)

The following table shows changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category and additions to the allowance that have been charged to expenses for the periods presented.

   
For the three months ended September 30,
 
   
2009
   
2008
 
   
(Restated)
       
Balance at beginning of period
  $ 12,041,000     $ 2,974,000  
Charge-offs:
               
Commercial, Financial, Agricultural
    -       -  
Real Estate – Construction
    (1,504,000 )     -  
Real Estate – Mortgage
    (32,000 )     (17,000 )
Consumer Installment loans
    (19,000 )     (48,000 )
Lease Financing
    -       -  
      (1,555,000 )     (65,000 )
Recoveries:
               
Commercial, Financial, Agricultural
    60,000       -  
Real Estate – Construction
    36,000       -  
Real Estate – Mortgage
    -       1,000  
Consumer Installment loans
    25,000       -  
Lease Financing
    -       -  
 
    121,000       1,000  
Net recoveries (charge-offs)
    (1,434,000 )     (64,000 )
Provision for loan loss
    -       105,000  
Balance at end of period
  $ 10,607,000     $ 3,015,000  
                 
Average loans outstanding (1)
  $ 296,464,000     $ 301,035,000  
                 
Net charge-offs as a percentage of average loans (2)
    1.92 %     0.08 %
                 
(1) Includes loans held for sale and non-accruing loans
               
(2) Annualized
               

 
30

 

 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 11.  ALLOWANCE FOR LOAN LOSSES (continued)

   
For the nine months ended September 30,
 
   
2009
   
2008
 
   
(Restated)
       
Balance at beginning of period
  $ 8,531,000     $ 2,891,000  
Charge-offs:
               
Commercial, Financial, Agricultural
    (238,000 )     (32,000 )
Real Estate – Construction
    (2,939,000 )     -  
Real Estate – Mortgage
    (182,000 )     (238,000 )
Consumer Installment loans
    (80,000 )     (124,000 )
Lease Financing
    -       -  
      (3,439,000 )     (394,000 )
Recoveries:
               
Commercial, Financial, Agricultural
    61,000       2,000  
Real Estate – Construction
    36,000       -  
Real Estate – Mortgage
    1,000       3,000  
Consumer Installment loans
    27,000       8,000  
Lease Financing
    -       -  
 
    125,000       13,000  
Net charge-offs
    (3,314,000 )     (381,000 )
Provision for loan loss
    5,390,000       505,000  
Balance at end of period
  $ 10,607,000     $ 3,015,000  
                 
Average loans outstanding (1)
  $ 302,571,000     $ 308,421,000  
                 
Net charge-offs as a percentage of average loans (2)
    1.46 %     0.17 %
                 
(1) Includes loans held for sale and non-accruing loans
               
(2) Annualized
               

The charge offs as of September 30, 2009, were a result of the Company analyzing its impaired loans with collateral deficiencies and charging off portions of loans not covered by the Company’s collateral as a result of new real estate appraisals obtained.  Even though a portion of individual loans were charged off, management will continue to obtain and convert the collateral and pursue the borrower(s) for full collection of the entire loan, including the partial charge off amount.

NOTE 12.  OTHER COMPREHENSIVE INCOME (LOSS)

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income.  However, certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities are reported as a separate component of the equity section of the balance sheet.  Such items, along with net income, are components of comprehensive income.
 
 
31

 

 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 12.  OTHER COMPREHENSIVE INCOME (LOSS) (continued)

The components of other comprehensive income (loss) and related tax effects for the nine months ended September 30, 2009 and 2008 are as follows:

   
For the three months ended September 30, 2009
   
For the three months ended September 30, 2008
   
For the nine months ended September 30, 2009
   
For the nine months ended September 30, 2008
 
Unrealized holding gains (losses)
    on available-for-sale securities
  $ 550,000     $ (85,000 )   $ 643,000     $ (38,000 )
Reclassification adjustment for
   gains realized in income
    -       -       (5,000 )     (95,000 )
Net unrealized gains (losses)
    550,000       (85,000 )     638,000       (133,000 )
Tax effect
    (220,000 )     34,000       (255,000 )     53,000  
Net-of-tax amount
  $ 330,000     $ (51,000 )   $ 383,000     $ (80,000 )

NOTE 13.  WRITTEN AGREEMENT

On July 28, 2009, the Company and the Bank entered into a Written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia and the New Jersey Department of Banking and Insurance (collectively, the “Regulators”).  The Agreement is based on findings of the Regulators identified in an examination of the Bank that commenced on January 5, 2009.
 
Under the terms of the Agreement, the Bank agreed, among other things, to engage, within 30 days of the Agreement, an independent consultant acceptable to the Regulators to assess the Bank’s staffing needs and the qualifications and performance of all senior executive officers of the Bank and to prepare a written report. Within 45 days of receipt of such report, the Bank agreed to submit to the Regulators a written management plan addressing the findings of the report.  In addition, within 60 days of the Agreement, the Bank will submit to the Regulators written plans to: strengthen board oversight of the management and operation of the Bank; strengthen the Bank’s management of commercial real estate; strengthen lending and credit administration, which includes a prohibition on the capitalization of interest; improve the periodic review and grading of the Bank’s loan portfolio; improve the Bank’s position regarding past due loans, problem loans, adversely classified loans; improve the Bank’s internal audit program; maintain sufficient capital at the Bank; improve the Bank’s earnings; improve management of the Bank’s liquidity position; and correct criticisms detailed in the Regulators’ examination report of the Bank’s compliance with all federal laws relating to anti-money laundering. The Bank has also agreed to maintain an adequate allowance for loan and lease losses; charge-off or collect assets classified as “loss” in the Regulators’ examination report that have not been previously collected or charged off, and not to extend or renew any credit to or for the benefit of any borrower who is obligated to the Bank on an extension of credit that has been charged off or classified as “loss” in the Regulators’ examination report.  Under the Agreement, neither the Company nor Bank is permitted to declare or pay any dividends.  The Company has also agreed not to distribute any interest, principal or other sums on trust preferred securities; issue, increase or guarantee any debt; nor purchase or redeem any shares of the Company’s stock.
 

 
 
32


 

STERLING BANKS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 13.  WRITTEN AGREEMENT (continued)
 
The Board of Directors of the Company and the Bank are also required to appoint a joint Compliance Committee to monitor and coordinate the Company’s and the Bank’s compliance with the provisions of the Agreement, obtain prior approval for the appointment of new directors, the hiring or change in responsibilities of senior executive officers, and to comply with restrictions on severance payments and indemnification payments to institution affiliated parties. Failure to comply with the provisions of the Agreement could subject the Company and/or the Bank to additional enforcement actions. We believe that the Company and or the Bank have already implemented or are acting in accordance with most of the requirements of the Agreement, and we intend to take such actions as may be necessary to enable the Company and or the Bank to comply with the remaining requirements of the Agreement.  However, there can be no assurance that the Company and or the Bank will be able to comply fully with the provisions of the Agreement, or that efforts to comply with the Agreement will not have adverse effects on the operations and financial condition of the Company or the Bank.
 
The Agreement does not affect the Bank’s ability to continue to conduct its banking business with customers in a normal fashion.  The Bank’s deposits will remain insured by the FDIC to the maximum limits allowed by law.  The Agreement will remain effective and enforceable until stayed, modified, terminated or suspended in writing by the Regulators.
 

 
 
33

 

 
 

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The Company may from time to time make written or oral “forward-looking statements”, including statements contained in the Company’s filings with the Securities and Exchange Commission (including this Quarterly Report on Form 10-Q), in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations, estimates and intentions, which are subject to change based on various important factors (some of which are beyond the Company’s control).  The following factors, among others, could cause the Company's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; the effect that maintaining regulatory capital requirements could have on the growth of the Company; inflation; changes in prevailing short term and long term interest rates; national and global liquidity of the banking system; changes in loan portfolio quality; adequacy of loan loss reserves; changes in the rate of deposit withdrawals; changes in the volume of loan refinancings; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services; the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities and insurance), including the increase in the cost of FDIC insurance; technological changes; changes in consumer spending and saving habits; findings of the Bank’s examinations by the FRB; changes in the local competitive landscape, including the acquisition of local and regional banks in the Company’s geographic marketplace; possible impairment of intangible assets, specifically core deposit premium from the Company’s acquisition of Farnsworth; the ability of our borrowers to repay their loans; the uncertain credit environment in which the Company operates; the ability of the Company to manage the risk in its loan and investment portfolios; the ability of the Company to reduce noninterest expenses and increase net interest income, its growth, results of possible collateral collections and subsequent sales; and the success of the Company at managing the risks resulting from these factors.

The Company cautions that the above-listed factors are not exclusive.  The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Bank.

Readers should carefully review the risk factors described in other reports the Company files from time to time with the Securities and Exchange Commission, including the Company’s Form 10-K for the year ended December 31, 2008, and its subsequent quarterly reports on Form 10-Q and current reports on Form 8-K.

General

Our principal source of revenue is net interest income, which is the difference between the interest income from our earning assets and the interest expense of our deposits and borrowings.  Interest-earning assets consist principally of loans, investment securities and federal funds sold, while our interest-bearing liabilities consist primarily of deposits and borrowings.  Our net income is also affected by our provision for loan losses, noninterest income and noninterest expenses, which include salaries, benefits, occupancy costs and charges relating to non-performing and other classified assets.
 
 
34


 

Consolidated Results of Operations
Three Months Ended September 30, 2009 and 2008
(Unaudited)

The following discussion compares the results of operations for the three months ended September 30, 2009 (unaudited) to the results of operations for the three months ended September 30, 2008 (unaudited).  This discussion should be read in conjunction with the accompanying financial statements (unaudited) and related notes, as well as statistical information included in this Form 10-Q.

Net Loss. For the three months ended September 30, 2009, the net loss totaled $579,000, compared to net income of $79,000 for the three months ended September 30, 2008.  Decreased earnings for the three months ended September 30, 2009 were attributable primarily to a decrease in net interest income after provision for loan losses of $376,000, a decrease in noninterest income of $106,000 and an increase in noninterest expenses of $236,000.  Basic and diluted income (loss) per share for the three months ended September 30, 2009 and 2008 totaled ($0.09) and $0.01, respectively.

Net Interest Income. Net interest income for the three months ended September 30, 2009 totaled $2,862,000, a decrease of 14.4% from $3,343,000 for the three months ended September 30, 2008.  This decrease is primarily as a result of a decrease in the net interest margin, from 4.00% for the three months ended September 30, 2008 to 3.24% for the three months ended September 30, 2009, or $626,000, including lost interest income on nonaccrual loans of approximately $152,000, partially offset by an increase in interest earning assets of $145,000 in 2009.

Interest income decreased by $700,000 for the three months ended September 30, 2009 from the same period in 2008, attributable to a 122 basis point decrease in the yield on average earning assets from 6.61% in 2008 to 5.39% in 2009, partially offset by an increase in average interest earning assets of $17.8 million.  Average interest earning loans outstanding decreased by $12.8 million while average investment securities increased $20.0 million and due from banks and federal funds sold increased $10.6 million.  The decrease in average interest earning loans outstanding is attributable primarily to an increase in average nonaccrual loans of $7.5 million, an increase in repossessed property of $1.6 million and normal monthly payments and/or payoffs, while the increase in average investment securities and federal funds sold was attributable to management’s efforts to decrease the Bank’s general level of risk on the balance sheet.  Interest expense decreased by $219,000 from the same time period in 2008.  Average interest-bearing liabilities increased by $35.4 million, which was attributable to an increase in borrowed funds of $12.3 million in an effort to increase the Bank’s net interest income by borrowing at a lower cost and investing in higher yielding assets and an increase in interest bearing deposits.  The average rate paid on interest-bearing liabilities decreased to 2.28% for the three months ended September 30, 2009 from 2.85% for the same period of 2008.

Provision for Loan Losses.  No provision for loan losses was made during the three months ended September 30, 2009.  Provision for loan losses was $105,000 for the three months ended September 30, 2009 and 2008.  As a result of an analysis of the loan portfolio, management concluded that the amount of the allowance for loan losses was sufficient and no provision was necessary in the third quarter of 2009.

Noninterest Income.  Noninterest income decreased $106,000, or 37.5%, for the three months ended September 30, 2009 to $177,000 compared to $283,000 for the same period of 2008, primarily as a result of decreased prepayment penalties for early loan payoffs of $61,000, a decrease in late charges of $16,000, and a decrease in miscellaneous fees of $10,000.

Noninterest Expenses.  For the three months ended September 30, 2009, noninterest expenses increased by $236,000, or 7.0%, to $3,618,000, compared to $3,382,000 for the same period of 2008, primarily as a result of an increase in FDIC insurance of $281,000 and an increase in loan workout and repossessed property expenses of $128,000, which were partially offset by decreases in personnel costs of $139,000, reflecting the effect of staff and benefit reductions, including as a result of the closure of one of our branch locations in November 2008.



 
35

 

 

Income Taxes.  During the second quarter of 2009, management determined that there was a need for a valuation allowance on the Company’s deferred tax assets.  Based on forecasts of the Company’s future profitability, management concluded full recognition of these tax assets was unlikely because it is more likely than not that this portion of the deferred tax assets will not be realized as a result of cumulative tax losses and uncertainties of future taxable income.  As a result, the Company recorded a tax benefit during the third quarter of 2009, but it was fully reserved through an increase in the valuation allowance.  During the three months ended September 30, 2008, we recorded income tax expense of $60,000 on income before taxes of $139,000, resulting in an effective tax rate of 43.2%.

Consolidated Results of Operations
Nine Months Ended September 30, 2009 and 2008
(Unaudited)

The following discussion compares the results of operations for the nine months ended September 30, 2009 (unaudited) to the results of operations for the nine months ended September 30, 2008 (unaudited).  This discussion should be read in conjunction with the accompanying financial statements (unaudited) and related notes, as well as statistical information included in this Form 10-Q.

Net Loss. For the nine months ended September 30, 2009, the net loss totaled $10,718,000, compared to net loss of $405,000 for the nine months ended September 30, 2008.  Decreased earnings for the nine months ended September 30, 2009 were attributable primarily to a decrease in net interest income after provision for loan losses of $6,537,000, management’s determination that there was a need for a valuation allowance of the Company’s deferred tax assets resulting in an increase in tax expense of $3,128,000, a decrease in noninterest income of $213,000 and an increase in noninterest expenses of $435,000.  Basic and diluted loss per share for the nine months ended September 30, 2009 and 2008 totaled $1.83 and $0.07, respectively.

Net Interest Income. Net interest income for the nine months ended September 30, 2009 totaled $8,024,000, a decrease of 17.1% from $9,676,000 for the nine months ended September 30, 2008.  This decrease is primarily as a result of a decrease in the net interest margin, from 3.74% for the nine months ended September 30, 2008 to 3.04% for the nine months ended September 30, 2009, or $1,837,000, including lost interest income on nonaccrual loans of approximately $457,000, partially offset by an increase in interest earning assets of $185,000 in 2009.

Interest income decreased by $2,827,000 for the nine months ended September 30, 2009 from the same period in 2008, attributable to a 122 basis point decrease in the yield on average earning assets from 6.62% in 2008 to 5.40% in 2009, partially offset by an increase in average interest earning assets of $8.1 million.  Average interest earning loans outstanding decreased by $13.0 million while average investment securities increased $14.5 million and due from banks and federal funds sold increased $6.6 million.  The decrease in average interest earning loans outstanding is attributable primarily to an increase in average nonaccrual loans of $7.1 million, an increase in repossessed property of $1.5 million and normal monthly payments and/or payoffs, while the increase in average investment securities and federal funds sold was attributable to management’s efforts to decrease the Bank’s general level of risk on the balance sheet.  Interest expense decreased by $1.2 million from the same time period in 2008.  Average interest-bearing liabilities increased by $23.7 million, which was attributable to an increase in borrowed funds in an effort to increase the Bank’s net interest income by borrowing at a lower cost and investing in higher yielding assets and an increase in interest bearing deposits.  The average rate paid on interest-bearing liabilities decreased to 2.52% for the nine months ended September 30, 2009 from 3.22% for the same period of 2008.

Provision for Loan Losses. Provision for loan losses was $5,390,000 and $505,000 for the nine months ended September 30, 2009 and 2008.

Noninterest Income.  Noninterest income decreased $213,000, or 26.8%, for the nine months ended September 30, 2009 to $582,000 compared to $795,000 for the same period of 2008, primarily as a result of a decrease in gains on sales of available-for-sale securities and fixed assets of $95,000, a decrease in prepayment penalties on early loan payoffs of $27,000, a decrease in mortgage origination revenue of $13,000, a decrease in late charges of $11,000 in 2009, and a one time fee of $30,000 for the sale of branch rights in 2008.
 
 
 
36


 

Noninterest Expenses.  For the nine months ended September 30, 2009, noninterest expenses increased by $435,000, or 4.1%, to $11,023,000, compared to $10,588,000 for the same period of 2008.  Increases in FDIC insurance of $587,000, including a one time special assessment of $183,000, in loan workout and repossessed property expenses of $431,000, a partial write down on the Company’s former Gaither Road office of $82,000 and losses on sales of or partial write downs on repossessed property of $77,000, were partially offset by decreases in personnel costs of $736,000, reflecting bonuses expensed in 2008 and the effect of staff and benefit reductions, including as a result of the closure of one our branch locations in November 2008.

Income Taxes.  We recorded income tax expense of $2,911,000 on loss before taxes of $7,807,000 for the nine months ended September 30, 2009.  During the second quarter of 2009, management determined that there was a need for a valuation allowance on the Company’s deferred tax assets.  Based on forecasts of the Company’s future profitability, management concluded full recognition of these tax assets was unlikely because it is more likely than not that this portion of the deferred tax assets will not be realized as a result of cumulative tax losses and uncertainties of future taxable income.  During the nine months ended September 30, 2008, we recorded an income tax benefit of $217,000 on loss before taxes of $622,000, resulting in an effective tax rate of 34.9% for the 2008 period.

Consolidated Financial Condition
At September 30, 2009 and December 31, 2008
(Unaudited)

The following discussion compares the financial condition at September 30, 2009 (unaudited) to the financial condition at December 31, 2008.  This discussion should be read in conjunction with the accompanying financial statements (unaudited) and related notes as well as statistical information included in this Form 10-Q.

Total Assets. Total assets increased $4.0 million, or 1.1%, to $383.1 million at September 30, 2009, compared to $379.1 million at December 31, 2008.  This was due to management’s efforts to increase the Bank’s net interest margin and liquidity.

Loans. Loans outstanding decreased $8.7 million, or 2.9%.  The decrease in loans was due primarily to normal contractual loan payments and/or payoffs in the loan portfolio and a decrease in originations of residential mortgage construction loans.

Allowance for Loan Losses.  The allowance for loan losses was $10.6 million at September 30, 2009 as compared to $8.5 million at December 31, 2008.  This increase was primarily due to a provision of $5.4 million and partially offset the charging off of certain loans that were impaired.  The ratio of the allowance for loan losses to total loans was 3.6% and 2.8% at September 30, 2009 and December 31, 2008, respectively.  The allowance for loan losses was increased and provision for loan losses was decreased from amounts previously reported to reflect adjustments of the qualitative factors in the allowance general reserves and impairment amounts within the allowance specific reserves that the Company’s wholly owned subsidiary, Sterling Bank, utilized in calculating the allowance for loan losses as of June 30, 2009. The adjustment in qualitative factors reflected third quarter adverse trends in delinquent, classified and non-performing loans in the Bank’s portfolio, which were raised as part of the Bank’s regulatory examinations by the FRB.  As a result of subsequent discussions with the FRB, the Company concluded that the allowance for loan losses as of June 30, 2009 should be increased by $5.0 million.  This adjustment also impacted reported amounts in the Original Filing.  The Company’s management has considered nonperforming assets and other assets of concern in establishing the allowance for loan losses.  The Company continues to monitor its allowance for possible loan losses and will make future additions or reductions in light of the level of loans in its portfolio and as economic conditions dictate.

 
 
37


 

The table below recaps loans accruing but past due 90 days or more, non-accrual loans, OREO (Other Real Estate Owned), and troubled debt restructurings as of the dates listed.
 
   
September 30, 2009
   
December 31, 2008
 
   
(Restated)
       
Restructured loans:
           
  Real Estate – Construction
  $ 1,012,000     $ 642,000  
  Real Estate – Mortgage
    4,039,000       -  
Total restructured loans
    5,051,000       642,000  
Loans accruing, but past due 90 days or more:
               
  Commercial, Financial and Agricultural
    75,000       92,000  
  Real Estate – Construction
    2,006,000       2,360,000  
  Real Estate – Mortgage
    454,000       178,000  
  Consumer Installment loans
    41,000       77,000  
Total loans accruing, but past due 90 days or more
    2,576,000       2,707,000  
Nonaccrual Loans:
               
  Commercial, Financial and Agricultural
    245,000       -  
  Real Estate – Construction
    12,523,000       9,840,000  
  Real Estate – Mortgage
    1,288,000       55,000  
Total nonaccrual loans
    14,056,000       9,895,000  
Total nonperforming loans
    21,683,000       13,244,000  
Other Real Estate Owned
    1,786,000       923,000  
Total nonperforming assets
  $ 23,469,000     $ 14,167,000  
Non-performing loans/Total loans (1)
    7.30 %     4.33 %
Non-performing assets/Total assets
    6.13 %     3.74 %
Allowance for loan losses/Total non-performing loans
    48.92 %     64.41 %
(1) Includes loans held for sale.
 
During 2009, to conform to bank regulatory reporting requirements and general practices within the banking industry for impaired collateral dependent loans where repayment is expected solely from the underlying collateral, we reduced the carrying value through a partial charge-off of certain loans as shown in the table below:

 
Real Estate:
 
Loan Balance
   
Direct charge-off
   
Adjusted Loan Balance
   
% Charged-off
 
  Construction
  $ 14,748,000     $ 2,941,000     $ 11,807,000       19.94 %
  Mortgage
    182,000       182,000       -       100.00  
 
  $ 14,930,000     $ 3,123,000     $ 11,807,000       20.92 %

The current level of the allowance for loan losses is the result of management’s assessment of the risks within the portfolio based on the information revealed in credit monitoring processes.  The Company utilizes a risk-rating system on all commercial, business, agricultural, construction and multi-family and commercial real estate loans, including purchased loans.  A quarterly risk analysis is performed on all types of loans to establish the necessary reserve based on the estimated risk within the portfolio.  This assessment of risk takes into account the composition of the loan portfolio, historical loss experience for each loan category, previous loan experience, concentrations of credit, current economic conditions and other factors that in management’s judgment deserve consideration.

 
 
38


 

Although management believes that it uses the best information available to determine the allowance, unforeseen market conditions could result in adjustments and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in making the final determinations.  Future additions to the Company’s allowance may result from periodic loan, property and collateral reviews and thus cannot be predicted in advance.

The allowance for loan losses is calculated under FASB ASC Topic 310 and FASB ASC Topic 450.  Non-performing and impaired loans are evaluated under FASB ASC Topic 310, using either the fair value of collateral or present value of future cash flows method.  In our case, all non-performing and impaired loans are evaluated using the fair value of collateral method since all the non-performing and impaired loans are collateralized by real estate.  When a loan is evaluated using this method, a new appraisal(s) of the primary and secondary collateral is obtained and compared to the outstanding balance of the loan.  A specific reserve is added to the allowance for loan losses, if a collateral shortfall exists.

The Company had $14.1 million and $9.9 million, respectively, in loans on nonaccrual status at September 30, 2009 and December 31, 2008.  This increase is the result of 30 loans that the Company placed on nonaccrual status during the first nine months of 2009, less 4 that were transferred to other real estate owned, less 2 that were paid in full, less 1 that was sold.  Of the 30 loans that were placed on nonaccrual status during the first nine months of 2009, 15 were deemed impaired as of December 31, 2008 and no additional valuation reserve was needed for these loans during the first nine months of 2009.  The remaining 15 were classified impaired and put on nonaccrual status during the first nine months of 2009, and required $45,000 in valuation reserves.  Impaired loans increased by $9.5 million, or 54%, between December 31, 2008 and September 30, 2009; however, as a result of the charge offs or partial charge offs, the valuation reserve decreased by $1,571,000, or 56%.  Impaired loans without a valuation allowance increased $18.7 million since December 31, 2008 as a result of the Company designating new loans as impaired where the current appraisal supports the full amount of the loan and existing impaired loans, where the Company charged off or partially charged off $3.4 million during the nine months ended September 30, 2009, based upon current appraisals obtained by the Company or, serving as a proxy, a 40% reduction in appraised value on older appraisals.

Restructured loans increased $4.5 million, from $0.6 million as of December 31, 2008 to $5.3 million as of September 30, 2009, primarily as a result of the Company’s implementation of a term principal amortization plan for certain residential spot lot construction loans.  The process of modifying these construction loans to principal amortizing loans is completed in order for the Company to begin receiving principal reductions on these loans.  As a result of certain changes in terms under which these loans were modified, seven of these loans are considered troubled debt restructurings and included within impaired loans.

The Company utilizes a risk rating system on all unimpaired loans which takes into account loans with similar characteristics and historical loss experience related to each group.  In addition, qualitative adjustments are made for levels and trends in delinquencies and nonaccruals, downturns in specific industries, changes in credit policy, experience and ability of staff, national and local economic conditions, and concentrations of credit within the portfolio.  The total loans outstanding in each group of loans with similar characteristics is multiplied by the sum of the historical loss factors and the qualitative factors (for that group), to produce the allowance for the unimpaired loan loss balance required.

Unimpaired commercial real estate loans analyzed decreased $28.3 million, or 21%, between December 31, 2008 and September 30, 2009 due to payments, payoffs, loans converted to mini-perms and loans characterized as impaired.  Unimpaired spot lot construction loans, a component type within the real estate - construction portfolio, had their qualitative adjustment factors increased an average of 91% due to the risk present in this portfolio segment and the increasing historical charge off qualitative factor.  As a result of the above mentioned activity during the first nine months of 2009, management concluded that a provision for loan losses of $5,390,000 was needed during the first nine months of 2009.

Deposits.  Deposits totaled $343.2 million at September 30, 2009, increasing $14.6 million, or 4.4%, from the December 31, 2008 balance of $328.6 million.  The increase in deposits resulted primarily from management’s efforts to increase the bank’s net interest margin and liquidity.
 
 
39


 

Federal Home Loan Bank Advances and Other Borrowings. Federal Home Loan Bank advances and other borrowings totaled $21.4 and $22.2 million at September 30, 2009 and December 31, 2008, respectively.

Shareholders’ Equity.  Shareholders’ equity decreased by $10.3 million, or 37.9%, mainly as a result of our net loss, partially offset by a decrease in other comprehensive loss.

Comparative Average Balances, Interest and Yields:

   
Three Months Ended
 
   
September 30, 2009
   
September 30, 2008
 
   
(Restated)
       
   
Average
Balance
   
Interest
Income/Expense
   
Annual Yield/Cost
   
Average Balance
   
Interest
Income/Expense
   
Annual Yield/Cost
 
Assets
                                   
Loans, net (1)
  $ 285,952,000     $ 4,294,000       5.96 %   $ 298,773,000     $ 5,125,000       6.90 %
Investment securities (2)
    49,003,000       465,000       3.77       28,955,000       318,000       4.41  
Due from banks and Federal funds sold
    15,435,000       5,000       0.12       4,852,000       21,000       1.72  
Total interest-earning assets
    350,390,000       4,764,000       5.39       332,580,000       5,464,000       6.61  
                                                 
Allowance for loan losses
    (12,025,000 )                     (3,006,000 )                
Other assets
    44,879,000                       48,636,000                  
Total assets
  $ 383,244,000                     $ 378,210,000                  
                                                 
Liabilities and shareholders’ equity
                                               
Time deposits
  $ 200,451,000     $ 1,407,000       2.79 %   $ 181,059,000       1,636,000       3.59 %
NOW/MMDA/savings accounts
    108,937,000       225,000       0.64       105,213,000       349,000       1.32  
Borrowed funds
    22,121,000       270,000       4.83       9,821,000       136,000       5.48  
Total interest-bearing liabilities
    331,509,000       1,902,000       2.28       296,093,000       2,121,000       2.85  
                                                 
Noninterest-bearing demand deposits
    33,175,000                       37,971,000                  
Other liabilities
    1,591,000                       1,430,000                  
Shareholders’ equity
    16,969,000                       42,716,000                  
Total liabilities and shareholders’ equity
  $ 383,244,000                     $ 378,210,000                  
                                                 
Net interest income
          $ 2,862,000                     $ 3,343,000          
                                                 
Interest rate spread (3)
                    3.11 %                     3.76 %
                                                 
Net interest margin (4)
                    3.24 %                     4.00 %
 
 
 
40


 

   
Nine Months Ended
 
   
September 30, 2009
   
September 30, 2008
 
   
(Restated)
       
   
Average
Balance
   
Interest
Income/Expense
   
Annual Yield/Cost
   
Average Balance
   
Interest
Income/Expense
   
Annual Yield/Cost
 
Assets
                                   
Loans, net (1)
  $ 288,230,000     $ 12,799,000       5.94 %   $ 301,245,000     $ 15,839,000       7.02 %
Investment securities (2)
    48,930,000       1,450,000       4.47       34,412,000       1,093,000       4.24  
Due from banks and Federal funds sold
    16,122,000       17,000       0.14       9,479,000       161,000       2.27  
Total interest-earning assets
    353,282,000       14,266,000       5.40       345,136,000       17,093,000       6.62  
                                                 
Allowance for loan losses
    (9,650,000 )                     (2,866,000 )                
Other assets
    44,703,000                       48,393,000                  
Total assets
  $ 388,335,000                     $ 390,663,000                  
                                                 
Liabilities and shareholders’ equity
                                               
Time deposits
  $ 201,309,000     $ 4,743,000       3.15 %   $ 194,283,000       5,926,000       4.07 %
NOW/MMDA/savings accounts
    107,584,000       699,000       0.87       103,211,000       1,068,000       1.38  
Borrowed funds
    22,215,000       800,000       4.81       9,882,000       423,000       5.72  
Total interest-bearing liabilities
    331,108,000       6,242,000       2.52       307,376,000       7,417,000       3.22  
                                                 
Noninterest-bearing demand deposits
    33,333,000                       38,422,000                  
Other liabilities
    498,000                       1,856,000                  
Shareholders’ equity
    23,396,000                       43,009,000                  
Total liabilities and shareholders’ equity
  $ 388,335,000                     $ 390,663,000                  
                                                 
Net interest income
          $ 8,024,000                     $ 9,676,000          
                                                 
Interest rate spread (3)
                    2.88 %                     3.40 %
                                                 
Net interest margin (4)
                    3.04 %                     3.74 %
________________________________
(1)
Includes loans held for sale.  Also includes loan fees, which are not material.  Does not include loans on nonaccrual.
(2)
Yields are not on a tax-equivalent basis.
(3)
Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(4)   Net interest margin represents net interest income as a percentage of average interest-earning assets.

Liquidity

Liquidity describes our ability to meet the financial obligations that arise out of the ordinary course of business.  Liquidity addresses the Company’s ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund current and planned expenditures.  Liquidity is derived from loan and investment securities repayments and income from interest-earning assets.  Our loan to deposit ratio was 86.5% and 93.0% at September 30, 2009 and December 31, 2008, respectively.

The Company seeks to rely primarily on core deposits from customers to provide stable and cost-effective sources of funding to support growth.  The Company also seeks to augment such deposits with longer term and higher yielding certificates of deposit.  To the extent that retail deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term funds market.  As of September 30, 2009, the Company maintained lines of credit with correspondent banks of $39.2 million.  Longer term funding requirements can be satisfied through advances from the Federal Home Loan Bank.

As of September 30, 2009, the Company’s investment securities portfolio included $33.5 million of mortgage-backed securities that provide significant cash flow each month.  The majority of the investment portfolio is classified as available-for-sale, is readily marketable, and is available to meet liquidity needs.  The Company’s residential real estate portfolio includes loans, which are underwritten to secondary market criteria, and provide an additional source of liquidity.


 
 
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Capital Resources

The Company is subject to various regulatory capital requirements.  Regulatory capital is defined in terms of Tier I capital (shareholders’ equity adjusted for unrealized gains or losses on available-for-sale securities), Tier II capital (which includes a portion of the allowance for loan losses) and Total capital (Tier I plus Tier II).  Risk-based capital ratios are expressed as a percentage of risk-weighted assets.  Risk-weighted assets are determined by assigning various weights to all assets and off-balance sheet associated risk.  Regulators have also adopted minimum Tier I leverage ratio standards, which measure the ratio of Tier I capital to average assets.

At September 30, 2009, management believes that the Bank is “adequately capitalized,” as defined by regulatory banking agencies.  The Company’s long term goal is to ensure that the Bank is “well capitalized” under the applicable regulatory standards.  To assist in this goal, the Company issued $6.0 million of trust preferred securities (the “Securities”) on May 1, 2007.  The Securities bear interest at 6.744% for the first five years.  Subsequently, the interest rate will be adjusted quarterly based on a three month LIBOR rate plus 1.70%.  The Securities are callable by the Company after five years with a final maturity of May 1, 2037.  The Company contributed $4.5 million of the proceeds of the Securities to the capital of the Bank as Tier I capital.  If the Company determines that there is a need to preserve capital or improve liquidity, the ability exists to defer interest payments for a maximum of five years.  During the second and third quarters of 2009, the Company elected to defer the interest payments due.  Further, pursuant to the terms of the Agreement with the Regulators, the Company will not make any interest payments in the future without prior approval from the Regulators.

Off-Balance Sheet Arrangements

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, including unused portions of lines of credit and standby letters of credit.  The Company has also entered into long-term lease obligations for some of its premises and equipment, the terms of which generally include options to renew.  The above instruments and obligations involve, to varying degrees, elements of off-balance sheet risk in excess of the amount recognized in the balance sheets.  None of these instruments or obligations have or are reasonably likely to have a current or future effect on the Company's financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

As of September 30, 2009, commitments to extend credit and unused lines of credit amounted to approximately $35.8 million and standby letters of credit were approximately $4.2 million.  See Note 8 to the Notes to Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 for additional information regarding the Bank’s long-term lease obligations.
 
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable.
 
ITEM 4T.  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer previously concluded that our disclosure controls and procedures were effective as of September 30, 2009 and management reported that there was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2009 that materially affected, or was reasonably likely to materially affect, our internal control over financial reporting.
 
 
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As a result of the restatement of our financial statements as discussed in Note 2 to the accompanying unaudited condensed consolidated financial statements a re-evaluation was performed as of September 30, 2009, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.  Based upon this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective as of September 30, 2009, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act are recorded, processed, summarized and reported as and when required due to a material weakness in our internal control over financial reporting.

Our conclusion was primarily related to our review and reassessment of management’s policies and procedures for the monitoring and timely evaluation of and revision to management’s approach for assessing credit risk inherent in the loan portfolio to reflect changes in the economic environment in the allowance for loan losses.

The Company has restated its condensed consolidated financial statements as of and for the three and nine months ended September 30, 2009 in this Form 10Q/A as discussed in Note 2 to the accompanying financial statements.  The Company has taken certain other remedial actions as of the date of filing of this Form−10Q/A and believes that the consolidated financial statements included in this Form−10Q/A present fairly, in all material respects, the Company’s financial position, results of operations, and cash flows for the periods presented.

Changes in Internal Control over Financial Reporting

The Company has identified a material weakness as described above.  There were no other changes in the Company’s internal control over financial reporting (as defined in Rules 13a−15(f) and 15d−15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2009, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Remediation Steps to Address Material Weakness

As of the date of this amended filing, the Company is in the process of establishing new policies and procedures with respect to how the allowance for loan losses are established and disclosed.  Additionally, in order to ensure that adequacy and accuracy in these determinations are consistently present, a procedure of external review of management’s assessments of the allowance for loan losses will be completed on a timely basis each quarter.


PART II.  OTHER INFORMATION

ITEM 1.  Legal Proceedings.

Not Applicable.

ITEM 1A.  Risk Factors.

Not Applicable.

ITEM 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

Not Applicable.
 
 
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ITEM 3.  Defaults Upon Senior Securities.

 
None.

ITEM 4.  Submission of Matters to a Vote of Security Holders.

None.

ITEM 5.  Other Information.

 
None.

ITEM 6.  Exhibits.

 
The following are filed as exhibits to this report:




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In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


 
STERLING BANKS, INC.
     
     
Date: March 8, 2010
By:
/s/ Robert H. King
   
Robert H. King
   
President and Chief Executive Officer
     
     
Date: March 8, 2010
By:
/s/ R. Scott Horner
   
R. Scott Horner
   
Executive Vice President and Chief
   
Financial Officer

 
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