10-K 1 w58665e10-k.txt 10-K FOR THE PERIOD OF 12/31/2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ------ EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE ------ SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________________ TO _______________ COMMISSION FILE NUMBER 0-16276 ------------ STERLING FINANCIAL CORPORATION ------------------------------ (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2449551 -------------------------------- ------------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 NORTH POINTE BOULEVARD LANCASTER, PENNSYLVANIA 17601-4133 --------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (717) 581-6030 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $5.00 PER SHARE --------------------------------------- (Title of class) Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___ 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 --- --- The aggregate market value of the voting stock held by non-affiliates of the Registrant at March 1, 2002 was approximately $300,053,000. The number of shares of Registrant's Common Stock outstanding on March 1, 2002 was 13,467,811. DOCUMENTS INCORPORATED BY REFERENCE Portions of the 2002 Proxy Statement for the Registrant are incorporated by reference into Part III of this report. 1 Sterling Financial Corporation Table of Contents
Page ---- PART I Item 1. Business................................................................................... 3 Item 2. Properties................................................................................. 8 Item 3. Legal Proceedings.......................................................................... 8 Item 4. Submission of Matters to a Vote of Security Holders........................................ 8 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.................. 9 Item 6. Selected Financial Data.................................................................... 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 11 Item 7A. Quantitative and Qualitative Disclosure About Market Risk.................................. 32 Item 8. Financial Statements and Supplementary Data................................................ 35 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....... 66 PART III Item 10. Directors and Executive Officers of the Registrant......................................... 66 Item 11. Executive Compensation..................................................................... 66 Item 12. Security Ownership of Certain Beneficial Owners and Management............................. 66 Item 13. Certain Relationships and Related Transactions............................................. 66 PART IV. Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................ 67 Signatures.................................................................................................. 70
2 PART I The management of Sterling Financial Corporation has made forward-looking statements in this Annual Report on Form 10-K. These forward-looking statements may be subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of Sterling Financial Corporation and its wholly-owned subsidiaries, Bank of Lancaster County, N.A., First National Bank of North East, Bank of Hanover and Trust Company, HOVB Investment Company, T&C Leasing, Inc., Pennbanks Insurance Company SPC, Sterling Mortgage Services, Inc. (inactive), Town & Country, Inc. and Sterling Financial Trust Company. When words such as "believes," "expects," "anticipates," "may," "could," "should," "estimates" or similar expressions occur in this annual report, management is making forward-looking statements. Shareholders should note that many factors, some of which are discussed elsewhere in this report, could affect the future financial results of Sterling Financial Corporation and its subsidiaries, both individually and collectively, and could cause those results to differ materially from those expressed in this report. These risk factors include the following: - Operating, legal and regulatory risks; - Economic, political and competitive forces impacting our various lines of business; - The risk that our analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful; - The possibility that increased demand or prices for Sterling's financial services and products may not occur; - Volatility in interest rates; - The success of our merger of Hanover Bancorp, Inc. and pending acquisition of Equipment Finance Inc.; and - Other risks and uncertainties. Sterling undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in other documents Sterling files periodically with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. ITEM 1 - BUSINESS Sterling Financial Corporation Sterling Financial Corporation is a $1.861 billion financial holding company headquartered in Lancaster, Pennsylvania. Through its banking and nonbanking subsidiaries, Sterling provides a full range of banking and financial services to individuals and businesses, including commercial and retail banking, leasing, wealth management and insurance. Sterling's operations are conducted through its primary operating subsidiaries including Bank of Lancaster County, N.A., Bank of Hanover and Trust Company, First National Bank of North East, Town & Country, Inc. and Sterling Financial Trust Company. The Company's footprint is its 51 branch banking offices in south central Pennsylvania and northern Maryland, although its leasing subsidiary conducts business in virtually every state. Sterling's major source of operating funds is dividends that it receives from its subsidiary banks. Sterling's expenses consist principally of operating expenses. Dividends that Sterling pays to shareholders consist, in part, of dividends declared and paid to Sterling by the subsidiary banks. Sterling and its subsidiaries are not dependent upon a single customer or a small number of customers, the loss of which would not have a material adverse effect on the Company. Sterling does not depend on foreign sources of funds, nor does it make foreign loans. The common stock of Sterling is listed on The Nasdaq Stock Market under the symbol SLFI. Banking Subsidiaries Bank of Lancaster County, N.A. Bank of Lancaster County, N.A. is a full service commercial bank operating under charter from 3 the Office of the Comptroller of the Currency. The bank's principal market area is Lancaster County, Pennsylvania, which is the sixth largest county in Pennsylvania in terms of population. Lancaster County has one of the strongest and most stable economies in the state, with agriculture, industry and tourism all contributing to the overall strength of the economy. No single sector dominates the county's economy. At December 31, 2001, Bank of Lancaster County had total assets of $1.15 billion, net loans of $682 million and total deposits of $976 million. The main office of the bank is located at 1 East Main Street, Strasburg, Pennsylvania. In addition to its main office, the bank has 30 branches in Lancaster County, 1 branch in Chester County, Pennsylvania and 2 branches in Lebanon County (operating as Bank of Lebanon County). Bank of Lancaster County's delivery channels of services to its customers also include the ATM network, Internet and telephone banking. Bank of Lancaster County has two wholly owned operating subsidiaries, Town & Country, Inc., and Sterling Financial Trust Company. Town & Country, Inc., is a small to mid-sized national lessor with a significant presence in the fleet management and equipment leasing industry. Its principal office is located in East Petersburg, PA, although it leases to companies located throughout the United States. Assets totaled $146 million at December 31, 2001, including approximately $83 million of finance lease assets, and $56 million in assets held for operating leases. In 2001, Sterling Financial Trust Company was incorporated as a state-charted trust company. Effective January 1, 2002, the wealth management divisions of Bank of Lancaster County and Bank of Hanover were combined into this single entity. Through the formation of a separate trust company, Sterling believes it will be able to increase revenue generation opportunities, while increasing operating efficiencies. On May 18, 1999, Bank of Lancaster County, N.A. and Murray Insurance Associates, Inc. formed the Lancaster Insurance Group, LLC, a limited liability company under the laws of the Commonwealth of Pennsylvania. Lancaster Insurance Group offers comprehensive personal insurance coverage as well as a complete range of business insurance programs. The Bank of Lancaster County and Murray each own 50% of the organization. The bank is subject to regulation and periodic examination by the Office of the Comptroller of the Currency. The Federal Deposit Insurance Corporation, as provided by law, insures the bank's deposits. First National Bank of North East On June 15, 1999, Sterling Financial Corporation acquired Northeast Bancorp, Inc., which was the parent company of First National Bank of North East, North East, Maryland. The main office of the bank is located at 14 South Main Street, North East, Maryland. In addition to the main office, there are three branches located in Cecil County, Maryland. First National's delivery channels of its services also include the ATM network, Internet and telephone banking. At December 31, 2001, the bank had total assets of approximately $102 million, loans of $70 million and total deposits of $92 million. The bank is subject to regulation and periodic examination by the Office of the Comptroller of the Currency. The Federal Deposit Insurance Corporation, as provided by law, insures the bank's deposits. Bank of Hanover and Trust Company On July 27, 2000, Sterling consummated the merger with Hanover Bancorp, Inc., parent company of Bank of Hanover and Trust Company. Bank of Hanover became a wholly owned subsidiary of Sterling. Bank of Hanover and Trust Company conducts its business principally through fourteen banking offices located in York and Adams Counties, Pennsylvania and one office located in Westminster, Maryland. Bank of Hanover's delivery channels of services to its customers also include the ATM network, Internet and telephone banking. At December 31, 2001, the bank had total assets of $559 million, total loans of $337 million and total deposits of $471 million. The bank is subject to regulation and periodic examination by the Federal Deposit Insurance 4 Corporation and Pennsylvania Department of Banking. The Federal Deposit Insurance Corporation, as provided by law, insures the bank's deposits. Nonbanking Subsidiaries HOVB Investment Company HOVB Investment Company became a wholly owned subsidiary of Sterling upon the completion of the merger with Hanover Bancorp, Inc. It is a Delaware investment company whose principal activity is managing an equity securities portfolio. Total assets totaled $7.9 million at December 31, 2001. T&C Leasing, Inc. Sterling owns all of the outstanding stock of a second leasing company, T&C Leasing, Inc., which was incorporated in 1998. T&C Leasing is also a fleet management and equipment leasing company is headquartered in East Petersburg, Pennsylvania. This leasing company was formed to facilitate the fleet management and equipment leasing needs of our existing customer base. Pennbanks Insurance Co., SPC Segregated Portfolio Cells #5 and #8 Pennbanks Insurance Co., SPC and its segregated portfolios, including Segregated Portfolios #5 and #8 that Sterling owns, holds an unrestricted Class "B" Insurer's License under Cayman Islands Insurance Law. The segregated portfolios are engaged in the business of reinsuring credit life and credit accident and disability risks of their respective shareholders. Total assets of the segregated portfolios as of December 31, 2001 totaled $1.5 million. COMPETITION The financial services industry in Sterling's market area is highly competitive, including competition from commercial banks, savings banks, credit unions, finance companies and nonbank providers of financial services. Several of Sterling's competitors have legal lending limits that exceed Sterling's subsidiaries, as well as funding sources on the capital markets that exceeds Sterling's availability. The increased competition has resulted from a changing legal and regulatory climate, as well as from the economic climate. SUPERVISION AND REGULATION Bank Holding Company Regulation Sterling is a financial holding company and, as such, is subject to the regulations of the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956. Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve. The Federal Reserve has issued regulations under the Bank Holding Company Act that requires a financial holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve may require Sterling to stand ready to use its resources to provide adequate capital funds to the banks during periods of financial stress or adversity. Under the Bank Holding Company Act, the Federal Reserve may require a financial holding company to end a non-banking business if the nonbanking business constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company. The Bank Holding Company Act prohibits Sterling from acquiring direct or indirect control of more than 5% of the outstanding voting stock of any bank, or substantially all of the assets of any bank, or merger with another bank holding company, without the prior approval of the Federal Reserve. The Bank Holding Company Act allows interstate bank acquisitions and interstate branching by acquisition and consolidation in those states that had not elected out by the required deadline. The Pennsylvania Department of Banking also must approve any similar consolidation. Pennsylvania law permits Pennsylvania financial holding companies to control an unlimited number of banks. In addition, the Bank Holding Company Act restricts Sterling's nonbanking activities to those that are determined by the Federal Reserve Board to be financial in nature, incidental to such financial activity, 5 or complementary to a financial activity. The Bank Holding Company Act does not place territorial restrictions on the activities of nonbank subsidiaries of financial holding companies. The Federal Deposit Insurance Corporation Improvement Act requires a bank holding company to guarantee the compliance of any insured depository institution subsidiary that may become "undercapitalized", as defined by regulations, with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency, up to specified limits. Financial Services Modernization Legislation The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act, was signed into law in 1999, and amended the Bank Holding Company Act of 1956. The law repeals Depression-era banking laws and permits banks, insurance companies and securities firms to engage in each other's business after complying with certain conditions and regulations. Accordingly, the legislation allows for a single financial organization to offer customers a more complete array of financial products and services. The Gramm-Leach-Bliley Act provides an enhanced regulatory framework through the Federal Reserve Board, which is an umbrella regulatory for financial holding companies. However, the subsidiaries of a financial holding company are still subject to the rules and regulations of their primary functional regulator. In order to engage in new activities, the Gramm-Leach-Bliley Act requires "satisfactory" or higher Community Reinvestment Act compliance for insured depository institutions and their financial holding companies. Sterling and its subsidiary banks do not believe that the Financial Services Modernization Act will have a material effect on our operations in the near-term. However, the act may result in increased competition from larger financial service companies, many of which have substantially more financial resources than Sterling, and now may offer banking services in addition to insurance and brokerage services. The act also modifies current law related to financial privacy and community reinvestment. The new privacy provisions will generally prohibit financial institutions, including Sterling and its subsidiaries, from disclosing nonpublic personal financial information to nonaffiliated third parties unless customers have the opportunity to opt out of the disclosure. Dividends Sterling is a legal entity separate and distinct from the subsidiary banks and nonbank subsidiaries. Sterling's revenues, on a parent company only basis, result almost entirely from dividends paid to the corporation by its subsidiaries. Federal and state laws regulate the payment of dividends by Sterling's subsidiaries. See "Supervision and Regulation - Regulation of the Banks," below. Further, it is the policy of the Federal Reserve that bank holding companies should pay dividends only out of current earnings. Federal banking regulators also have the authority to prohibit banks and bank holding companies from paying a dividend if they should deem such payment to be an unsafe or unsound practice. FDIC Insurance The subsidiary banks are subject to Federal Deposit Insurance Corporation assessments. The FDIC has adopted a risk-related premium assessment system for both the Bank Insurance Fund for banks and the Savings Association Insurance Fund for savings associations. Under this system, FDIC insurance premiums are assessed based on capital and supervisory measures. Under the risk-related premium assessment system, the FDIC, on a semiannual basis, assigns each institution to one of three capital groups, "well capitalized," "adequately capitalized," or "undercapitalized," and further assigns such institution to one of three subgroups within a capital group corresponding to the FDIC's judgment of its strength based on supervisory evaluations, including examination reports, statistical analysis, and other information relevant to gauging the risk posed by the institution. Only institutions with a total risk-based capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater, are assigned to the well capitalized group. Sterling and its subsidiary banks, at December 31, 2001, qualify as "well capitalized" under these regulatory standards. 6 Regulation of Banks The operations of the subsidiary banks are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System, and to banks whose deposits are insured by the FDIC. The banks' operations are also subject to regulations of the Office of the Comptroller of the Currency, the Federal Reserve, the FDIC, and the Pennsylvania Department of Banking. The Office of the Comptroller of the Currency, which has primary supervisory authority over national banks, and the FDIC which is the primary regulator of the state charted bank, regularly examines banks in such areas as reserves, loans, investments, management practices, and other aspects of operations. These examinations are designed for the protection of the banks' depositors rather than Sterling's shareholders. The subsidiary banks must file quarterly and annual reports to the FDIC. The National Bank Act requires the subsidiary national banks to obtain the prior approval of the Office of the Comptroller of the Currency for the payment of dividends if the total of all dividends declared by the banks in one year would exceed the banks' net profits, as defined and interpreted by regulation, for the two preceding years, less any required transfers to surplus. In addition, the banks may only pay dividends to the extent that their retained net profits, including the portion transferred to surplus, exceed statutory bad debts, as defined by regulation. Under Pennsylvania statutes, state chartered banks are restricted, unless prior regulatory approval is obtained, in the amount of dividends, which it may declare in relation to its accumulated profits, less any required transfer to surplus. These restrictions have not had, nor are they expected to have any impact on the corporation's dividend policy. Under the Federal Deposit Insurance Corporation Insurance Act of 1991, any depository institution, including the banks are prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy their minimum capital requirement. A subsidiary bank of a bank holding company, such as Bank of Lancaster County, First National Bank of North East, and Bank of Hanover, is subject to certain restrictions imposed by the Federal Reserve Act, including: - Extensions of credit to the bank holding company or its subsidiaries; - Investments in the stock or other securities of the bank holding company or its subsidiaries; and - Taking such stock or securities as collateral for loans. The Federal Reserve Act and Federal Reserve regulations also place certain limitations and reporting requirements on extensions of credit by a bank to the principal shareholders of its parent holding company, among others, and to related interests of principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship. Sterling and its subsidiary banks are affected by the monetary and fiscal policies of government agencies, including the Federal Reserve and FDIC. Through open market securities transactions and changes in its discount rate and reserve requirements, the Board of Governors of the Federal Reserve exerts considerable influence over the cost and availability of funds for lending and investment. The nature of monetary and fiscal policies on future business and earnings of Sterling cannot be predicted at this time. Other From time to time, various federal and state legislation is proposed that could result in additional regulation of, and restrictions on, the business of Sterling and the subsidiary banks, or otherwise change the business environment. Management cannot predict whether any of this legislation will have a material effect on the business of Sterling. EMPLOYEES As of December 31, 2001, Sterling had 725 full-time equivalent employees. None of these 7 employees are represented by a collective bargaining agreement, and Sterling believes it enjoys good relations with its personnel. ITEM 2 - PROPERTIES Sterling Financial Corporation owns no real estate. The Bank of Lancaster County, in addition to its main office, had a branch network of 31 offices and 4 off-site electronic MAC/ATM installations at December 31, 2001. All branches are located in Lancaster County with the exception of one office located in Chester County and two offices located in Lebanon County. Branches at 21 locations are occupied under leases and at three branches, the bank owns the building, but leases the land. In addition to the branch locations, Bank of Lancaster County owns a building which houses its administrative service center as well as other support groups of the subsidiary banks and Town & Country, Inc. Another building is owned by Bank of Lancaster County, which serves as the corporate headquarters of Sterling Financial Corporation and houses the executive offices of the Corporation and the Bank, as well as a branch office. In addition, a certain amount of space in each of the building is leased to third parties. In addition to its main office located at 14 South Main Street, North East, Maryland, First National Bank of North East owns the property for three other branches in Cecil County. In addition to its main office located at 25 Carlisle Street, Hanover, Pennsylvania, Bank of Hanover operated thirteen branches located in York and Adams Counties, Pennsylvania with one branch located in Westminster, Maryland. Branches at 10 locations are occupied under leases. All other properties were owned in fee. All real estate and buildings owned by the Bank of Hanover are free and clear of encumbrances. All real estate owned by the subsidiary banks is free and clear of encumbrances. The leases of the subsidiary banks expire intermittently over the years through 2021 and most are subject to one or more renewal options. During 2001, aggregate annual rentals for real estate paid did not exceed 3% of the any bank's operating expenses. ITEM 3 - LEGAL PROCEEDINGS As of December 31, 2001, there were no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which Sterling or its subsidiaries are a party or by which any of their property is the subject. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of 2001. 8 PART II ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Sterling Financial Corporation's common stock trades on The NASDAQ Stock Market under the symbol SLFI. There are 35,000,000 shares of common stock authorized at December 31, 2001, and 12,511,953 shares outstanding. As of December 31, 2001, Sterling had approximately 4,645 stockholders of record. There is no other class of stock authorized or outstanding. Sterling is restricted as to the amount of dividends that it can pay to stockholders by virtue of the restrictions on the subsidiaries' ability to pay dividends to Sterling. The following table reflects the quarterly high and low prices of Sterling's common stock for the periods indicated and the cash dividends declared on the common stock for the periods indicated.
Price Range Per Share Per Share High Low Dividend --------------- -------------- --------------- 2001 ---- First Quarter $20.88 $15.13 $.190 Second Quarter 24.33 19.00 .190 Third Quarter 26.00 20.20 .200 Fourth Quarter 25.00 20.85 .200
Price Range Per Share Per Share 2000 High Low Dividend ---- --------------- -------------- --------------- First Quarter $30.50 $16.56 $.185 Second Quarter 20.88 12.25 .185 Third Quarter 19.69 14.19 .190 Fourth Quarter 19.13 15.00 .190
Sterling maintains a Dividend Reinvestment and Stock Purchase Plan for eligible shareholders who elect to participate in the plan. You may obtain a copy of the prospectus for the plan by writing to: Bank of Lancaster County, N.A., Dividend Reinvestment and Stock Purchase Plan, 101 North Pointe Boulevard, Lancaster, Pennsylvania 17601-4133. 9 ITEM 6 - SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ---------------- --------------- ---------------- ---------------- ---------------- (Dollars in thousands, except per share data) SUMMARIES OF INCOME Interest income $115,916 $113,319 $101,626 $97,054 $89,960 Interest expense 57,274 58,501 47,404 45,938 41,136 ---------------- --------------- ---------------- ---------------- ---------------- Net interest income 58,642 54,818 54,222 51,116 48,824 Provision for loan losses 1,217 605 1,060 2,016 2,039 ---------------- --------------- ---------------- ---------------- ---------------- Net interest income after provision for loan losses 57,425 54,213 53,162 49,100 46,785 Noninterest income 43,925 37,508 33,539 31,698 26,187 Noninterest expenses 75,172 70,203 62,459 58,534 52,669 ---------------- --------------- ---------------- ---------------- ---------------- Income before income taxes 26,178 21,518 24,242 22,264 20,303 Applicable income taxes 5,844 4,951 6,257 5,670 5,340 ---------------- --------------- ---------------- ---------------- ---------------- NET INCOME $20,334 $16,567 $17,985 $16,594 $14,963 ================ =============== ================ ================ ================ OPERATING INCOME (1) $20,334 $18,831 $18,359 $16,594 $14,963 ================ =============== ================ ================ ================ FINANCIAL CONDITION AT YEAR END Assets $1,861,439 $1,726,138 $1,556,323 $1,466,105 $1,319,648 Loans, net 1,087,102 1,021,499 946,583 867,264 831,429 Deposits 1,535,649 1,420,300 1,288,814 1,218,978 1,113,248 Borrowed money 141,378 139,506 125,997 98,688 73,197 Stockholders' equity 152,111 139,347 122,760 125,129 114,776 PER COMMON SHARE DATA Earnings per share - basic $1.62 $1.32 $1.43 $1.32 $1.18 Earnings per share - diluted 1.62 1.32 1.43 1.31 1.18 Operating earnings per share - basic (1) 1.62 1.50 1.46 1.32 1.18 Operating earnings per share - diluted (1) 1.62 1.50 1.46 1.31 1.18 Cash dividends declared 0.780 0.750 0.721 0.664 0.625 Book value 12.16 11.11 9.79 9.96 9.14 Realized book value (3) 11.72 10.91 10.30 9.49 8.78 Weighted average number of common shares: Basic 12,529 12,545 12,559 12,581 12,654 Diluted 12,580 12,557 12,620 12,645 12,671 Dividend payout ratio (2) 48.1% 56.8% 50.4% 50.3% 53.0% PROFITABILITY RATIOS ON EARNINGS Return on average assets 1.14% 1.02% 1.19% 1.20% 1.21% Return on average equity 13.74% 12.99% 14.43% 13.76% 13.48% Return on average realized equity (3) 14.41% 12.36% 14.46% 14.36% 13.82% Average equity to average assets 7.94% 7.83% 8.23% 8.73% 8.97% PROFITABILITY RATIOS ON OPERATING EARNINGS (1) Return on average assets 1.14% 1.16% 1.21% 1.20% 1.21% Return on average equity 13.74% 14.77% 14.73% 13.76% 13.48% Return on average realized equity (3) 14.41% 14.05% 14.76% 14.36% 13.82% SELECTED ASSET QUALITY RATIOS Nonperforming loans to total loans 0.80% 0.59% 0.38% 0.51% 0.64% Net charge-offs to average loans outstanding 0.17% 0.08% 0.07% 0.18% 0.20% Allowance for loan losses to total loans 1.01% 1.13% 1.24% 1.31% 1.31% Allowance for loan losses to nonperforming loans 125.8% 192.1% 328.6% 255.2% 204.1%
(1) Excludes merger and restructuring charges, net of tax, of $2,264 and $374 for the years ended December 31, 2000 and 1999. (2) Calculated by taking dividends per share divided by basic earnings per share. (3) Excluding unrealized gains (losses) on securities available-for-sale. 10 ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides management's analysis of the consolidated financial condition and results of operations of Sterling Financial Corporation and its wholly-owned subsidiaries, Bank of Lancaster County, N.A., First National Bank of North East, Bank of Hanover and Trust Company, HOVB Investment Co., T&C Leasing, Inc. (T&C), Pennbanks Insurance Company, SPC and Sterling Mortgage Services, Inc. (inactive). The consolidated financial statements also include Town & Country, Inc. and Sterling Financial Trust Company, wholly-owned subsidiaries of Bank of Lancaster County. Sterling Financial Trust Company was incorporated in 2001; however, it commenced operations on January 1, 2002. Management's discussion and analysis should be read in conjunction with the audited financial statements and footnotes appearing elsewhere in this report. In addition to historical information, Management's Discussion and Analysis contains forward-looking statements. The forward-looking statements are subject to certain risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of Sterling, and its subsidiaries, or the combined company. When we use words such as "believes," "expects," "anticipates" or similar expressions, we are making forward-looking statements. Shareholders should note that many factors, some of which are discussed elsewhere in this report, could affect the future financial results of Sterling and its subsidiaries, both individually and collectively, and could cause those results to differ materially from those expressed in this report. These factors include the following: - operating, legal and regulatory risks; - economic, political and competitive forces impacting our various lines of business; - the risk that our analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful; - the possibility that increased demand or prices for Sterling's financial services and products may not occur; - volatility in interest rates; - the success of our merger of Hanover Bancorp, Inc. and pending acquisition of Equipment Finance, Inc.; and - other risks and uncertainties. Sterling undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in other documents Sterling files periodically with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets and on noninterest expenses, which tend to rise during periods of general inflation. Inflationary pressures over the last few years have been modest, although the potential for future inflationary pressure is always present given changing trends in the economy. One of the greatest external influences that impacts financial institutions is the interest rate environment. During 2001, the Federal Reserve aggressively reduced interest rates during the year in order to mitigate the effects of a slumping national economy. Interest rates were cut 11 times during 2001, resulting in a reduction of the prime-lending rate from 9.50% at January 1, 2001 to 4.75% at December 31, 2001. The prime rate of 4.75% represents a thirty year low in this key interest rate indicator. The declines in interest rates experienced in 2001 were in contrast to interest rate movements in 2000, in which the Federal Reserve incrementally raised interest rates four times, for a total increase in the prime lending rate of 100 basis points (b.p.). The declining interest rate environment dictated by the Federal Reserve had an immediate impact on repricing variable interest rate interest earning assets and interest bearing liabilities, which led to some compression in the net interest margin. Management recognizes that asset/liability management, including the effect of rate changes on interest earning assets and interest bearing liabilities, remains a critical responsibility in ensuring continuing profitability of the corporation. 11 RESULTS OF OPERATIONS (All dollar amounts presented within tables are in thousands, except per share data.) OVERVIEW Sterling's net income totaled $20,334,000, or $1.62 per diluted share, compared to $16,567,000, or $1.32 per diluted share in 2000, and $17,985,000 or $1.43 per diluted share in 1999. Included in reported net income for 2000 were after-tax merger related restructuring charges of $2,264,000 in 2000 and $374,000 in 1999. These amounts reduced diluted earnings per share by $.18 in 2000 and $.03 in 1999. Returns on average realized equity, excluding merger related and restructuring charges, were 14.41% in 2001, 14.05% in 2000, and 14.76% in 1999. Returns on average assets, excluding merger related and restructuring charges, totaled 1.14% in 2001, 1.16% in 2000, and 1.21% in 1999. On November 5, 2001, Sterling announced that it had reached an agreement to acquire Equipment Finance, Inc., a commercial finance company that specializes in financing forestry, and land clearing equipment. Under the terms of the agreement, shareholders of Equipment Finance will receive consideration of $30 million of which approximately 70% will be paid in stock and 30% in cash. Sterling issued approximately 955,000 shares of its common stock to acquire Equipment Finance. The transaction closed on February 28, 2002 and was accounted for under the provisions of Statement No. 142. The Equipment Finance acquisition will add approximately $90 million in assets to Sterling and is expected to be accretive to earnings per share during 2002. NET INTEREST INCOME The primary source of Sterling's traditional banking revenue is net interest income, which represents the difference between interest income on earning assets and interest expense on liabilities used to fund those assets. Earning assets include loans, securities, and federal funds sold. Interest-bearing funds include deposits and borrowings. To compare the tax-exempt yields to taxable yields, amounts are adjusted to pretax equivalents based on a 35% Federal corporate income tax rate. Net interest income is affected by changes in interest rates, volume of interest bearing assets and liabilities, and the composition of those assets and liabilities. The "interest rate spread" and "net interest margin" are two common statistics related to changes in net interest income. The interest rate spread represents the difference between the yields earned on interest earning assets and the rates paid for interest bearing liabilities. The net interest margin is defined as the percentage of net interest income to average earning assets. Due to demand deposits and stockholders equity, the net interest margin exceeds the interest rate spread, as these funding sources are noninterest bearing. Table 1 presents net interest income on a fully taxable equivalent basis, interest rate spread and net interest margin for the years ending December 31, 2001, 2000 and 1999. Table 2 analyzes the changes in net interest income for the periods broken down by their rate and volume components. Tax equivalent net interest income in 2001 was $64,295,000, compared to $59,976,000 in 2000 and $58,423,000 in 1999. Sterling has been able to increase its net interest income over the last two years primarily through increases in average earning assets, offset somewhat by a declining net interest rate spread. The interest rate spread and net interest margin have experienced compression over the last three years. The interest rate spread was 3.47% in 2001, down from 3.52% in 2000 and 3.82% in 1999. The net interest margin experienced similar declines, totaling 3.95% in 2001, down from 4.03% in 2000 and 4.27% in 1999. Several factors impacted 2001's net interest margin. First, Sterling is in a liability sensitive interest rate risk position, and in a rapidly falling rate environment like that experienced in 2001, interest earning assets tend to reprice quicker than interest bearing liabilities, as a greater portion of 12 assets are variable rate. Longer-term funding sources, including certificates of deposits, have to reach their maturity date to reprice. Second, Sterling had a less profitable interest earning asset mix, in which federal funds sold carried significantly higher balances as the Corporation tried to increase liquidity to fund loan growth Additionally, the market area served by Sterling is highly competitive, resulting in financial institutions pricing quality credits competitively in order to increase volume. Finally, the decline in net interest margin was due to increased reliance on third party borrowings to fund both finance and operating leases. This impacts the margin in two ways. First, third party funding tends to be more costly than average rates paid on deposit accounts, and the interest expense associated with funding attributed to the operating lease portfolio increases interest expense, but the revenues earned on operating leases appear as rental income, and not interest income. Average earning assets were $1,629,482,000 in 2001, an increase of 9.5% over 2000's balance of $1,488,459,000. Average earning assets for 1999 totaled $1,369,308,000. Loan growth was the primary contributor to the increase in average earning assets during these periods. Average loans totaled $1,071,157,000 for the year ended December 31, 2001, compared to $1,006,794,000 in 2000 and $921,062,000 in 1999. The favorable economic climate in Sterling's market area has resulted in strong commercial loan demand, fueling the growth in the loan balances. Additionally, strong marketing efforts to professionals in the market area has resulted in increased referrals, as these professionals have a greater awareness of Sterling's products and services. Sterling has also experienced growth in the consumer loan balances, due to effective marketing campaigns. Average securities were $493,591,000 in 2001, versus $452,611,000 in 2000 and $412,705,000 in 1999. The increase in securities, in part, reflects the growth trends in deposits during the years. Strong deposit growth, which outpaced loan growth during the year, resulted in additional funding sources being invested in the security portfolio. Many of the securities have a relatively short duration that should provide sufficient liquidity to assist in the funding of loan demand during 2002. Average interest-bearing liabilities were $1,436,190,000 in 2001, up from $1,316,687,000 in 2000 and $1,211,286,000 in 1999. Funding needs to support loan and lease growth partially led to the increase in interest-bearing liabilities in 2001 and 2000, with the continued shift in mix from lower-cost demand and savings deposits to time deposits and borrowed money. 13 TABLE 1 - DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY INTEREST RATES AND INTEREST DIFFERENTIAL-TAX EQUIVALENT YIELDS (UNAUDITED)
Years Ended December 31, ---------------------------------------------------------- 2001 ---------------------------------------------------------- Average Balance Interest Annual Rate ------------------- ---------------- ----------------- Assets: Federal funds sold $63,070 $2,040 3.23% Interest-bearing deposits with banks 1,664 61 3.68% Securities: U.S. Treasury 25,374 1,322 5.21% U.S. Government agencies 138,173 8,726 6.32% State and municipal 191,773 14,336 7.48% Other 138,271 8,755 6.33% ------------------- ---------------- ----------------- Total securities 493,591 33,139 6.71% ------------------- ---------------- ----------------- Loans: Commercial 552,534 43,527 7.88% Consumer 279,057 23,346 8.37% Mortgages 154,083 12,147 7.88% Leases 85,483 7,309 8.55% ------------------- ---------------- ----------------- Total loans 1,071,157 86,329 8.06% ------------------- ---------------- ----------------- Total interest earning assets 1,629,482 121,569 7.46% ------------------- ---------------- ----------------- Allowance for loan losses (11,374) Cash and due from banks 47,915 Other assets 111,390 ------------------- TOTAL ASSETS $1,777,413 =================== Liabilities and Stockholders' Equity: Interest-bearing liabilities: Demand deposits $435,199 $8,606 1.98% Savings deposits 167,978 3,520 2.10% Time deposits 689,797 37,486 5.43% Borrowed funds 143,216 7,662 5.35% ------------------- ---------------- ----------------- Total interest-bearing liabilities 1,436,190 57,274 3.99% ------------------- ---------------- ----------------- Demand deposits 168,678 Other liabilities 24,533 Stockholders' equity 148,012 ------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,777,413 =================== Net interest rate spread 3.47% Net interest income (FTE) Net interest margin 64,295 3.95% Taxable-equivalent adjustment (5,653) ---------------- Net interest income $58,642 ================
Years Ended December 31, ----------------------------------------------------------------- 2000 ----------------------------------------------------------------- Average Balance Interest Annual Rate --------------- -------------- ----------------- Assets: Federal funds sold $27,437 $1,786 6.51% Interest-bearing deposits with banks 1,617 111 6.86% Securities: U.S. Treasury 30,489 1,802 5.91% U.S. Government agencies 146,841 9,623 6.55% State and municipal 163,289 12,628 7.73% Other 111,992 6,882 6.15% --------------- -------------- ----------------- Total securities 452,611 30,935 6.83% --------------- -------------- ----------------- Loans: Commercial 501,154 43,057 8.59% Consumer 267,834 23,151 8.64% Mortgages 162,335 12,920 7.96% Leases 75,471 6,517 8.64% --------------- -------------- ----------------- Total loans 1,006,794 85,645 8.51% --------------- -------------- ----------------- Total interest earning assets 1,488,459 118,477 7.96% --------------- -------------- ----------------- Allowance for loan losses (11,779) Cash and due from banks 64,579 Other assets 87,348 --------------- TOTAL ASSETS $1,628,607 =============== Liabilities and Stockholders' Equity: Interest-bearing liabilities: Demand deposits $413,486 $11,930 2.89% Savings deposits 138,262 2,786 2.02% Time deposits 635,765 35,929 5.65% Borrowed funds 129,174 7,856 6.08% --------------- -------------- ----------------- Total interest-bearing liabilities 1,316,687 58,501 4.44% --------------- -------------- ----------------- Demand deposits 158,560 Other liabilities 25,825 Stockholders' equity 127,535 --------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,628,607 =============== Net interest rate spread 3.52% Net interest income (FTE) Net interest margin 59,976 4.03% Taxable-equivalent adjustment (5,158) -------------- Net interest income $54,818 ==============
Years Ended December 31, ------------------------------------------------------------ 1999 ------------------------------------------------------------ Average Balance Interest Annual Rate ----------------- ------------------ ---------------- Assets: Federal funds sold $33,401 $1,671 5.00% Interest-bearing deposits with banks 2,140 139 6.50% Securities: U.S. Treasury 40,860 2,393 5.86% U.S. Government agencies 130,250 8,204 6.30% State and municipal 131,480 10,331 7.86% Other 110,115 6,057 5.50% ----------------- ------------------ ---------------- Total securities 412,705 26,985 6.54% ----------------- ------------------ ---------------- Loans: Commercial 445,140 37,307 8.38% Consumer 257,117 21,513 8.37% Mortgages 153,797 12,168 7.91% Leases 65,008 6,044 9.30% ----------------- ------------------ ---------------- Total loans 921,062 77,032 8.36% ----------------- ------------------ ---------------- Total interest earning assets 1,369,308 105,827 7.73% ----------------- ------------------ ---------------- Allowance for loan losses (11,780) Cash and due from banks 49,737 Other assets 108,198 ----------------- TOTAL ASSETS $1,515,463 ================= Liabilities and Stockholders' Equity: Interest-bearing liabilities: Demand deposits $420,159 $10,262 2.44% Savings deposits 129,887 2,587 1.99% Time deposits 555,849 28,802 5.18% Borrowed funds 105,391 5,753 5.46% ----------------- ------------------ ---------------- Total interest-bearing liabilities 1,211,286 47,404 3.91% ----------------- ------------------ ---------------- Demand deposits 148,208 Other liabilities 31,327 Stockholders' equity 124,642 ----------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,515,463 ================= Net interest rate spread 3.82% Net interest income (FTE) Net interest margin 58,423 4.27% Taxable-equivalent adjustment (4,201) ------------------ Net interest income $54,222 ==================
Yields on tax-exempt assets have been computed on a fully taxable equivalent basis assuming a 35% tax rate. For yield calculation purposes, nonaccruing loans are included in the average loan balance. 14 TABLE 2 - ANALYSIS OF CHANGES IN NET INTEREST INCOME The rate-volume variance analysis set forth in the table below, which is computed on a taxable equivalent basis, compares changes in net interest income for the periods indicated by their rate and volume components. The change in interest income/expense due to both volume and rate has been allocated to change in rate.
2001 VERSUS 2000 2000 Versus 1999 --------------------------------------- ---------------------------------------- Increase/(Decrease) DUE TO CHANGES IN Due to Changes in --------------------------------------- ---------------------------------------- VOLUME RATE TOTAL Volume Rate Total -------- -------- -------- -------- -------- -------- Interest income: Federal funds sold $2,320 $(2,066) $254 $(298) $413 $115 Interest-bearing deposits with banks 3 (53) (50) (34) 6 (28) Securities 2,801 (597) 2,204 2,609 1,341 3,950 Loans 5,475 (4,791) 684 7,170 1,443 8,613 -------- -------- -------- -------- -------- -------- Total interest income 10,599 (7,507) 3,092 9,447 3,203 12,650 -------- -------- -------- -------- -------- -------- Interest expense: Interest-bearing demand 626 (3,950) (3,324) (163) 1,831 1,668 Savings deposits 599 135 734 167 32 199 Time deposits 3,054 (1,497) 1,557 4,141 2,986 7,127 Borrowed funds 854 (1,048) (194) 1,298 805 2,103 -------- -------- -------- -------- -------- -------- Total interest expense 5,133 (6,360) (1,227) 5,443 5,654 11,097 -------- -------- -------- -------- -------- -------- Net interest income $5,466 $(1,147) $4,319 $4,004 $(2,451) $1,553 ======== ======== ======== ======== ======== ========
For yield calculation purposes, nonaccruing loans are included in the average loan balances. PROVISION FOR LOAN LOSSES The provision for loan losses charged against earnings was $1,217,000 in 2001, compared to $605,000 in 2000 and $1,060,000 in 1999. Sterling adjusts the provision for loan losses periodically as deemed necessary to maintain the allowance at a level deemed to meet the risk characteristics of the loan portfolio. The $612,000, or 101%, increase in the provision for loan losses during 2001 compared to 2000, was reflective of increases in net charge-offs and some deterioration in asset quality ratios. See further discussion in the asset quality discussion of this annual report. 15 NONINTEREST INCOME Details of noninterest income follow: TABLE 3 - NONINTEREST INCOME
2001 VERSUS 2000 --------------------------------------------------------------------------- Increase/(Decrease) 2001 AMOUNT % 2000 --------------- ------------------ ------------- ----------------- Income from fiduciary activities $4,166 $224 5.7% $3,942 Service charges on deposit accounts 4,897 176 3.7% 4,721 Other service charges, commissions and fees 4,188 548 15.1% 3,640 Mortgage banking income 2,222 1,388 166.4% 834 Gain on sale of real estate 21 (322) (93.9)% 343 Rental income on leased property 24,319 2,140 9.6% 22,179 Other operating income 1,402 244 21.1% 1,158 Securities gains 2,710 2,019 292.2% 691 --------------- ------------------ ------------- ----------------- Total $43,925 $6,417 17.1% $37,508 =============== ================== ============= =================
2000 VERSUS 1999 ---------------------------------------------------------- Increase/(Decrease) AMOUNT % 1999 ------------------ ------------- ----------------- Income from fiduciary activities $437 12.5% $3,505 Service charges on deposit accounts (12) (0.3%) 4,733 Other service charges, commissions and fees 327 9.9% 3,313 Mortgage banking income (613) (42.4)% 1,447 Gain on sale of real estate 343 100% - Rental income on leased property 3,710 20.1% 18,469 Other operating income 301 35.1% 857 Securities gains (524) (43.1)% 1,215 ------------------ ------------- ----------------- Total $3,969 11.8% $33,539 ================== ============= =================
Noninterest income totaled $43,925,000 for the year ended December 31, 2001, a 17.1% increase over 2000. For the year ended December 31, 2000, noninterest income totaled $37,508,000, an increase of 11.8% over 1999 totals. Income from fiduciary activities, which includes both institutional trust and personal wealth management services, grew to $4,166,000 for the year ended December 31, 2001, up from $3,942,000 in 2000 and $3,505,000 in 1999. A higher level of assets under management supported the revenue increases in both 2001 and 2000. At December 31, 2001, Sterling had total assets under administration of approximately $980 million compared to $887 million at the end of 2000 and $856 million at the end of 1999. These numbers include assets under management of $737 million, $662 million and $636 million at December 31, 2001, 2000 and 1999. The positive effects of new business development were able to offset the market declines in the past two years that would negatively influence fee-based income. This resulted in the positive gains noted in both income from fiduciary activities and assets under administration. Management strongly believes that wealth management business represents a significant growth opportunity for the Corporation. Sterling will continue its concerted efforts to expand this business, including marketing efforts aimed at cross-selling these services, and the hiring of experienced professionals. In addition, effective January 1, 2002, the wealth management divisions of Bank of Lancaster County and Bank of Hanover were combined into a single entity, Sterling Financial Trust Company. Through the formation of a separate trust company, Sterling believes it will be able to increase revenue generation opportunities, while increasing operating efficiencies. Other service charges, commissions and fees totaled $4,188,000 in 2001, a 15.1% increase over 2000's total of $3,640,000. 2000 experienced a similar increase over 1999's results, which totaled $3,313,000. Increased customer debit card usage, higher fees implemented in the latter half of 1999 on non-customer ATM transactions and higher volumes of customers enrolled in cash management programs have led to the revenue increases in this category. Mortgage banking income totaled $2,222,000 in 2001, compared to $834,000 in 2000 and $1,447,000 in 1999. Mortgage banking income has been favorably influenced by the trend noted in the financial services industry, which has seen an increased volume of mortgage loan originations/refinancing 16 during 2001. This increase in originations/refinancing volumes is the direct result of lower interest rates on mortgage loan products offered in 2001 versus 2000. This lower interest rate environment has accelerated prepayment speeds. During 2001, Sterling recognized a $21,000 gain on the sale of Maryland real estate, versus a $343,000 gain in 2000. Rental income on operating leases has increased 9.6% from $22,179,000 in 2000 to $24,319,000 in 2001. This follows an increase of 20.1% in 2000 over 1999 results. The increase in rental income is primarily due to an increase in the number of units under operating leases, which totaled 5,864, 5,330 and 4,648 as of December 31, 2001, 2000 and 1999. Sterling recognizes that leasing operations represent a growth opportunity for the corporation and has committed resources to expand this line of business. These resources include increased marketing efforts, not only in developing new customer relationships, but also in maintaining existing customer relationships. Other operating income totaled $1,402,000 for the year ended December 31, 2001, an increase of $244,000, or 21.1%, over 2000's operating of $1,158,000. The 2000 increase is primarily attributable to the revenues generated from reinsurance credit life and disability activities that began in 2001, through Sterling's Cayman Island captive reinsurance company. The $301,000 increase in other operating income in 2000 over 1999 is the result of normal increases in other operating income levels that have been supplemented in the current year with the reinsurance activities. Securities gains and losses, all from the available-for-sale portfolio, are summarized as follows:
2001 2000 1999 -------------------- --------------- ----------------- Net realized gains (losses): Debt securities Gains $728 $291 $162 Losses (51) (136) (150) Equity securities Gains 2,442 751 1,288 Losses ( 409) (215) (85) -------------------- --------------- ---------------- $2,710 $691 $1,215 ==================== =============== ================
Gains and losses on debt securities are realized as part of ongoing investment portfolio and balance sheet management strategies. Equity security gains and losses are generated primarily through Sterling's equity portfolio of financial institution sector stocks. NONINTEREST EXPENSES Details of noninterest expense follow: 17 TABLE 4 - NONINTEREST EXPENSES
2001 VERSUS 2000 2000 VERSUS 1999 ---------------------- -------------------- Increase/(Decrease) 2001 AMOUNT % 2000 AMOUNT % 1999 ------- ------- ------- ------- ------- ----- ------- Salaries and employee benefits $30,990 $3,211 11.6% $27,779 $1,530 5.8% $26,249 Net occupancy 3,826 395 11.5% 3,431 338 10.9% 3,093 Furniture & equipment 5,081 471 10.2% 4,610 (12) (0.3)% 4,622 Professional services 2,412 453 23.1% 1,959 (291) (12.9)% 2,250 Depreciation on operating lease assets 19,217 1,748 10.0% 17,469 2,828 19.3% 14,641 Merger related and restructuring costs -- (2,898) (100)% 2,898 2,475 585.1% 423 Other 13,646 1,589 13.2% 12,057 876 7.8% 11,181 ------- ------- ------- ------- ------- ------- ------- Total $75,172 $4,969 7.1% $70,203 $7,744 12.4% $62,459 ======= ======= ======= ======= ======= ======= =======
The largest component of noninterest expense is salaries and employee benefits, which increased $3,211,000, or 11.6%, to $30,990,000 in 2001, after increasing $1,530,000 or 5.8% in 2000. The increase in salaries and employee benefits during 2001 is attributable to the following factors: - Normal merit increases for employees; - The growth that Sterling has experienced, including several branches opened throughout 2000 which were fully operational for the entire year and two new branches opened in the fourth quarter of 2001; - Duplication of a limited number of positions, in anticipation of operations staff relocating from Hanover to Lancaster. As a result, training had to be completed for new employees, while severed employees worked through their arranged dates resulting in some redundancy of positions; - Increased overtime pay and temporary help incurred as result of the additional efforts required to ensure four successful core processing system conversions that occurred throughout 2001; and - Increases in employee benefit costs, particularly health and welfare benefit plans, consistent with the increased health care cost trend noted nationwide. Net occupancy expense totaled $3,826,000 in 2001, $3,431,000 in 2000 and $3,093,000 in 1999. The 11.5% increase experienced in 2001 was primarily the result of several branches that opened throughout 2000, which were fully operational for the entire 2001 year. Additionally, expansion and renovations made at other existing branches led to the increase in occupancy expense. Similarly, the 10.2%, or $471,000 increase in furniture and equipment expense during 2001 versus 2000 was the result of an increase in number of locations, as well as the increased maintenance costs associated with more sophisticated delivery channels offered to our customer base. Professional service expense totaled $2,412,000 for the year ended December 31, 2001, a 23.1% increase over 2000 results. This followed a 12.9% decrease in professional service expense experienced in 2000 as compared to 1999. The increase in professional services can be attributed to the following factors: - Sterling's continued reliance on services outsourced to third parties who can bring a greater degree of knowledge and experience to the organization that can be obtained internally; - Obtain temporary professional resources to assist in the four core processing conversions that took place throughout 2001; - Legal and other consulting fees associated with the formation of two new business ventures, including Sterling Financial Trust Company and Professional Services Group; and - Management's desire to increase awareness of the parent company's name. As a result, 18 professional service fees were incurred in establishing, reserving and preserving the "Sterling" name in the communities served. Depreciation on operating lease assets totaled $19,217,000 in 2001, $17,469,000 in 2000, and $14,641,000 in 1999. The 10.0% and 19.3% increases noted in 2001 and 2000 are consistent with the 9.6% and 20.1% increases noted in rental income on operating leases discussed above. Depreciation on operating lease assets as a percent of rental income on operating leases remained at approximately 79% for all three years. During the third quarter of 2000, Sterling completed its merger with Hanover Bancorp, Inc. and incurred $2,898,000 of merger related and restructuring charges. The direct costs that resulted from the merger totaled $1,426,000, and consisted principally of legal, accounting, investment advising fees, as well as regulatory filing fees and other miscellaneous expenses. In addition, Sterling incurred restructuring costs totaling $1,472,000, which primarily consists of severance and related benefits, professional fees, termination fees related to non-cancelable service contracts and asset write-offs related to conversion of the banking subsidiaries into a common core processing system. Sterling expects the conversion of the banking subsidiaries into one common core processing system will result in operating efficiencies through a better leveraging of technology, a greater array of products being offered to customers, and better customer service. The conversion to the new core processing system and resulting reduction in the workforce is expected to result in an estimated net annual savings of approximately $1.5 million. Of this amount, approximately 33% was realized in 2001 and 100% will be realized in years 2002 and beyond. The following summarizes the restructuring expenses charged to operations during 2000, and the remaining restructuring accrual balance at December 31, 2001. The remaining unpaid expenses will be paid throughout 2001-2002.
Initial Remaining Expense Accrual ----------------------------- ---------------------------- Employee termination $718 $355 Asset disposal/write-downs 334 - Noncancelable contracts 312 121 Professional fees 88 28 Other 20 - ----------------------------- ---------------------------- $1,472 $504 ============================= ============================
Merger related costs during 1999 totaled $423,000 and was a direct result of Sterling's acquisition of Northeast Bancorp, Inc. completed in June 1999. These merger expenses consisted entirely of attorney, accountant, investment advisory and application fees. Other noninterest expenses totaled $13,646,000 during 2001, versus $12,057,000 in 2000 and $11,181,000 in 1999. Significant expense components in this category include marketing and advertising, postage, utilities, MAC fees, and Pennsylvania Shares Tax. The increase in expense noted during 2001 and 2000 was the direct result of Sterling's overall growth, which requires many of these types of expenses to increase as well. Operating expenses levels are often measured by the efficiency ratio, which expresses noninterest expense, excluding merger related and restructuring charges, as a percentage of tax-equivalent net interest income and other income. In calculating its efficiency ratio, Sterling nets depreciation on operating leases with the related rental income to more consistently present operating results with the banking industry. The efficiency ratio was 63.9%, 62.9% and 62.3% for the years ended December 31, 2001, 2000 and 1999. The deterioration in the efficiency ratio can be attributed to compression in the net interest margin, certain redundancies in operational staffing related to centralizing 19 support units, and the opening of five denovo branches throughout 2000 and 2001 whose revenue streams are growing. INCOME TAXES Sterling recognized income taxes of $5,844,000, or 22.3% of pre-tax income, in 2001. Income tax expense totaled $4,951,000, or 23.0% of pretax income in 2000, and $6,257,000 or 25.8% of pre-tax income in 1999. The variances from the federal statutory rate of 35% are generally due to tax-exempt income, investments in low-income housing partnerships (which qualify for federal tax credits), offset somewhat by certain non-deductible merger related costs and state income taxes. The decline in the effective tax rate during 2001 is a result of non-deductible merger costs expensed in 2000, with no similar costs incurred in 2001. The downward trend in the effective tax rate from 1999 to 2001 is consistent with the increase in tax-free investment securities during this period. FINANCIAL CONDITION Average earning assets increased in 2001 to $1,629,482,000 from $1,488,459,000 in 2000 and $1,369,308,000 in 1999. Solid growth in commercial loans, consumer loans, and finance leases contributed greatly to the increase in average earning assets. Additionally, Sterling's security portfolio increased over the last three years, as a result of its funding exceeding the loan demand. Average funding sources, or interest bearing liabilities, increased in 2001 to $1,436,190,000 from $1,316,687,000 in 2000 and $1,211,286,000 in 1999. INVESTMENT SECURITIES Sterling utilizes investment securities to generate interest and dividend income, to manage interest rate risk, and to provide liquidity. The growth in the security portfolio, in part, reflects the trends in loans, deposits, and borrowed funds during 2001. As deposit and borrowing growth outpaced loan growth during 2001, excess funding was invested in the securities portfolio. Much of the investment activity focused on U.S. Government agencies, tax-free municipal, and corporate securities. These securities provide the appropriate characteristics with respect to yield and maturity relative to the management of the overall balance sheet. At December 31, 2001, the securities balance included a net unrealized gain on available-for-sale securities of $8,357,000, versus a net unrealized gain of $3,851,000 at December 31, 2000. The reduction in long-term interest rates at December 31, 2001 versus 2000 led to the appreciation in the fair value of securities during 2001. TABLE 5 - INVESTMENT SECURITIES The following table shows the amortized cost of the held-to-maturity securities owned by Sterling as of the dates indicated. Securities are stated at cost adjusted for amortization of premiums and accretion of discounts. 20
DECEMBER 31, ---------------------------------------------- 2001 2000 1999 -------------- --------------- --------------- U.S. Treasury securities $- $- $501 U.S. Government agencies 109 604 1,460 States and political subdivisions 33,757 39,151 42,518 Mortgage-backed securities 497 676 1,033 Corporate securities 1,540 2,866 4,757 -------------- --------------- --------------- Subtotal 35,903 43,297 50,269 Non-marketable equity securities 5,885 7,788 8,160 -------------- --------------- --------------- Total $41,788 $51,085 $58,429 ============== =============== ===============
The following table shows the amortized cost and fair value of the available-for-sale securities owned as of the dates indicated.
DECEMBER 31, ----------------------------------------------------------------------- 2001 2000 1999 ----------------------- ----------------------- ----------------------- AMORTIZED AMORTIZED AMORTIZED COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE ----------- ----------- ----------- ----------- ----------- ----------- U.S. Treasury securities $15,188 $15,685 $35,835 $35,986 $37,010 $36,814 U.S. Government agencies 87,714 89,569 70,711 70,988 59,081 57,726 States and political subdivisions 164,357 164,746 139,343 139,064 111,969 107,011 Mortgage-backed securities 57,232 57,781 73,447 72,812 83,149 79,975 Corporate securities 148,734 151,044 100,407 100,698 82,346 80,848 ----------- ----------- ----------- ----------- ----------- ----------- Subtotal 473,225 478,825 419,743 419,548 373,555 362,374 Equity securities 9,373 12,130 11,702 15,748 8,504 9,824 ----------- ----------- ----------- ----------- ----------- ----------- Total $482,598 $490,955 $431,445 $435,296 $382,059 $372,198 =========== =========== =========== =========== =========== ===========
TABLE 6 - INVESTMENT SECURITIES (YIELDS) The following table shows the maturities of held-to-maturity debt securities at amortized cost as of December 31, 2001 and approximate weighted average yields of such securities. Yields on states and political subdivision securities are shown on a tax equivalent basis, assuming a 35% federal income tax rate.
OVER 1 THRU 5 OVER 5 THRU 1 YEAR AND LESS YEARS 10 YEARS OVER 10 YEARS TOTAL ---------------- ------------------ ----------------- ------------------ ------------------ AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD ------- ------- --------- ------- -------- ------- --------- ------- --------- ------- U.S. Government agencies $- 0.00% $- 0.00% $44 5.71% $65 6.10% $109 5.94% States and political subdivisions 2,021 6.66% 11,897 7.40% 18,443 7.08% 1,396 7.67% 33,757 7.19% Mortgage-backed securities 18 7.92% 272 7.59% 156 8.67% 51 6.21% 497 7.80% Corporate securities 526 6.04% 501 6.05% - - 513 9.36% 1,540 7.15% ------- ------- --------- ------- -------- ------- --------- ------- --------- ------- Total $2,565 6.54% $12,670 7.35% $18,643 7.09% $ 2,025 8.02% $35,903 7.20% ======= ======= ========= ======= ======== ======= ========= ======= ========= =======
The following table shows the maturities of available-for-sale debt securities at fair value as of December 31, 2001 and approximate weighted average yields of such securities. Yields on states and political subdivision securities are shown on a tax equivalent basis, assuming a 35% federal income tax rate. 21
OVER 1 THRU 5 OVER 5 THRU 10 1 YEAR AND LESS YEARS YEARS OVER 10 YEARS TOTAL ---------------- ------------------ ----------------- --------- ------- ------------------ AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD ------- ------- --------- ------- -------- ------- --------- ------- --------- ------- U.S. Treasury securities $7,423 5.48% $8,262 5.55% $- .00% $- .00% $15,685 5.52% U.S. Government agencies 5,326 5.59% 58,800 5.32% 22,013 6.03% 3,430 6.33% 89,569 5.55% States and political subdivisions 2,073 6.56% 21,479 6.54% 33,675 6.69% 107,519 7.29% 164,746 7.06% Mortgage-backed securities 192 4.80% 6,161 5.85% 7,033 5.32% 44,395 6.58% 57,781 6.34% Corporate securities 27,722 6.36% 109,440 6.06% 7,891 5.81% 5,991 4.75% 151,044 6.05% ------- ------- --------- ------- -------- ------- --------- ------- --------- ------- Total $42,736 6.11% $204,142 5.87% $70,612 6.25% $161,335 6.98% $478,825 6.32% ======= ======= ========= ======= ======== ======= ========= ======= ========= =======
There is no issuer of securities in which the aggregate book value of that issuer, other than securities of the U.S. Treasury, U.S. Government agencies or corporations, exceeds 10% of stockholders' equity. LOANS Loans outstanding increased $64,958,000, or 6.3% in 2001, compared to 7.8% growth experienced in 2000. The growth in loans is consistent with a stable local economy, and continued for loans to support existing customers' growth. The commercial loan portfolio experienced strong growth during the period, increased by $75,461,000, or 14.4%. This growth trend is consistent with the trend noted in prior years, and is the result of actively marketing commercial services to professionals in the target market, leading to an increased referral base. Additionally, Sterling has been able to develop a network of regional community banks to participate loans. The $25,421,000 decrease in real estate mortgage loans has been a result of increasing our emphasis on commercial loan products, combined with holding fewer mortgage loans for portfolio. As mentioned previously, interest rates hit 30 year lows, which produced a great deal of refinancings of portfolio loans. Given the low interest rates on newly originated loans, management has sold a higher percentage of mortgage loans in the secondary market than in the past in order to manage its interest rate risk position. TABLE 7 - LOAN PORTFOLIO The following table sets forth the composition of Sterling's loan portfolio as of the dates indicated:
DECEMBER 31, ---------------------------------------------------------------------- 2001 2000 1999 1998 1997 ------------- ------------- ------------- ------------- -------------- Commercial, financial and agricultural $598,174 $522,713 $456,958 $418,469 $384,343 Real estate-construction 19,710 9,665 9,127 8,164 8,345 Real estate-mortgage 117,293 142,534 155,894 146,515 150,171 Consumer 279,139 279,645 263,356 247,855 246,610 Lease financing (net of unearned income) 83,857 78,658 73,123 57,736 52,566 ------------- ------------- ------------- ------------- -------------- Total $1,098,173 $1,033,215 $958,458 $878,739 $842,035 ============= ============= ============= ============= ==============
22 TABLE 8 - LOAN MATURITY AND INTEREST SENSITIVITY The following table sets forth the maturity of the loan portfolio as of December 31, 2001:
AFTER ONE WITHIN ONE BUT WITHIN AFTER FIVE YEAR FIVE YEARS YEARS TOTAL ------------- ------------- ------------- -------------- Commercial, financial and agricultural $73,910 $158,079 $366,185 $598,174 Real estate-construction 11,370 2,842 5,498 19,710 ------------- ------------- ------------- -------------- $85,280 $160,921 $371,683 $617,884 ============= ============= ============= ==============
Loans due after one year totaling $176,066,000 have variable interest rates. The remaining $356,538,000 in loans have fixed rates. ASSET QUALITY Sterling's loan portfolios are subject to varying degrees of credit risk. Credit risk is mitigated through prudent underwriting standards, on-going credit review, and monitoring and reporting asset quality measures. Additionally, loan portfolio diversification, limiting exposure to a single industry or borrower, and requiring collateral also reduces Sterling's credit risk. Sterling's commercial, consumer and residential mortgage loans are principally to borrowers in south central Pennsylvania and northern Maryland. As the majority of Sterling's loans are located in this area, a substantial portion of the debtor's ability to honor their obligations may be affected by the level of economic activity in the market area. The unemployment rate in Sterling's market area remained below the national average during 2001. Additionally, reasonably low interest rates, a stable local economy and minimal inflation continued to support favorable economic conditions in the area. Non-performing assets include nonaccrual and restructured loans, accruing loans past due 90 days or more and other foreclosed assets. Sterling's general policy has been to cease accruing interest on loans when management determines that a reasonable doubt exists as to the collectibility of additional interest. When management places a loan on nonaccrual status, it reverses unpaid interest credited to income. Sterling recognizes income on these loans only to the extent that it receives cash payments. Sterling typically returns nonaccrual loans to performing status when the borrower brings the loan current and performs in accordance with contractual terms for a reasonable period of time. Sterling categorizes a loan as restructured if it changes the terms of the loan such as interest rate, repayment schedule or both, to terms that it otherwise would not have granted originally. 23 TABLE 9 - NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS The following table presents information concerning the aggregate amount of nonaccrual, past due and restructured loans:
DECEMBER 31, -------------------------------------------------------------- 2001 2000 1999 1998 1997 ----------- ----------- ------------ ----------- ----------- Nonaccrual loans $6,707 $3,102 $771 $1,425 $1,645 Accruing loans, past due 90 days or more 1,562 1,145 882 1,079 1,443 Restructured loans 531 1,851 1,961 1,993 2,326 ----------- ----------- ------------ ----------- ----------- Total non-performing loans 8,800 6,098 3,614 4,497 5,414 Foreclosed assets 74 469 504 261 577 ----------- ----------- ------------ ----------- ----------- Total non-performing assets $8,874 $6,567 $4,118 $4,758 $5,991 =========== =========== ============ =========== =========== Nonaccrual loans: Interest income that would have been recorded under original terms $429 $196 $98 $138 $221 Interest income recorded 43 94 8 22 59 Ratios: Non-performing loans to total loans 0.80% 0.59% 0.38% 0.51% 0.64% Non-performing assets to total loans and foreclosed assets 0.81% 0.64% 0.43% 0.54% 0.71% Non-performing assets to total assets 0.48% 0.38% 0.26% 0.32% 0.45%
As of December 31, 2001, total non-performing assets totaled $8,874,000, an increase of $2,307,000 or 35.1% from December 31, 2000. The increase in nonaccrual loans is primarily the result of two large credits that moved into nonaccrual status during 2001. One of these loans is fully secured by real estate, while the other loan is partially secured by real estate. As a result of the increase in nonaccrual loans, Sterling experienced an increase in non-performing loans to total loans outstanding, as well as non-performing assets to total loans and foreclosed assets. However, these levels are within acceptable limits and are consistent with Sterling's peer group. Potential problem loans are defined as performing loans that have characteristics that cause management to have serious doubts as to the ability of the borrower to perform under present loan repayment terms and which may result in the reporting of these loans as nonperforming loans in the future. Total potential problem loans approximated $1.8 million at December 31, 2001. Additionally, outstanding letter of credit commitments totaling approximately $1.4 million could result in potential problem loans if drawn upon. The majority of these loans are secured by real estate with acceptable loan-to-value ratios. ALLOWANCE FOR LOAN LOSSES Sterling maintains the allowance for loan losses at a level believed adequate by management to absorb potential losses in the loan portfolio and is established through a provision for loan losses charged to earnings. Quarterly, the company utilizes a defined methodology in determining the adequacy of the allowance for loan losses, which considers specific credit reviews, past loan loss historical experience, and qualitative factors. This methodology, which has remained consistent for the past several years, results in an allowance consisting of two components, "allocated" and "unallocated." 24 Management assigns internal risk ratings to all commercial relationships with aggregate borrowings or commitments to extend credit in excess of $100,000. Utilizing migration analysis for the previous eight quarters, management develops a loss factor test, which it then uses to estimate losses on impaired loans, potential problem loans and non-classified loans. When management finds loans with uncertain collectibility of principal and interest, it places those loans on the "problem list," and evaluates them on a quarterly basis in order to estimate potential losses. Management's analysis considers: - adverse situations that may affect the borrower's ability to repay; - estimated value of underlying collateral; and - prevailing market conditions. If management determines that a specific reserve allocation is not required, it assigns the general loss factor to determine the reserve. For homogeneous loan types, such as consumer and residential mortgage loans, management bases specific allocations on the average loss ratio for the previous two years for each specific loan pool. Additionally, management adjusts projected loss ratios for other factors, including the following: - trends in delinquency levels, - trends in non-performing and potential problem loans, - trends in composition, volume and terms of loans, - effects in changes in lending policies or underwriting procedures, - experience ability and depth of management, - national and local economic conditions, - concentrations in lending activities, - other factors that management may deem appropriate. Management determines the unallocated portion of the allowance for loan losses based on the following criteria: - risk of error in the specific and general reserve allocations; - other potential exposure in the loan portfolio; - variances in management's assessment of national and local economic conditions; and - other internal or external factors that management believes appropriate at that time. Management believes the above methodology accurately reflects losses inherent in the portfolio. Management charges actual loan losses to the allowance for loan losses. Management periodically updates the methodology discussed above, which reduces the difference between actual losses and estimated losses. Management bases the provision for loan losses, or lack of provision, on the overall analysis taking into account the methodology discussed above. 25 A summary of the activity in the allowance for loan losses is as follows: TABLE 10 - SUMMARY OF LOAN LOSS EXPERIENCE
YEARS ENDED DECEMBER 31, ---------------------------------------------------------------------- 2001 2000 1999 1998 1997 ------------- ------------- --------------- ------------- ------------ Beginning balance $11,716 $11,875 $11,475 $11,050 $10,662 ------------- ------------- --------------- ------------- ------------ Loans charged off during year: Commercial, financial and agricultural 1,152 568 350 584 270 Real estate mortgage 1 53 107 116 122 Consumer 864 459 661 1,328 1,639 Lease financing 577 101 31 54 121 ------------- ------------- --------------- ------------- ------------ Total charge-offs 2,594 1,181 1,149 2,082 2,152 ------------- ------------- --------------- ------------- ------------ Recoveries: Commercial, financial and agricultural 436 95 198 112 181 Real estate mortgage - 10 - 34 - Consumer 269 301 247 317 255 Lease financing 27 11 44 28 65 ------------- ------------- --------------- ------------- ------------ Total recoveries 732 417 489 491 501 ------------- ------------- --------------- ------------- ------------ Net loans charged off 1,862 764 660 1,591 1,651 Provision for loan losses 1,217 605 1,060 2,016 2,039 ------------- ------------- --------------- ------------- ------------ Balance at end of year $11,071 $11,716 $11,875 $11,475 $11,050 ============= ============= =============== ============= ============ Ratio of net loans charged off to average loans outstanding 0.17% 0.08% 0.07% 0.18% 0.20% Ending allowance for loan losses to net loans charged off 5.9x 15.3x 18.0x 7.2x 6.7x Net loans charged off to provision for loan losses 152.9% 126.2% 62.3% 78.9% 81.0% Allowance for loan losses as a percent of total loans outstanding 1.01% 1.13% 1.24% 1.31% 1.31% Allowance for loan losses as a percent of non-performing loans 125.8% 192.1% 328.6% 255.2% 204.1%
The allowance for loan losses decreased $645,000 from $11,716,000 at December 31, 2000 to $11,071,000 at December 31, 2001. The allowance represents 1.01% of loans outstanding at December 31, 2001, versus 1.13% as of the prior year-end. Net charge-offs totaled $1,862,000 for the year ended December 31, 2001, versus $764,000 in 2000, an increase of 143.7%. A primary reason for the increase in charge-offs was a charge-off of approximately $770,000 in loans that were determined to have had fraudulent collateral associated with them. During the first quarter of 2002, Sterling recovered $598,000 in insurance proceeds, which represents a large portion of the fraudulent loans. Additionally, consumer loan charge-offs increased 88%, primarily the result of our higher consumer debt and delinquencies. The increase in the lease financing charge-offs during 2001 as compared to previous years is the result of rising fuel prices, escalating insurance costs, and a downturn in the economy, which has led to increased delinquencies and subsequent charge-offs of certain transportation industry lease receivables. As a result of the increased net loan charge-offs, Sterling increased its provision for loan losses by $612,000, or 101%. 26 TABLE 11 - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
YEARS ENDED DECEMBER 31, -------------------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ------------------ --------------- ---------------- --------------------- ------------------ Loans Loans Loans Loans Loans % to % to % to % to % to total total total total total Amount loans Amount loans Amount loans Amount loans Amount loans ---------- ------- --------- -------- --------- ------ --------- -------- --------- -------- Commercial, financial and agricultural $6,751 54% $7,816 50% $6,821 48% $5,825 47% $5,085 46% Real estate, mortgage and construction 188 13% 255 15% 256 17% 291 18% 218 19% Consumer 791 25% 1,283 27% 1,649 27% 1,585 28% 1,792 29% Leases 617 8% 512 8% 638 8% 527 7% 599 6% Unallocated 2,724 - 1,850 - 2,511 - 3,247 - 3,356 - ---------- ------- --------- -------- --------- ------ --------- -------- --------- -------- Total $11,071 100% $11,716 100% $11,875 100% $11,475 100% $11,050 100% ========== ======= ========= ======== ========= ====== ========= ======== ========= ========
The allocation of the allowance for loan losses between the various loan portfolios has changed over the past few years, consistent with the historical net loss experience in each of the portfolios. The largest reserve allocation is to the commercial, financial and agricultural loan portfolio, which represents approximately 54% of the reserve balance. Despite a 14% increase in this portfolio and higher charge-offs of commercial loans during 2001, the total reserve allocation has declined. Factors contributing to this decrease were the 2000 reserve allocation of $770,000 for fraudulent loans that were subsequently charged-off in 2001, and an overall improvement in the credit quality of the commercial loan portfolio. In the first quarter of 2002, Sterling recovered approximately $600,000 of the fraudulent loan principal balance through insurance proceeds and recorded them as a recovery. Although nonaccrual loans have increased during the year, this was primarily the result of two large credits. Absent these two credits, the overall credit rating of the portfolio has improved since 2000. This nonhomogeneous loan portfolio continues to represent the greatest risk exposure to Sterling, as the credits generally are significantly larger than the remainder of the portfolio and the related collateral is not as marketable. Additionally, other external factors such as competition for high rated credits have also been considered in allocating this reserve balance. Sterling sold its credit card portfolio in 1998, which resulted in a significant improvement in net charge-offs within the consumer loan portfolio since the sale of this portfolio. Over time, the allocation of the reserve of the consumer loan portfolio has declined, as the historical aggregate charge-offs to average loans outstanding improves, thereby resulting in a lower reserve allocation on the existing portfolio. Further, management has been more aggressive in charging off consumer loans, which results in a portfolio requiring lower reserves. This reduction in allocated allowance is due to continued decreases in net charge-offs and enhanced performance in this portfolio. During 2001, the reserve allocation related to the lease portfolio has increased, consistent with the trends noted in lease charge-offs during the period and continued uncertainty as to the impact of the economy on the slumping transportation industry. Over the past several years, the allowance for loan losses as a percent of outstanding loan balance has declined from 1.31% at December 31, 1997 to 1.01% at December 31, 2001. The unallocated portion of the allowance reflects estimated inherent losses within the portfolio that have not been detected. The unallocated portion of the reserve results due to risk of error in the specific and 27 general reserve allocations, other potential exposure in the loan portfolio, variances in management's assessment of national and local economic conditions, and other internal or external factors that management believes appropriate at the time. While management believes Sterling's allowance for loan losses is adequate based on information currently available, future adjustments to the reserve may be necessary due to changes in economic conditions, and management's assumptions as to future delinquencies or loss rates. ASSETS HELD FOR OPERATING LEASES Assets held for operating leases, net of accumulated deprecation, totaled $58,996,000 at December 31, 2001, an increase of $4,702,000 from the December 31, 2000 balance of $54,294,000. Assets held for operating leases totaled $47,639,000 at December 31, 1999. The increase is a direct result of an increase in the number of units under operating leases, which totaled 5,864, 5,330, and 4,648 as of December 31, 2001, 2000 and 1999. Operating leases have residual value risk associated with them. Operating lease terms, including monthly rental payment and length of the lease, are established based upon the residual value, or the estimate of fair value of the leased asset at the end of the lease term. If, at the end of the lease term, the fair value of the leased property is less than the residual value calculated at lease origination, a loss on disposal could result. Sterling mitigates this risk through the utilization of anticipated values published by various industries, and in some instances, discussions with industry experts. Further, the lease terms include provisions that the lessee shares the risk of loss on disposal of equipment, up to 50% of the residual value. DEPOSITS Sterling continues to rely heavily on deposit growth as the primary source of funds for lending activities. Average deposits increased 8.6%, or $116 million, in 2001. This increase is consistent with the growth trend noted in 2000. This growth has been achieved through the development of products that meets the needs of our customers. Additionally, due to consumers' confidence slipping in the stock and mutual fund markets, deposits have grown as these consumers migrate towards deposit products, which are generally regarded as safer, more liquid investments. Sterling will continue to explore new products for its customers, to mitigate increased consumer preference for higher risk investments, such as mutual funds and equity securities. An example of this is the development of a cash management product that was promoted to customers that historically had their balances swept into a non-deposit product. TABLE 12 - AVERAGE DEPOSIT BALANCES AND RATES PAID The following table summarizes the average amounts of deposits and rates paid for the years indicated:
YEARS ENDING DECEMBER 31, ----------------------------------------------------------------- 2001 2000 1999 --------------------- --------------------- --------------------- AMOUNT RATE AMOUNT RATE AMOUNT RATE ------------- ------- ------------- ------- ------------- ------- Noninterest-bearing demand deposits $168,678 0.00% $158,560 0.00% $148,208 0.00% Interest-bearing demand deposits 435,199 1.98% 413,486 2.89% 420,159 2.44% Savings deposits 167,978 2.10% 138,262 2.02% 129,887 1.99% Time deposits 689,797 5.43% 635,765 5.65% 555,849 5.18% ------------- ------------- ------------- Total $1,461,652 $1,346,073 $1,254,103 ============= ============= =============
28 TABLE 13 - DEPOSIT MATURITY The following table summarizes the maturities of time deposits of $100,000 or more as of the dates indicated:
DECEMBER 31, ---------------------------- 2001 2000 ------------- -------------- Three months or less $21,464 $22,274 Over three through six months 49,001 19,280 Over six through twelve months 23,091 21,995 Over twelve months 9,369 31,853 ------------- -------------- Total $102,925 $95,402 ============= ==============
BORROWINGS Short-term borrowings are comprised primarily of securities sold under agreements to repurchase, U.S. Treasury demand notes and lines of credit. As of December 31, 2001, short-term borrowings totaled $20,285,000, a decline of $5,371,000 from the December 31, 2000 balance of $25,656,000. Long-term debt consists primarily of advances from the Federal Home Loan Bank and borrowings from other financial institutions to fund Sterling's growth in its finance and operating lease portfolios. Long-term debt totaled $121,093,000 at December 31, 2001, an increase of $7,243,000 from December 31, 2000. Sterling increased its reliance on long-term debt during 2001, including utilization of long-term debt to reduce its short-term obligations. The increase in long-term debt was a direct result of management's intention to capitalize on the 30 year lows in interest rates, and matching finance and operating lease growth with these long-term funds. CAPITAL The management of capital in a regulated financial services industry must properly balance return on equity to stockholders while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. Additionally, capital management must also consider acquisition opportunities that may exist, and the resulting accounting treatment. Sterling's capital management strategies have been developed to provide attractive rates of returns to stockholders, while maintaining its "well-capitalized" position at each of the banking subsidiaries. The primary source of additional capital to Sterling is earnings retention, which represents net income less dividends declared. During 2001, Sterling retained $10,562,000, or 52%, of its net income. Stockholders' equity also increased as a result of $2,935,000 in other comprehensive income, which relates exclusively to unrealized gains on securities available-for-sale. During the first quarter of 2001, Sterling announced the Board of Directors authorized the repurchase of up to 150,000 shares of its outstanding common stock. Through December 31, 2001, 53,077 shares have been repurchased under this program at an average price of $20.00. Sterling and its banking subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Sterling and the subsidiary banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Sterling and its banking subsidiaries must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The 29 capital amounts and reclassifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require Sterling and its banking subsidiaries to maintain minimum amounts and ratios of total and Tier 1 capital to average assets. Management believes, as of December 31, 2001 and 2000 that Sterling and the subsidiary banks met all minimum capital adequacy requirements to which they are subject and are categorized as "well capitalized." There are no conditions or events since the notification that management believes have changed the subsidiary banks' category. TABLE 14 - RISKED-BASED CAPITAL Sterling's actual capital amount and ratios are as follows:
MINIMUM CAPITAL ACTUAL CAPITAL REQUIREMENT --------------------------- ---------------------------- AMOUNT RATIO AMOUNT RATIO ------------- ------------- ------------- -------------- December 31, 2001 Total capital to risked weighted assets $157,350 11.0% $114,742 8.0% Tier 1 capital to risked weighted assets 144,960 10.1% 57,371 4.0% Tier 1 capital to average assets 144,960 7.8% 74,202 4.0% December 31, 2000 Total capital to risked weighted assets $148,361 11.5% $103,099 8.0% Tier 1 capital to risked weighted assets 135,086 10.5% 51,549 4.0% Tier 1 capital to average assets 135,086 7.4% 72,852 4.0%
On March 14,2002, Sterling and its newly created financing subsidiary, Sterling Financial Statutory Trust I, a Connecticut business trust, entered in to a placement agreement in which the Trust will issue $20 million of trust preferred securities to investors. Dividends on the securities are variable at a rate equal to 3-month LIBOR plus 360 basis points, and adjusts quarterly. The initial dividend rate is 5.59%. Sterling Financial Statutory Trust I will invest 100% of the proceeds into junior subordinated debentures of Sterling Financial Corporation that have the same terms of the preferred securities. Sterling's obligations under the debentures and related documents taken together, constitute a full and unconditional guarantee by Sterling of the Trust's obligations under the preferred securities. The preferred securities must be redeemed upon maturity of the subordinated debentures in March 2032. LIQUIDITY Effective liquidity management ensures the cash flow requirements of depositors and borrowers, as well as the operating cash needs of Sterling are met. Sterling's funds are available from a variety of sources, including assets that are readily convertible to cash (federal funds sold, short-term investments), securities portfolio, scheduled repayments of loans receivable, core deposit base, short-term borrowing capacity with a number of correspondent banks and the FHLB, and the ability to package residential mortgage loans originated for sale. As of December 31, 2001, capacity to borrow from the FHLB totaled approximately $122 million. The liquidity of the parent company also represents an important aspect of liquidity management. The parent company's cash outflows consist principally of dividends to shareholders and unallocated corporate expenses. The main source of funding for the parent company is the dividends it receives from its banking subsidiaries. Federal and state banking regulations place certain restrictions on dividends paid to the parent company from the subsidiary banks. The total amount of dividends that may be paid from the subsidiary banks to Sterling total $36,797,000 at December 31, 2001. 30 Sterling manages liquidity by monitoring projected cash inflows and outflows on a daily basis, and believes it has sufficient funding sources to maintain sufficient liquidity under varying degrees of business conditions. NEW FINANCIAL ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, requires all derivative instruments to be carried at fair value on the balance sheet. This requirement is in contrast to previous accounting guidance, which did not require unrealized gains and losses on derivatives used for hedging purposes to be recorded in the financial statements. The new statement does allow hedge accounting treatment for derivatives used to hedge various risks and sets forth specific criteria to be used to determine when hedge accounting can be applied. Hedge accounting treatment provides for changes in fair value or cash flows of both the derivative and the hedged item to be recognized in earnings in the same period. Statement No. 133 does not change the accounting for those derivative instruments not designated in a hedge accounting relationship, considered trading derivatives, for which fair value changes are recorded through earnings as they occur. On January 1, 2001, Sterling adopted the provisions of Statement No. 133, with no material impact on Sterling's financial condition or results of operations. In September 2000, Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities was issued. This statement replaces Statement No. 125. The guidance in Statement No. 140, while not changing most of the guidance originally issued in Statement No. 125, revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain additional disclosures related to transferred assets. Certain provisions of the statement relate to recognition, reclassification and disclosure of collateral, as well as the disclosure of securitization transactions, became effective for Sterling for 2000 year-end reporting. Other provisions related to the transfer and servicing of financial assets and extinguishments of liabilities were effective for transactions occurring after March 31, 2001. The application of the new rules did not have a material impact on Sterling's financial condition, results of operations, or liquidity. In June 2001, Statement No. 141, Business Combinations, was issued. Statement No. 141 requires all business combinations to be accounted for by the purchase method of accounting and eliminates the pooling-of-interest method of accounting for business combinations that was previously allowed by APB Opinion 16. Statement No. 141 will affect future business combinations, if undertaken; the issuance of the new guidance had no effect on the Corporation's results of operations, financial position or liquidity. In connection with the issuance of the new guidance for business combinations, the FASB also issued Statement No. 142, Goodwill and Other Intangible Assets, which supersedes APB Opinion 17, and addresses the accounting and reporting for acquired goodwill and other intangible assets. Under Statement No. 142, goodwill (other than goodwill enacted under FASB Statement No. 72, Acquisitions by Bank and Thrift Institutions) and certain other intangible assets, which do not possess finite useful lives, will no longer be amortized into net income over an estimated life but rather will be tested at least annually for impairment based on specific guidance provided in the new standard. Intangible assets determined to have finite lives will continue to be amortized over their estimated useful lives and also continue to be subject to impairment testing. Under current rules, Statement No. 72 goodwill shall continue to be amortized upon adoption of Statement No. 142. The provisions of Statement No. 142, including Statement No. 72 considerations, were adopted by Sterling as required on January 1, 2002. Application of this statement did not have a material impact on Sterling's financial condition or results of operations. 31 ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Financial institutions can be exposed to several market risks that may impact the value or future earnings capacity of an organization. These risks involve interest rate risk, foreign currency exchange risk, commodity price risk and equity market price risk. Sterling's primary market risk is interest rate risk. Interest rate risk is inherent because as a financial institution, Sterling derives a significant amount of its operating revenue from "purchasing" funds (customer deposits and borrowings) at various terms and rates. These funds are then invested into earning assets (loans, leases, investments, etc.) at various terms and rates. This risk is further discussed below. Equity market risk is not a significant risk to the corporation as equity investments on a cost basis comprise less than 1% of corporate assets. Sterling does not have any exposure to foreign currency exchange risk or commodity price risk. INTEREST RATE RISK Interest rate risk is the exposure to fluctuations in the corporation's future earnings (earnings at risk) and value (value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest earning assets and interest bearing liabilities that reprice within a specified time period as a result of scheduled maturities and repayment and contractual interest rate changes. The primary objective of the corporation's asset/liability management process is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent and appropriate yet is not essential to the corporation's profitability. Thus the goal of interest rate risk management is to maintain a balance between risk and reward such that net interest income is maximized while risk is maintained at a tolerable level. Management endeavors to control the exposures to changes in interest rates by understanding, reviewing and making decisions based on its risk position. The corporate and bank subsidiary asset/liability committees are responsible for these decisions. The corporation primarily uses the securities portfolios and FHLB advances to manage its interest rate risk position. Additionally, pricing, promotion and product development activities are directed in an effort to emphasize the loan and deposit term or repricing characteristics that best meet current interest rate risk objectives. At present, the use of off-balance sheet instruments is not significant. The committees operate under management policies defining guidelines and limits on the level of risk. These policies are approved by the Boards of Directors. The corporation uses simulation analysis to assess earnings at risk and net present value analysis to assess value at risk. These methods allow management to regularly monitor both the direction and magnitude of the corporation's interest rate risk exposure. These modeling techniques involve assumptions and estimates that inherently cannot be measured with complete precision. Key assumptions in the analyses include maturity and repricing characteristics of both assets and liabilities, prepayments on amortizing assets, other imbedded options, non-maturity deposit sensitivity and loan and deposit pricing. These assumptions are inherently uncertain due to the timing, magnitude and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and provide a relative gauge of the corporation's interest rate risk position over time. Earnings at Risk Simulation analysis evaluates the effect of upward and downward changes in market interest rates on future net interest income. The analysis involves changing the interest rates used in determining 32 net interest income over the next twelve months. The resulting percentage change in net interest income in various rate scenarios is an indication of the corporation's shorter-term interest rate risk. The analysis utilizes a "static" balance sheet approach. The measurement date balance sheet composition (or mix) is maintained over the simulation time period, with maturing and repayment dollars being rolled back into like instruments for new terms at current market rates. Additional assumptions are applied to modify volumes and pricing under the various rate scenarios. These include prepayment assumptions on mortgage assets, the sensitivity of non-maturity deposit rates, and other factors deemed significant. The simulation analysis results are presented in the graph in Table 15a. These results as of December 31, 2001 indicate that the corporation would expect net interest income to decrease over the next twelve months by 0.4% assuming an immediate upward shift in market interest rates of 2.00% and to increase by 0.4% if rates shifted downward in the same manner. This profile reflects a relatively neutral short-term rate risk position and is with the guidelines set by policy. At December 31, 2000, annual net interest income was expected to decrease by 2.2% in the upward scenario and to increase by 3.8% in the downward scenario. The change in the risk position from year to year reflects the shift to a less liability sensitive position as projected over the next twelve months. The change in the earnings at risk position is in part reflective of management's efforts throughout the year to extend liability maturities. Value at Risk The net present value analysis provides information on the risk inherent in the balance sheet that might not be taken into account in the simulation analysis due to the shorter time horizon used in that analysis. The net present value of the balance sheet is defined as the discounted present value of expected asset cash flows minus the discounted present value of the expected liability cash flows. The analysis involves changing the interest rates used in determining the expected cash flows and in discounting the cash flows. The resulting percentage change in net present value in various rate scenarios is an indication of the longer term repricing risk and options embedded in the balance sheet. The net present value analysis results are presented in the graph in Table 15b. These results as of December 31, 2001 indicate that the net present value would decrease 11.6% assuming an immediate upward shift in market interest rates of 2.00% and to increase 11.0% if rates shifted downward in the same manner. The risk position of Sterling is within the guidelines set by policy. 33 At December 31, 2000, the analysis indicated that the net present value would decrease 9.5% assuming an immediate upward shift in market interest rates of 2.00% and to increase 5.2% if rates shifted downward in the same manner. The change in the analysis results from year to year highlight that while efforts to extend liability maturities reduced the shorter term earnings at risk in the simulation analysis, growth in longer term assets and expectations for changes in asset prepayments and non-maturity deposit lives and rates have created greater value at risk.
TABLE 15a TABLE 15b NET INTEREST INCOME PROJECTIONS PRESENT VALUE EQUITY Changes in Changes in Basis Points % Change Basis Points % Change ------------------------------------------------------ ------------------------------------------------------ -200 0.4% -200 11.0% -100 1.1% -100 6.8% 0 0.0% 0 0.0% 100 -0.4% 100 -5.7% 200 -0.4% 200 -11.6%
34 ITEM 8 - FINANCIAL STATEMENTS (a) The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the following pages:
Page ---- Report of Independent Auditors............................................................36 Consolidated Balance Sheets...............................................................37 Consolidated Statements of Income.........................................................38 Consolidated Statements of Changes in Stockholders' Equity................................39 Consolidated Statements of Cash Flows.....................................................40 Notes to Consolidated Financial Statements................................................41
35 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders Sterling Financial Corporation We have audited the accompanying consolidated balance sheets of Sterling Financial Corporation and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The statements of income, stockholders' equity and cash flows of Sterling Financial Corporation for the year ended December 31, 1999 were audited by other auditors whose report dated January 20, 2000 except for Note 26 as to which the date is January 25, 2000, expressed an unqualified opinion on those statements. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sterling Financial Corporation and subsidiaries at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Philadelphia, Pennsylvania January 22, 2002, except for Note 23, as to which the date is February 28, 2002 36 STERLING FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, --------------------------------- (Dollars in Thousands) 2001 2000 ---------------- ---------------- ASSETS Cash and due from banks $68,926 $61,287 Federal funds sold 25,606 42,280 ---------------- ---------------- Cash and cash equivalents 94,532 103,567 Interest-bearing deposits in banks 2,367 516 Short-term investments 1,277 603 Mortgage loans held for sale 21,024 1,978 Securities held-to-maturity (fair value 2001 - $42,763; 2000 - $51,854) 41,788 51,085 Securities available-for-sale 490,955 435,296 Loans, net of allowance for loan losses 2001- $11,071; 2000- $11,716 1,087,102 1,021,499 Premises and equipment, net 32,186 29,807 Assets held for operating leases, net 58,996 54,294 Other real estate owned 74 419 Accrued interest receivable 12,116 11,987 Other assets 19,022 15,087 ---------------- ---------------- TOTAL ASSETS $1,861,439 $1,726,138 ================ ================ LIABILITIES Deposits: Noninterest-bearing $193,318 $171,370 Now and money market 469,238 413,828 Savings 173,290 167,200 Time 699,803 667,902 ---------------- ---------------- Total deposits 1,535,649 1,420,300 ---------------- ---------------- Short-term borrowings 20,285 25,656 Long-term debt 121,093 113,850 Accrued interest payable 8,747 10,080 Other liabilities 23,554 16,905 ---------------- ---------------- TOTAL LIABILITIES 1,709,328 1,586,791 ---------------- ---------------- STOCKHOLDERS' EQUITY Common stock ($5.00 par value) 62,733 62,732 No. of shares authorized: 35,000,000 No. of shares issued: 2001 - 12,546,663; 2000 - 12,546,477 No. of shares outstanding: 2001 - 12,511,953; 2000 - 12,546,477 Capital surplus 17,849 17,856 Retained earnings 66,823 56,261 Accumulated other comprehensive income 5,433 2,498 Common stock in treasury, at cost (2001 - 34,710 shares; 2000 - 0 shares) (727) - ---------------- ---------------- TOTAL STOCKHOLDERS' EQUITY 152,111 139,347 ---------------- ---------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,861,439 $1,726,138 ================ ================
The accompanying notes are an integral part of these consolidated financial statements. 37 STERLING FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, --------------------------------------------------- (Dollars in Thousands, except per share data) 2001 2000 1999 ---------------- ---------------- ---------------- INTEREST AND DIVIDEND INCOME Loans, including fees $85,283 $84,590 $76,235 Debt securities Taxable 19,245 18,477 16,654 Tax-exempt 8,556 7,495 6,322 Dividends 731 860 605 Federal funds sold 2,040 1,786 1,671 Deposits in other banks 61 111 139 ---------------- ---------------- ---------------- Total interest and dividend income 115,916 113,319 101,626 ---------------- ---------------- ---------------- INTEREST EXPENSE Deposits 49,612 50,645 41,651 Short-term borrowings 617 1,931 1,127 Long-term debt 7,045 5,925 4,626 ---------------- ---------------- ---------------- Total interest expense 57,274 58,501 47,404 ---------------- ---------------- ---------------- Net interest income 58,642 54,818 54,222 ---------------- ---------------- ---------------- Provision for loan losses 1,217 605 1,060 ---------------- ---------------- ---------------- Net interest income after provision for loan losses 57,425 54,213 53,162 ---------------- ---------------- ---------------- NONINTEREST INCOME Income from fiduciary activities 4,166 3,942 3,505 Service charges on deposit accounts 4,897 4,721 4,733 Other service charges, commissions and fees 4,188 3,640 3,313 Mortgage banking income 2,222 834 1,447 Gain on sale of real estate 21 343 - Rental income on operating leases 24,319 22,179 18,469 Other operating income 1,402 1,158 857 Security gains 2,710 691 1,215 ---------------- ---------------- ---------------- Total noninterest income 43,925 37,508 33,539 ---------------- ---------------- ---------------- NONINTEREST EXPENSES Salaries and employee benefits 30,990 27,779 26,249 Net occupancy 3,826 3,431 3,093 Furniture and equipment 5,081 4,610 4,622 Professional services 2,412 1,959 2,250 Depreciation on operating lease assets 19,217 17,469 14,641 Merger related and restructuring costs - 2,898 423 Other 13,646 12,057 11,181 ---------------- ---------------- ---------------- Total noninterest expenses 75,172 70,203 62,459 ---------------- ---------------- ---------------- INCOME BEFORE INCOME TAXES 26,178 21,518 24,242 Income tax expenses 5,844 4,951 6,257 ---------------- ---------------- ---------------- NET INCOME $20,334 $16,567 $17,985 ================ ================ ================ Per share information: Basic and diluted earnings per share $1.62 $1.32 $1.43 Dividends declared .780 .750 .721
The accompanying notes are an integral part of these consolidated financial statements. 38 STERLING FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
ACCUMULATED SHARES OTHER COMMON COMMON CAPITAL RETAINED COMPREHENSIVE TREASURY STOCK STOCK SURPLUS EARNINGS INCOME (LOSS) STOCK TOTAL ------------------------------------------------------------------------------------------ (Dollars in Thousands) Balance, January 1, 1999 10,080,022 $50,400 $31,132 $38,912 $5,870 $(1,185) $125,129 Comprehensive income: Net income 17,985 17,985 Change in net unrealized gain (loss) on securities AFS, net of reclassification adjustment and tax effects (12,337) (12,337) ------------ Total comprehensive income 5,648 ------------ Common stock issued 7,555 38 109 147 5-for-4 stock split effected in the form of a 25% common stock dividend 2,514,878 12,574 (12,574) (32) (32) Cash dividends declared (8,161) (8,161) Issuance of treasury stock Dividend reinvestment plan (26,248 shares) 19 1,007 1,026 Directors' compensation plan (2,000 shares) (6) 74 68 Stock options (80 shares) (1) 3 2 Stock transactions of pooled entities (56,597) (283) (784) - (1,067) ------------------------------------------------------------------------------------------ Balance, December 31, 1999 12,545,858 62,729 17,895 48,704 (6,467) (101) 122,760 Comprehensive income: Net income 16,567 16,567 Change in net unrealized gain (loss) on securities AFS, net of reclassification adjustment and tax effects 8,965 8,965 ------------ Total comprehensive income 25,532 ------------ Common stock issued 1,133 5 11 16 Cash dividends declared (9,010) (9,010) Issuance of treasury stock Directors' compensation plan (3,220 shares) (49) 101 52 Cash paid in lieu of fractional shares (514) (2) (1) (3) ------------------------------------------------------------------------------------------ Balance, December 31, 2000 12,546,477 62,732 17,856 56,261 2,498 - 139,347 Comprehensive income: Net income 20,334 20,334 Change in net unrealized gain (loss) on securities AFS, net of reclassification adjustment and tax effects 2,935 2,935 ------------ Total comprehensive income 23,269 ------------ Common stock issued 186 1 2 3 Cash dividends declared (9,772) (9,772) Purchases of treasury stock (53,077 shares) (1,061) (1,061) Issuance of treasury stock Directors' compensation plan (3,000 shares) 12 54 66 Stock options (15,367 shares) (21) 280 259 ------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 2001 12,546,663 $62,733 $17,849 $66,823 $5,433 $(727) $152,111 ==========================================================================================
The accompanying notes are an integral part of these consolidated financial statements. 39 STERLING FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, ------------------------------------------- 2001 2000 1999 ------------- ------------- ------------- (Dollars in Thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $20,334 $16,567 $17,985 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 23,001 21,166 18,227 Accretion and amortization of investment securities 38 18 620 Provision for loan losses 1,217 605 1,060 Provision for deferred income taxes (1,113) 256 1,269 Gain on sale of real estate (21) (343) -- Gain on sales of securities available-for-sale (2,710) (691) (1,215) Gain on sale of mortgage loans (898) (180) (418) Proceeds from sales of mortgage loans 142,242 35,109 73,619 Originations of mortgage loans held for sale (160,390) (35,787) (66,565) Change in operating assets and liabilities: (Increase) in accrued interest receivable (129) (1,674) (528) (Increase) decrease in other assets (3,590) (883) 1,416 Increase (decrease) in accrued interest payable (1,333) 2,994 275 Increase (decrease) in other liabilities 6,071 (33) 32 --------- --------- --------- Net cash provided by operating activities 22,719 37,124 45,777 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Net (increase) decrease in interest-bearing deposits in other banks (1,851) 2,534 566 Net increase in short-term investments (674) (574) (29) Proceeds from sales of securities available-for-sale 28,107 21,766 29,360 Proceeds from maturities or calls of securities held-to-maturity 13,784 8,074 13,022 Proceeds from maturities or calls of securities available-for-sale 141,010 54,791 46,620 Purchases of securities held-to-maturity (4,737) (726) (1,165) Purchases of securities available-for-sale (217,346) (125,274) (141,010) Net loans and direct finance leases made to customers (66,820) (75,521) (80,379) Purchases of equipment acquired for operating leases, net (23,920) (24,124) (25,109) Purchases of premises and equipment (6,560) (3,313) (2,320) Proceeds from sale of premises and equipment 419 812 32 --------- --------- --------- Net cash used by investing activities (138,588) (141,555) (160,412) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 115,349 131,486 69,836 Net increase (decrease) in short-term borrowings (5,371) (14,716) 24,480 Proceeds from issuance of long-term debt 56,000 70,740 25,063 Repayment of long-term debt (48,757) (42,515) (22,234) Proceeds from issuance of common stock 3 16 147 Cash dividends (9,654) (8,736) (7,828) Cash paid in lieu of fractional shares -- (8) (32) Purchase of treasury stock (1,061) -- (1,067) Proceeds from issuance of treasury stock 325 52 1,096 --------- --------- --------- Net cash provided by financing activities 106,834 136,319 89,461 --------- --------- --------- Net change in cash and cash equivalents (9,035) 31,888 (25,174) CASH AND CASH EQUIVALENTS: Beginning of year 103,567 71,679 96,853 --------- --------- --------- End of year $94,532 $103,567 $71,679 ========= ========= ========= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash payments for: Interest $58,607 $55,507 $47,129 Income taxes 6,660 5,350 5,218
The accompanying notes are an integral part of these consolidated financial statements. 40 STERLING FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts presented in the tables are in thousands, except per share data) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Consolidation - The consolidated financial statements include the accounts of Sterling Financial Corporation (Sterling) and its wholly-owned subsidiaries, Bank of Lancaster County, N.A.(Bank of Lancaster County), First National Bank of North East (First National), Bank of Hanover and Trust Company (Bank of Hanover), HOVB Investment Co., T & C Leasing, Inc. (T&C), Pennbanks Insurance Company, SPC and Sterling Mortgage Services, Inc. (inactive). The consolidated financial statements also include Town & Country, Inc. (Town & Country), a wholly-owned subsidiary of Bank of Lancaster County. All significant intercompany balances and transactions have been eliminated in consolidation. Use of Estimates - In preparing consolidated financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Business - Sterling, through its subsidiaries, provides a full range of financial services to individual and corporate customers located in south central Pennsylvania and northern Maryland. Concentration of Credit Risk - Sterling operates primarily in its defined market area and, accordingly, the banks have extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region's economy. The loan portfolio is well diversified and Sterling does not have any significant concentrations of credit risk. The banks are limited in extending credit by legal lending limits to any single group of borrowers. Cash and Cash Equivalents - For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from banks and federal funds sold, generally which mature in one day. Interest-bearing Deposits in Banks - Interest-bearing deposits in banks mature within one year and are carried at cost. Securities - Debt securities that management has the positive intent and ability to hold to maturity are classified as "held-to-maturity" and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as "available-for-sale" and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over terms of the securities using the constant yield method. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings when realized. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Mortgage Loans Held for Sale - Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Loans - Sterling grants mortgage, commercial and consumer loans to customers and leasing alternatives to companies. The ability of Sterling's debtors to honor their contracts is dependent upon the real estate and general economic conditions in the market area. 41 Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off, generally are reported at their outstanding principal balance adjusted for charge-offs, the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Lease contracts which meet the appropriate criteria specified in Statement of Financial Accounting Standards No. 13, Accounting for Leases, are classified as direct finance leases. Direct finance leases are recorded upon acceptance of the equipment by the customer. Unearned lease income represents the excess of the gross lease investment over the cost of the leased equipment, which is recognized over the lease term at a constant rate of return on the net investment in the lease. Loan and lease origination fees and loan origination costs are deferred and recognized as an adjustment of the related loan yield using the interest method. The accrual of interest on loans is generally discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued, but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income. The interest received on these loans is applied to reduce the carrying value of the loan or, if principal is considered fully collectible, recognized as interest income until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Allowance for Loan Losses - Sterling maintains the allowance for loan losses at a level believed adequate by management to absorb potential losses in the loan portfolio. It is established and maintained through a provision for loan losses charged to earnings. Quarterly, the company utilizes a defined methodology in determining the adequacy of the allowance for loan losses, which considers specific credit reviews, past loan loss historical experience, and qualitative factors. This methodology, which has remained consistent for the past several years, results in an allowance consisting of two components, "allocated" and "unallocated." Management assigns internal risk ratings to all commercial relationships with aggregate borrowings or commitments to extend credit in excess of $100,000. Utilizing migration analysis for the previous eight quarters, management develops a loss factor test, which it then uses to estimate losses on impaired loans, potential problem loans and non-classified loans. When management finds loans with uncertain collectibility of principal and interest, it places those loans on the "problem list", and evaluates them on a quarterly basis in order to estimate potential losses. Management's analysis considers adverse situations that may affect the borrower's ability to repay, estimated value of underlying collateral, and prevailing market conditions. If management determines that a specific reserve allocation is not required, it assigns a general loss factor to determine the reserve necessary for each loan. For homogeneous loan types, such as consumer and residential mortgage loans, management bases specific allocations on the average loss ratio for the previous two years for each specific loan pool. Additionally, management projects loss ratios for other factors, including trends in delinquency levels, trends in non-performing and potential problem loans, trends in composition, volume and terms of loans, effects of changes in lending policies or underwriting procedures, experience ability and depth of management, national and local economic conditions, concentrations in lending activities, and other factors that management may deem appropriate. Management determines the unallocated portion of the allowance for loan losses based on the following criteria: risk of error in the specific and general reserve allocations; other potential exposure in the loan portfolio; variances in management's assessment of national and local economic conditions; and other internal or external factors that management believes appropriate at that time. Management believes the above methodology accurately reflects losses inherent in the portfolio. Management charges actual losses to the allowance for loan losses. Management periodically updates the methodology discussed above, which reduces the difference between actual losses and estimated 42 losses. A loan is considered impaired when, based on current information and events, it is probable that Sterling will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. 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 loans effective interest rate, the loans 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, Sterling does not separately identify individual consumer and residential loans for impairment disclosures. Credit Related Financial Instruments - In the ordinary course of business, Sterling has entered into commitments to extend credit, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded. Foreclosed Assets - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of fair value or carrying value at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenues and expenses from operations and changes in the valuation allowance are included in other non-interest expenses. Premises and Equipment - Land is carried at cost. Buildings, furniture, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation is computed primarily on the straight-line method over the estimated useful lives of the asset. Assets Held for Operating Leases - Leases that do not meet the criteria of direct finance leases are accounted for as operating leases. Leased equipment is recorded at cost and depreciated over the lease term, to the estimated residual value at the expiration of the lease term, generally on a straight-line basis. Sterling periodically reviews estimated net realizable values and records losses in current earnings if the estimated residual balance indicates impairment. Income Taxes - Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Advertising - Sterling expenses advertising costs as incurred. The expenses for 2001, 2000 and 1999 were $1,172,000, $1,042,000 and $947,000. Stock Compensation Plans - Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value-based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date over the amount an employee must pay to acquire the stock. Stock options issued under Sterling's stock incentive plan have no intrinsic value at the grant date, and under Opinion No. 25, no compensation cost is recognized for them. Sterling has elected to continue with the accounting 43 methodology in Opinion No. 25 and, as a result, has provided pro forma disclosures of net income, earnings per share and other disclosures, as if the fair value based method of accounting had been applied. Earnings Per Share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if potential dilutive common shares had been issued. Potential common shares that may be issued by Sterling consist solely of outstanding stock options and are determined using the treasury stock method. Earnings per common share have been computed based on the following:
YEARS ENDED DECEMBER 31, ------------------------------------ 2001 2000 1999 ---------- ---------- ---------- Net available income to stockholders $20,334 $16,567 $17,985 ---------- ---------- ---------- Average number of shares outstanding 12,528,542 12,544,533 12,559,580 Effect of dilutive stock options 51,604 12,107 60,535 ---------- ---------- ---------- Average number of shares outstanding used to calculate diluted earnings per common share 12,580,146 12,556,640 12,620,115 ========== ========== ==========
All prior year per share amounts have been properly restated to reflect the 5-for-4 stock split effected in the form of a 25% stock dividend declared in 1999. Comprehensive Income - Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although 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. The components of other comprehensive income and related tax effects are as follows:
YEARS ENDED DECEMBER 31, ---------------------------------------- 2001 2000 1999 ----------- ----------- ----------- Unrealized holding gains (losses) on available-for-sale securities $7,216 $14,483 $(17,620) Reclassification adjustment for gains realized in income (2,710) (691) (1,215) ----------- ----------- ----------- Net unrealized gains (losses) 4,506 13,792 (18,835) Income tax (expense) benefit (1,571) (4,827) 6,498 ----------- ----------- ----------- Net-of-tax amount $2,935 $8,965 $(12,337) =========== =========== ===========
Reclassifications - Certain items in the 2000 and 1999 consolidated financial statements have been reclassified to conform to the 2001 presentation format. Such reclassifications had no impact on net income. Recent Accounting Pronouncements - Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, requires all derivative instruments to be carried at fair value on the balance sheet. This requirement is in contrast to previous accounting guidance, which did not require unrealized gains and losses on derivatives used for hedging purposes to be recorded in the financial statements. The new statement does allow hedge accounting treatment for derivatives used to hedge various risks and sets forth specific criteria to be used to determine when hedge accounting can be applied. Hedge accounting treatment provides for changes in fair value or cash flows of both the derivative and the hedged item to be recognized in earnings in the same period. Statement No. 133 does not change the accounting for those derivative instruments not designated in a hedge accounting relationship, considered trading derivatives, for which fair value 44 changes are recorded through earnings as they occur. On January 1, 2001, Sterling adopted the provisions of Statement No. 133, with no material impact on Sterling's financial condition or results of operations. In September 2000, Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, was issued. This statement replaces Statement No. 125. The guidance in Statement No. 140, while not changing most of the guidance originally issued in Statement No. 125, revised the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain additional disclosures related to transferred assets. Certain provisions of the statement relating to recognition, reclassification and disclosure of collateral, as well as the disclosure of securitization transactions, became effective for Sterling for 2000 year-end reporting. Other provisions related to the transfer and servicing of financial assets and extinguishments of liabilities were effective for transactions occurring after March 31, 2001. The application of the new rules did not have a material impact on Sterling's financial condition, results of operations or liquidity. In June 2001, Statement No. 141, Business Combinations, was issued. Statement No. 141 requires all business combinations to be accounted for by the purchase method of accounting and eliminates the pooling-of-interest method of accounting for business combinations that was previously allowed by APB Opinion 16. Statement No. 141 will affect future business combinations, if undertaken; the issuance of the new guidance had no effect on the Corporation's results of operations, financial position or liquidity. In connection with the issuance of the new guidance for business combinations, the FASB also issued Statement No. 142, Goodwill and Other Intangible Assets, which supersedes APB Opinion 17, and addresses the accounting and reporting for acquired goodwill and other intangible assets. Under Statement No. 142, goodwill (other than goodwill enacted under FASB Statement No. 72, Acquisitions by Bank and Thrift Institutions) and certain other intangible assets, which do not possess finite useful lives, will no longer be amortized into net income over an estimated life but rather will be tested at least annually for impairment based on specific guidance provided in the new standard. Intangible assets determined to have finite lives will continue to be amortized over their estimated useful lives and also continue to be subject to impairment testing. Under current rules, Statement No. 72 goodwill shall continue to be amortized upon adoption of Statement No. 142. The provisions of Statement No. 142, including Statement No. 72 considerations, were adopted by Sterling as required on January 1, 2002. Application of this statement did not have a material impact on Sterling's financial condition or results of operations. NOTE 2 - BUSINESS COMBINATIONS Hanover Bancorp, Inc. - On July 27, 2000, Sterling completed its merger with Hanover Bancorp, Inc. (Hanover), parent company of Bank of Hanover and Trust Company, headquartered in Hanover, Pennsylvania. Bank of Hanover, with 14 branches in York and Adams counties, Pennsylvania, and one branch in Westminster, Maryland, continues to operate as a separate commercial bank. Under the terms of the agreement, Hanover Bancorp shareholders received .93 shares of Sterling common stock for each share of Hanover Bancorp's common stock in a tax-free exchange. Sterling issued 3,611,409 shares of its common stock in connection with the merger. Northeast Bancorp, Inc. - On June 15, 1999, Sterling completed the acquisition of Northeast Bancorp, Inc. (Northeast), the parent company of First National Bank of North East, headquartered in North East, Maryland. First National, with four branches in Cecil County, Maryland, continues to operate as a separate commercial bank. 45 Under the terms of the agreement, Northeast shareholders received two shares of Sterling common stock for each share of Northeast's common stock in a tax-free exchange. Sterling issued 677,624 shares of its common stock in connection with this merger. Both transactions were accounted for under the pooling-of-interests method of accounting. Accordingly, the consolidated financial statements have been restated to include the consolidated accounts of Hanover Bancorp and Northeast Bancorp for all periods presented. The effect of the Northeast and Hanover mergers on Sterling's results of operations were as follows:
STERLING HISTORICAL NORTHEAST (1) HANOVER COMBINED -------------- ------------- -------------- -------------- For the year ended 1999 Net interest income $36,029 $1,888 $16,305 $54,222 Net income 12,904 335 4,746 17,985 Dividends declared 6,276 85 1,800 8,161
(1) Represents Northeast's results through June 30, 1999, the nearest interim period prior to the merger. The effect of the Hanover merger on Sterling's financial condition is as follows:
STERLING HANOVER ELIMINATIONS COMBINED -------------- ------------- ------------- -------------- As of December 31, 1999 Assets $1,059,374 $503,924 $(6,975) $1,556,323 Liabilities 969,356 471,176 (6,969) 1,433,563 Stockholders' equity 90,018 32,748 (6) 122,760
Financial data for Sterling and Hanover from January 1 to July 31, 2000 is presented below. Although the consummation date was July 27, 2000, the financial data presented is for the nearest interim period.
STERLING HANOVER COMBINED ------------- ------------- ------------- Net interest income $22,507 $9,652 $32,159 Net income 8,603 2,650 11,253 Dividends declared 3,305 932 4,237
NOTE 3 - RESTRICTIONS ON CASH AND DUE FROM BANKS Sterling's subsidiary banks are required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against their deposit liabilities. The average amount of these reserve balances for the years ended December 31, 2001 and 2000 was approximately $7,157,000 and $13,491,000. Balances maintained at the Federal Reserve Bank are included in cash and due from banks. NOTE 4 - SECURITIES Securities pledged to secure government and other public deposits, trust deposits, short-term borrowings, and other balances as required or permitted by law were carried at $126,207,000 in 2001 and $120,837,000 in 2000. 46 The amortized cost and fair values of securities were as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- --------- DECEMBER 31, 2001: AVAILABLE-FOR-SALE: U.S. Treasury securities $15,188 $497 $-- $15,685 U.S. Government agencies 87,714 1,967 112 89,569 States and political subdivisions 164,357 2,761 2,372 164,746 Mortgage-backed securities 57,232 712 163 57,781 Corporate securities 148,734 3,304 994 151,044 -------- -------- -------- -------- Subtotal 473,225 9,241 3,641 478,825 Equity securities 9,373 3,238 481 12,130 -------- -------- -------- -------- Total $482,598 $12,479 $4,122 $490,955 ======== ======== ======== ======== HELD-TO-MATURITY: U.S. Government agencies $109 $2 $-- $111 States and political subdivisions 33,757 933 15 34,675 Mortgage-backed securities 497 25 -- 522 Corporate securities 1,540 30 -- 1,570 -------- -------- -------- -------- Subtotal 35,903 990 15 36,878 Equity securities 5,885 -- -- 5,885 -------- -------- -------- -------- Total $41,788 $990 $15 $42,763 ======== ======== ======== ======== DECEMBER 31, 2000: AVAILABLE-FOR-SALE: U.S. Treasury securities $35,835 $170 $19 $35,986 U.S. Government agencies 70,711 581 304 70,988 States and political subdivisions 139,343 2,071 2,350 139,064 Mortgage-backed securities 73,447 374 1,009 72,812 Corporate securities 100,407 575 284 100,698 -------- -------- -------- -------- Subtotal 419,743 3,771 3,966 419,548 Equity securities 11,702 4,683 637 15,748 -------- -------- -------- -------- Total $431,445 $8,454 $4,603 $435,296 ======== ======== ======== ======== HELD-TO-MATURITY: U.S. Government agencies $604 $-- $5 $599 States and political subdivisions 39,151 786 21 39,916 Mortgage-backed securities 676 19 -- 695 Corporate securities 2,866 1 11 2,856 -------- -------- -------- -------- Subtotal 43,297 806 37 44,066 Equity securities 7,788 -- -- 7,788 -------- -------- -------- -------- Total $51,085 $806 $37 $51,854 ======== ======== ======== ========
Included in held-to-maturity equity securities are Federal Reserve Bank stock, Federal Home Loan Bank of Pittsburgh stock and Atlantic Central Bankers Bank stock. The amortized cost and fair value of securities at December 31, 2001, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities or call dates because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 47
SECURITIES SECURITIES AVAILABLE-FOR-SALE HELD-TO-MATURITY --------------------------- --------------------------- Amortized Fair Amortized Fair Cost Value Cost Value ------------ ------------ ----------- ------------ Due in one year or less $41,763 $42,544 $2,547 $2,593 Due after one year through five years 192,989 197,981 12,398 12,840 Due in five years through ten years 63,035 63,579 18,487 18,935 Due after ten years 118,206 116,940 1,974 1,988 -------- -------- -------- -------- 415,993 421,044 35,406 36,356 Mortgage-backed securities 57,232 57,781 497 522 -------- -------- -------- -------- $473,225 $478,825 $35,903 $36,878 ======== ======== ======== ========
Proceeds from sales of securities available-for-sale were $28,107,000, $21,766,000 and $29,360,000 for the years ended December 31, 2001, 2000 and 1999. Gross gains of $3,170,000, $1,042,000 and $1,450,000 were realized on these sales for the years ended December 31, 2001, 2000 and 1999. Gross losses of $460,000, $351,000 and $235,000 were realized on these sales for the years ended December 31, 2001, 2000 and 1999. NOTE 5 - LOANS A summary of the balances of loans follows:
DECEMBER 31, --------------------------- 2001 2000 ------------- ------------- Commercial, financial and agricultural $598,174 $522,713 Real estate - construction 19,710 9,665 Real estate - mortgage 117,293 142,534 Consumer 279,139 279,465 Lease financing receivables (net of unearned income) 83,857 78,658 ------------- ------------- Total loans $1,098,173 $1,033,215 ============= =============
Changes in the allowance for loan losses are as follows:
YEARS ENDED DECEMBER 31, ------------------------------------------ 2001 2000 1999 ------------- ------------ ------------- Balance at January 1 $11,716 $11,875 $11,475 Provisions for loan losses 1,217 605 1,060 Loans charged off (2,594) (1,181) (1,149) Recoveries of loans previously charged off 732 417 489 ------------- ------------ ------------- Balance at December 31 $11,071 $11,716 $11,875 ============= ============ =============
Information concerning impaired loans is as follows:
DECEMBER 31, --------------------------- 2001 2000 ------------- ------------- Impaired loans with a valuation allowance $7,239 $4,953 Impaired loans without a valuation allowance - - ------------- ------------- Total impaired loans $7,239 $4,953 ============= ============= Valuation allowance related to impaired loans $952 $1,184 ============= =============
48
Years Ended December 31, ------------------------------------------ 2001 2000 1999 -------------- ------------- ------------- Average investment in impaired loans $7,298 $4,505 $3,015 Interest income recognized on impaired loans 72 266 168 Interest income recognized on a cash basis on impaired loans 72 266 168
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were $325,030,000 and $276,436,000 at December 31, 2001 and 2000. NOTE 6 - PREMISES AND EQUIPMENT A summary of the cost and accumulated depreciation of premises and equipment follows:
DECEMBER 31, ------------------------------ 2001 2000 --------------- -------------- Land $5,320 $5,320 Buildings 24,342 23,820 Leasehold improvements 2,464 2,331 Equipment, furniture and fixtures 30,452 25,681 --------------- -------------- 62,578 57,152 Less: Accumulated depreciation (30,392) (27,345) --------------- -------------- $32,186 $29,807 =============== ==============
The subsidiary banks of Sterling lease certain banking facilities under operating leases which expire on various dates through 2022. Renewal options are available on these leases. Minimum future rental payments as of December 31, 2001, under noncancelable real estate leases, are payable as follows:
Due in 2002 $1,072 Due in 2003 971 Due in 2004 850 Due in 2005 747 Due in 2006 672 Thereafter 5,540 ------------- Total minimum future rental payments $9,852 =============
Total rent expense charged to operations amounted to $1,096,000, $961,000 and $900,000 for the years ended December 31, 2001, 2000 and 1999. NOTE 7 - LEASES Information concerning net investment in direct financing leases, included in loans receivable:
DECEMBER 31, --------------------------- 2001 2000 ------------- ------------- Minimum lease payments receivable $96,071 $91,574 Lease origination costs 587 541 Unearned income (12,801) (13,457) ------------- ------------- $83,857 $78,658 ============= =============
49 The allowance for uncollectible lease payments, included in the allowance for loan losses, was $813,000 and $767,000 at December 31, 2001 and 2000. Investments in property on operating lease and property held for lease by major classes is as follows:
DECEMBER 31, --------------------------- 2001 2000 ------------- ------------- Automobiles $29,228 $27,103 Heavy trucks, trailers and buses 16,582 16,878 Trucks, light and medium duty 42,867 37,409 Other 25,383 20,873 ------------- ------------- 114,060 102,263 Less: Accumulated depreciation (55,064) (47,969) ------------- ------------- $58,996 $54,294 ============= =============
Minimum future rentals on noncancelable finance and operating leases as of December 31, 2001 are as follows:
FINANCE OPERATING ------------- ------------- Due in 2002 $34,446 $24,122 Due in 2003 26,452 10,228 Due in 2004 21,834 4,895 Due in 2005 9,981 2,121 Due in 2006 3,358 658 Thereafter - 66 ------------- ------------- Total minimum future rentals $96,071 $42,090 ============= =============
NOTE 8 - DEPOSITS The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2001 and 2000 was $102,925,000 and $95,402,000. At December 31, 2001, the scheduled maturities of time deposits are as follows: Due in 2002 $436,828 Due in 2003 178,113 Due in 2004 36,970 Due in 2005 27,987 Due in 2006 9,559 Thereafter 10,346 ------------- Total $699,803 =============
50 NOTE 9 - SHORT-TERM BORROWINGS Short-term borrowings and weighted average interest rates consist of the following:
DECEMBER 31, -------------------------------------------------------------------- 2001 2000 ---------------------------------- --------------------------------- AMOUNT RATE AMOUNT RATE ---------------- ---------------- ---------------- ---------------- Securities sold under repurchase agreements $8,407 1.17% $8,676 5.67% Interest-bearing demand notes issued to the U.S. Treasury 5,878 1.40% 5,980 5.74% Lines of credit 6,000 2.86% 11,000 7.10% ---------------- ---------------- Total $20,285 $25,656 ================ ================
The securities sold under repurchase agreements represent collateral to the lending party and are primarily U.S. Treasury and agency securities. These securities are maintained under Sterling's control. NOTE 10 - LONG-TERM DEBT Long-term debt consisted of the following:
DECEMBER 31, --------------------------------- 2001 2000 ---------------- --------------- FHLB redeemable advances, 5.06% - 7.52%, due 2001 - 2014, with a weighted average interest rate of 6.18% and 6.03% at December 31, 2001 and 2000. $50,000 $65,669 FHLB nonredeemable advances, 3.00% - 7.52%, due 2001 - 2010, with a weighted average interest rate of 5.10% and 6.37% at December 31, 2001 and 2000. 33,624 25,400 Notes payable to five financial institutions, generally with an original maturity of 36 months. Interest rates on the notes range from 3.84% to 7.84%, with a weighted average interest rate of 5.68% and 6.70% at December 31, 2001 and 2000. The notes mature through 2004. 37,469 22,781 ---------------- --------------- $121,093 $113,850 ================ ===============
The contractual maturities of long-term debt as of December 31, 2001 are shown below. Actual maturities may differ from contractual maturities due to the convertible features of the FHLB advances, which may be prepaid by Sterling, in the event the FHLB converts them to adjustable rate. Due in 2002 $24,980 Due in 2003 20,675 Due in 2004 10,146 Due in 2005 10,014 Due in 2006 5,015 Thereafter 50,263 -------------- Total $121,093 ==============
Under the terms of the notes payable to financial institutions, Sterling is required to meet certain conditions, including specific financial ratios, as measured on a periodic basis. Sterling was in compliance with these covenants during the periods presented. As of December 31, 2001, Sterling has unused funding commitments from these financial institutions and the FHLB totaling $130,964,000. 51 NOTE 11 - INCOME TAXES The allocation of income taxes between current and deferred is as follows:
YEARS ENDED DECEMBER 31, ---------------------------------------------------- 2001 2000 1999 ---------------- ---------------- ---------------- Current $6,957 $4,695 $4,988 Deferred (1,113) 256 1,269 ---------------- ---------------- ---------------- Total $5,844 $4,951 $6,257 ================ ================ ================
The reason for the differences between the federal statutory income tax rate and the effective tax rates are summarized as follows:
YEARS ENDED DECEMBER 31, --------------------------------------------------- 2001 2000 1999 ---------------- ---------------- ---------------- Pretax income 35.0% 35.0% 35.0% Increase (decrease) resulting from: Tax-exempt interest income (14.0)% (15.6)% (11.4)% Disallowed interest 1.8% 2.2% 1.4% Disallowed merger costs 1.8% 0.4% Low-income housing credits (0.8)% (1.0)% (0.9)% State tax, net of federal tax benefit 0.7% 0.8% 0.7% Other, net (0.4)% (0.2)% 0.6% ---------------- ---------------- ---------------- Effective tax rates 22.3% 23.0% 25.8% ================ ================ ================
The income tax provision includes $949,000, $242,000 and $421,000 of income taxes relating to realized securities gains for the years ended December 31, 2001, 2000 and 1999. The significant components of Sterling's deferred tax assets and liabilities are as follows:
DECEMBER 31, ----------------------------------- 2001 2000 ----------------- ----------------- Deferred tax assets Allowance for loan losses $3,736 $3,853 Employee benefit plans 532 447 Accrued directors fees 585 568 State net operating loss carryforwards 174 333 Property and equipment 5 - Restructuring charge reserve 234 439 Other 325 157 ----------------- ----------------- 5,591 5,797 ----------------- ----------------- Deferred tax liabilities Leasing (9,363) (10,464) Premises and equipment - (85) Deferred loan fees (537) (462) Securities accretion and mark-to-market (127) (332) Unrealized gain on securities available-for-sale (2,938) (1,349) Other (50) (53) ----------------- ----------------- (13,015) (12,745) ----------------- ----------------- Net deferred tax liability $(7,424) $(6,948) ================= =================
A subsidiary of Sterling has generated net operating loss carryforwards in numerous states, the 52 most significant of which totals $2,026,000 and expires through the year 2010. NOTE 12 - COMMITMENTS AND CONTINGENT LIABILITIES Sterling is a party to credit related 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 and letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. Sterling's exposure to credit loss is represented by the contractual amount of these commitments. Sterling follows the same credit policies in making commitments as it does for on-balance sheet instruments. The following outstanding instruments have contract amounts that represent credit risk.
DECEMBER 31, ------------------------------- 2001 2000 -------------- ------------- Commitments to extend credit: Unused home equity lines of credit $45,958 $38,680 Other commitments to extend credit 190,142 192,836 Standby letters of credit 52,901 49,309
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation of the customer and generally consists of real estate. Excluded from these amounts are commitments to extend credit in the form of check credit or related plans. Standby letters of credit are conditional commitments issued by Sterling to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Sterling generally holds collateral supporting those commitments if deemed necessary. From time to time, Sterling and its subsidiaries may be named as defendants in legal proceedings that arise during the normal course of business. While any litigation has an element of uncertainty, management is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the consolidated financial condition or results of operations of Sterling. NOTE 13 - STOCKHOLDERS' EQUITY AND REGULATORY MATTERS Sterling maintains a dividend reinvestment and stock purchase plan. Under the Plan, shareholders may purchase additional shares of Sterling's common stock at the prevailing market prices with reinvested dividends and voluntary cash payments. Sterling has reserved 1,378,125 shares of the corporation's common stock to be issued under the dividend reinvestment and stock purchase plan. As of December 31, 2001, 1,085,595 shares were available to be issued under the plan. Sterling also maintains a directors' stock compensation plan (Directors' Plan). Under the Directors' Plan, each non-employee director is entitled to receive 250 shares of Sterling's common stock each July 1. Sterling has reserved 31,500 shares of the corporation's common stock to be issued under 53 the director's stock compensation plan. As of December 31, 2001, 17,900 shares were available to be issued under the plan. During the first quarter of 2001, Sterling announced that the Board of Directors authorized the repurchase of up to 150,000 shares of the outstanding common stock. Through December 31, 2001, 53,077 shares have been repurchased under the repurchase program. Sterling (on a consolidated basis) and its banking subsidiaries are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Sterling's and the banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Sterling and its banking subsidiaries must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and reclassifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require Sterling and its banking subsidiaries to maintain minimum amounts and ratios (set forth in the following table) of Total and Tier 1 capital (as defined) to average assets (as defined in the Regulations). Management believes, as of December 31, 2001 and 2000, that Sterling and the banks met all minimum capital adequacy requirements to which they are subject. As of December 31, 2001, the most recent notification from the Federal Deposit Insurance Corporation categorized the banks as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," institutions must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the banks' category. Sterling's and the banks' actual capital amounts and ratios as of December 31, 2001 and 2000 are also presented in the table.
MINIMUM TO BE WELL CAPITALIZED UNDER MINIMUM CAPITAL PROMPT CORRECTIVE ACTUAL REQUIREMENT ACTION PROVISIONS ------------------------- -------------------------- ------------------------- Amount Ratio Amount Ratio Amount Ratio ---------------- -------- ---------------- -------- ---------------- -------- DECEMBER 31, 2001 Total capital to risk weighted assets Sterling (consolidated) $157,350 11.0% $114,742 8.0% N/A N/A Bank of Lancaster County, N.A. 98,674 10.0% 78,696 8.0% $98,370 10.0% Bank of Hanover and Trust Company 37,037 10.0% 29,571 8.0% 36,963 10.0% First National Bank of North East 9,218 13.2% 5,573 8.0% 6,966 10.0% Tier 1 capital to risk weighted assets Sterling (consolidated) 144,960 10.1% 57,371 4.0% N/A N/A Bank of Lancaster County, N.A. 90,224 9.2% 39,348 4.0% 59,022 6.0% Bank of Hanover and Trust Company 33,681 9.1% 14,785 4.0% 22,178 6.0% First National Bank of North East 8,634 12.4% 2,787 4.0% 4,180 6.0% Tier 1 capital to average assets Sterling (consolidated) 144,960 7.8% 74,202 4.0% N/A N/A Bank of Lancaster County, N.A. 90,224 7.6% 47,534 4.0% 59,417 5.0% Bank of Hanover and Trust Company 33,681 6.1% 22,256 4.0% 27,821 5.0% First National Bank of North East 8,634 8.7% 3,966 4.0% 4,958 5.0%
54 DECEMBER 31, 2000 Total capital to risk weighted assets Sterling (consolidated) $148,361 11.5% $103,099 8.0% n/a n/a Bank of Lancaster County, N.A. 91,608 10.4% 70,791 8.0% $88,489 10.0% Bank of Hanover and Trust Company 35,334 10.1% 27,885 8.0% 34,856 10.0% First National Bank of North East 8,655 13.2% 5,240 8.0% 6,550 10.0% Tier 1 capital to risk weighted assets Sterling (consolidated) 135,086 10.5% 51,549 4.0% n/a n/a Bank of Lancaster County, N.A. 82,915 9.4% 35,395 4.0% 53,093 6.0% Bank of Hanover and Trust Company 31,289 9.0% 13,943 4.0% 20,914 6.0% First National Bank of North East 8,153 12.4% 2,620 4.0% 3,930 6.0% Tier 1 capital to average assets Sterling (consolidated) 135,086 7.4% 72,852 4.0% n/a n/a Bank of Lancaster County, N.A. 82,915 8.0% 41,590 4.0% 51,988 5.0% Bank of Hanover and Trust Company 31,289 5.8% 21,673 4.0% 27,091 5.0% First National Bank of North East 8,153 8.8% 3,718 4.0% 4,648 5.0%
NOTE 14- MERGER RELATED COSTS During the third quarter of 2000, Sterling completed its merger with Hanover Bancorp, Inc. and incurred $2,898,000 of merger related and restructuring charges. The direct costs that resulted from the merger totaled $1,426,000, and consisted primarily of legal, accounting, and investment advising fees, as well as regulatory filing fees and other miscellaneous expenses. In addition, Sterling incurred restructuring costs totaling $1,472,000, which primarily consists of severance and related benefit, professional fees, termination fees related to non-cancelable service contracts and asset write-offs related to the conversion of the banking subsidiaries into a common core processing system. The conversion to the new core processing system and resulting reduction in the workforce is expected to result in an estimated net annual savings of approximately $1.5 million, of which approximately 33% was realized in 2001 and 100% will be realized in years 2002 and beyond. The following summarizes the restructuring expenses charged to operations during 2000, and the remaining restructuring accrual balance at December 31, 2001. The remaining unpaid expenses will be paid throughout 2002.
INITIAL REMAINING EXPENSE ACCRUAL --------------- ---------------- Employee termination $718 $355 Asset disposal/write-downs 334 - Noncancelable contracts 312 121 Professional fees 88 28 Other 20 - --------------- ---------------- $1,472 $504 =============== ================
Merger related costs during 1999 totaled $423,000 and were a direct result of Sterling's acquisition of Northeast, completed in June 1999. These merger expenses consisted entirely of attorney, accountant, investment advisory and application fees. NOTE 15 - EMPLOYEE BENEFIT PLANS Sterling maintains various employee benefits plans for its employees. In December 2000, Bank of Lancaster County's Board of Directors approved a resolution that 55 terminated its qualified non-contributory plan in 2001, including the freezing of benefits effective February 28, 2001. All excess funds that remain after satisfaction of all liabilities of the plan will be provided to eligible active participants to provide additional retirement income benefits. As a result of the board's action, plan assets were converted to cash equivalents in the first quarter of 2001, thereby causing the expected return on plan assets to be lowered from 9.0% to 5.5%. Further, the discount rate used in calculating the projected benefit obligation was lowered from 7.00% in 1999 to 5.50% in 2000, to more closely match the short-term nature of the settlement. Sterling will account for the settlement and termination of the plan in accordance with FASB Statement No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and expects to record a settlement loss in 2002, which will result in net expense that approximates the prepaid expense balance. The settlement will include lump-sum payments and the purchase of annuity contracts that will benefit the participants. The Bank of Lancaster County also sponsored a retirement restoration plan for any officer whose compensation exceeds $170,000. The plan was designed to "restore" the level of benefits that is lost to these employees under the qualified retirement plans because of Internal Revenue Code restrictions. Consistent with termination of the qualified non-contributory plan, in 2001, the Board of Directors also terminated the retirement restoration plan. The settlement and termination of this plan is not expected to have a material impact on Sterling's results of operations. Sterling sponsors a qualified postretirement benefit plan that provides certain health care insurance benefits for retired employees who have attained the age of 60 and have completed 10 years of full-time or limited benefits employment. The change in benefit obligation and the change in fair value of plan assets related to the qualified pension plans, nonqualified pension and other postretirement benefits for each of the years in the two-year period ended December 31, 2001, is as follows:
OTHER POSTRETIREMENT QUALIFIED PENSION NONQUALIFIED PENSION BENEFITS ------------------------ ------------------------ ------------------------- 2001 2000 2001 2000 2001 2000 ------------ ----------- ----------- ------------ ------------ ------------ CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year $16,721 $10,895 $309 $276 $1,226 $1,164 Effect of curtailment (2,832) - - - - - Service cost - 667 16 15 50 65 Interest cost 757 753 21 19 69 80 Benefit payments (435) (359) - - (40) (57) Actuarial (gains) losses (200) 623 4 (1) (31) (26) Change in discount rate and plan amendments - 4,142 57 - (30) - ------------ ----------- ----------- ------------ ------------ ------------ Benefit obligation at end of year 14,011 16,721 407 309 1,244 1,226 ------------ ----------- ----------- ------------ ------------ ------------ CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year 13,889 12,668 - - - - Return on plan assets 557 1,103 - - - - Employer contributions - 477 - - 40 57 Benefit payments (435) (359) - - (40) (57) ------------ ----------- ----------- ------------ ------------ ------------ Fair value of plan assets at end of year 14,011 13,889 - - - - ------------ ----------- ----------- ------------ ------------ ------------ RECONCILIATION OF FUNDED STATUS Funded status of plans - (2,832) (407) (309) (1,244) (1,226) Unrecognized net transition obligation - - - - 101 615 Unrecognized prior service costs - (85) 67 87 171 (174) Unrecognized net (gains) losses 397 3,229 53 (7) (425) (541) ------------ ----------- ----------- ------------ ------------ ------------ PREPAID (ACCRUED) BENEFIT EXPENSE $397 $312 $(287) $(229) $(1,397) $(1,326) ============ =========== =========== ============ ============ ============
56 OTHER POSTRETIREMENT QUALIFIED PENSION NONQUALIFIED PENSION BENEFITS ------------------------ ------------------------ ------------------------- 2001 2000 2001 2000 2001 2000 ------------ ----------- ----------- ------------ ------------ ------------ ASSUMPTIONS Discount rate 5.50% 5.50% 5.50% 7.00% 6.50% 7.00% Expected return on plan assets 5.50% 9.00% 9.00% 9.00% - - Weighted average rate of increase in future compensation levels 4.50% 4.50% 4.50% 4.50% - -
The components of the retirement benefits cost are presented below.
QUALIFIED PENSION NONQUALIFIED PENSION ------------------------------------- ------------------------------------- YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31, ------------------------------------- ------------------------------------- 2001 2000 1999 2001 2000 1999 ----------- ----------- ------------ ------------ ------------ ----------- RETIREMENT BENEFIT COSTS Service cost $ - $ 667 $ 683 $16 $15 $14 Interest cost 757 753 698 21 19 16 Return on plan assets (557) (1,103) (1,287) - - - Amortization of transition gains - - (69) - - - Amortization of prior service cost - (8) (8) 20 20 20 Actuarial gains (losses) (200) (58) 294 - - - ----------- ----------- ------------ ------------ ------------ ----------- Net retirement benefits cost $ - $ 251 $ 311 $57 $54 $50 =========== =========== ============ ============ ============ ===========
OTHER POSTRETIREMENT BENEFITS ------------------------------------- YEARS ENDED DECEMBER 31, ------------------------------------- 2001 2000 1999 ----------- ----------- ------------ RETIREMENT BENEFIT COSTS Service cost $50 $65 $61 Interest cost 69 80 75 Amortization of transition losses 9 51 51 Amortization of unrecognized prior service cost 14 (19) (19) Actuarial losses (31) (31) (24) ----------- ----------- ------------ Net retirement benefits cost $111 $146 $144 =========== =========== ============
Health care cost trend rates assumed with respect to other postretirement benefits in measuring the accumulated postretirement benefit were 5.0% in 2001, decreasing to 4.5% in 2002 and later. The health care cost trend rate assumption has a significant effect on the amounts reported. The following table reflects the effect of a 1% point increase and a 1% point decrease in the health care cost trend rates:
1% POINT 1% POINT INCREASE DECREASE -------------- -------------- Effect on total of service and interest cost components $15 $13 Effect on postretirement benefit obligation 136 118
The individual banking affiliates of Sterling Financial Corporation each sponsored 401(k) retirement plans for their employees. These plans were merged into the Sterling Financial Corporation 401(k) Retirement Plan, which was approved by the Board of Directors and was implemented effective July 1, 2001. Banking affiliate employees who have attained age 18 and have completed 30 days of employment may participate in the plan through salary deferral. To be eligible for the matching contribution and the performance incentive feature, the employee must be age 18 and have completed one year of service with 1000 hours. Employees of Town and Country, a wholly owned subsidiary of Bank of Lancaster County, participate only in the salary deferral portion of the plan. 57 Under the salary deferral feature of the plan a participant may contribute from 1% to 20% of their compensation. Sterling makes matching contributions equal to 100% of the first 2% of the employee's contributions to the plan that are fully vested at all times and employees may direct the investment of those contributions to one or all of the thirteen funds available. Matching contributions as of July 1, 2001 and forward are also fully vested and are invested based on the employee's direction. Under the performance incentive feature of the plan, additional contributions are made to participant accounts for each plan year for an amount determined by the Board of Directors based on achieving certain performance objectives. The performance incentive feature is paid entirely in Sterling common stock. Total expense for the performance incentive feature and employer matching contribution was $1,105,000, $733,000 and $721,000 for the years ended December 31, 2001, 2000 and 1999. The number of shares owned at December 31, 2001 in the Sterling Financial 401(k) Retirement Plan total 840,395 shares, with an approximate market value of $20,472,000. Dividends totaling $651,000 were reinvested in additional shares of Sterling common stock. NOTE 16 - STOCK COMPENSATION Sterling has an omnibus stock incentive plan under which incentive and nonqualified stock options, stock appreciation rights, or restricted stock may be issued. To date, only incentive and nonqualified stock options have been issued under the plan. The options are granted periodically to key employees at a price not less than the fair value of the shares at the date of grant, and have a term of ten years. As of December 31, 2001, Sterling had approximately 190,198 shares of common stock reserved for issuance under the stock incentive plans. Sterling applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations in accounting for its employee stock options. Accordingly, no compensation cost has been recognized. If compensation expense for Sterling's stock incentive plans had been determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by FASB Statement No. 123, Accounting for Stock Based Compensation, net income and earnings per share would have been adjusted to the proforma amounts indicated below:
YEARS ENDED DECEMBER 31, -------------------------------------------------- 2001 2000 1999 ---------------- ---------------- ---------------- Net income: As reported $20,334 $16,597 $17,985 Proforma 19,571 15,763 17,492 Basic earnings per share: As reported $1.62 $1.32 $1.43 Proforma 1.56 1.26 1.39 Diluted earnings per share: As reported $1.62 $1.32 $1.43 Proforma 1.56 1.26 1.39
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: 58
YEARS ENDED DECEMBER 31, --------------------------------------------------- 2001 2000 1999 ----------------- ---------------- ---------------- Dividend yield 4.47% 4.45% 2.62% Risk-free interest rate 4.96% 5.56% 6.44% Expected life 10 10 10 Expected volatility 49.0% 38.1% 23.3%
A summary of the status of Sterling's stock option plans is presented below:
DECEMBER 31, --------------------------------------------------------------------------------- 2001 2000 1999 -------------------------- -------------------------- ------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------------ ------------ ------------ ------------ ------------ ------------ Outstanding at January 1 331,189 $23.91 331,184 $24.06 226,212 $23.04 Granted 132,400 17.00 23,405 15.83 111,473 25.74 Exercised (15,553) 16.84 - - (3,783) 15.21 Forfeited (2,657) 17.22 (23,400) 18.83 (2,718) 20.71 ------------ ------------ ------------ Outstanding at December 31 445,379 $22.07 331,189 $23.91 331,184 $24.06 ============ ============ ============ Options exercisable at December 31 280,957 $23.94 239,792 $22.38 111,418 $21.33 Weighted average fair value of options granted during period $6.23 $4.54 $9.72
Information pertaining to options outstanding at December 31, 2001 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------------------- ---------------------------------------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING WEIGHTED AVERAGE AVERAGE CONTRACTUAL AVERAGE REMAINING RANGE OF NUMBER EXERCISE LIFE (IN NUMBER EXERCISE CONTRACTUAL EXERCISE PRICES OUTSTANDING PRICE YEARS) OUTSTANDING PRICE LIFE (IN YEARS) -------------------- ----------------- ----------------- --------------- ---------------- ----------------- ---------------- $14.92-$15.75 38,822 $15.39 5.8 29,822 $15.28 4.9 $16.00-$22.14 260,912 18.03 7.8 132,262 19.03 6.4 $29.00-$33.80 145,645 31.10 7.6 118,873 31.57 7.5 ----------------- ---------------- 445,379 $22.07 7.5 280,957 $23.94 6.7 ================= ================
NOTE 17 - RELATED PARTY TRANSACTIONS Certain directors and officers of Sterling Financial Corporation and its subsidiaries, their immediate families and companies in which they are principal owners (more than 10%), were indebted to the subsidiary banks during 2001 and 2000. All loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and, in the opinion of the management of the banks, do not involve more than a normal risk 59 of collectibility or present other unfavorable features. Total loans to these persons at December 31, 2001 and 2000 amounted to $7,331,000 and $8,188,000. During 2001, $2,729,000 of new loans were made and repayments totaled $3,586,000. NOTE 18 - RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made to Sterling by its subsidiary banks. The amount of dividends that may be paid from the subsidiary banks to Sterling totals $36,797,000 at December 31, 2001. However, dividends paid by the subsidiary banks would be prohibited if the effect thereof would cause the banks' capital to be reduced below applicable minimum capital requirements. Under current Federal Reserve regulations, the subsidiary banks are limited to the amounts they may loan to their affiliates, including Sterling. Loans to a single affiliate may not exceed 10%, and the aggregate of loans to all affiliates may not exceed 20% of each bank subsidiary's capital and surplus (as defined by regulation). At December 31, 2001, the maximum amount available for loans to Sterling totaled $14,493,000. NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for Sterling's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of Sterling. The following methods and assumptions were used by Sterling in estimating fair value disclosures for financial instruments. Cash and cash equivalents: The carrying amounts of cash, due from banks and federal funds sold approximate fair value. Interest-bearing deposits in banks and short-term investments: The carrying amounts of interest-bearing deposits and short-term investments maturing within 90 days approximate their fair values. Fair values of other interest-bearing deposits and short-term investments are estimated using discounted cash flows analyses based on current rates for similar type instruments. Securities: Fair values for securities, excluding restricted equity securities, are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The carrying value of restricted stock approximates fair value based on the redemption provisions of the security. Mortgage loans held for sale: Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices. Loans receivable: Fair values for loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Lease contracts are specifically exempt from fair value reporting and are not included in this table. Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amount). Fair values for fixed-rate 60 certificates of deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Short-term borrowings: The carrying amounts of short-term borrowings maturing within 90 days and floating rate short-term borrowings approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on Sterling's current incremental borrowing rates for similar types of borrowing arrangements. Long-term debt: The fair values of Sterling's long-term debt are estimated using discounted cash flow analyses based on current incremental borrowings rates for similar types of borrowing arrangements. Accrued interest: The carrying amounts of accrued interest approximate fair value. Off-balance sheet instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair values of off-balance sheet instruments are not significant at December 31, 2001 and 2000. The estimated fair values and related carrying or notional amounts of Sterling's financial instruments are as follows:
DECEMBER 31, ---------------------------------------------------------------------- 2001 2000 ---------------------------------- ---------------------------------- CARRYING AMOUNT FAIR VALUE CARRYING AMOUNT FAIR VALUE ---------------- ---------------- ---------------- ----------------- Financial Assets: Cash and cash equivalents $94,532 $94,532 $103,567 $103,567 Interest-bearing deposits in banks 2,367 2,367 516 516 Short-term investments 1,277 1,277 603 603 Mortgage loans held for sale 21,024 21,024 1,978 1,978 Securities held-to-maturity 41,788 42,763 51,085 51,854 Securities available-for-sale 490,955 490,955 435,296 435,296 Loans 1,004,059 1,035,529 943,608 950,146 Accrued interest receivable 12,116 12,116 11,987 11,987 Financial Liabilities: Deposits 1,535,649 1,549,076 1,420,300 1,424,268 Short-term borrowings 20,285 20,285 25,656 25,656 Long-term debt 121,093 124,720 113,850 118,141 Accrued interest payable 8,747 8,747 10,080 10,080
61 NOTE 20 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY Financial information pertaining only to Sterling Financial Corporation is as follows:
DECEMBER 31, ---------------------------------- BALANCE SHEETS 2001 2000 ---------------- ---------------- Assets Cash $3,418 $1,715 Securities available-for-sale 1,509 1,389 Investments in: Bank subsidiaries 139,690 126,189 Nonbank subsidiaries 9,298 11,200 Other assets 315 262 ---------------- ---------------- Total assets $154,230 $140,755 ================ ================ Liabilities $2,119 $1,408 Stockholders' equity 152,111 139,347 ---------------- ---------------- Total liabilities and stockholders' equity $154,230 $140,755 ================ ================
YEARS ENDED DECEMBER 31, ---------------------------------------------------- STATEMENTS OF INCOME 2001 2000 1999 ---------------- ---------------- ---------------- Income Dividends from banking subsidiaries $9,780 $12,489 $10,419 Dividends from nonbanking subsidiaries 1,350 155 - Dividends on securities available-for-sale 27 35 108 Gain on securities available-for-sale 180 8 126 Other 3 7 3 ---------------- ---------------- ---------------- Total income 11,340 12,694 10,656 Operating expenses 548 1,851 636 ---------------- ---------------- ---------------- Income before income taxes and equity in undistributed 10,792 10,843 10,020 net income of subsidiaries Income tax expense (benefit) (83) (252) (112) ---------------- ---------------- ---------------- 10,875 11,095 10,132 Equity in undistributed net income of: Banking subsidiaries 10,015 5,335 7,643 Other subsidiaries (556) 137 210 ---------------- ---------------- ---------------- Net Income $20,334 $16,567 $17,985 ================ ================ ================
62
YEARS ENDED DECEMBER 31, --------------------------------------------------- STATEMENT OF CASH FLOWS 2001 2000 1999 ---------------- ---------------- ---------------- Cash flows from operating activities Net Income $20,334 $16,567 $17,985 Adjustments to reconcile net income to net cash provided by operating activities Equity in undistributed net income of subsidiaries (9,459) (5,472) (7,853) Gain on sale of securities available-for-sale (180) (8) (126) (Increase) decrease in other assets 87 28 (211) Increase (decrease) in other liabilities 609 (351) (328) ---------------- ---------------- ---------------- Net cash provided by operating activities 11,391 10,764 9,467 ---------------- ---------------- ---------------- Cash flows from investing activities Purchase of securities available-for-sale (493) (620) (3,040) Proceeds from sales and maturities of securities available-for-sale 512 180 1,506 Investment in nonbanking subsidiary (70) (1,567) (650) Return of capital from nonbanking subsidiaries 750 - - ---------------- ---------------- ---------------- Net cash provided by (used in) investing activities 699 (2,007) (2,184) ---------------- ---------------- ---------------- Cash flows from financing activities Proceeds from issuance of common stock 3 16 147 Cash dividends (9,654) (8,736) (7,828) Cash paid in lieu of fractional shares - (8) (32) Purchase of treasury stock (1,061) - (1,067) Proceeds from issuance of treasury stock 325 52 1,096 ---------------- ---------------- ---------------- Net cash used in financing activities (10,387) (8,676) (7,684) ---------------- ---------------- ---------------- Increase (decrease) in cash 1,703 81 (401) Cash Beginning of year 1,715 1,634 2,035 ---------------- ---------------- ---------------- End of year $3,418 $1,715 $1,634 ================ ================ ================
NOTE 21 - SEGMENT REPORTING Sterling has two reportable segments: 1) community banking and related services, and 2) leasing operations. The community-banking segment provides financial services to consumers, businesses, and governmental units in south central Pennsylvania and northeastern Maryland. These services include providing various types of loans to customers, wealth management services, accepting deposits, and other typical banking services. The leasing segment provides vehicle and equipment financing alternatives to businesses primarily located in south central Pennsylvania and northeastern Maryland, although assets are located throughout the United States. 63 Information about reportable segments, and reconciliation of such information to the consolidated financial statements follows:
COMMUNITY BANKING AND RELATED INTERSEGMENT CONSOLIDATED SERVICES LEASING ELIMINATIONS TOTALS ---------------- ---------------- ----------------- ------------------ YEAR ENDED DECEMBER 31, 2001 Interest income $114,083 $7,309 $(5,476) $115,916 Interest expense 54,970 7,780 (5,476) 57,274 Provision for loan losses 620 597 - 1,217 Noninterest income 19,013 24,912 - 43,925 Noninterest expense 52,962 22,210 - 75,172 Income before income taxes 24,544 1,634 - 26,178 Income tax expense 5,159 685 - 5,844 Net income 19,385 949 - 20,334 Assets 1,800,246 148,000 (86,807) 1,861,439 YEAR ENDED DECEMBER 31, 2000 Interest income $111,616 $6,755 $(5,052) $113,319 Interest expense 55,922 7,631 (5,052) 58,501 Provision for loan losses 485 120 - 605 Noninterest income 14,762 22,746 - 37,508 Noninterest expense 49,926 20,277 - 70,203 Income before income taxes 20,045 1,473 - 21,518 Income tax expense 4,334 617 - 4,951 Net income 15,711 856 - 16,567 Assets 1,674,199 135,858 (83,919) 1,726,138 YEAR ENDED DECEMBER 31, 1999 Interest income $99,784 $6,066 $(4,224) $101,626 Interest expense 45,256 6,372 (4,224) 47,404 Provision for loan losses 970 90 - 1,060 Noninterest income 14,606 18,933 - 33,539 Noninterest expense 45,238 17,221 - 62,459 Income before income taxes 22,926 1,316 - 24,242 Income tax expense 5,666 591 - 6,257 Net income 17,260 725 - 17,985 Assets 1,491,543 123,190 (58,410) 1,556,323
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Sterling's reportable segments are strategic business units that offer different products and services. They are managed separately because each segment appeals to different markets and, accordingly, requires different technology and marketing strategies. Sterling's chief operating decision 64 maker utilizes interest income, interest expense, noninterest income, noninterest expense and the provision for income taxes in making decisions and determining resources to be allocated to the segments. Sterling does not have operating segments other than those reported above. Parent company and treasury function income is included in the community-banking segment, as the majority of effort of these functions is related to this segment. Sterling does not have a single external customer from whom it derives 10% or more of its revenue. NOTE 22 - QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of the quarterly results of operations for the years ended December 31 follows:
Three Months Ended ------------------------------------------------------------------- December 31 September 30 June 30 March 31 ---------------- --------------------------------- ---------------- 2001 Interest and dividend income $28,370 $29,017 $29,193 $29,336 Interest expense 12,554 14,140 14,949 15,631 Provision for loan losses 130 290 495 302 Securities gains 252 538 1,441 479 Noninterest income 11,076 10,488 10,136 9,515 Noninterest expense 20,197 19,062 18,533 17,380 Income before income taxes 6,817 6,551 6,793 6,017 Income tax expense 1,532 1,484 1,555 1,273 Net income 5,285 5,067 5,238 4,744 Per share information: Basic and diluted earnings per share $0.42 $0.40 $0.42 $0.38 Dividends declared 0.200 0.200 0.190 0.190 2000 Interest and dividend income $29,738 $28,910 $27,837 $26,834 Interest expense 16,120 15,280 14,064 13,037 Provision for loan losses 158 158 139 150 Securities gains 34 134 263 260 Noninterest income 9,665 9,158 9,362 8,632 Noninterest expense 17,419 19,757 16,656 16,371 Income before income taxes 5,740 3,007 6,603 6,168 Income tax expense 1,236 608 1,618 1,489 Net income 4,504 2,399 4,985 4,679 Per share information: Basic and diluted earnings per share $0.36 $0.19 $0.40 $0.37 Dividends declared 0.190 0.190 0.185 0.185
NOTE 23 - SUBSEQUENT EVENTS On November 5, 2001, Sterling announced that it had reached an agreement to acquire Equipment Finance, Inc., a commercial finance company that specializes in financing forestry, and land clearing equipment. Under the terms of the agreement, shareholders of Equipment Finance will receive 65 consideration of $30 million of which approximately 70% will be paid in stock and 30% in cash. Sterling issued approximately 955,000 shares of its common stock to acquire Equipment Finance. The transaction closed on February 28, 2002 and was accounted for under the provisions of Statement No. 142. ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Incorporated by reference is the information appearing in Sterling's Current Report on Form 8-K dated November 8, 1999. PART III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated by reference is the information appearing under the headings "Information about Nominees and Continuing Directors" and "Executive Officers" in the 2002 Annual Meeting Proxy Statement. Section 16(a) of the Securities Exchange Act of 1934 requires Sterling's directors, executive officers and shareholders who beneficially own more than 10% of Sterling's outstanding equity stock to file initial reports of ownership and reports of changes in ownership of common stock and other equity securities of Sterling with the Securities and Exchange Commission. Based on a review of copies of such reports we received, and on the statements of the reporting persons, Sterling believes that all Section 16(a) filing requirements were complied with in a timely fashion during 2001, with the exception of Mr. Robert H. Caldwell, a former director, who inadvertently filed one Form 4 late. Mr. Caldwell's Form 4 reported one transaction. ITEM 11 - EXECUTIVE COMPENSATION Incorporated by reference is the information under the headings "Executive Compensation" and "Sterling Financial Corporation Directors' Compensation" in the 2002 Annual Meeting Proxy Statement. ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference is the information appearing under the headings "Principal Holders" and "Beneficial Ownership of Executive Officers, Directors and Nominees" in the 2002 Annual Meeting Proxy Statement. ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference is the information appearing under the heading "Transactions with Directors and Executive Officers" in the 2002 Annual Meeting Proxy Statement and under "Notes to Consolidated Financial Statements - Note 17 - Related Party Transactions" located elsewhere in this Form 10-K. 66 PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS OF FORM 8-K (a) The following documents are filed as part of this report: 1. The financial statements listed on the index set forth in Item 8 of this Annual Report on Form 10-K are filed as part of this Annual Report. 2. Financial Statement Schedules All schedules are omitted because they are not either applicable, the data are not significant or the required information is shown in the financial statements or the notes thereto or elsewhere herein. 3. Exhibits The following is a list of the Exhibits required by Item 601 of Regulation S-K and are incorporated by reference herein or annexed to this Annual Report. 2.1 Agreement and Plan of Reorganization, dated as of November 2, 2001, by and among Sterling Financial Corporation, Sterling EFI Acquisition Corporation and Equipment Finance., including Exhibits (Incorporated by reference to Exhibit 2.1 To Registrant's Registration Statement No. 333-75650 on Form S-4, as amended filed with the Commission on January 16, 2002). 3(i) Amended and Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3(i) to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, and filed with the Commission, on November 14, 2001.) 3(ii) Amended Bylaws. (Incorporated by reference to Exhibit 3(ii) to Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission, on April 25, 2000.) 4.1 Amended and Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3(i) to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, and filed with the Commission, on November 14, 2001.) 4.2 Amended Bylaws. (Incorporated by reference to Exhibit 3(ii) to Registrant's Current Report on form 8-K, filed with the Commission on April 25, 2000.) 10.1 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 4.3 of Registration Segment No. 333-28065 on Form S-8, filed with the Commission, on May 30, 1997.) 10.2 Dividend Reinvestment and Stock Purchase Plan (Incorporated by reference to Registration Statement No. 33-55131 on Form S-3, filed with the Commission on August 18, 1994, and as amended by Registrant's Rule 424 (b) prospectus, filed with the Commission on December 23, 1998, and by Amendment No. 1, filed with the Commission on January 16, 2001.) 10.3 Stock Disposition Agreement, dated September 6, 2001, by and between Howard E Groff, Sr. and Sterling Financial Corporation. (Incorporated by reference to Exhibit 99.1 in Registrant's Current Report on Form 8-K, dated September 6, 2001, and filed with the Commission on September 26, 2001.) 67 10.4 1997 Directors Stock Compensation Plan and Policy. (Incorporated by reference to Exhibit 4.3 to Registrant's Registration Statement No. 333-28101 on Form S-8, filed with the Commission on May 30, 1997.) 10.5 Change in Control Agreement, dated July 27, 1999, between Sterling Financial Corporation, Bank of Lancaster County and John E. Stefan. (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on 10-Q for the quarter ended September 30, 1999, filed with the Commission on November 15, 1999, and as amended on April 4, 2000.) 10.6 Employment Agreement, dated December 18, 2001, between Sterling Financial Corporation, Bank of Lancaster County and J. Roger Moyer, Jr. (Incorporated by reference to Exhibit 10.6 to Registrant's Registration Statement No. 333-75650 on Form S-4, filed with the Commission on January 16, 2002.) 10.7 Change in Control Agreement, dated July 30, 1999, between Sterling Financial Corporation, Bank of Lancaster County and Jere L. Obetz. (Incorporated by reference to Exhibit 10.3 to Registrant's Quarterly Report on 10-Q for the quarter ended September 30, 1999, filed with the Commission on November 15, 1999, and as amended on April 25, 2000.) 10.8 Change in Control Agreement, dated July 7, 1999, between Sterling Financial Corporation, Bank of Lancaster County and Thomas P. Dautrich. (Incorporated by reference to Exhibit 10.3 to Registrant's Quarterly Report on 10-Q for the quarter ended September 30, 1999, filed with the Commission on November 15, 1999, and as amended on April 25, 2000.) 10.9 Employment Agreement, dated July 27, 1999, between Sterling Financial Corporation, Bank of Lancaster County and John E. Stefan. (Incorporated by reference to Exhibit 10.4 to Registrant's Quarterly Report on 10-Q for the quarter ended September 30, 1999, filed with the Commission on November 15, 1999, and as amended on April 25, 2000.) 10.10 Employment Agreement, dated as of February 28, 2002, among Sterling Financial Corporation, Bank of Lancaster County, N.A. and J. Bradley Scovill. 10.11 Employment Agreement, dated as of November 2, 2001, among Sterling Financial Corporation, Equipment Finance, Inc. and George W. Graner. (Incorporated by reference to Exhibit 10.11 to Registrant's Registration Statement No. 333-75650 on Form S-4, as amended, filed with the Commission on January 16, 2002.) 10.12 Employment Agreement, dated as of November 2, 2001, among Sterling Financial Corporation, Equipment Finance, Inc. and Michael J. Shlager. (Incorporated by reference to Exhibit 10.12 to Registrant's Registration Statement No. 333-75650 on Form S-4, as amended, filed with the Commission on January 16, 2002.) 10.13 Employment Agreement, dated as of November 2, 2001, among Sterling Financial Corporation, Equipment Finance, Inc. and Joseph M. Brass (Incorporated by reference to Exhibit 10.13 to Registrant's Registration Statement No. 333-75650 on Form S-4, as amended, filed with the Commission on January 16, 2002.) 11 Statement re: Computations of Earnings Per Share (included herein at Item 8 at Notes to Consolidated Financial Statements, Note 1.) 21 Subsidiaries of the Registrant 23.1 Consent of Ernst & Young LLP 23.2 Consent of Trout, Ebersole & Groff, LLP 68 99 Independent Auditors' Reports of Trout, Ebersole & Groff, LLP Copies of the Exhibits referenced above will be provided to Shareholders without charge by writing to Shareholder Relations, Sterling Financial Corporation, 101 North Pointe Boulevard, Lancaster, PA 17601-4133. (b) Reports on Form 8-K During the quarter ended December 31, 2001, the registrant filed the following reports on Form 8-K:
Date of Report Item Description -------------- ---- ----------- 10/23/01 5 Press release announcing 3rd Quarter and year-to-date earnings 11/2/01 5 Press release announcing Agreement and Plan of Reorganization to acquire Equipment Finance Inc. 11/7/01 9 Slide presentation from Mid-Atlantic 2001 Super-Community Bank Conference in Baltimore, Maryland 11/21/01 5 Press release announcing quarterly dividend
69 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. STERLING FINANCIAL CORPORATION By: /s/ John E. Stefan --------------------------------- John E. Stefan Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities indicated have signed this report below.
Signature Title Date -------------------------------- ----------------------------------------------------------------------- -------------- /s/ John E. Stefan -------------------------------- (John E. Stefan) Chairman of the Board and Chief Executive Officer; Director March 12, 2002 /s/ J. Roger Moyer, Jr. -------------------------------- (J. Roger Moyer, Jr.) President, Chief Operating Officer, Assistant Secretary; Director March 12, 2002 /s/ J. Bradley Scovill -------------------------------- (J. Bradley Scovill) Executive Vice President, Chief Financial Officer, Treasurer; Director March 12, 2002 /s/ Douglas P. Barton -------------------------------- (Douglas P. Barton, CPA) Vice President, Chief Accounting Officer, Secretary March 12, 2002 /s/ Richard H. Albright, Jr. -------------------------------- (Richard H. Albright, Jr.) Director March 12, 2002 /s/ S. Amy Argudo -------------------------------- (S. Amy Argudo) Director March 12, 2002 /s/ Bertram F. Elsner -------------------------------- (Bertram F. Elsner) Director March 12, 2002 /s/ Howard E. Groff, Jr. -------------------------------- (Howard E. Groff, Jr.) Director March 12, 2002 /s/ Joan R. Henderson -------------------------------- (Joan R. Henderson) Director March 12, 2002 /s/ Calvin G. High -------------------------------- (Calvin G. High) Director March 12, 2002 /s/ Terrence L. Hormel -------------------------------- (Terrence L. Hormel) Director March 12, 2002 /s/ David E. Hosler -------------------------------- (David E. Hosler) Director March 12, 2002 /s/ E. Glenn Nauman -------------------------------- (E. Glenn Nauman) Director March 12, 2002 /s/ W. Garth Sprecher -------------------------------- (W. Garth Sprecher) Director March 12, 2002 /s/ Glenn R. Walz -------------------------------- (Glenn R. Walz) Director March 12, 2002
70 Exhibit Index Exhibits Required Pursuant to Item 601 of Regulation S-K
Page (in accordance with sequential Item numbering No. Description system) ---- ----------- ---------- 2.1 Agreement and Plan of Reorganization, dated as of November 2, 2001, by and among Sterling Financial Corporation, Sterling EFI Acquisition Corporation and Equipment Finance., including Exhibits (Incorporated by reference to Exhibit 2.1 To Registrant's Registration Statement No. 333-75650 on Form S-4, as amended filed with the Commission on January 16, 2002). 3(i) Amended and Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3(i) to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, and filed with the Commission, on November 14, 2001.) 3(ii) Amended Bylaws. (Incorporated by reference to Exhibit 3(ii) to Registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission, on April 25, 2000.) 4.1 Amended and Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3(i) to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, and filed with the Commission, on November 14, 2001.) 4.2 Amended Bylaws. (Incorporated by reference to Exhibit 3(ii) to Registrant's Current Report on form 8-K, filed with the Commission on April 25, 2000.) 10.1 1996 Stock Incentive Plan (Incorporated by reference to Exhibit 4.3 of Registration Statement No. 333-28065 on Form S-8, filed with the Commission on May 30, 1997.) 10.2 Dividend Reinvestment and Stock Purchase Plan (Incorporated by reference to Registration Statement No. 33-55131 on Form S-3, filed with the Commission on August 18, 1994, and as amended by Registrant's Rule 424 (b) prospectus, filed with the Commission on December 23, 1998, and by Amendment No. 1, filed with the Commission on January 16, 2001.) 10.3 Stock Disposition Agreement, dated September 6, 2001, by and between Howard E. Groff, Sr. and Sterling Financial Corporation. (Incorporated by reference to Exhibit 99.1 in Registrant's Current Report on Form 8-K, dated September 6, 2001, and filed with the Commission on September 26, 2001.) 10.4 1997 Directors Stock Compensation Plan and Policy. (Incorporated by reference to Exhibit 4.3 to Registrant's Registration Statement No. 333-28101 on Form S-8, filed with the Commission on May 30, 1997.) 10.5 Change in Control Agreement, dated July 27, 1999, between Sterling Financial Corporation, Bank of Lancaster County and John E. Stefan. (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on 10-Q for the quarter ended September 30, 1999, filed with
71 the Commission on November 15, 1999, and as amended on April 4, 2000.) 10.6 Employment Agreement, dated December 18, 2001, between Sterling Financial Corporation, Bank of Lancaster County and J. Roger Moyer, Jr. (Incorporated by reference to Exhibit 10.6 to Registrant's Registration Statement No. 333-75650 on Form S-4, filed with the Commission on January 16, 2002. 10.7 Change in Control Agreement, dated July 30, 1999, between Sterling Financial Corporation, Bank of Lancaster County and Jere L. Obetz. (Incorporated by reference to Exhibit 10.3 to Registrant's Quarterly Report on 10-Q for the quarter ended September 30, 1999, which Report was filed with the Commission on November 15, 1999, and as amended on April 25, 2000.) 10.8 Change in Control Agreement, dated July 7, 1999, between Sterling Financial Corporation, Bank of Lancaster County and Thomas P. Dautrich. (Incorporated by reference to Exhibit 10.3 to Registrant's Quarterly Report on 10-Q for the quarter ended September 30, 1999, which Report was filed with the Commission on November 15, 1999, and as amended on April 25, 2000.) 10.9 Employment Agreement, dated July 27, 1999, between Sterling Financial Corporation, Bank of Lancaster County and John E. Stefan. (Incorporated by reference to Exhibit 10.4 to Registrant's Quarterly Report on 10-Q for the quarter ended September 30, 1999, which Report was filed with the Commission on November 15, 1999, and as amended on April 25, 2000.) 10.10 Employment Agreement, dated as of December 18, 2002, among Sterling Financial Corporation, Bank of Lancaster County, N.A. and J. Bradley Scovill. 10.11 Employment Agreement, dated as of November 2, 2001, among Sterling Financial Corporation, Equipment Finance, Inc. and George W. Graner. (Incorporated by reference to Exhibit 10.11 to Registrant's Registration Statement No. 333-75650 on Form S-4, as amended, filed with the Commission on January 16, 2002.) 10.12 Employment Agreement, dated as of November 2, 2001, among Sterling Financial Corporation, Equipment Finance, Inc. and Michael J. Schlager. (Incorporated by reference to Exhibit 10.12 to Registrant's Registration Statement No. 333-75650 on Form S-4, as amended, filed with the Commission on January 16, 2002.) 10.13 Employment Agreement, dated as of November 2, 2001, among Sterling Financial Corporation, Equipment Finance, Inc. and Joseph M. Brass (Incorporated by reference to Exhibit 10.13 to Registrant's Registration Statement No. 333-75650 on Form S-4, as amended, filed with the Commission on January 16, 2002.) 11 Statement re: Computations of Earnings Per Share (included herein at Item 8 at Notes to Consolidated Financial Statements, Note 1.) 21 Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young, LLP. 23.2 Consent of Trout, Ebersole & Groff, LLP.
72 99 Independent Auditor's Report of Trout, Ebersole & Groff, LLP.
73