10-K 1 a12201310-k.htm 10-K 12 2013 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 FORM 10-K
(Mark One)
þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the year ended DECEMBER 31, 2013

¨ 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 001-34696
STERLING FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington
 
91-1572822
(State of incorporation)
 
(I.R.S. Employer Identification No.)
111 North Wall Street, Spokane, Washington 99201
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (509) 358-8097
Securities registered pursuant to Section 12(b) of the Act:
Common Stock
 
Nasdaq
(Title of each class)
 
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
(Title of class) None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes þ  No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨  No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ  No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
þ
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨  No þ
As of June 30, 2013, the aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the average of the bid and asked prices on such date as reported by the NASDAQ Capital Market, was $840,325,916.
The number of shares outstanding of the registrant's common stock as of January 31, 2014 was 62,386,209.

DOCUMENTS INCORPORATED BY REFERENCE
Specific portions of the registrant's Proxy Statement for its 2014 annual meeting of shareholders are incorporated by reference into Part III hereof. In the event that Sterling does not file a Proxy Statement as a result of consummating the transactions contemplated by the merger agreement, Sterling will amend this Annual Report on Form 10-K to include the information required by this Item.



TABLE OF CONTENTS
December 31, 2013
 
PART I
 
Item 1
Item 1A
Item 1B
Item 2
Item 3
Item 4
PART II
Item 5
Item 6
Item 7
Item 7A
Item 8
Item 9
Item 9A
Item 9B
PART III
Item 10
Item 11
Item 12
Item 13
Item 14
PART IV
Item 15
SIGNATURES
 




PART I
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For a discussion of the risks and uncertainties inherent in such statements, see "Business—Forward-Looking Statements" and "Risk Factors."

Item 1. Business

General

Sterling Financial Corporation, with headquarters in Spokane, Washington, was organized under the laws of Washington State in 1992 as the bank holding company for Sterling Savings Bank, which commenced operations in 1983. References to "Sterling," "the Company," "we," "our," or "us" in this report are to Sterling Financial Corporation, a Washington corporation, and its consolidated subsidiaries on a combined basis, unless otherwise specified or the context otherwise requires. References to "Sterling Bank" refer to our subsidiary Sterling Savings Bank, a Washington state-chartered commercial bank. Sterling Savings Bank does business as Sterling Bank in Washington, Oregon and Idaho, and as Argent Bank in California, offering retail and commercial banking products and services, mortgage lending and trust and investment products to individuals, small businesses, commercial organizations and corporations. As of December 31, 2013, Sterling had assets of $10.32 billion and operated 173 depository branches in Washington, Oregon, Idaho and California.

Recent Developments

Net income for the years ended December 31, 2013, 2012 and 2011 was $93.6 million, $385.7 million, and $39.1 million, respectively. The changes in operating results over the years presented included an increase in net interest income and net interest margin, and lower credit costs. A significant item affecting comparability over the years presented was an income tax benefit of $292.0 million recorded during 2012 in connection with the release of a deferred tax asset valuation allowance, while 2013 included an income tax provision of $37.9 million. Sterling did not recognize any federal or state income tax provision or benefit during 2011. Mortgage banking income declined for 2013, as compared with 2012, from lower refinancing activity.

The net interest margin expanded to 3.64% for the year ended December 31, 2013, from 3.46% and 3.29% for the years ended December 31, 2012 and 2011, respectively, principally driven by a decline in funding costs. The decline in funding costs reflected a shift in the mix and repricing of deposits, as well as a lower balance of wholesale borrowings from securities sold under repurchase agreements in conjunction with the balance sheet repositioning activity undertaken during the fourth quarter of 2012. Net interest income expanded by $19.6 million during 2013, and $9.5 million during 2012, reflecting the decline in funding costs and an increase in interest income on loans, partially offset by a decline in interest income on mortgage-backed securities ("MBS").

During 2013, there was no provision for credit losses, compared with a $10.0 million and $30.0 million provision during 2012 and 2011, respectively, reflecting the decline in nonperforming assets. At December 31, 2013, the ratio of nonperforming assets to total assets was 1.21% compared to 2.28% at December 31, 2012, and 4.01% at December 31, 2011.

On February 28, 2013, Sterling completed the acquisition of American Heritage Holdings, the holding company for Borrego Springs Bank, N.A. ("Borrego"), for $8.7 million in consideration, adding an aggregate of $103.7 million of gross loans and $118.2 million of deposits. A bargain purchase gain of $7.5 million was recorded in connection with the acquisition, reflecting the fair value of net assets acquired in excess of the purchase price. On May 10, 2013, Sterling paid $123.0 million to acquire the Puget Sound operations of Boston Private Bank & Trust Company ("Boston Private"), which added $278.5 million of performing loans and $168.2 million of deposits. On October 1, 2013, Sterling paid $42.9 million in cash to acquire Newport Beach, Calif.-based Commerce National Bank ("CNB"). At closing, CNB had assets of $260.8 million, loans of $164.8 million, and deposits of $189.6 million.

On September 11, 2013, Sterling entered into a definitive agreement to merge (the "Merger") with and into Umpqua Holdings Corporation ("Umpqua"), with headquarters in Portland, Oregon. Immediately after the Merger, Sterling Bank will merge (the "Bank Merger") with and into Umpqua Bank, an Oregon state chartered bank and wholly owned subsidiary of Umpqua. Upon completion of the mergers, the combined company will operate under the Umpqua Bank name and brand. The transaction is expected to be completed in the second quarter of 2014, subject to regulatory approval and other customary closing conditions. Under the terms of the Merger, Sterling shareholders will receive 1.671 shares of Umpqua common stock and $2.18 in cash,

1


without interest, for each share of Sterling common stock. On February 25, 2014, the shareholders of both Sterling and Umpqua approved the Merger.

Business Strategy

Sterling's goal has been to be one of America's great community banks by offering customers a range of highly personalized financial products and services. This strategy has centered on bringing the full product suite of a large regional institution to consumer and commercial customers with the personalized service of a local community bank. The four tenets of this philosophy are:

Knowledgeable bankers—We actively promote employee development, training and compensation initiatives designed to enable our talented team of bankers to capably serve our customers across our footprint.
Fair pricing—We offer a meaningful value proposition for our customers, while providing competitive funding and returns.
Convenience and ease of use—We have retail banking and mortgage loan origination offices with customer-oriented hours of operations; automatic teller machines located throughout our footprint; and full-service consumer and business internet banking and on-line bill pay services, including mobile banking applications.
Competitive products and services—We offer a full range of consumer, small business, commercial, corporate, wealth management and mortgage banking products and services across our four-state footprint. Our treasury management products include an advanced and easy to use Remote Deposit Capture system that is comparable to those of the largest banks operating in our area.

Our banking model is built around core customer relationships, and reflects our belief that every customer deserves a banking relationship built on trust and a superior experience with every interaction. In addition to organic growth based upon the tenets outlined above, an integral part of Sterling's strategy has included acquiring other financial institutions or branches thereof, or other substantial assets or deposit liabilities. During 2013, Sterling has strategically grown its presence in the Southern California market through its acquisitions of Borrego and CNB, and the opening of three new commercial banking offices in Glendale, Oxnard, and Encino, CA.

Profitability and Shareholder Wealth

The following strategies and objectives are integral to our profitability and ability to build wealth for our shareholders:

Improving our deposit base, both in the mix and cost of deposits;
Focusing on asset quality, by actively managing our nonperforming assets;
Growing loan balances, built on customer relationships;
Reducing operating expenses, by improving efficiencies; and
Actively managing capital levels.

We continue to shift our deposit mix towards lower cost transaction, savings and money market deposit accounts ("MMDA"). An asset quality focus is reflected by our robust underwriting and credit approval functions, and our asset quality metrics. We are focused on expanding full relationship banking products and services, and generating high quality assets, while implementing initiatives directed towards controlling our expenses and achieving efficiencies essential to our profitability. Sterling believes these strategies, combined with our active risk and capital management, will contribute to high quality, consistent earnings, and the building of shareholder value. The effect of these strategies on Sterling's financial results is discussed further in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A").

Segment Information

Sterling's operations are divided into two primary business segments that represent our core businesses:

Community Banking - providing traditional banking services through the retail banking, private banking and commercial banking groups, including the originating and servicing of commercial real estate, owner occupied CRE and C&I loans.

2


Home Loan Division - originating and selling residential real estate loans through its mortgage banking operations, on both a servicing-retained and servicing-released basis.

The results of operations are reported by segment in Note 24 of "Notes to Consolidated Financial Statements."
 
Lending Activities

A description of Sterling's lending products and activities are as follows:

Commercial Real Estate Lending. Sterling offers commercial real estate loans for investor non-owner occupied, multifamily, and construction projects, collateralized by real property. Permanent fixed- and adjustable-rate loans on existing properties typically have maturities of three to 30 years. In general, commercial real estate loans involve a higher degree of risk than one- to four-family residential real estate loans, because they typically involve large loan balances to single borrowers or groups of related borrowers. The performance of commercial real estate loans is subject to certain risks not present in one- to four-family residential mortgage lending, including: excessive vacancy rates, inadequate operating cash flows, construction delays, cost overruns, insufficient values and environmental risks.

Commercial Lending. Sterling provides a full range of credit and financial services products to small- and medium-sized businesses. These products include commercial and industrial ("C&I") lending such as: lines of credit, receivable and inventory financing, and equipment loans. These products also include term financing for owner occupied commercial real estate properties. These loans are at fixed or adjustable rate structures, typically with terms of 12 months to 15 years. Loans may be fully secured, partially secured or unsecured, based on certain credit criteria. The product line for businesses includes standardized products, including access to the Small Business Administration ("SBA") and U.S. Department of Agriculture ("USDA") guaranteed lending programs, as well as customized solutions, including cash flow and treasury management services.

Consumer Lending. Consumer loans and lines of credit are originated directly through Sterling's retail branches and private banking teams, and indirectly through Sterling's dealer banking department. Sterling finances the purchase of consumer goods, including automobiles, boats and recreational vehicles, and lines of credit for personal use. Generally, consumer loans have fixed or adjustable rate structures, and are at terms ranging from six months to 10 years. Sterling also makes loans secured by borrowers' savings accounts and equity loans collateralized by residential real estate. Home equity loans may have maturities of up to 20 years.

One- to Four-Family Residential Lending. Sterling originates residential mortgages that are generally underwritten to conform with guidelines of the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), guidelines established by government insured loan programs, or guidelines established by investors (correspondent banks). Loans are originated through Sterling's network of retail mortgage offices and depository branches. Products include: a) fixed-rate residential mortgages; and b) adjustable-rate residential mortgages ("ARMs"), which have interest rates that adjust annually with a fixed period of three, five, seven or 10 years and are indexed to a variety of market indices. Sterling focuses its residential lending efforts on originating traditional amortizing loans for owner occupied homes, second homes and investment properties. Generally, conventional and government guaranteed residential mortgage loans are originated for up to 80% of the appraised value or selling price of the mortgaged property, whichever is less. Borrowers must purchase mortgage insurance from approved third parties so that Sterling's risk is limited to approximately 80% of the appraised value at origination on most loans with loan-to-value ratios in excess of 80%. Sterling's residential lending programs are designed to comply with all applicable regulatory requirements.

Loan Servicing and Secondary Market Activities. Sterling sells mortgage loans on a servicing-retained basis to Fannie Mae and Freddie Mac, or on a servicing-released basis to correspondent banks. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, holding and disbursing escrow funds for the payment of real estate taxes and insurance premiums, contacting delinquent borrowers and supervising foreclosures in the event of unremedied defaults. For sales of loans on a servicing-retained basis, Sterling records a servicing asset, while for sales of loans on a servicing-released basis, Sterling receives a fee. In 2013, Sterling began using a subservicer to service its residential mortgage portfolio.

Loans sold into the secondary market are sold with limited recourse against Sterling, meaning that Sterling may be obligated to repurchase or otherwise reimburse the investor for incurred losses on any loans that suffer an early payment default, are not underwritten in accordance with investor guidelines or are determined to have pre-closing borrower misrepresentations. Sterling maintains a reserve for unfunded credit commitments to cover the costs associated with these potential indemnification

3


obligations. As a Government National Mortgage Association ("Ginnie Mae") issuer, loans sold via securitization by Sterling to correspondent banks contain government guarantees as to the timely payment of principal and interest for federally insured or guaranteed Federal Housing Administration ("FHA"), the Department of Veterans Affairs ("VA") or USDA loans.

Sterling also purchases and sells nonresidential loans in the secondary market. Agents who present loans to Sterling for purchase are required to provide a processed loan package prior to commitment. Sterling then underwrites the loans in accordance with its established lending standards. Nonresidential loan sales provide Sterling with fee income, and assist with managing portfolio concentration risks.

Credit Quality Management

Details of Sterling's problem asset classifications and allowance for credit losses policies and procedures are as follows:

Classified and Nonperforming Assets. To measure the quality of loans and other real estate owned ("OREO"), Sterling has established guidelines for classifying and determining provisions for anticipated losses. Sterling's system employs the risk rating categories of "substandard," "doubtful" and "loss" for its classified assets. Substandard assets have deficiencies, which give rise to the distinct possibility that Sterling will sustain some loss if the deficiencies are not corrected. Doubtful assets have the same weaknesses as substandard assets, and on the basis of currently existing facts, are also deemed to have a high probability of loss. The portion of the asset considered uncollectible and of such little value that it should not be included as an asset of Sterling is classified as a loss. In such cases, Sterling establishes a specific valuation reserve.

The credit administration group focuses on identifying and resolving potential problem credits before they become classified. When an asset becomes classified, management of the relationship is assumed by Sterling's special assets department. Sterling actively engages the borrower and guarantor to remedy the situation by requesting updated financial information from the borrower(s) and guarantor(s) to determine a course of action. In addition, updated collateral values are obtained in order for Sterling's management to perform evaluations for regulatory and decision making purposes and updated title information is obtained to determine the status of encumbrances on the collateral. When possible, Sterling will require the borrower to provide additional collateral. In conjunction with the receipt of additional collateral, Sterling will sometimes modify the terms of the loan. Often the modified terms of the loan are consistent with terms that Sterling would offer a new borrower. If the borrower is having financial difficulties and the modification of terms is considered concessionary, Sterling designates the loan as a "troubled debt restructure" and reports it as a nonperforming loan. A loan designated as a troubled debt restructuring may be returned to accrual status after the borrower performs in accordance with the modified loan terms, generally for a period of at least six months. A loan may have its troubled debt restructure status removed after at least one year of satisfactory performance under the modified terms of the loan, unless the modification includes an interest rate concession that is below a market rate of interest for a loan with similar characteristics.

Sterling also may permit a borrower to sell the underlying collateral for less than the outstanding balance on the loan if the current collateral evaluation supports the offer price. These transactions are known as "short sales." In such situations, Sterling typically requires the borrower to sign a new note or bring cash to closing for the resulting deficiency.

If Sterling and a borrower are unable to achieve an acceptable resolution, Sterling may take a deed in lieu of foreclosure or initiate foreclosure on the underlying collateral. Under such circumstances, Sterling also simultaneously evaluates legal action for potential recovery against the borrowers and guarantors. After obtaining the collateral, Sterling actively works to sell the collateral.

Allowance for Credit Losses. Sterling regularly reviews its classified assets for impairment. If a loan is determined to be impaired, Sterling performs a valuation analysis on the loan. Valuation analysis compares the estimated fair value (discounted cash flow analysis or collateral market value less selling costs), and the book balance (loan principal and accrued interest). For loans that are considered collateral-dependent, the difference between the fair value and the book value is charged off as a confirmed loss. During times of declining real estate values, a specific reserve may be recorded on collateral-dependent impaired loans to recognize market declines since the last appraisal. For certain non-collateral-dependent loans, Sterling generally establishes a specific reserve for the difference between fair value and book value of these loans. Specific reserves are established and periodically adjusted, if necessary, based on the review of information obtained through on-site inspections, market analysis, appraisals and purchase offers.

Sterling maintains an allowance for credit losses at a level deemed appropriate by management to provide for losses related to specifically identified loans and estimated losses in the remaining portfolio, as well as unfunded commitments. The allowance

4


is based upon historical loss experience, loan migration analysis, delinquency trends, portfolio size, concentrations of risk, prevailing and anticipated economic conditions, industry experience, estimated collateral values, management's assessment of credit risk inherent in the portfolio, specific problem loans and other relevant factors. The portfolio is grouped into several segments for loans collectively evaluated for impairment based on characteristics such as loan type, borrower and collateral. Loan migration to loss data is used to determine the annual "probability of default." The annual probability of default is adjusted for the estimated loss emergence period and may be further adjusted based on an assessment of qualitative factors. The estimated loss rates are established considering historical life-to-date losses, net of recoveries, on loans remaining in the portfolio, the trailing twelve months of losses on OREO (including losses on foreclosure, write-downs, and losses on sale), and losses on discounted note sales, resulting in a quantified "loss given default." The adjusted probability of default is multiplied by the loss given default to calculate the estimated loss rates for each loan class. The resulting estimated loss rates are validated against multiple metrics, including historical one-year and three-year annualized losses, net of recoveries, the historical trend in prior period estimated loss rates and management's assessment of the inherent losses based upon specific knowledge of the loan portfolio. Sterling may also maintain an unallocated allowance to provide for other credit losses that may exist in the loan portfolio that are not taken into consideration in establishing the probability of default and loss given default.

Additions to the allowance, in the form of provisions, are reflected in current operating results, while charge-offs to the allowance are made when a loss is determined to be a confirmed loss. Because the allowance for credit losses is based on management's estimate, ultimate losses may materially differ from the estimates.

Investments and MBS

Sterling invests primarily in Freddie Mac, Fannie Mae and Ginnie Mae MBS. Sterling also has investments in municipal bonds and nonagency collateralized mortgage obligations. Such investments provide Sterling with a relatively liquid source of interest income and collateral, which can be used to secure borrowings and assist with managing the interest rate risk and credit risk of Sterling's balance sheet.

Sources of Funds

Sterling's primary sources of funds are: retail, public and brokered deposits; the collection of principal and interest from loans and MBS; the sale of loans into the secondary market in connection with Sterling's mortgage banking activities and other loan sale activities; borrowings from the Federal Home Loan Bank ("FHLB") and the Federal Reserve; and borrowings from commercial banks (including repurchase agreements). The availability and volume of these funds are influenced significantly by prevailing interest rates and other economic conditions, as well as regulatory statutes. Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and to match repricing intervals of assets.

Deposit Activities. Sterling offers a wide variety of deposit products and related services to businesses, individuals, and public sector entities throughout its primary market areas. Deposit accounts include noninterest bearing and interest bearing transaction (checking) accounts, savings accounts, MMDA, and certificates of deposit ("CDs"). Interest rates are established by management and are based on a competitive market analysis. The method of compounding varies from simple interest credited at maturity to daily compounding, depending on the type of account. With the exception of certain promotional CDs and variable-rate products, most CDs carry a fixed rate of interest for a defined term from the opening date of the account. Penalties are imposed if principal is withdrawn from most CDs prior to maturity.

Sterling competes with other financial institutions and financial intermediaries in attracting deposits. There is strong competition for transaction, money market and time deposit balances from commercial banks, credit unions and nonbank corporations, such as securities brokerage companies, mutual funds and other diversified companies, some of which have nationwide networks of offices. Many of Sterling's marketing efforts have been directed toward attracting additional deposit customer relationships and balances. Sterling provides electronic banking products, including debit card, online banking, mobile banking applications, bill pay, merchant services and treasury management services, which include remote deposit capture. All of these products and services are intended to enhance customer relationships and attract and increase retail deposit balances.

Sterling supplements its retail deposit gathering by soliciting funds from public entities and through the acquisition of brokered deposits. Public funds are generally obtained by competitive bidding among qualifying financial institutions, and usually

5


require Sterling to provide the public entities with collateral in the form of qualifying securities for any portion of the deposit that exceeds FDIC deposit insurance limits.

Borrowings. Although deposits are Sterling's primary source of funds, Sterling also uses other borrowings to supplement its deposit gathering efforts. These borrowings include advances from the FHLB, repurchase agreements, primary credits and term auction facilities from the Federal Reserve, and federal funds purchased. See "MD&A—Liquidity and Capital Resources."

The FHLB of Seattle is part of a system that consists of 12 regional Federal Home Loan Banks that provide secured credit to financial institutions. As a condition of membership in the FHLB of Seattle, Sterling Bank is required to own stock of the FHLB of Seattle, with the amount determined as the greater of either a percentage of Sterling's total mortgage related assets, or a percentage of Sterling's total advances outstanding from the FHLB of Seattle. At December 31, 2013, Sterling Bank held more than the minimum FHLB of Seattle stock ownership requirement.

Sterling also borrows funds under repurchase agreements with major broker/dealers and financial entities pursuant to which it sells investments (generally, U.S. agency obligations and MBS) under an agreement to buy them back at a specified price at a later date. These agreements to repurchase are deemed to be borrowings collateralized by the investments and MBS sold. The use of repurchase agreements and other secured borrowings may expose Sterling to certain risks, including the possibility that additional collateral may have to be provided if the market value of the pledged collateral declines.

Subsidiaries

Sterling's principal operating subsidiary is Sterling Bank. See exhibit 21.1 for a complete list of subsidiaries for Sterling and Sterling Bank.

Competition

Sterling faces strong competition, both in attracting deposits and in originating, purchasing and selling loans, from commercial banks, savings and loan associations, mortgage companies, mutual savings banks, credit unions and other institutions, many of which have greater resources than Sterling. Sterling also faces strong competition in marketing financial products such as annuities, mutual funds and other financial products and in pursuing acquisition opportunities. Some or all of these competitive businesses operate in Sterling's market areas.


6


As of June 30, 2013, Sterling Bank's deposit market share was as follows, as compiled from SNL:

Washington
 
Oregon
County
 
Branches
 
Rank
 
Market Share
 
County
 
Branches
 
Rank
 
Market Share
Adams
 
2

 
3

 
21.6
%
 
Baker
 
1

 
2

 
28.6
%
Asotin
 
2

 
2

 
19.4
%
 
Benton
 
1

 
8

 
2.8
%
Benton
 
4

 
8

 
4.9
%
 
Clackamas
 
2

 
16

 
0.7
%
Clallam
 
2

 
11

 
3.5
%
 
Columbia
 
1

 
3

 
16.1
%
Clark
 
10

 
4

 
13.1
%
 
Coos
 
5

 
2

 
27.6
%
Columbia
 
1

 
3

 
26.4
%
 
Curry
 
3

 
1

 
29.3
%
Douglas
 
1

 
5

 
6.0
%
 
Deschutes
 
4

 
10

 
2.6
%
Franklin
 
1

 
9

 
5.2
%
 
Douglas
 
1

 
7

 
1.4
%
Garfield
 
1

 
1

 
53.5
%
 
Grant
 
1

 
3

 
23.5
%
Grant
 
2

 
5

 
8.6
%
 
Harney
 
1

 
3

 
21.8
%
Grays Harbor
 
3

 
4

 
9.5
%
 
Jackson
 
4

 
10

 
4.6
%
King
 
16

 
11

 
1.3
%
 
Josephine
 
2

 
11

 
3.2
%
Kitsap
 
1

 
14

 
0.9
%
 
Klamath
 
5

 
2

 
26.9
%
Kittitas
 
2

 
3

 
12.1
%
 
Lake
 
1

 
3

 
27.8
%
Klickitat
 
2

 
1

 
34.8
%
 
Lane
 
3

 
13

 
1.1
%
Lewis
 
4

 
2

 
16.4
%
 
Malheur
 
3

 
2

 
22.3
%
Okanogan
 
2

 
2

 
22.5
%
 
Marion
 
1

 
13

 
1.1
%
Pierce
 
2

 
17

 
0.6
%
 
Multnomah
 
4

 
12

 
0.7
%
Skamania
 
1

 
1

 
60.1
%
 
Polk
 
1

 
7

 
5.8
%
Snohomish
 
2

 
24

 
0.4
%
 
Tillamook
 
2

 
2

 
31.3
%
Spokane
 
9

 
3

 
11.6
%
 
Umatilla
 
2

 
6

 
5.7
%
Thurston
 
4

 
13

 
3.1
%
 
Union
 
3

 
1

 
24.3
%
Walla Walla
 
3

 
6

 
4.4
%
 
Wallowa
 
1

 
2

 
25.6
%
Whatcom
 
3

 
12

 
2.6
%
 
Washington
 
3

 
11

 
2.5
%
Whitman
 
3

 
7

 
4.1
%
 
Yamhill
 
1

 
8

 
2.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Idaho
 
California
County
 
Branches
 
Rank
 
Market Share
 
County
 
Branches
 
Rank
 
Market Share
Ada
 
2

 
19

 
0.5
%
 
Contra Costa
 
2

 
20

 
0.3
%
Adams
 
1

 
2

 
34.6
%
 
Marin
 
2

 
13

 
0.7
%
Benewah
 
1

 
4

 
16.9
%
 
Orange
 
1

 
41

 
0.3
%
Idaho
 
3

 
1

 
48.4
%
 
San Diego
 
3

 
30

 
0.2
%
Kootenai
 
3

 
10

 
3.3
%
 
Sonoma
 
9

 
7

 
5.9
%
Latah
 
3

 
2

 
26.0
%
 
 
 
 
 
 
 
 
Nez Perce
 
2

 
2

 
17.9
%
 
 
 
 
 
 
 
 
Valley
 
2

 
3

 
27.6
%
 
 
 
 
 
 
 
 



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Personnel

As of December 31, 2013, Sterling had 2,547 full-time equivalent employees. Employees are not represented by a collective bargaining unit.

Regulation

The following is a summary of some of the more significant provisions of laws applicable to Sterling and its subsidiaries. This regulatory framework is designed to protect depositors, federal deposit insurance funds and the banking system as a whole, and not to protect security holders. To the extent that the information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Further, such statutes, regulations and policies are continually under review by Congress and state legislatures, and federal and state regulators. A change in statutes, regulations or regulatory policies applicable to Sterling, including changes in interpretation or implementation thereof, could have a material effect on Sterling's business.

General. As a bank holding company, Sterling is subject to regulation, examination and supervision by the Board of Governors of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and by the Washington Department of Financial Institutions (the "WDFI"). Our subsidiary Sterling Bank is a Washington state-chartered commercial bank, and its deposits are insured by the FDIC. It is subject to regulation, examination and supervision by the FDIC and the WDFI. Numerous federal and state laws, as well as regulations promulgated by the Federal Reserve, the FDIC and state banking regulators, govern almost all aspects of the operation of Sterling Bank, and Sterling's non-bank subsidiaries are also subject to regulation by applicable federal and state regulators for the states in which they conduct business.

Bank Holding Company Regulation. The BHCA limits a bank holding company's business to owning or controlling banks and engaging in other banking-related activities. Bank holding companies must obtain the Federal Reserve's approval before they: (1) acquire direct or indirect ownership or control of any voting shares of any bank that results in total ownership or control, directly or indirectly, of more than 5% of the voting shares of such bank; (2) merge or consolidate with another bank holding company; or (3) acquire substantially all of the assets of any additional banks. Subject to certain state laws, such as age and contingency restrictions, a bank holding company that is adequately capitalized and adequately managed may acquire the assets of both in-state banks and out-of-state banks. With certain exceptions, the BHCA prohibits bank holding companies from acquiring direct or indirect ownership or control of voting shares in any company that is not a bank or a bank holding company unless the Federal Reserve determines that the activities of such company are incidental or closely related to the business of banking. If a bank holding company is well-capitalized and meets certain criteria specified by the Federal Reserve, it may engage de novo in certain permissible non-banking activities without prior Federal Reserve approval.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"), affects the regulation and operations of banks and bank holding companies in many ways. Pursuant to the Dodd-Frank Act, the FDIC has back-up supervisory authority over bank holding companies engaging in conduct that poses a foreseeable and material risk to the Deposit Insurance Fund ("DIF"), and the Federal Reserve has heightened authority to examine, prescribe regulations and take action with respect to all of a bank holding company's subsidiaries. The Office of Financial Research, has authority to collect data from all financial institutions for the purpose of studying threats to U.S. financial stability. Banks and bank holding companies with $10 billion or more in assets are required to conduct and publish the results of annual capital stress tests.

On July 31, 2013, the U.S. District Court for the District of Columbia issued an order granting summary judgment to the plaintiffs in a case challenging certain provisions of the Federal Reserve's rule concerning debit card transaction fees that were adopted to implement Section 1075 of the Dodd-Frank Act, known as the Durbin Amendment. If this decision is ultimately upheld, the amount of debit card interchange fees that a bank subject to the Durbin Amendment would be permitted to charge likely would be reduced further than the current 21 cent cap per transaction.

On December 10, 2013, the final rule implementing section 619 of the Dodd-Frank Act, commonly referred to as the "Volcker Rule," was released. The Volker Rule relates to the trading of securities and the type of securities that may be held by banks, and is primarily applicable to institutions with large broker-dealer and proprietary trading activities. One provision of the Volker Rule prohibits the holding of certain collateralized debt obligations ("CDOs"), including pooled trust preferred securities, except for certain trust preferred securities grandfathered in under subsequent revisions to the rule. Trust preferred debentures issued by banks with less than $15 billion in assets, that were pooled into CDOs before May 19, 2010, and were held prior to December 10, 2013, are excluded from the Volker Rule. As of December 31, 2013, Sterling did not hold any securities subject to the rule.

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Holding companies of banks chartered under Washington law are subject to applicable provisions of Washington's banking laws and to the examination, supervision and enforcement powers of the WDFI. Among other powers, the WDFI has the authority to issue and enforce cease and desist orders on such holding companies and to bring actions to remove their directors, officers and employees.

Change in Control. Subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with regulations promulgated thereunder, require Federal Reserve approval prior to any person or company acquiring "control" of a bank or bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of an institution's voting securities and either that institution has registered securities under Section 12 of the Exchange Act or no other person owns a greater percentage of that class of voting securities immediately after the transaction. In certain cases, a company may also be presumed to have control under the BHCA if it acquires 5% or more of any class of voting securities.

On September 22, 2008, the Federal Reserve issued a policy statement on minority equity investments in banks and bank holding companies that permits investors—without triggering the various regulatory requirements associated with control—to (1) acquire up to 33% of the total equity of a target bank or bank holding company, subject to certain conditions including (but not limited to) the condition that the investing firm does not acquire 15% or more of any class of voting securities, and (2) designate at least one director to serve on the board of directors.

Pursuant to the Dodd-Frank Act, a bank holding company may acquire control of an out-of-state bank only if the bank holding company is well-capitalized and well-managed, and interstate merger transactions are prohibited unless the resulting bank would be well-capitalized and well-managed following the transaction. Washington state law requires that the WDFI be given notice at least 30 days in advance of any proposed change of control of a Washington state-chartered bank. Washington law defines "control" of an entity to mean directly or indirectly, alone or in concert with others, to own, control or hold the power to vote 25% or more of the outstanding stock or voting power of the entity.

Capital Requirements. The Federal Reserve has adopted guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a bank holding company such as Sterling, and in analyzing applications under the BHCA. The FDIC has adopted similar guidelines to assess the adequacy of capital in state-chartered non-member banks such as Sterling Bank. These guidelines include quantitative measures that assign risk weightings to assets and off-balance sheet items and that define and set minimum regulatory capital requirements. The definitions of capital and the tests for measuring the adequacy of capital required by the Federal Reserve for bank holding companies and by the FDIC for state-chartered non-member banks are similar, but not identical.

In general, all bank holding companies are required to maintain a tier 1 leverage ratio of at least 3%, tier 1 risk-based capital ratio of at least 4%, and total risk-based capital ratio (the sum of tier 1 capital and tier 2 capital) of at least 8%.

Under FDIC regulations, all insured depository institutions are assigned to one of the following capital categories:

Well-Capitalized—A well-capitalized insured depository institution: (1) has a total risk-based capital ratio of 10% or greater; (2) has a tier 1 risk-based capital ratio of 6% or greater; (3) has a leverage capital ratio of 5% or greater; and (4) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.
Adequately Capitalized—An adequately capitalized insured depository institution: (1) has a total risk-based capital ratio of 8% or greater; (2) has a tier 1 risk-based capital ratio of 4% or greater; and (3) has a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.
Undercapitalized—An undercapitalized insured depository institution: (1) has a total risk-based capital ratio of less than 8%; (2) has a tier 1 risk-based capital ratio of less than 4%; or (3) has a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMELS rating system, a leverage capital ratio of less than 3%.
Significantly Undercapitalized—A significantly undercapitalized insured depository institution: (1) has a total risk-based capital ratio of less than 6%; (2) has a tier 1 risk-based capital ratio of less than 3%; or (3) a leverage capital ratio of less than 3%.

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Critically Undercapitalized—A critically undercapitalized institution: has a ratio of tangible equity to total assets that is equal to or less than 2%.

The regulations permit the appropriate federal banking regulator to downgrade an institution to the next lower category if the regulator determines that the institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any of the categories of asset quality, management, earnings or liquidity in its most recent examination. Supervisory actions by the appropriate federal banking regulator depend upon an institution's classification within the five regulatory capital categories. For the purposes of these tests, tier 1 capital generally consists of common equity, retained earnings and a limited amount of qualifying preferred stock, less accumulated other comprehensive income (loss), goodwill and certain core deposit intangibles. Tier 2 capital consists of non-qualifying preferred stock, certain types of debt and a limited amount of other items.

In measuring the adequacy of risk-based capital, assets are weighted for risk at rates that range from zero percent to 100%. Certain assets, such as cash and U.S. government securities, have a zero percent risk weighting. Others, such as certain commercial and consumer loans, have a 100% risk weighting. Risk weightings and asset equivalent factors are also assigned for off-balance sheet items such as loan commitments. The various items are multiplied by the appropriate risk-weighting to determine risk-adjusted assets for the capital calculations. For the leverage ratio mentioned above, assets are not risk-weighted.

On July 2, 2013, the Federal Reserve issued capital regulations generally consistent with new capital standards commonly referred to as "Basel III," and will become effective January 1, 2015. The regulations include: a permanent grandfathering of the existing tier 1 capital status of trust preferred junior subordinated debentures for banks with less than $15 billion in total assets (subject to exceptions in the case of mergers) and an option to exclude unrealized gains and losses on available for sale securities from tier 1 capital for banks with less than $250 billion in total assets (subject to certain limitations for acquisition related asset growth). Under Basel III, mortgage risk weightings increased for nonperforming loans, mortgage servicing rights, and deferred tax assets. Pursuant to Basel III, the Federal Reserve established a tier 1 common capital ratio minimum of 5% for bank holding companies, or 6% for systemically important financial institutions (the eight largest U.S. banks). If the new regulations had been in effect at December 31, 2013, they would not have materially impacted Sterling's or Sterling Bank's regulatory capital ratios.

Commitments to Subsidiary Bank. Under Federal Reserve policy, Sterling is expected to act as a source of financial strength to Sterling Bank, and to commit resources to support Sterling Bank in circumstances when we might not do so absent such policy. The Dodd-Frank Act requires this Federal Reserve policy to be implemented into formal regulations, which have not yet been proposed. Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve's determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary. Further, the Federal Reserve has discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the Federal Reserve determines that any such divestiture may aid the depository institution's financial condition. In addition, any capital loans by Sterling to Sterling Bank would be subordinate in right of payment to depositors and to certain other indebtedness of Sterling Bank.

If Sterling were to enter bankruptcy, any commitment by it to a federal bank regulatory agency to maintain the capital of Sterling Bank would generally be assumed by the bankruptcy trustee and entitled to a priority of payment. However, recent case law has held that, under certain circumstances, the assumption by the trustee and the priority of payment may be disallowed. It is not clear what impact, if any, this case law would have on our obligations in such an event.

Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") established a system of prompt corrective action to resolve the problems of undercapitalized insured depository institutions. Under this system, the federal banking regulators are required to rate insured depository institutions on the basis of five capital categories as described above under "Capital Requirements." The federal banking regulators are also required to take mandatory supervisory actions and are authorized to take other discretionary actions with respect to insured depository institutions in the three undercapitalized categories, the severity of which will depend upon the capital category in which the insured depository institution is assigned. Generally, subject to a narrow exception, FDICIA requires the banking regulators to appoint a receiver or conservator for an insured depository institution that is critically undercapitalized. The federal banking regulations specify the relevant capital level for each category.

FDICIA generally prohibits a depository institution from making any capital distribution, including payment of a dividend, or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. See

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"Dividends." "Undercapitalized" depository institutions are also subject to restrictions on borrowing from the Federal Reserve System, may not accept brokered deposits absent a waiver from the FDIC, and are subject to growth limitations. In addition, a depository institution's holding company must guarantee a capital plan, up to an amount equal to the lesser of 5% of the depository institution's assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. Federal banking regulators may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.

"Significantly undercapitalized" depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator.

Washington state law gives the WDFI powers similar to those granted to the FDIC under the prompt corrective action provisions of FDICIA.

Dividends. Sterling is a legal entity separate and distinct from Sterling Bank and other subsidiaries. The principal source of funds for Sterling's payment of dividends on its capital stock and principal and interest on its debt is dividends from Sterling Bank. Various federal and state statutory provisions and regulations limit the amount of dividends, if any, Sterling, Sterling Bank and certain other subsidiaries may pay without regulatory approval.

Under the Federal Reserve guidance reissued on February 24, 2009 the Federal Reserve may restrict Sterling's ability to pay dividends on any class of capital stock or any other tier 1 capital instrument if it is not deemed to have a strong capital position. In addition, dividends may have to be reduced or eliminated if:

Sterling's net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends;
Sterling Bank's prospective rate of earnings retention is not consistent with the holding company's capital needs and overall current and prospective financial condition; or
Sterling will not meet, or is in danger of not meeting, Sterling's minimum regulatory capital adequacy ratios.

The FDIC has the authority to prohibit Sterling Bank from engaging in unsafe or unsound practices in conducting its business, and the payment of dividends, depending on the Bank's financial condition, could be deemed an unsafe or unsound practice. The ability of Sterling Bank to pay dividends in the future will continue to be influenced by bank regulatory capital guidelines, and is subject to regulatory approval.

Under Washington banking law, Sterling Bank may not pay a dividend greater than its retained earnings without WDFI approval. As of December 31, 2013, Sterling Bank had an accumulated deficit of $633.0 million, and is therefore generally required to seek approval to pay any dividends. Sterling Bank, however, has been granted a waiver that remains in effect so long as certain capital requirements and regulatory exam ratings are maintained.

FDICIA generally prohibits a depository institution from making any capital distribution, including payment of a dividend, or paying any management fee to its holding company if the institution would thereafter be undercapitalized. In addition, federal and state banking regulations applicable to us and our bank subsidiaries require minimum levels of capital that limit the amounts available for payment of dividends.

Deposit Insurance and Assessments. Deposits held by Sterling Bank are insured by the DIF as administered by the FDIC. The Dodd-Frank Act raised the standard maximum deposit insurance amount to $250,000 per depositor, per insured depository institution for each account ownership category.

The FDIC maintains the DIF by assessing each depository institution an insurance premium. The amount of the FDIC assessments paid by a DIF member institution is based on its relative risk of default as measured by the company's FDIC supervisory rating, and other various measures, such as the level of brokered deposits, secured debt and debt issuer ratings.

In February 2011, the FDIC redefined the deposit insurance assessment base, and updated the assessment rates. The DIF assessment base rate currently ranges from 2.5 to 45 basis points for institutions that do not trigger factors for brokered deposits

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and unsecured debt, and higher rates for those that do trigger those risk factors. On October 9, 2012, the FDIC revised this guidance to clarify definitions used to identify concentrations in certain high risk assets of depository institutions with more than $10 billion in assets, and provides for higher premiums in cases where high risk assets are in excess of prescribed thresholds.

The Dodd-Frank Act effects further changes to the law governing deposit insurance assessments. There is no longer an upper limit for the reserve ratio designated by the FDIC each year, and the maximum reserve ratio may not be less than 1.35% of insured deposits, or the comparable percentage of the assessment base. Under prior law the maximum reserve ratio was 1.15%. The Dodd-Frank Act permits the FDIC until September 30, 2020 to raise the reserve ratio to 1.35%. The FDIC is required to offset the effect of increased assessments necessitated by the Dodd-Frank Act on insured depository institutions with total consolidated assets of less than $10 billion. The Dodd-Frank Act also eliminates requirements under prior law that the FDIC pay dividends to member institutions if the reserve ratio exceeds certain thresholds. In lieu of dividends, the FDIC will adopt lower rate schedules when the reserve ratio exceeds certain thresholds.

Transactions with Affiliates and Insiders. A variety of legal limitations restrict Sterling Bank from lending or otherwise supplying funds or in some cases transacting business with Sterling or its nonbank subsidiaries. Sterling Bank is subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. Section 23A places limits on the amount of covered transactions which include loans or extensions of credit to, investments in or certain other transactions with, affiliates as well as the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited to 10% of the bank's capital and surplus for any one affiliate and 20% for all affiliates. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements ranging from 100% to 130%. Also, banks are prohibited from purchasing low quality assets from an affiliate.

Section 23B, among other things, prohibits an institution from engaging in certain transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with nonaffiliated companies. Except for limitations on low quality asset purchases and transactions that are deemed to be unsafe or unsound, Regulation W generally excludes affiliated depository institutions from treatment as affiliates. Transactions between a bank and any of its subsidiaries that are engaged in certain financial activities may be subject to the affiliated transaction limits. The Federal Reserve also may designate bank subsidiaries as affiliates.

Banks are also subject to quantitative restrictions on extensions of credit to executive officers, directors, principal shareholders, and their related interests. In general, such extensions of credit: (1) may not exceed certain dollar limitations; (2) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties; and (3) must not involve more than the normal risk of repayment or present other unfavorable features. Certain extensions of credit also require the approval of a bank's board of directors.

The Dodd-Frank Act expands the 23A and 23B affiliate transaction rules. Among other things, upon the statutory changes' effective date, the scope of the definition of "covered transaction" under 23A will expand, collateral requirements will increase and certain exemptions will be eliminated.

Standards for Safety and Soundness. The Federal Deposit Insurance Act requires the federal bank regulators to prescribe the operational and managerial standards for all insured depository institutions relating to: (1) internal controls; (2) information systems and audit systems; (3) loan documentation; (4) credit underwriting; (5) interest rate risk exposure; and (6) asset quality.

The regulators also must prescribe standards for earnings, and stock valuation, as well as standards for compensation, fees and benefits. The Interagency Guidelines Prescribing Standards for Safety and Soundness set forth the safety and soundness standards used to identify and address problems at insured depository institutions before capital becomes impaired. Under the rules, if a regulator determines that a bank fails to meet any standards prescribed by the guidelines, the regulator may require the bank to submit an acceptable plan to achieve compliance, consistent with deadlines for the submission and review of such safety and soundness compliance plans.

Regulatory Examination. Federal and state banking regulations mandate that Sterling provide audited financial statements in compliance with minimum standards and procedures. Sterling and Sterling Bank must undergo regular on-site examinations by the appropriate banking agency. Regulators conducting an examination have complete access to the books and records of the examined institution. The results of the examination are confidential. The cost of examinations may be assessed against the examined institution as the agency deems necessary or appropriate.


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State Law and Regulation. Sterling Bank, as a Washington state-chartered institution, is subject to regulation by the WDFI, which conducts regular examinations to ensure that its operations and policies conform with applicable law and safe and sound banking practices. Among other things, state law regulates the amount of credit that can be extended to any one borrower and the amount of money that can be invested in various types of assets. Sterling Bank generally cannot extend credit to any one borrower in an amount greater than 20% of Sterling Bank's capital and surplus. State law also regulates the types of loans Sterling Bank can make. With the WDFI's approval, Sterling Bank can currently invest up to 10% of its total assets or 50% of its net worth (whichever is less) in other corporations, whether or not such corporations are engaged in activities related to Sterling Bank's business, but such authority is subject to restrictions imposed by federal law. Sterling Bank also operates depository branches within the states of Oregon, Idaho and California, and therefore, its operations in these states are subject to the supervision of the Oregon Department of Consumer and Business Services, the Idaho Department of Finance and the California Department of Financial Institutions, as applicable. Sterling and its subsidiaries are also required to comply with the applicable laws and regulations for the various states in which it does business.

Community Reinvestment Act. The Community Reinvestment Act (the "CRA") requires that the appropriate federal bank regulator evaluate the records of Sterling Bank in meeting the credit needs of its local community, including low and moderate income neighborhoods. These evaluations are considered by regulatory agencies in their review of applications to approve bank mergers, acquisitions, and new branches or facilities. Failure to adequately meet these criteria could result in additional requirements and limitations on the Bank. As of Sterling Bank's last CRA regulatory exam completed in May 2012, the rating was "satisfactory."

Consumer Protection Regulations. Retail activities of banks are subject to a variety of statutes and regulations designed to protect consumers. The Dodd-Frank Act established the Consumer Financial Protection Bureau (the "CFPB") that, together with the statute's changes to consumer protection laws such as limits on debit card interchange fees and provisions on mortgage-related matters, will likely increase the compliance costs of consumer banking operations. Interest and other charges collected or contracted for by banks are subject to state usury laws and federal laws concerning interest rates. The CFPB has exclusive authority to require reports and conduct examinations, for purposes of ensuring compliance with federal consumer financial laws and related matters, of insured depository institutions with more than $10 billion of assets. For insured depository institutions with assets of $10 billion or less, the CFPB can require reports and conduct examinations on a sample basis.

Loan operations are also subject to federal laws applicable to credit transactions, such as:

the federal Truth-In-Lending Act and Regulation Z issued by the Federal Reserve, governing disclosures of credit terms to consumer borrowers;
the Home Mortgage Disclosure Act and Regulation C issued by the Federal Reserve, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
the Equal Credit Opportunity Act and Regulation B issued by the Federal Reserve, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
the Fair Credit Reporting Act and Regulation V issued by the Federal Reserve, governing the use and provision of information to consumer reporting agencies;
the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
the guidance of the various federal agencies charged with the responsibility of implementing such federal laws.

Deposit operations also are subject to:

the Truth in Savings Act and Regulation DD issued by the Federal Reserve, which requires disclosure of deposit terms to consumers;
Regulation CC issued by the Federal Reserve, which relates to the availability of deposit funds to consumers;
the Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

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the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of ATMs and other electronic banking services.

Commercial Real Estate Lending. Lending operations that involve concentrations of commercial real estate loans are subject to enhanced scrutiny by federal banking regulators. The regulators have advised financial institutions of the risks posed by commercial real estate lending concentrations. Such loans generally include land development, construction loans and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes guidelines for examiners to help identify institutions that are potentially exposed to excessive risk concentrations and may warrant greater supervisory scrutiny when:

total construction and land development loans represent 100% or more of the institution's total risk-based capital (the ratio was 15% for Sterling Bank at December 31, 2013), or

total commercial real estate loans, as defined, represent 300% or more of the institution's total risk-based capital (the ratio was 295% for Sterling Bank at December 31, 2013), and the outstanding balance of the institution's commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.

The Dodd-Frank Act contains provisions on credit risk retention that require federal banking regulators to adopt regulations mandating the retention of 5% of the credit risk of certain loans transferred, sold or conveyed through issuances of asset-backed securities. Implementing regulations will provide for the allocation of the risk retention obligation between securitizers and originators of loans.

Branching. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit these purchases. Additionally, banks are permitted to merge with banks in other states, as long as the home state of neither merging bank has opted out under the legislation. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.

Washington enacted "opting in" legislation in accordance with the Interstate Act, allowing banks to engage in interstate merger transactions, subject to certain "aging" requirements. Once an out-of-state bank has acquired a bank within the state, either through merger or acquisition of all or substantially all of the bank's assets, the out-of-state bank may open additional branches within the state. In addition, an out-of-state bank may establish a new branch in Washington or acquire a branch in Washington if the out-of-state bank's home state gives Washington banks substantially the same or more favorable rights to establish and maintain branches in that state.

Anti-Tying Restriction. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for products and services on the condition that: (1) the customer obtain or provide some additional credit, property, or services from or to the bank or bank holding company or their subsidiaries; or (2) the customer not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. A bank may, however, offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products. Also, certain foreign transactions are exempt from the general rule.

Anti-Money Laundering. Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and the periodic testing of the program. Sterling Bank is prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence in dealings with foreign financial institutions and foreign customers. We also must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions. Recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering requirements have been substantially strengthened as a result of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act"), enacted in 2001 and renewed in 2006 and extended, in part, in 2011. Bank regulators routinely examine institutions for compliance with these requirements and must consider compliance in connection with the regulatory review of applications.


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The USA Patriot Act amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. The statute also creates enhanced information collection tools and enforcement mechanics for the U.S. government, including: (1) requiring standards for verifying customer identification at account opening; (2) promulgating rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (3) requiring reports by nonfinancial trades and businesses filed with the Treasury's Financial Crimes Enforcement Network for transactions exceeding $10,000; and (4) mandating the filing of suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations. The statute also requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.

The Federal Bureau of Investigation may send bank regulators lists of the names of persons suspected of involvement in terrorist activities. Sterling Bank may be subject to a request for a search of its records for any relationships or transactions with persons on those lists and may be required to report any identified relationships or transactions. Furthermore, the Office of Foreign Assets Control ("OFAC") is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, bank regulators lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we find a name on any transaction, account or wire transfer that matches the OFAC list, the account is frozen, a suspicious activity report is filed and the appropriate authorities are notified.

Privacy and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential customer information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties, with some exceptions, such as the processing of transactions requested by the consumer. Financial institutions generally may not disclose certain consumer or account information to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing. Federal and state bank regulators have prescribed standards for maintaining the security and confidentiality of consumer information, and we are subject to such standards, as well as certain federal and state laws or standards for notifying consumers in the event of a security breach.

Sterling Bank utilizes credit bureau data for loan underwriting purposes. Use of such data is regulated under the Fair Credit Reporting Act and Regulation V on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates and the use of credit data. The Fair and Accurate Credit Transactions Act, which amended the Fair Credit Reporting Act, permits states to enact identity theft laws that are consistent with the conduct required by the provisions of that Act.

Enforcement Powers. Banks and their "institution-affiliated parties," including directors, management, employees, agents, independent contractors and consultants, such as attorneys and accountants, and others who participate in the conduct of the institution's affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. Violations can include failure to timely file required reports, filing false or misleading information or submitting inaccurate reports. Civil penalties may be as much as $1 million a day for such violations and criminal penalties for some financial institution crimes may include imprisonment for 20 years. Regulators have flexibility to commence enforcement actions against institutions and institution-affiliated parties, and the FDIC has the authority to terminate deposit insurance. When issued by a banking regulator, cease-and-desist orders or other regulatory agreements may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions determined to be appropriate by the ordering agency. Federal and state banking regulators also may remove a director or officer from an insured depository institution (or bar them from the industry) if a violation is willful or reckless.

Corporate Governance. The Dodd-Frank Act contains a number of provisions that require changes to financial institutions' corporate governance and executive compensation practices, including proxy access for publicly-traded banks' director nominations, clawback of incentive-based compensation from executive officers and increased disclosure on compensation arrangements. Publicly-traded bank holding companies with more than $10 billion in assets are required to have risk committees with a number of independent directors to be determined by the Federal Reserve and that include at least one risk management expert. Sterling has had such a committee in place since 2011.

Monetary Policy and Economic Controls. Our earnings are affected by the policies of regulatory authorities, including the monetary policy of the Federal Reserve. An important function of the Federal Reserve is to promote orderly economic growth

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by influencing interest rates and the supply of money and credit. Among the methods that have been used to achieve this objective are open market operations in U.S. government securities, changes in the discount rate for bank borrowings, expanded access to funds for nonbanks and changes in reserve requirements against bank deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, interest rates on loans and securities, and rates paid for deposits. In recent years, in response to the financial crisis, the Federal Reserve has created several innovative programs to stabilize certain financial institutions and to ensure the availability of credit. The effects of the various Federal Reserve policies on our future business prospects and earnings cannot be predicted.

Depositor Preference Statute. Federal law provides that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution are afforded priority over other general unsecured claims against such institution, including federal funds and letters of credit, in the liquidation or other resolution of the institution by any receiver.

Environmental Laws. Hazards related to the environment have become a source of high risk and potentially unlimited liability for financial institutions relative to their loans. Contaminated properties owned by an institution's borrowers may result in a drastic reduction in the value of the collateral securing the institution's loans to such borrowers, high clean-up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean-up costs, and liability to the institution for clean-up costs if it forecloses on the contaminated property or becomes involved in the management of the property. To minimize this risk, Sterling may require an environmental examination and report with respect to the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. This examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, with the costs of such examinations and reports being the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with Sterling. Sterling is not aware of any borrower who is currently subject to any environmental investigation or clean-up proceeding that is likely to have a material adverse effect on the financial condition or results of operations of Sterling.


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Cautionary Statement Regarding Forward-Looking Statements
This annual report on Form 10-K contains certain "forward-looking statements" within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of words such as "anticipate," "may," "can," "believe," "expect," "project," "intend," "likely," "plan," "seek," "should," "would," "estimate" and similar expressions and any other statements that predict or indicate future events or trends or that are not statements of historical facts. These forward-looking statements include, but are not limited to, statements about Sterling's plans, objectives, expectations, strategies and intentions and other statements contained in this release that are not historical facts and pertain to Sterling's future operating results and capital position, including Sterling's ability to reduce future loan losses, improve its deposit mix, execute its asset resolution initiatives, execute its lending initiatives, contain costs and potential liabilities, realize operating efficiencies, execute its business strategy, make dividend payments, compete in the marketplace and provide increased customer support and service. All forward-looking statements are subject to numerous risks and uncertainties. Actual results may differ materially from the results discussed in these forward-looking statements because such statements are inherently subject to significant assumptions, risks and uncertainties, many of which are difficult to predict and are generally beyond Sterling's control. These risks and uncertainties include, but are not limited to, the following: changes in general economic conditions that may, among other things, increase default and delinquency risks in Sterling's loan portfolios; shifts in market interest rates that may result in lower interest rate margins; shifts in the demand for Sterling's loan and other products; changes in the monetary and fiscal policies of the federal government; changes in laws, regulations or the competitive environment; exposure to material litigation; the timing to consummate the proposed Merger; the risk that a condition to closing of the proposed Merger may not be satisfied; the risk that a regulatory approval that may be required for the proposed Merger is not obtained or is obtained subject to conditions that are not anticipated; the ability of Sterling and Umpqua to achieve the synergies and value creation contemplated by the proposed Merger, or lower-than-expected revenue or cost savings or other issues in connection with mergers and acquisitions generally; the parties' ability to promptly and effectively integrate the businesses of Sterling and Umpqua; the diversion of management time on issues related to the Merger; and the failure to consummate or delay in consummating the Merger for other reasons. Sterling undertakes no obligation (and expressly disclaims any such obligation) to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. For additional information concerning factors that could cause actual conditions, events or results to materially differ from those described in the forward-looking statements, please refer to the factors set forth under the headings "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this annual report and Umpqua's most recent Form 10-K and to Sterling's and Umpqua's most recent Form 10-Q and 8-K reports, which are available online at www.sec.gov. No assurances can be given that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what impact they will have on the results of operations or financial condition of Sterling or Umpqua.

Where You Can Find More Information

The periodic reports Sterling files with the SEC are available on Sterling's website at www.SterlingFinancialCorporation.com after the reports are filed with the SEC. The SEC maintains a website located at www.sec.gov that also contains this information. The information on Sterling's website and the SEC's website is not part of this annual report on Form 10-K. Sterling will provide you with copies of these reports, without charge, upon request made to:

Investor Relations
Sterling Financial Corporation
111 North Wall Street
Spokane, Washington 99201
(509) 358-8097


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Item 1A. Risk Factors

Set forth below and elsewhere in this Annual Report on Form 10-K and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K.

The risks described below are not the only ones facing our company. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. Our business, financial condition, results of operations or prospects could be materially and adversely affected by any of these risks. The trading price of, and market for, shares of Sterling common stock could decline due to any of these risks.

The Merger is subject to regulatory approval and other customary closing conditions, which may not be received, may take longer than expected or may impose conditions that are not presently anticipated or that could have an adverse effect on the combined company following the Merger. Before the Merger and the Bank Merger may be completed, Sterling and Umpqua must obtain approvals from the Federal Reserve Board and the FDIC. Other approvals, waivers or consents from regulators may also be required. In determining whether to grant these regulatory approvals the regulators consider a variety of factors, including the regulatory standing of each party and the financial and managerial resources and future prospects of the combined company. An adverse development in either company's regulatory standing or other factors could result in an inability to obtain approval or delay receipt of approval. These regulators may impose conditions on the completion of the Merger or the Bank Merger or require changes to the terms of the Merger or the Bank Merger. Such conditions or changes could have the effect of delaying or preventing completion of the Merger or the Bank Merger or imposing additional costs on or limiting the revenues of the combined company following the Merger and the Bank Merger, any of which might have an adverse effect on the combined company following the Merger.

Combining the two companies may be more difficult, costly or time consuming than expected and the anticipated benefits and cost savings of the Merger may not be realized. Sterling and Umpqua have operated and, until the completion of the Merger, will continue to operate, independently. The success of the Merger, including anticipated benefits and cost savings, will depend, in part, on Umpqua's ability to successfully combine and integrate the businesses of Sterling and Umpqua in a manner that permits growth opportunities and does not materially disrupt the existing customer relations nor result in decreased revenues due to loss of customers. It is possible that the integration process could result in the loss of key employees, the disruption of either company's ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the combined company's ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the Merger. If difficulties with the integration process are encountered, the anticipated benefits of the Merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause Sterling to lose customers or cause customers to remove their accounts from Sterling and move their business to competing financial institutions. Integration efforts between the two companies will also divert management attention and resources. These integration matters could have an adverse effect on Sterling during this transition period and for an undetermined period on the combined company after completion of the Merger.

Termination of the merger agreement could negatively impact Sterling. If the merger agreement is terminated, there may be various consequences. For example, Sterling's businesses may have been impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the Merger, without realizing any of the anticipated benefits of completing the Merger. Additionally, if the merger agreement is terminated, the market price of Sterling's common stock could decline to the extent that the current market price reflects a market assumption that the Merger will be completed. If the Merger agreement is terminated under certain circumstances, Sterling may be required to pay to Umpqua a termination fee of $75 million.

Sterling will be subject to business uncertainties and contractual restrictions while the Merger is pending. Uncertainty about the effect of the Merger on employees and customers may have an adverse effect on Sterling. These uncertainties may impair Sterling's ability to attract, retain and motivate key personnel until the Merger and associated integration process is completed, and could cause customers and others that deal with Sterling to seek to change or terminate existing business relationships with Sterling. Retention of certain employees by Sterling may be challenging while the Merger is pending, as certain employees may experience uncertainty about their future roles with Sterling. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with Sterling, Sterling's business could be harmed. In addition, subject to certain exceptions, Sterling has agreed to operate its business in the ordinary course and to comply with certain other operational restrictions, prior to closing.

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If the Merger is not completed, Sterling will have incurred substantial expenses without realizing the expected benefits of the Merger. Sterling has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the merger agreement. If the Merger is not completed, Sterling would have to recognize these expenses without realizing the expected benefits of the Merger.

The merger agreement limits Sterling's ability to pursue acquisition proposals and requires Sterling to pay a termination fee of $75 million under limited circumstances relating to alternative acquisition proposals. Additionally, these and other provisions of the merger agreement, Sterling's articles of incorporation and bylaws and Washington law may deter potential acquirers. The merger agreement prohibits Sterling and Umpqua from soliciting, initiating, knowingly encouraging or knowingly facilitating certain third-party acquisition proposals. The merger agreement also provides that Sterling must pay a termination fee in the amount of $75 million in the event that the merger agreement is terminated under certain circumstances, including a termination resulting from Sterling's failure to abide by certain obligations not to solicit alternate acquisition proposals. Further, the merger agreement also prohibits Sterling from waiving confidentiality and standstill provisions in its favor in existing agreements with third parties. These provisions may discourage or prohibit a potential competing acquirer that might have an interest in acquiring all or a significant part of Sterling from considering or proposing an alternative acquisition. In addition, under Washington law, certain business combinations involving Sterling with its large shareholders are restricted without the approval of the board of directors of Sterling.

These provisions and agreements, and other provisions of Sterling's articles of incorporation or bylaws or of the Washington Business Corporation Act, could make it more difficult for an acquirer to acquire control of Sterling or may discourage a potential competing acquirer.

Our allowance for loan losses, or the amount of capital we hold, may be insufficient. We maintain an allowance for credit losses, with the level of the allowance reflecting estimates as to future losses. The determination of the appropriate level of the allowance for credit losses inherently involves a high degree of subjectivity and requires management to make significant estimates and judgments regarding current credit risks and future trends, all of which may undergo material changes. If our estimates prove to be incorrect, our allowance for credit losses may not be adequate to cover our actual loan losses. Bank regulatory agencies periodically review the adequacy of our allowance for credit losses as part of their examination process, and may require an increase therein. We are required to maintain a certain level of capital. The level of required capital to hold may change through new regulations. Also, the level of capital we hold changes, based on our financial performance, and balance sheet size and composition. We may be required to raise capital in the future, and it may be at a time that the capital is not available to us or not available at favorable terms.

Credit risk concentrations could have a material adverse effect on our business, financial condition, and results of operations. A large portion of our loan portfolio is secured by real estate, which is primarily located in the Pacific Northwest and California. In addition, a significant portion of our multifamily loans originated since 2011 are secured by properties located in the greater Los Angeles and San Francisco markets. Deterioration in the economic conditions or a prolonged delay in economic recovery in our primary market areas could result in the following consequences, any of which could materially and adversely affect our business: collateral for loans, especially real estate, may decline in value, in turn reducing customers' borrowing power and the value of assets and collateral associated with our existing loans; loan delinquencies may increase; problem assets and foreclosures may increase; demand for our products and services may decrease; and access to low cost or noninterest bearing deposits may decrease.

Approximately 45% of our loan portfolio was comprised of commercial real estate loans as of December 31, 2013. Included in commercial real estate loans are investor real estate loans, which may have a higher degree of risk than some other loan types, as they typically are dependent on the cash flows generated from the underlying property. Commercial and consumer delinquency levels and real estate market values could affect our level of net charge-offs and provision for credit losses, which could have a material adverse effect on our business, financial condition and results of operations and prospects. Acts of nature, including earthquakes, floods and fires, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also have a negative impact on our financial condition. In addition, we may face risks associated with our real estate lending under various federal, state and local environmental laws that impose certain requirements on the owner or operator of a property.

Interest rate risk is inherently present in our business. As a financial institution, the substantial majority of our assets and liabilities are subject to interest rate risk, which affects both the life and value of our interest earning assets and interest bearing liabilities, such as loans, investments and MBS, mortgage servicing rights, deposits and borrowings. The level of sensitivity for

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these interest earning assets and interest bearing liabilities to changes in interest rates is measured by duration, with duration mismatches combined with changes from both shifts and twists in the yield curve affecting both our future net interest income and the current economic value of Sterling's equity. Exposure to interest rate risk may have an adverse effect on our profitability, financial condition and liquidity, including a decline in our net interest margin, fair value charges on certain assets, such as mortgage servicing rights and requests for additional collateral on certain of our secured borrowings. Increases in interest rates may shorten the life of certain of our liabilities, and we would have to replace these funds with alternative funds at a higher cost, or sell assets to meet liquidity requirements. Decreases in interest rates may shorten the life of certain of our assets, and we would be faced with reinvesting the funds at lower rates or retiring certain of our funding liabilities at unfavorable prices.

General economic conditions and developments affect our operating results and financial condition. Our business is affected by conditions outside our control, including the rate of economic growth in general, the level of unemployment, increases in inflation and the level of interest rates. Economic conditions affect the level of demand for and the profitability of our products and services. A slowdown in the general economic recovery, particularly in the Western United States, could negatively impact our business. The fiscal and monetary policies of the United States government, and its level of indebtedness may have an impact on interest rates and inflation, which may adversely affect our profitability and financial condition. Our profitability is greatly dependent upon our earning a positive interest spread between our loan and securities portfolio, and our funding deposits and borrowings. Changes in the level of interest rates, or a prolonged unfavorable interest rate environment, or a decrease in our level of deposits that increases our cost of funds could negatively affect our profitability and financial condition.

We are currently subject to certain pending litigation, and may be subject to litigation in the future. A securities class action lawsuit has been filed against Sterling and certain of Sterling's current and former officers alleging that the defendants violated sections 10(b) and 20(a) of the Securities Exchange Act and SEC Rule 10b-5 by making false and misleading statements concerning our business and financial results. This lawsuit is premised on allegations that: 1) the defendants failed to adequately disclose the extent of Sterling's delinquent commercial real estate, construction and land development loans, properly record losses for impaired loans, properly reserve for loan losses, and properly account for goodwill and deferred tax assets, thereby causing Sterling's stock price to be artificially inflated during the purported class period; or 2) the defendants failed to prevent Sterling from issuing improper financial statements, maintain a sufficient allowance for loan and lease losses, and establish effective credit risk management and oversight mechanisms.

In connection with the Merger, purported Sterling shareholders have filed putative shareholder class action lawsuits against Sterling, the members of the Sterling board of directors and Umpqua.  Among other remedies, the plaintiffs seek to enjoin the Merger. Although the parties to the litigation have entered into a memorandum of understanding to settle the consolidated litigation, the settlement is subject to certain conditions. If the cases are not resolved, these lawsuits could prevent or delay completion of the Merger and result in substantial costs to Umpqua and Sterling, including any costs associated with the indemnification of directors and officers. Plaintiffs may file additional lawsuits against Umpqua, Sterling and/or the directors and officers of either company in connection with the Merger.

These lawsuits could divert resources of our management and cause us to incur significant expenses for legal fees and costs, including those associated with our advancement of fees and costs on behalf of our current and former officers and directors. We cannot predict the outcome of these lawsuits. An unfavorable outcome of these lawsuits could result in the payment of substantial damages in connection with a settlement or judgment and have a material adverse effect on our business, financial condition, results of operations or cash flows. See Item 3 "Legal Proceedings."

We are subject to extensive regulation, including Federal Reserve guidelines and rules, which may affect our business operations and profitability, required levels of capital and liquidity, including limitations on our ability to pay dividends. We are subject to extensive regulation under federal and state laws, including regulation and supervision by the Federal Reserve, FDIC, WDFI and the SEC. Sterling is also subject to the listing standards of the NASDAQ Capital Market. If our regulators determine that we have failed to comply with our regulatory requirements, including minimum capital levels, we may need to raise additional capital, which could result in the dilution of our existing shareholders, or reduce or eliminate our common stock dividend. We could become subject to regulatory enforcement actions, which could result in material limitations on our business operations. The Dodd-Frank Act imposes stress testing and corporate governance requirements on banking entities with $10 billion or greater of assets, which we will have to comply with in future periods, if the Merger is not completed.
As of December 31, 2013, Sterling had assets in excess of $10 billion. Sterling therefore will be subject to the Durbin Amendment beginning July 1, 2014. If the Merger is not completed, without the anticipated volume increase in fees, the overall level of our earnings could decline by approximately $6 million annually due to the cap on debit card transaction fees.

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The level of our liquidity and our ability to repay indebtedness, pay dividends and repurchase shares depends upon the results of operations and financial condition of Sterling Bank. Sterling is a separate and distinct legal entity from its subsidiaries, and receives substantially all of its revenue from dividends paid by Sterling Bank. There are legal limitations on the extent to which Sterling Bank may extend credit, pay dividends or otherwise supply funds to, or engage in transactions with, Sterling. The inability to receive dividends from Sterling Bank would reduce liquidity available to Sterling, which could adversely affect Sterling's financial condition or Sterling's ability to pay dividends on its common stock.
As a result of our 2010 recapitalization, a limited number of shareholders are substantial holders of our stock. As of January 31, 2014, certain Thomas H. Lee funds (collectively, "THL") and Warburg Pincus Private Equity X, L.P. ("Warburg Pincus") each beneficially owned approximately 23% of our outstanding common stock. Each has a representative on our Board of Directors. Accordingly, THL and Warburg Pincus have substantial influence over the election of directors to our board and over corporate policy, including decisions to enter into mergers or other extraordinary transactions. In pursuing their economic interests, THL and Warburg Pincus may make decisions with respect to fundamental corporate transactions that may not be aligned with the interests of other shareholders.

We may suffer substantial losses due to our agreements to indemnify certain investors against a broad range of potential claims. We have agreed to indemnify THL and Warburg Pincus, along with the other private placement investors in the 2010 recapitalization, for a broad range of claims, including any losses arising out of or resulting from any legal, administrative or other proceedings arising in connection with the recapitalization transactions. While these indemnities are capped at the aggregate amount of capital raised of $730 million, if all or some claims were successfully brought against Sterling, it could potentially result in significant losses.

We rely on certain key personnel, whose loss could materially adversely affect us. Certain of our employees and executives are key contributors to our financial success, including, but not limited to, the generation and identification of lending and deposit customer relationships, and the management of our company. Our ability to retain these individuals is a large factor in our ability to be successful, and any failure to do so could have a materially adverse effect on our business.

We could be materially and adversely affected if we or any of our officers or directors fail to comply with bank and other laws and regulations. Sterling and Sterling Bank are subject to extensive regulation by U.S. federal and state regulatory agencies and face risks associated with investigations and proceedings by regulatory agencies, including those that we may believe to be immaterial. Like any corporation, we are also subject to risk arising from potential employee misconduct, including non-compliance with our policies. Any interventions by authorities may result in adverse judgments, settlements, fines, penalties, injunctions, suspension or expulsion of our officers or directors from the banking industry or other relief. In addition to the monetary consequences, these measures could, for example, impact our ability to engage in, or impose limitations on, certain of our businesses. The number of these investigations and proceedings, as well as the amount of penalties and fines sought, has increased substantially in recent years with regard to many firms in the industry. Significant regulatory action against us or our officers or directors could materially and adversely affect our business, financial condition or results of operations or cause us significant reputational harm.

We may have reduced access to wholesale funding sources. As a part of our liquidity management, we use a number of funding sources in addition to core deposits, maturities and sales of loans and investments. Our financial flexibility will be severely constrained if we are unable to maintain sufficient collateral or access to funding on acceptable terms. If we are required to rely more heavily on more expensive funding sources, and our revenues do not increase in proportion with our costs, our profitability will be adversely impacted.

A decline in the value of our Federal Home Loan Bank ("FHLB") common stock may occur, resulting in an other-than-temporary impairment ("OTTI") charge which would cause our earnings and shareholders' equity to decrease. We own common stock of the FHLB in order to qualify for membership in the FHLB system, which enables us to borrow funds under the FHLB advance program. The carrying value of our FHLB common stock was $95.3 million as of December 31, 2013, the substantial majority of which was with the FHLB of Seattle. FHLB stock does not have a readily determinable fair value and the equity ownership rights are more limited than would be the case for ownership rights in a public company. FHLB stock is viewed as a long term investment and is carried at cost.

Our business relies heavily on technology and our ability to manage the operational risks associated with technology. We depend on internal and outsourced technology to support all aspects of our business operations. Interruption or failure of these systems creates a risk of business loss as a result of adverse customer experiences, damage claims and civil fines. Risk management programs are expensive to maintain and will not protect us from all risks associated with maintaining the security

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of customer information, proprietary data, external and internal intrusions, disaster recovery and failures in the controls used by vendors. Our computer systems could be vulnerable to unforeseen problems. Because we conduct part of our business over the Internet and outsource several critical functions to third parties, operations will depend on our ability, as well as the ability of third-party service providers, to protect computer systems and network infrastructure against damage from fire, power loss, telecommunications failure, physical break-ins or similar catastrophic events. Any damage or failure that causes interruptions in operations could have a material adverse effect on our business, financial condition and results of operations.

In addition, a significant barrier to online financial transactions is the secure transmission of confidential information over public networks. Our Internet banking system relies on encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential information. Advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms our third-party service providers use to protect customer transaction data. If any such compromise of security were to occur, it could have a material adverse effect on our business, financial condition and results of operations.

We depend, and will continue to depend, to a significant extent, on a number of relationships with third-party service providers. Specifically, we receive core systems processing, residential mortgage servicing, essential web hosting and other Internet systems, and deposit and other transaction processing services from third-party service providers. If these third-party service providers experience difficulties or terminate their services, and we are unable to replace them with other service providers, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition and results of operations could be materially and adversely affected.

Our internal control systems could fail to detect certain events. We are subject to certain operational risks, including but not limited to data processing system failures and errors and customer or employee fraud. We maintain a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks, but should such an event occur that is not prevented or detected by our internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations.

We could be held responsible for environmental liabilities of properties we acquire. We may acquire real property for various reasons, including, for example, as a result of foreclosing on a defaulted mortgage loan to recover our investment, or in connection with acquiring the assets and operations of other banks. We may be subject to environmental liabilities related to the real property as a result of hazardous substances or wastes, contaminants, pollutants or sources thereof that may be discovered on such properties during our ownership or after a sale to a third party. The amount of environmental liability could exceed the value of the real property because we may be fully liable for the entire cost of any removal and clean-up on an acquired property, the cost of removal and clean-up may exceed the value of the property, and we may be unable to recover costs from any third party. In addition, we may find it difficult or impossible to sell the property prior to or following any environmental remediation.

The financial services industry in general is highly competitive. Our industry is highly competitive in regard to the pricing and features of existing products and services, growth opportunities from the acquisition of other companies in whole or in part, and the building of new customer relationships. A number of our competitors are significantly larger than we are and may have certain advantages from a greater access to capital and other resources, as well as larger lending limits and branch systems, and a wider array of banking services. Our growth and opportunities for growth are greatly affected by this competitive environment.

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Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

Sterling owns the building in which its headquarters are located in Spokane, Washington. As of December 31, 2013, Sterling also owned 90 of its 173 depository banking offices, while leasing the remainder of the properties. These facilities are located throughout Sterling's banking network, primarily in the Pacific Northwest. Additionally, Sterling operates 56 non-depository loan production offices throughout the western United States, the majority of which are leased. The properties that Sterling occupies are used for corporate purposes across all of its business segments. See Note 7 of "Notes to Consolidated Financial Statements."

During 2013, Sterling sold four branches, while during 2012, Sterling sold its Montana operations, which included seven branches.

Item 3. Legal Proceedings

Merger Litigation. Sterling, its directors and Umpqua are named as defendants in three lawsuits pending in the Superior Court of Washington in and for Spokane County, which have been consolidated under the caption In re Sterling Financial Corp. Merger Litigation, Lead No. 13-2-03848-4. The consolidated litigation generally alleges that the directors of Sterling breached their duties to the Sterling shareholders by approving the Merger, failing to take steps to maximize shareholder value, engaging in a flawed sales process, and agreeing to deal protection provisions in the merger agreement that are alleged to unduly favor Umpqua. Umpqua is alleged to have aided and abetted the alleged breaches of duty. The consolidated litigation also alleges that the disclosures approved by the Sterling board in connection with the Merger and the vote thereon are false and misleading in various respects. As relief, the complaints seek, among other things, an injunction against consummation of the Merger, rescission of the Merger if it is effected, damages in an unspecified amount, and the payment of plaintiffs' attorneys' fees and costs. The defendants believe that the lawsuits are without merit. On January 16, 2014 the parties to the consolidated litigation entered into a memorandum of understanding to settle the consolidated litigation (such memorandum including plaintiffs' agreement to stay the consolidated litigation, except for proceedings relating to the settlement), subject to court approval and other customary conditions, including the execution of definitive documentation. The proposed settlement covers all holders of Sterling common stock (other than the defendants and their immediate families, heirs and assigns) from and including November 1, 2012 until the consummation of the Merger. The proposed settlement provides for the defendants to make certain additional disclosures, which were included in the proxy statement/prospectus that was mailed to Sterling shareholders in connection with the special meeting at which the Merger was approved. The proposed settlement does not provide for any other consideration from the defendants, including any monetary consideration (other than potentially attorneys' fees as described in the following paragraph). Sterling shareholders who are members of the proposed settlement class will, at a later date, receive written notice containing the full terms of the proposed settlement and proposed release of class claims and related matters.

In the event that the parties enter into a settlement, a hearing will be scheduled at which the Superior Court of Washington in and for Spokane County will consider the fairness, reasonableness, and adequacy of the settlement. If the settlement is finally approved by the court, it will resolve and release all claims in the consolidated litigation that were or could have been brought challenging any aspect of the proposed Merger, the merger agreement and the transactions contemplated thereby, and any disclosure made in connection therewith (but excluding dissenters' rights pursuant to Chapter 23B.13 of the WBCA), among other claims, pursuant to terms that will be disclosed to shareholders prior to final approval of the settlement. In addition, in connection with the settlement, the parties contemplate that plaintiffs' counsel will file a petition in the Superior Court of Washington in and for Spokane County for an award of attorneys' fees and expenses to be paid by Sterling or its successor, which the defendants may oppose. Sterling or its successor will pay or cause to be paid any attorneys' fees and expenses awarded by the Superior Court of Washington in and for Spokane County. There can be no assurance that the parties will ultimately enter into a settlement or that the Superior Court of Washington in and for Spokane County will approve the settlement even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the memorandum of understanding may be terminated. Sterling management believes the proposed settlement will have no adverse material impact on Sterling.


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Neither the memorandum of understanding nor the ultimate settlement is, and neither should be construed as, an admission of wrongdoing or liability by any defendant. Sterling, its directors and Umpqua continue to believe that the consolidated litigation is without merit and vigorously deny the allegations that Sterling's directors breached their fiduciary duties.

Securities Class Action Litigation. On December 11, 2009, a putative securities class action complaint, captioned City of Roseville Employees' Retirement System v. Sterling Financial Corp., et al., No. CV 09-00368-EFS, was filed in the United States District Court for the Eastern District of Washington against Sterling and certain of its current and former officers. The Court appointed City of Roseville Employees' Retirement System as lead plaintiff on March 9, 2010. On June 18, 2010, lead plaintiff filed a consolidated complaint alleging that the defendants violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 by making false and misleading statements concerning our business and financial results. The consolidated complaint purported to be brought on behalf of a class of persons who purchased or otherwise acquired Sterling's stock during the period from July 23, 2008 to October 15, 2009. The consolidated complaint alleged that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by failing to disclose the extent of Sterling's delinquent commercial real estate, construction and land development loans, properly record losses for impaired loans, and properly reserve for loan losses, thereby causing Sterling's stock price to be artificially inflated during the purported class period. Plaintiffs sought unspecified damages and attorneys' fees and costs. On August 30, 2010, Sterling moved to dismiss the Complaint. On March 2, 2011, after complete briefing, the court held a hearing on the motion to dismiss. On August 5, 2013, the court granted the motion to dismiss without prejudice. On October 11, 2013, the lead plaintiff filed an amended consolidated complaint. The amended consolidated complaint names the same defendants, specifies the same class period, alleges the same violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and seeks the same relief. The amended consolidated complaint contains similar allegations of improper disclosure regarding Sterling's lending practices, status of loans and reserving and accounting for loans. On January 24, 2014, Sterling moved to dismiss the amended consolidated complaint. Sterling believes the lawsuit is without merit and continues to vigorously defend against it. Failure by Sterling to obtain a favorable resolution of the claims set forth in the complaint could have a material adverse effect on our business, results of operations and financial condition. Currently, a loss resulting from these claims is not considered probable or reasonably estimable in amount.

Additionally, Sterling is involved in ongoing litigation, primarily related to its normal business operations. When establishing a liability for contingent litigation losses, Sterling determines a range of potential losses for each matter that is both probable and estimable, and records the amount it considers to be the best estimate within the range. For these matters and others where an unfavorable outcome is reasonably possible but not probable, there is no estimable range of possible losses. Sterling believes that the eventual outcome from these cases will not, individually or in the aggregate, have a material adverse effect on its consolidated financial position.

Item 4. Mine Safety Disclosures

Not applicable.


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PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Sterling's common stock is listed on the NASDAQ Capital Market under the symbol "STSA." As of January 31, 2014, Sterling's common stock was held by 1,236 shareholders of record. The following table sets forth certain per share information for Sterling's common stock for the periods indicated:
 
2013 Quarters Ended
 
December 31
 
September 30
 
June 30
 
March 31
Dividends declared per common share
$
0.20

 
$
0.20

 
$
0.55

 
$
0.00

Dividends paid per common share
0.20

 
0.55

 
0.20

 
0.00

Market price per common share:
 
 
 
 
 
 
 
High
35.20

 
29.76

 
23.80

 
22.52

Low
28.36

 
23.80

 
20.20

 
20.37

Quarter end
34.08

 
28.65

 
23.78

 
21.69

 
2012 Quarters Ended
 
December 31
 
September 30
 
June 30
 
March 31
Dividends declared per common share
$
0.65

 
$
0.15

 
$
0.00

 
$
0.00

Dividends paid per common share
0.65

 
0.15

 
0.00

 
0.00

Market price per common share:
 
 
 
 
 
 
 
High
23.22

 
23.00

 
21.18

 
21.94

Low
19.56

 
18.75

 
17.19

 
16.66

Quarter end
20.90

 
22.27

 
18.89

 
20.88



25


Information concerning securities authorized for issuance under equity compensation plans is set forth under the caption "Equity Compensation Plan Information" in Sterling's Proxy Statement and is incorporated herein by reference. In the event that Sterling does not file a Proxy Statement as a result of consummating the transactions contemplated by the merger agreement, Sterling will amend this Annual Report on Form 10-K to include the information required by this Item. The following graph, which is "furnished," not "filed," compares the cumulative return of our common stock during the five years ended December 31, 2013, with the Russell 2000 Index and the SNL Bank NASDAQ Index. The presentation assumes an initial investment of $100 and the reinvestment of dividends.



26


Item 6. Selected Financial Data

The following selected financial data is derived from Sterling's audited financial statements. The information below is not necessarily indicative of our future results of operations and should be read in conjunction with Item 1A, "Risk Factors," Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 8, "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K in order to fully understand the factors that may affect the comparability of the information presented below.
 
Years Ended December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Income Statement Data:
(in thousands, except per share amounts)
Interest income
$
379,021

 
$
389,200

 
$
404,292

 
$
445,133

 
$
599,347

Interest expense
54,787

 
84,522

 
109,097

 
161,106

 
255,370

Net interest income
324,234

 
304,678

 
295,195

 
284,027

 
343,977

Provision for credit losses
0

 
10,000

 
30,000

 
250,229

 
681,371

Net interest income (loss) after provision for credit losses
324,234

 
294,678

 
265,195

 
33,798

 
(337,394
)
Noninterest income
140,586

 
154,253

 
126,328

 
136,965

 
123,814

Noninterest expense before impairment charge
333,312

 
355,253

 
352,390

 
395,045

 
369,974

Goodwill impairment
0

 
0

 
0

 
0

 
227,558

Total noninterest expense
333,312

 
355,253

 
352,390

 
395,045

 
597,532

Income (loss) before income taxes
131,508

 
93,678

 
39,133

 
(224,282
)
 
(811,112
)
Income tax (provision) benefit (1)
(37,867
)
 
292,043

 
0

 
0

 
(26,982
)
Net income (loss)
93,641

 
385,721

 
39,133

 
(224,282
)
 
(838,094
)
Preferred stock dividend
0

 
0

 
0

 
(11,598
)
 
(17,369
)
Other shareholder allocations (2)
0

 
0

 
0

 
(520,263
)
 
0

Net income (loss) applicable to common shareholders
$
93,641

 
$
385,721

 
$
39,133

 
$
(756,143
)
 
$
(855,463
)
Earnings (loss) per common share:
 
 
 
 
 
 
 
 
 
Basic (3)
$
1.50

 
$
6.21

 
$
0.63

 
$
(53.05
)
 
$
(1,087.41
)
Diluted (3)
1.48

 
6.14

 
0.63

 
(53.05
)
 
(1,087.41
)
Dividends declared per common share (3)
$
0.95

 
$
0.80

 
$
0.00

 
$
0.00

 
$
0.00

Weighted average shares outstanding:
 
 
 
 
 
 
 
 
 
Basic (3)
62,290,361

 
62,122,862

 
61,955,659

 
14,253,869

 
786,701

Diluted (3)
63,371,763

 
62,772,079

 
62,231,208

 
14,253,869

 
786,701

Other Data:
 
 
 
 
 
 
 
 
 
Book value per common share (3)
$
19.50

 
$
19.58

 
$
14.16

 
$
12.45

 
$
36.80

Tangible book value per common share (3)
$
18.41

 
$
18.91

 
$
13.96

 
$
12.17

 
$
9.21

Return on average assets
0.97
%
 
4.10
%
 
0.42
%
 
(2.21
)%
 
(6.81
)%
Return on average common equity
7.7
%
 
35.8
%
 
4.8
%
 
(297.2
)%
 
(129.8
)%
Dividend payout ratio
64
%
 
13
%
 
0
%
 
0
 %
 
0
 %
Shareholders' equity to total assets
11.8
%
 
13.2
%
 
9.6
%
 
8.1
 %
 
3.0
 %
Tangible common equity to tangible assets (4)
11.2
%
 
12.8
%
 
9.4
%
 
8.0
 %
 
0.1
 %
Efficiency ratio (5)
69.2
%
 
71.1
%
 
74.7
%
 
81.9
 %
 
69.1
 %
Tax equivalent net interest margin
3.64
%
 
3.46
%
 
3.29
%
 
2.83
 %
 
2.92
 %
Nonperforming assets to total assets
1.21
%
 
2.28
%
 
4.01
%
 
8.83
 %
 
9.08
 %
Employees (full-time equivalents)
2,547

 
2,532

 
2,496

 
2,498

 
2,641

Depository branches
173

 
174

 
175

 
178

 
178


27



 
As of December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Balance Sheet Data:
(in thousands)
Total assets
$
10,319,249

 
$
9,236,910

 
$
9,193,237

 
$
9,493,169

 
$
10,877,423

Loans receivable, net
7,331,228

 
6,101,749

 
5,341,179

 
5,379,081

 
7,344,199

Investments and MBS - available for sale
1,429,812

 
1,513,157

 
2,547,876

 
2,825,010

 
2,160,325

Investments - held to maturity
165

 
206

 
1,747

 
13,464

 
17,646

Deposits
7,074,990

 
6,436,117

 
6,485,818

 
6,911,007

 
7,775,190

FHLB advances
1,146,103

 
605,330

 
405,609

 
407,211

 
1,337,167

Securities sold under repurchase agreements and funds purchased
531,679

 
586,867

 
1,055,763

 
1,032,512

 
1,049,146

Other borrowings
245,299

 
245,294

 
245,290

 
245,285

 
248,281

Shareholders' equity
1,215,947

 
1,217,923

 
878,557

 
770,767

 
323,249

Regulatory Capital Ratios:
 
 
 
 
 
 
 
 
 
Sterling:
 
 
 
 
 
 
 
 
 
Tier 1 leverage ratio
11.6
%
 
12.1
%
 
11.4
%
 
10.1
%
 
3.5
%
Tier 1 risk-based capital ratio
14.9
%
 
17.5
%
 
17.8
%
 
16.2
%
 
4.9
%
Total risk-based capital ratio
16.1
%
 
18.7
%
 
19.1
%
 
17.5
%
 
7.9
%
Tier 1 common capital ratio
11.8
%
 
13.6
%
 
13.8
%
 
12.4
%
 
3.6
%
Sterling Bank:
 
 
 
 
 
 
 
 
 
Tier 1 leverage ratio
11.3
%
 
12.0
%
 
11.1
%
 
9.8
%
 
4.2
%
Tier 1 risk-based capital ratio
14.5
%
 
17.2
%
 
17.4
%
 
15.7
%
 
5.9
%
Total risk-based capital ratio
15.8
%
 
18.5
%
 
18.7
%
 
17.0
%
 
7.3
%

(1) The income tax benefit during 2012 was from the release of a deferred tax asset valuation allowance.
(2) The August 26, 2010 conversion of Series C preferred stock into common stock resulted in an increase in income available to common shareholders. The October 22, 2010 conversion of Series B and D preferred stock into common stock resulted in a decrease in income available to common shareholders.
(3) Reflects the 1-for-66 reverse stock split in November 2010.
(4) Common shareholders' equity less goodwill and other intangible assets, divided by assets, less goodwill and other intangible assets.
(5) The efficiency ratio is noninterest expense, excluding OREO and amortization of other intangible assets, divided by net interest income (tax equivalent) plus noninterest income, excluding gain on sales of securities, other-than-temporary impairment losses on securities, charge on prepayment of debt, gain on branch divestiture and bargain purchase gain.


28


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto presented elsewhere in this report. This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For a discussion of the risks and uncertainties inherent in such statements, see "Business—Forward-Looking Statements" and "Risk Factors."

Overview

Net income for the years ended December 31, 2013, 2012 and 2011 was $93.6 million, $385.7 million, and $39.1 million, respectively. The changes in operating results over the years presented included an increase in net interest income and net interest margin, and lower credit costs. A significant item affecting comparability over the years presented was an income tax benefit of $292.0 million recorded during 2012 in connection with the release of a deferred tax asset valuation allowance, while 2013 included an income tax provision of $37.9 million. Sterling did not recognize any federal or state income tax provision or benefit during 2011. Mortgage banking income declined for 2013, as compared with 2012, from lower refinancing activity.

The net interest margin expanded to 3.64% for the year ended December 31, 2013, from 3.46% and 3.29% for the years ended December 31, 2012 and 2011, respectively, principally driven by a decline in funding costs. The decline in funding costs reflected a shift in the mix and repricing of deposits, as well as a lower balance of wholesale borrowings from securities sold under repurchase agreements in conjunction with the balance sheet repositioning activity undertaken during the fourth quarter of 2012. Net interest income expanded by $19.6 million during 2013, and $9.5 million during 2012, reflecting the decline in funding costs and an increase in interest income on loans, partially offset by a decline in interest income on MBS.

During 2013, there was no provision for credit losses, compared with a $10.0 million and $30.0 million provision during 2012 and 2011, respectively, reflecting the decline in nonperforming assets. At December 31, 2013, the ratio of nonperforming assets to total assets was 1.21% compared to 2.28% at December 31, 2012, and 4.01% at December 31, 2011.

On February 28, 2013, Sterling completed the acquisition of Borrego for $8.7 million in consideration, adding an aggregate of $103.7 million of gross loans and $118.2 million of deposits. A bargain purchase gain of $7.5 million was recorded in connection with the acquisition, reflecting the fair value of net assets acquired in excess of the purchase price. On May 10, 2013, Sterling paid $123.0 million to acquire the Puget Sound operations of Boston Private, which added $278.5 million of performing loans and $168.2 million of deposits. On October 1, 2013, Sterling paid $42.9 million in cash to acquire Newport Beach, Calif.-based CNB. At closing, CNB had assets of $260.8 million, loans of $164.8 million, and deposits of $189.6 million.

On September 11, 2013, Sterling entered into a definitive agreement to merge with and into Umpqua, with headquarters in Portland, Oregon. Immediately after the Merger, Sterling Bank will merge with and into Umpqua Bank, an Oregon state chartered bank and wholly owned subsidiary of Umpqua. Upon completion of the mergers, the combined company will operate under the Umpqua Bank name and brand. The transaction is expected to be completed in the second quarter of 2014, subject to regulatory approval and other customary closing conditions. Under the terms of the Merger, Sterling shareholders will receive 1.671 shares of Umpqua common stock and $2.18 in cash, without interest, for each share of Sterling common stock. On February 25, 2014, the shareholders of both Sterling and Umpqua approved the Merger.

Results of Operations

The most significant component of earnings for Sterling is net interest income, which is the difference between interest income, earned primarily from loans, MBS and investment securities, and interest expense on deposits and borrowings. Net interest spread refers to the difference between the yield on interest earning assets and the rate paid on interest bearing liabilities. Net interest margin refers to net interest income divided by total average interest earning assets and is influenced by the level and relative mix of interest earning assets and interest bearing liabilities. The following table sets forth, on a tax equivalent basis, information with regard to Sterling's net interest income, net interest spread and net interest margin:
 

29


 
Years Ended December 31,
 
2013
 
2012
 
2011
 
Average
Balance
 
Interest
Income/
Expense
 
Yields/
Rates
 
Average
Balance
 
Interest
Income/
Expense
 
Yields/
Rates
 
Average
Balance
 
Interest
Income/
Expense
 
Yields/
Rates
ASSETS:
(in thousands)
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage
$
4,368,794

 
$
196,027

 
4.49
%
 
$
3,834,111

 
$
188,563

 
4.92
%
 
$
3,484,108

 
$
177,992

 
5.11
%
Commercial and consumer
2,887,515

 
143,419

 
4.97
%
 
2,572,469

 
143,392

 
5.57
%
 
2,481,470

 
144,892

 
5.84
%
Total loans (1)
7,256,309

 
339,446

 
4.68
%
 
6,406,580

 
331,955

 
5.18
%
 
5,965,578

 
322,884

 
5.41
%
MBS (2)
1,257,119

 
31,015

 
2.47
%
 
1,890,314

 
47,442

 
2.51
%
 
2,375,515

 
71,216

 
3.00
%
Investments and cash (2)
414,905

 
12,587

 
3.01
%
 
520,590

 
13,971

 
2.68
%
 
676,677

 
14,659

 
2.17
%
FHLB stock
96,603

 
0

 
0.00
%
 
98,893

 
0

 
0.00
%
 
99,531

 
0

 
0.00
%
Total interest earning assets
9,024,936

 
383,048

 
4.24
%
 
8,916,377

 
393,368

 
4.41
%
 
9,117,301

 
408,759

 
4.48
%
Noninterest earning assets (3)
651,142

 
 
 
 
 
494,185

 
 
 
 
 
186,238

 
 
 
 
Total average assets
$
9,676,078

 
 
 
 
 
$
9,410,562

 
 
 
 
 
$
9,303,539

 
 
 
 
LIABILITIES and EQUITY:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing transaction
$
746,934

 
267

 
0.04
%
 
$
657,231

 
334

 
0.05
%
 
$
503,091

 
504

 
0.10
%
Savings and MMDA
2,465,697

 
3,401

 
0.14
%
 
2,261,858

 
3,912

 
0.17
%
 
1,994,335

 
7,004

 
0.35
%
Time deposits
1,748,838

 
20,195

 
1.15
%
 
2,250,999

 
33,451

 
1.49
%
 
3,063,679

 
52,126

 
1.70
%
Total interest bearing deposits
4,961,469

 
23,863

 
0.48
%
 
5,170,088

 
37,697

 
0.73
%
 
5,561,105

 
59,634

 
1.07
%
Borrowings
1,608,257

 
30,924

 
1.92
%
 
1,470,244

 
46,825

 
3.18
%
 
1,703,782

 
49,463

 
2.90
%
Total interest bearing liabilities
6,569,726

 
54,787

 
0.83
%
 
6,640,332

 
84,522

 
1.27
%
 
7,264,887

 
109,097

 
1.50
%
Noninterest bearing transaction
1,772,182

 
0

 
0.00
%
 
1,559,828

 
0

 
0.00
%
 
1,093,252

 
0

 
0.00
%
Total funding liabilities
8,341,908

 
54,787

 
0.66
%
 
8,200,160

 
84,522

 
1.03
%
 
8,358,139

 
109,097

 
1.31
%
Other noninterest bearing liabilities
111,806

 
 
 
 
 
131,860

 
 
 
 
 
126,435

 
 
 
 
Total average liabilities
8,453,714

 
 
 
 
 
8,332,020

 
 
 
 
 
8,484,574

 
 
 
 
Total average equity
1,222,364

 
 
 
 
 
1,078,542

 
 
 
 
 
818,965

 
 
 
 
Total average liabilities and equity
$
9,676,078

 
 
 
 
 
$
9,410,562

 
 
 
 
 
$
9,303,539

 
 
 
 
Net interest income and spread (4)
 
 
$
328,261

 
3.41
%
 
 
 
$
308,846

 
3.14
%
 
 
 
$
299,662

 
2.98
%
Net interest margin (4)
 
 
 
 
3.64
%
 
 
 
 
 
3.46
%
 
 
 
 
 
3.29
%
Deposits:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest bearing deposits
$
4,961,469

 
$
23,863

 
0.48
%
 
$
5,170,088

 
$
37,697

 
0.73
%
 
$
5,561,105

 
$
59,634

 
1.07
%
Noninterest bearing transaction
1,772,182

 
0

 
0.00
%
 
1,559,828

 
0

 
0.00
%
 
1,093,252

 
0

 
0.00
%
Total deposits
$
6,733,651

 
$
23,863

 
0.35
%
 
$
6,729,916

 
$
37,697

 
0.56
%
 
$
6,654,357

 
$
59,634

 
0.90
%
(1)
Includes gross nonaccrual loans.
(2)
Does not include market value adjustments on available for sale securities.
(3)
Includes charge-offs on nonperforming loans ("confirmed losses") and the allowance for loan losses.
(4)
Interest income on certain loans and securities are presented gross of their applicable tax savings using a 37% effective tax rate.

30


Changes in Sterling's net interest income are a function of changes in both rates and volumes of interest-earning assets and interest-bearing liabilities. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. The following table presents the composition of the change in net interest income, on a tax equivalent basis, for the periods presented. Interest income from municipal loans and bonds is presented gross of applicable tax savings. For each category of interest-earning assets and interest-bearing liabilities, the following table provides information on changes attributable to:

Volume—changes in volume multiplied by comparative period rate;
Rate—changes in rate multiplied by comparative period volume; and
Rate/volume—changes in rate multiplied by changes in volume.
 
Years Ended December 31,
 
2013
 
2012
 
Increase (Decrease) Due to:
 
Increase (Decrease) Due to:
 
 
 
 
 
Rate/
 
 
 
 
 
 
 
Rate/
 
 
 
Volume
 
Rate
 
Volume
 
Total
 
Volume
 
Rate
 
Volume
 
Total
Interest income:
(in thousands)
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage
$
26,296

 
$
(16,527
)
 
$
(2,305
)
 
$
7,464

 
$
17,881

 
$
(6,642
)
 
$
(668
)
 
$
10,571

Commercial and consumer
17,561

 
(15,621
)
 
(1,913
)
 
27

 
5,313

 
(6,573
)
 
(240
)
 
(1,500
)
Total loans
43,857

 
(32,148
)
 
(4,218
)
 
7,491

 
23,194

 
(13,215
)
 
(908
)
 
9,071

MBS
(15,891
)
 
(805
)
 
269

 
(16,427
)
 
(14,546
)
 
(11,598
)
 
2,370

 
(23,774
)
Investment and cash equivalents
(2,834
)
 
1,800

 
(350
)
 
(1,384
)
 
(3,381
)
 
3,500

 
(807
)
 
(688
)
Total interest income
25,132

 
(31,153
)
 
(4,299
)
 
(10,320
)
 
5,267

 
(21,313
)
 
655

 
(15,391
)
Interest expense:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
(1,521
)
 
(12,830
)
 
517

 
(13,834
)
 
(4,193
)
 
(19,086
)
 
1,342

 
(21,937
)
Borrowings
(4,395
)
 
(18,554
)
 
7,048

 
(15,901
)
 
(6,780
)
 
(4,800
)
 
8,942

 
(2,638
)
Total interest expense
(5,916
)
 
(31,384
)
 
7,565

 
(29,735
)
 
(10,973
)
 
(23,886
)
 
10,284

 
(24,575
)
Changes in net interest income on a tax equivalent basis
$
31,048

 
$
231

 
$
(11,864
)
 
$
19,415

 
$
16,240

 
$
2,573

 
$
(9,629
)
 
$
9,184


2013 versus 2012

Net Interest Income. Net interest income for the year ended December 31, 2013 expanded by $19.6 million and $9.5 million over 2012 and 2011, respectively, reflecting the decline in funding costs and an increase in interest income on loans, partially offset by a decline in interest income on MBS. Funding costs declined as a result of the decline in time deposits, as well as a lower balance of higher cost wholesale borrowings from securities sold under repurchase agreements. Average loan balances increased 13% and 7% during 2013 and 2012 respectively, while average MBS balances declined 33% and 20% over the same comparable periods. The decline in average MBS balances reflected sales during 2012 to fund the reduction in repurchase agreements.

Provision for Credit Losses. During 2013, there was no provision for credit losses, compared with $10.0 million and $30.0 million for 2012 and 2011, respectively. The reduced level of credit loss provisioning reflects improvement in asset quality as evidenced by the decline in nonperforming loans.


31


Noninterest Income. Noninterest income was as follows for the years presented:
 
 
Years Ended December 31,
 
2013
 
2012
 
% change
 
(in thousands)
 
 
Fees and service charges
$
60,917

 
$
55,773

 
9
 %
Mortgage banking operations
59,956

 
97,292

 
(38
)%
Bank-owned life insurance ("BOLI")
6,235

 
8,625

 
(28
)%
Gains on sales of securities, net
0

 
23,835

 
(100
)%
Other-than-temporary impairment losses on securities
0

 
(6,819
)
 
(100
)%
Charge on prepayment of debt
0

 
(35,342
)
 
(100
)%
Gains on other loan sales
3,998

 
4,372

 
(9
)%
Other
9,480

 
6,517

 
45
 %
Total noninterest income
$
140,586

 
$
154,253

 
(9
)%

Fees and service charges increased over the years presented due to an increase in deposit fee income and loan prepayment penalties associated with growth from acquisitions. The decline in BOLI income from 2012 was due to a $2.4 million death benefit recognized in 2012. During 2013, Sterling had no gains or losses on the sale of securities, compared with gains of $23.8 million in 2012. Also during 2012, Sterling recognized an other-than-temporary impairment charge of $6.8 million, and a prepayment of debt charge of $35.3 million, with no similar charges in the 2013. Gains on other loan sales during the 2013 were due mostly to the sale of SBA loans, while in 2012 the gains on other loan sales were due mostly to the sale of nonperforming loans.

Other noninterest income during 2013 included a $7.5 million bargain purchase gain in connection with the Borrego acquisition, and gains from branch divestitures. Three branches were sold during 2013 at a gain of $893,000, before associated expenses of $254,000, while 2012 included a gain of $9.1 million, before associated selling expenses, in conjunction with the Montana divestiture. Other noninterest income during 2012 also included a negative valuation adjustment of $600,000 on interest rate swaps.

During 2013, mortgage banking income declined 38% compared to 2012, as a result of lower margins and declining volumes. Included in income from mortgage banking operations during 2013 was a $6.9 million reversal of a valuation allowance on mortgage servicing rights, respectively, compared with write-downs of $230,000 during 2012. During 2013, income from mortgage banking also included a $1.3 million reduction in the fair value of a pool of portfolio residential mortgage loans that were previously classified as held for sale, compared with a $534,000 reduction during 2012.

The following table presents components of mortgage banking operations for the years presented:
 
 
Years Ended December 31,
 
2013
 
2012
 
(in thousands)
Residential loan sales
$
2,714,825

 
$
2,648,502

Change in warehouse and interest rate locks
(453,495
)
 
303,668

Total mortgage banking activity
$
2,261,330

 
$
2,952,170

Margin on mortgage banking activity
2.09
%
 
3.20
%


32


Noninterest Expense. Noninterest expense was as follows for the years presented:
 
Years Ended December 31,
 
2013
 
2012
 
% change
 
(in thousands)
 
 
Employee compensation and benefits
$
181,544

 
$
189,025

 
(4
)%
Occupancy and equipment
39,935

 
42,930

 
(7
)%
Data processing
27,984

 
27,091

 
3
 %
Professional fees
16,143

 
16,691

 
(3
)%
Depreciation
13,093

 
11,690

 
12
 %
Merger and acquisition
10,837

 
11,976

 
(10
)%
Advertising
7,942

 
12,688

 
(37
)%
OREO operations
7,389

 
11,829

 
(38
)%
Amortization of other intangible assets
6,799

 
6,780

 
0
 %
Travel and entertainment
5,911

 
5,756

 
3
 %
FDIC insurance
5,827

 
7,493

 
(22
)%
Other
9,908

 
11,304

 
(12
)%
Total noninterest expense
$
333,312

 
$
355,253

 
(6
)%

Employee compensation and benefits during 2013 included acquisition related activity and new employees added in Southern California, while 2012 included severance costs related to a reduction in force and a lower level of deferred commissions on loan production. Occupancy and equipment have declined from the 2012 comparable periods, as a result of branch consolidations and sales. OREO operations also declined from the comparable periods, as a result of a lower level of OREO properties. Advertising expense during 2012 included costs related to the rebranding of Sterling Savings Bank as Sterling Bank. Other noninterest expense during 2013 included a refund of $1.8 million for Washington State Business and Occupation tax, while other noninterest expense during 2012 included a similar refund of $1.9 million, and a charge of $2.0 million in connection with a tentative settlement related to a previously disclosed ERISA class action complaint.

Income Tax Provision. During 2013, Sterling recognized income tax expense of $37.9 million, reflecting a 29% effective tax rate. During 2012, an income tax benefit of $292.0 million was recognized, as a result of reversing substantially all of Sterling's deferred tax asset valuation allowance. The effective tax rate for 2013 reflects permanent differences between book income and tax income from the Borrego acquisition bargain purchase gain, as well as tax exempt municipal bond and BOLI income. As of December 31, 2013, the net deferred tax asset was $284.1 million, including $242.3 million of net operating loss and tax credit carry-forwards, compared with $292.1 million as of December 31, 2012, including $274.0 million of net operating loss and tax credit carry-forwards.

2012 versus 2011

Net Interest Income. Sterling's net interest income for the year ended December 31, 2012 compared with the year ended December 31, 2011 increased $9.5 million, as funding costs declined more than interest income. Interest income from mortgage backed securities declined $23.8 million, offsetting an increase in interest income on loans of $9.1 million. Interest expense declined $24.6 million, mainly from the lower cost of deposits.

The average balance of mortgage backed securities declined $485.2 million, or 20% during 2012, reflecting prepayments and sales. The decline in the yield on MBS over the period was due to prepayments and sales of securities with higher yields than new securities purchased and the average yield of the portfolio, reflecting market conditions and balance sheet management, including the management of prepayment and interest rate risk in the MBS portfolio.

The increase in interest income from higher average loan balances was partially offset by yield compression. Average loan balances increased $441.0 million, or 7% during 2012, reflecting growth from loan originations and purchases, and loans acquired in the First Independent transaction, net of repayments. Similar to MBS, the loan portfolio's average yield declined during 2012, as new loan production was at rates below that of maturities and repayments, and adjustable rate loans repriced downward. These reductions in yield were partially offset by the decline in the level of nonperforming loans and discount accretion on acquired loans.

33



During 2012, the composition of deposits shifted, including a decrease of $812.7 million, or 27% in the average balance of time deposits, and an increase of $466.6 million, or 43% in noninterest bearing transaction accounts. This change in deposit mix contributed to the 34 basis point decline in the cost of deposits.

Provision for Credit Losses. Sterling recorded a provision for credit losses of $10.0 million for the year ended December 31, 2012, as compared with $30.0 million in 2011. The reduced level of credit loss provisioning reflects improvement in asset quality as evidenced by the decline in nonperforming loans and charge-offs. Net charge-offs were $30.6 million during 2012, a decline of 69% over 2011. Charge-offs for unfunded commitments during 2012 included approximately $4 million in connection with a mortgage repurchase settlement with a financial institution.

Noninterest Income. Noninterest income was as follows for the years presented:
 
 
Years Ended December 31,
 
2012
 
2011
 
% change
 
(in thousands)
 
 
Fees and service charges
$
55,773

 
$
50,073

 
11
 %
Mortgage banking operations
97,292

 
49,163

 
98
 %
BOLI
8,625

 
6,448

 
34
 %
Gains on sales of securities, net
23,835

 
16,236

 
47
 %
Other-than-temporary impairment losses on securities
(6,819
)
 
0

 
*

Charge on prepayment of debt
(35,342
)
 
0

 
*

Gains on other loan sales
4,372

 
4,442

 
(2
)%
Other
6,517

 
(34
)
 
*

Total noninterest income
$
154,253

 
$
126,328

 
22
 %

* Results are not meaningful.

The increase in income from mortgage banking operations reflected higher margins on loan sales and volumes of residential lending. Historically low interest rates on home loans resulted in an elevated level of refinancing activity during 2012, while expansion in the margin on loans sales reflected conditions in the mortgage market.

The growth in fees and service charges was primarily due to increased activity related to the deposit accounts and trust business acquired in the First Independent transaction. BOLI income during 2012 included a $2.4 million gain relating to a death benefit.

During 2012, Sterling incurred prepayment penalties of $35.3 million related to the prepayment of $300 million of repurchase agreements. Security sales during 2012 included the management of prepayment and interest rate risk in the portfolio, as well as the sale of securities that were serving as collateral for the repurchase agreement borrowings that were prepaid. Other activity in the securities portfolio included the recognition of an other-than-temporary impairment charge of $6.8 million related to a single issuer trust preferred security during the second quarter of 2012. The security was sold during the fourth quarter at a gain of $2.5 million.

Other noninterest income during 2012 included a gain on the sale of assets of $9.1 million, before associated selling expenses, recognized in conjunction with the Montana divestiture. Gains on the sale of other loans related to the sale of nonperforming loans, multifamily, and SBA loans.


34


The following table presents components of mortgage banking operations for the years presented:
 
 
Years Ended December 31,
 
2012
 
2011
 
(in thousands)
Residential loan sales
$
2,648,502

 
$
2,059,351

Change in warehouse and interest rate locks
303,668

 
(41,886
)
Total mortgage banking activity
$
2,952,170

 
$
2,017,465

Margin on residential loan sales
3.20
%
 
2.45
%

Noninterest Expense. Noninterest expense was as follows for the years presented:
 
Years Ended December 31,
 
2012
 
2011
 
% change
 
(in thousands)
 
 
Employee compensation and benefits
$
189,025

 
$
171,643

 
10
 %
OREO operations
11,829

 
41,500

 
(71
)%
Occupancy and equipment
42,930

 
39,878

 
8
 %
Data processing
27,091

 
24,171

 
12
 %
FDIC insurance
7,493

 
14,328

 
(48
)%
Professional fees
16,691

 
13,902

 
20
 %
Depreciation
11,690

 
12,184

 
(4
)%
Advertising