Sterling Financial Corporation Q4 2007 Earnings Call Transcript

| About: Sterling Financial (STSA)

Sterling Financial Corporation

Q4 2007 Earnings Call

January 29, 2008 11:00 am ET


Harold B. Gilkey - Chairman and Chief Executive Officer

Shawna Manion – Investor Relations

Daniel G. Byrne - Executive Vice President and Chief Financial Officer


Brett Rabatin - FTN Midwest Securities Corp.

Matthew Clark - KBW

Jim Bradshaw - D.A. Davidson

Daniel Cardenas - Howe Barnes

Fred Cummings - Elizabeth Park Capital Management

Brian Hagler - Kennedy Capital Management


Good day, everyone, and welcome to the Fourth Quarter and Fiscal Year 2007 Earnings Conference Call. Each of you will be on listen-only mode until the question-and-answer session following today’s presentation.

Today’s conference is being recorded for replay. Additionally, the replay will be available at Sterling’s website,, immediately following the call.

I would now like to turn the call over to Mr. Harold Gilkey, CEO and Chairman of Sterling Financial Corporation.

Harold B. Gilkey

Thank you very much, Kim. To begin today’s meeting, I would like Shawna Manion to read our forward-looking statement.

Shawna Manion

Thanks Harold. Good morning and welcome to Sterling Financial Corporation fourth quarter earnings call. With us today I have Mr. Harold Gilkey, Chairman and Chief Executive Officer and Mr. Dan Byrne, Executive Vice President and Chief Financial Officer.

Before I turn the call over to Harold, I must remind you that during today’s, call Sterling’s management will be referencing forward-looking statements that are not historical facts and pertain to our future operating results.

These future-looking statements include but are not limited to statements about our plans, objectives, expectations and intentions and other statements contained in this reports that are not historical facts. These forward-looking statements are inherently subject to significant business, economic and competitive uncertainties, many of which are beyond our control.

In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Sterling’s actual results may differ materially from the results discussed in these forward-looking statements because of numerous possible risks and uncertainties.

These risks include, but are not limited to:

The possibility of adverse economic developments which may, among other things,

Increase delinquency risk in Sterling’s loan portfolio;

Shifts in industry, which may result in lower interest rate margins;

Shifts in demand for Sterling’s loans and other products;

Increasing cost or lower-than-expected revenues or cost savings in connection with acquisitions;

Changes in accounting policies;

Changes in the monetary and fiscal policies of the federal government;

And changes in laws, regulations and the competitive environment.

I would also like to note that Harold and Dan are presenting at the following upcoming conferences: on February 27 at the KBW 2008 Regional Bank Conference in Boston; March 11, at Sandler O’Neill 2000 West Coast Financial Services Conference in San Francisco, and on May 7 and 8, we will be at the D.A. Davidson Conference in Seattle.

With that said, I would now like to turn the call over to Mr. Harold Gilkey, Chairman and Chief Executive Officer of Sterling Financial Corporation.

Harold B. Gilkey

Thank you, Shawna. We couldn’t have done without that. 2007 was another significant year in the development of our company. Despite challenging economic conditions in some of our markets, we continue to build the Sterling franchise and serve customers in expanded geographic territory.

We increase our net income to $93.3 million, a 26% increase over 2006. We increased our total asset by 24% to just over $12 billion. Loans receivable increased 27% to nearly $9 billion while deposits were up 14% to $7.7 billion, and most importantly, our capital increased 51% or $1.19 billion. All of these are record levels.

Additionally, we set a record for loan originations of nearly $5.5 billion. With our growth in assets, Sterling became the second largest regional community bank holding company in the Western United States.

We are indeed proud of our accomplishments of 2007. In fact, in February we celebrated 20 years of trading on NASDAQ. We also completed the acquisition of Northern Empire and its subsidiary Sonoma National Bank. This was on the heels of completing the acquisition of FirstBank Northwest near the end of 2006.

In the first half of 2007, we successfully integrated the operations of both of these banks, what we call painting them Sterling green. These acquisitions brought significant resources in customers and employees to help us expand our geographic reach of our Hometown Helpful services and products.

During the second half of 2007 we were reminded why we always prided ourselves on the strength of our credit management team and our underwriting discipline.

While none of us really enjoy going through downside economic cycles, the recent slowdown in some of our residential construction markets has brought out the best in our people, as they have been taking positive proactive measures to protect asset quality, working with our residential construction customers, and of course taking appropriate measures when necessary.

Dan will get into more detail on our asset quality, but I would like to tell you that over the past 90 days, we have reviewed our position on every residential loan in our portfolio. We have received updated appraisals or broker’s opinion of value, which of course are more correct.

And either our credit administrator or our special assets staff had met with these borrowers and/or have inspected all the projects in Boise and Bend where we are seeing the biggest slowdown in our market area.

Our Chief Credit Officer and Head of Special Assets will be visiting California later this week. We are comfortable with the valuations on these properties. The majority of our residential construction borrowers have long-term relationships with our lending officer and our company.

So we feel we have a good understanding of their business but we are confident that they are solid bank customers. Additionally, we have a lot of experience in both the credit administration and the special assets group.

There has been some turnover of our non-performing portfolio as some of the issues are being resolved, while others have moved into the non-performing status. I would like to further note that Sterling is insulated but is certainly not isolated from the national economy, and the economy of Pacific Northwest has been very resilient.

The region remains relatively strong with economic growth expected to continue to exceed that of the nation as a whole. This region’s strength is due to the Pacific Rim trading position; significant employment roles in the industries such as aerospace and technology; and the strong commodity pricing for agriculture and mineral products.

Our long-term portfolio outside of the residential construction is performing as expected. The company’s core market in the Puget Sound and Portland area, where 60% of our residential home portfolio resides, also continues to perform well.

When you go through an economic cycle, you want the best people around you, and during 2007 we had the privilege of rounding out our management team for the road ahead. As you know, Heidi Stanley was elevated to the Chief Executive Officer of Sterling Savings Bank on January 1.

During this past year, Greg Seibly, a banker of 21 years joined our team as Chief Production Officer. Greg has the responsibility of loan and deposit production at Sterling Savings Bank. Additionally, Debbie Meekins, who joined us with the acquisition of Sonoma National Bank and has 35 years experience as a banker, has the responsibility of our branch network system.

Responsibility for the commercial banking rests with Carol Mangan, a banker of 28 years, and of course credit administration is the responsibility of Steve Page, our Chief Credit Officer, who was one of the original employees of Sterling and has over 30 years banking experience.

Portfolio management rests with the responsibility of Nancy McDaniel who has 22 years of banking experience. Joining them is Ezra Eckhardt as our Chief Administrative Officer and Tom Colosimo as the Chief Financial Officer of Sterling Savings Bank.

We are indeed pleased with the depth and seasoning of our management team, which is ready to meet the challenges before them.

During 2007 and after 17 years − yes, let me repeat that − after 17 years, we finally got our day in court to argue for the damages incurred as a result of the United States government breach of contract relating to our past acquisitions.

After three weeks in the courtroom, we proceeded with an exchange of briefings to the United States Court of Federal Claims and made closing arguments before that court on January 9, 2008. This case is nearing conclusion. We expect a decision in the first half of the year and we expect our litigation cost of 2008 to be substantially lower than the nearly $3 million we spent in 2007.

Regardless of the outside influences that impact our business, I still believe banking is a pretty simple business. Take a deposit; make a loan; collect it; charge a fee, and control your expenses.

We are about building a franchise that is a leading community bank for the benefit of our shareholders, our customers, our community and our employees. I am confident in our people and of our Hometown Helpful philosophy.

At this point, I’d like to turn the call over to Dan Byrne.

Daniel G. Byrne

Thanks, Harold. The supplementary information provided in the press release, I am going to focus on key highlights for the quarter and then provide the opportunity for you to ask specific questions during the Q&A session.

Yesterday, we announced earning of $16.9 million or $0.33 on a per diluted share basis. The increase in earnings from our guidance given in October 2007 for the fourth quarter was due to several items:

An increase in the provision for credit losses to $13 million, some $9 million more than our previous guidance or approximately $0.11 per share;

Interest margin compression resulting from the reversal of interest on non-performing assets approximately $2.6 million;

And the decrease in the prime rate by nearly a 100 basis points on certain loans, which re-priced to halve our funding cost and cost nearly $800,000 combined, just about $0.04 per share.

An early extinguishment charge of $2.1 million, approximately $0.03 per share, was to repay a high costing trust-preferred issuance which carried a 10.25% fix coupon. On this point, I would like to emphasize that even though we will be paying this trust-preferred off in January, the company does remain well capitalized and our key capital ratios are generally at historical high levels for this company.

We also incurred a charge related to the termination of a North Valley transaction and some other one-time charges totaling about $2 million or approximately $0.02 per share. Net interest income was $92.0 million for the fourth quarter 2007; that’s a decrease from the $93.7 million on a linked-quarter basis.

The net interest margin on a tax equivalent basis was 3.34% for the fourth quarter compared to 3.50% on a linked-quarter basis. Being asset sensitive in the near-term, our loans have been more responsive to the Fed rate cuts and have been reprising quicker than our deposits and borrowings.

The Fed’s reduction in short-terms interest rates reduced margin by approximately 9 basis points, and the increase in non-performing assets adversely affected our net interest margin by approximately 6 basis points during the fourth quarter.

Total non-interest income was also down approximately 13% in the fourth quarter primarily related to the mortgage banking operations, where we saw a decrease in the origination and sales of single-family mortgages.

Mortgage banking operating income for the fourth quarter 2007 was $6.7 million compared to $9.6 million in the same quarter one year ago, and $7.3 million on a linked-quarter basis.

In the fourth quarter, residential loan originations were $323 million and loan sales were $254 million, which generated approximately two-thirds of our mortgage banking operating income. The remaining third was primarily brokerage income.

Loans held for sale were $56 million at the end of the fourth quarter 2007. Because of the declines in prices for loans, we also backed away from selling some of our SBA and commercial loans.

With the lower spreads on sales, the payback period for holding the loans was just too short to give them up at this time. We are expecting the pricing to improve during 2008, so we’ll be back in the market at the appropriate time.

Regarding our Golf Savings Bank franchise, since the disruption of the mortgage markets in August, the level of loan production and profitability has steadily been rising. Although the pie is smaller, so is the competition. I would add just recently, we have seen an increase in the level of applications for residential and loans as mortgage rates have been dropping.

Our efficiency ratio went up slightly during the quarter, as the income components of the ratio decreased at a faster rate than the level of operating expenses. We have been working to reduce operating expenses through our continual improvement programs in our operations.

Full-time equivalent employees increased just slightly to 2,571 from 2,566 at the end of September 2007. During the fourth quarter, overall employee related expenses decreased 2% on a linked-quarter basis. This primarily reflects lower commissions associated with the lower loan production.

At the end of 2007, Sterling’s total assets were a record $12.15 billion and total loans receivable had increased to $9 billion. Sterling’s total loan originations were $1.12 billion for the fourth quarter.

I would add that residential construction has had a sharp decline in originations, down some 41% from the last quarter and down 56% from the same period a year-ago.

At December 31, 2007, nonperforming assets were $126.5 million, up from $57.7 million last quarter and $11.2 million from a year-ago period. As we’ve identified in previous press releases and conference calls, the lion’s share of the non-performers are in the residential construction, accounting for 75% of nonperforming assets and about 90% of the increase from the last quarter.

The balance of nonperforming assets and other loan types are more typical of a growing company and are pretty well diversified across our loan portfolio. We have found that our nonperforming residential construction loans are largely concentrated in three geographic markets.

Boise is still the market that has our closest attention. We have 30 borrowers in the Boise area that are in nonperforming status and these account for 28% of the residential construction nonperforming assets.

In the Bend, Oregon market we have two borrowers with a combined $18.5 million in nonperforming loans or approximately 20% of the residential construction nonperforming assets.

In Southern California, we have two additional borrowers with projects that have a combined $23.6 million in nonperforming loans, accounting for 25% of the nonperforming residential construction portfolio.

For additional granularity, I will tell you that most of the nonperforming residential construction loans are in spec housing and pre-sold starts representing some 71% of the total. The balance is evenly spread across other category such as log loans and acquisition and development.

I think it’s important to point out that our outstanding commitments in these three markets is relatively small compared to our total residential construction portfolio. Boise, Idaho, Bend, Oregon and Southern California combined add up to less than $420 million, which is only 16% of our residential construction commitments.

Our primary markets in the Puget Sound and Portland, Oregon add up to about 60% of our residential construction commitments, and these are holding up well. The economic data we have seen suggest that these markets are some of the healthiest in the country.

Classified assets, which include all of the non-performing assets, were $234 million, which is up only slightly from $216 million in the last quarter. We have scrutinized our classified assets and we have included both outstanding balances and total commitments to ensure that we are presenting a conservative and comprehensive look at the level of these assets.

The majority of the classified assets also fall into the residential construction category. We are cautious about the outlook in early 2008. We feel that this small increase in classified assets, however, is an encouraging sign.

With respect to income taxes, the accrual rate was down a bit in the fourth quarter to 30.4% compared to 33.5% in the third quarter of 2007. We continued to capitalize on the availability of tax credits throughout our operational footprint.

Now looking ahead to 2008. Our guidance for earnings per share for 2008 on a core operating basis is in the range of $1.80 to $1.90. We expect the first quarter of 2008 to be between the range of 38 and $0.42 per share.

We expect second quarter earnings to increase by $0.02 to $0.03 and the remaining third and fourth quarters to increase progressively a little bit faster. Obviously, there is uncertainty as to what will happen with the national and regional economic growth, as well as additional action from the Federal Reserve Board.

We have assumed that the economy in the Pacific Northwest will continue to slow but will remain much stronger than the national economy, and certainly stronger than some of our hard hit regional sectors around the country. It is our belief that Boise, Idaho market will slow but it will avoid recession and that the California economy will stabilize by the second half of 2008.

Additionally, with respect to interest rates, we believe the yield curve will steepen and LIBOR spreads will return to a more historical relationship at treasury rates. With these variables, we may see our net interest income under pressure in the first quarter and our margin may compress by some 10 to 14 basis points, if the Fed completes its easing in the first quarter, which we anticipate to be another 50 basis points tomorrow and 25 basis points by the end of the first quarter.

We expect that our margin will be flat to slightly up in the second quarter and we expect an increase in the second half of the year of approximately 3 to 5 basis points each quarter.

We expect to end 2008 with total assets of approximately $13 billion. We expect balances in the construction loan portfolio to be flat to down. The commercial loan, commercial real estate and consumer loan portfolio are expected to increase approximately 6% to 12%.

We plan to remain well capitalized through 2008, with core capital ratios improving throughout the year and the expected growth in retained earnings. Additionally, we have very good liquidity.

At the holding company, we have a $40 million line of credit that remains untapped, and at the bank level we have excellent collateral to support additional lending if we needed from the Federal Home Loan Bank or other borrowings.

We expect some turnover in nonperforming assets and some migration within the classified asset groupings from performing to nonperforming over the next three to six months. We anticipate nonperforming assets to be flat to down as the inventory of residential construction loans is worked off in the third quarter and we expect non-performers to decline in the fourth quarter.

We expect the composition to remain weighted toward residential construction. We do not expect a deterioration in the Puget Sound or Portland, Oregon markets. We do not expect deterioration in commercial real estate or non-mortgage loan types like we have seen in the residential construction portfolio.

We expect our provision for credit losses in 2008 to range between $25 million and $29 million with a little bit larger portion of that coming in the first half of the year. Other non-interest income is expected to increase, ranging from 5% to 10% in 2008, primarily from fees and service charge income.

We believe the volume of residential loans to be sold into the secondary market during 2008 will range from approximately $1.3 billion to $1.4 billion with loan sale margins in the 130 to 140 basis point range.

Fees and service charge income are expected to increase by approximately 8% to 12% in 2008. We believe that this will be fueled by an expanding range of business banking products and services including cash management services, check card and merchant services, as well as fees from our rollout of remote deposit capture.

Total operating expenses are expected to increase by approximately 4% to 8% during 2008. Much of this increase will account for the full year of expenses related to our acquisition of Sonoma National Bank Franchise which was completed during the first quarter of 2007.

Although Sterling generally expects to limit staffing increases in 2008, we expect to see increases to the production ranks in order to drive loan originations and net income.

Goodwill litigation expenses are expected to be lower in 2008, at approximately $500,000 to $600,000. Sterling’s effective tax rate is expected to range between 33% and 34% for 2008. The rate is expected to be higher than 2007 because we can’t count on whether tax credits will be available to us in 2008 the way they were in 2007.

We have assumed no additional de novo branching in 2008. We will continue to monitor markets and assess opportunities for siting of branches in the future. But these items will be treated as addendum to our basic plan.

We finish the year with just under 2600 FTEs. We expect the increase in 2007 to be a modest number of roughly 75 to a 100 depending on market requirements.

And with that, I’m going to turn it back to Harold.

Harold B. Gilkey

Thank you, Dan. The Pacific Northwest region remains relatively a stable economy. While we have been insulated from the national economy by the growth of companies like Boeing and Microsoft, we are not isolated from the housing related issues that have disrupted the housing finance programs.

We do anticipate slower growth in 2008, but we believe there is still considerable momentum in the region. Based on this outlook, we are comfortable with our ability to respond to the economy given that our headquarters and the majority of our business is in the Pacific Northwest.

We believe we have a strong management team that has the experience to address the current market disruption and the asset quality challenges.

We have developed a diversified loan portfolio and we still expect good demand in the commercial loans in our market, and have an aggressive plan to obtain the deposits needed to fund those loans. We will, of course, focus on building our commercial banking franchise in Sterling, and our residential and loan business in Golf Savings Bank.

As we look back at 2007, there are four important accomplishments for the company.

We have expanded our total assets of the franchise and our geographic footprint.

We generated net income of $93.3 million and strengthened our capital position.

We have installed a quality and experienced management team with demonstrated skills.

We have a very strong credit administration process and we have identified our loan problems, and we are confident in our ability to manage our way through this cycle.

With that, I’ll turn it back to Kim to begin our question-and-answer session.

Question-and-Answer Session


Your first question comes from Brett Rabatin - FTN Midwest.

Brett Rabatin - FTN Midwest

I wanted to ask you a few questions. I’ve actually got a ton, but I’ll just ask you a few here. First, I want to make sure I was clear: the $25 to $29 million in guidance, is that in credit loss or was that in provisioning?

Daniel G. Byrne

That’s in provisioning.

Brett Rabatin - FTN Midwest

And, Dan, can you walk us through the California exposure; how much of that is residential? And then how much in total is Southern California, and how much of that is residential? Because I thought I understood that most of the California exposure was commercial from the Sonoma acquisition, and so I’m a little surprised to hear this sort of language about South California, so to speak.

Daniel G. Byrne

With respect to the Southern California, we do have loan officers here in Spokane that have had long standing relationships in a prior life with the borrowers in Southern California. But we effectively have two borrowers in the Southern California that are in the nonperforming, and that’s what we identified in the press release and on the conference call.

Harold B. Gilkey

What’s our total commitment to California, Dan?

Daniel G. Byrne

Total commitment to California is about $250 million. On a commitment basis, it would be split about $140 million in Southern California and $105 million in Northern California.

Harold B. Gilkey

And over 50% of that would be commercial real estate?

Daniel G. Byrne

Those were just the residential construction portion of the loan over there.

Harold B. Gilkey


Brett Rabatin - FTN Midwest

The classified assets, obviously were about stable and so you had movement into non-accruals and some replenishment of the classifieds. With the provisioning level that you are assuming in ‘08, I was hoping to get some clarity on what gives you the confidence that the loss content in the NPAs in the classified assets is that restrained?

–I’d hate to open Pandora’s box, but can you tell us how much of that classified asset base is special mention versus substandard, or give us some idea of why any potential write-downs on the collateral of these loans that you have might be minimal?

Daniel G. Byrne

First-off Brett, I didn’t understand the first part of your statement.

Brett Rabatin - FTN Midwest

You’re obviously looking for 25 to 30 basis points of provisioning in ‘08, and so that would assume that net charge-offs also are pretty minimal too, unless you’re going to run down the reserve level, which I will presume is not the case.

Harold B. Gilkey

Brett, let me give you an overview: first of all our underwriting standards when we took the loans on were, what I would call 75% advance on construction up to about 80%, and then our land development loans were about 50%.

We have indeed had our credit administration and our loan officers review each of our construction loans and we’ve got it updated appraisal or a broker’s opinion. So, we feel that we’ve got as good a handle on valuation as you can.

The thing that obviously you can’t control is how long it’s going to take for the market to absorb the inventories in the various locations. As I indicated on the road in our last call, the inventory in Boise, it’s really an inventory issue.

There was irrational exuberance, to use somebody else’s term, as to the value of single-family dwellings and there were some people acquiring as many as nine or ten houses just to take advantage of flipping them.

So what’s happened is there is an inventory problem. Now, I must comment that I feel very comfortable with our competitors in that market area because new starts have been near zero.

And so consequently, I think the inventory will work its way off, but we just can’t identify how long that’s going to take, and with the disruption in interest rates − even though they are lowering − people are waiting for the lowest possible rate, and maybe to some extent to watch the price of housing come down, to take advantage of that.

And the selling season really is the latter part of the first quarter and first part of the second quarter. So, it’s really what happens to the market that we can’t control. We’re focusing on the things we can control and we’re dealing with the right folks at the right time.

Brett Rabatin - FTN Midwest

And I understand that, Harold. I didn’t come out from quite the right angle. Obviously, the selling season is coming up so to speak. I just don’t understand the guidance of 25 to 30 basis points of provisioning. It sounds like you’re pretty optimistic that things will start to really improve pretty quickly in terms of home sales in some of these softer markets?

Harold B. Gilkey

I don’t believe that our optimism is based on what’s happening in the market; our optimism is based on what we know about our individual clients. And then that will lead to them meeting their obligations to manage their portfolios.

Brett Rabatin - FTN Midwest

Okay. So maybe NPAs could be on a quarter or so longer than you might think, but it sounds like you are fairly confident in the loss potential.

Harold B. Gilkey

Yes, Brett, having been around as long as I have been, the one thing I do know is problem assets come on faster than you want them to and they take longer to get rid of than you have to.

So my expectation is that you’ll see some movement of classified assets in the nonperforming, which could mean a small rise in the NPAs. But having looked at each of the workout programs, I feel comfortable that the process will take place in the summer months.

Daniel G. Byrne

I would just like to add that the classified assets total is the broadest measure of problem accounts. It does include all of the nonperformers, and from our classification system, it does not include just special mention type loans and things are always moving around a little bit but we’ve given you our best shot of what we think is going to happen going into the future.

Brett Rabatin - FTN Midwest

Okay. So specials not in there. Okay. I have taken up enough time, I’ll circle back around.


And your next question comes from Matthew Clark - KBW.

Matthew Clark - KBW

Can you touch on the handful of non-performers here. It looks like, based on the breakdown by geography, you got a few projects here that are probably amongst the largest now in your NPA bucket. I think the highest one before was a lot project that was about $7 million in Boise.

Can you just give us a sense for the two, say, in Southern California, and I think there is another two somewhere else in Bend, in terms of what types of projects they are? Specifically, how far along they are? What the appraisals said about the project relative to the equity that you thought you had in the project, and then your ability to rebuild equity with some additional collateral, if that’s realistic or not?

Harold B. Gilkey

Easy question, hard to gather all of that. Let me deal a little bit with the California units. Those are really two; one is a residential land development loan and single-family structured loan. The project is complete. The residential construction is underway with 11 houses been completed.

The appraisal as you might imagine has come down. I think it’s near where we think our collateral covers it. As I mentioned in my presentation our Chief Credit Officer, and our special assets people are visiting in Southern California and Northern California later this week and will be seeing this project and meeting the developer.

The other project is a pre-development loan for a commercial project. The financing for the commercial project, which we were not doing, has evaporated and the developer’s seeking other financing for that project.

We have focused that more on the value of the individual who has got a very nice balance sheet, and our appraisal value has declined but we still believe that it has more value than are outstanding. Additionally, we’re looking for additional side collateral from the borrower. Now, I think that deals with the major processes in California.

In Bend, we have a couple of projects that are completed but they are lot loans with a couple of residential constructions on those lots. So there is no additional money that needs to be advanced except on, I think,- one house. And there as you know, Bend is a secondary home function and will depend on revival of the economy. But we feel comfortable where we are there.

Boise is just an inventory problem and we have 30 some odd builders, which we’ve dealt with. Probably the most problematic are the ones that we acquired in the acquisition of FirstBank Northwest, but we are dealing with those appropriately.

Matthew Clark - KBW

And then in terms of the LIBOR based liabilities that you have, in terms of borrowings relative to the asset side of the balance sheet, can you just give us a sense for the magnitude of those that are tied to LIBOR, again, on the borrowing side relative to your assets?

Daniel G. Byrne

That disparity has been between the assets that re-price at LIBOR versus borrowings is somewhere around $700 to $800 million. More recently that’s actually been on our favor, but obviously it’s been bouncing around.

Matthew Clark - KBW

So $700-$800 million more in related borrowings?

Daniel G. Byrne

In liabilities more than assets.

Matthew Clark - KBW

And I would assume you didn’t see the benefit of 3-month LIBOR coming down until more recently. So, probably wasn’t reflected in the fourth quarter?

Daniel G. Byrne

That’s correct.


Your next question comes from Jim Bradshaw - D.A. Davidson.

Jim Bradshaw - D.A. Davidson

Could you give me an idea, Harold, about the fluidity in classified assets; how much new came in the quarter versus things that went out?

Daniel G. Byrne

In the classified assets, we had a number of projects going both ways, but the overall level was probably influenced a little bit by making sure that we picked up the commitments in the classified balances. So the overall balance didn’t really increase that much, but it seemed like it slowed down considerably from the third quarter.

Jim Bradshaw - D.A. Davidson

Okay. And the number that was in the press release from September quarter did not include commitments, but the Q4 number did?

Daniel G. Byrne

Just on a few categories. With respect to the residential construction, it always has included, but I think we had some line of credits that weren’t fully being picked up, we made sure we have at the end of the fourth quarter.

Jim Bradshaw - D.A. Davidson

And then on the margin front Dan, I noticed that deposits down obviously a little bit this quarter, but (flub?) advances are up and other borrowings are up a little bit too. I presume that was a conscious effort given the weirdness of deposit prices.

What do you think you are likely to see in Q1 from a wholesale borrowing deposit base; shrink the deposit base again and build borrowings, or are you pretty happy with how that liability side looks right now?

Harold B. Gilkey

See Jim, I think that was driven more by our competitors than by us. The big animals were at prey and so we withdrew from that marketplace for a while and funded with our other lower cost reserve funds.

Obviously, core deposits are what we’re about and we’ll move aggressively into that territory, but when the big animals are out you’ve got to watch where you are.

Jim Bradshaw - D.A. Davidson

And then, last for me, just one housekeeping item. Dan, in that non-interest income line, the other expenses looks like a debit balance of $2.4 million; is that the prepayment on the TRUP, is that what’s in there, and then anything else?

Daniel G. Byrne

That’s the primary item that’s in there. We have some other things that net in, including I think, some of our tax credits go into that category. But those were the big items.

Jim Bradshaw - D.A. Davidson

And were the North Valley merger charges, I thought I heard you say $2 million, and I was only expecting that to be $1 million; did I just get it wrong?

Daniel G. Byrne

No, I think, what I meant to say was a $1 million for the North Valley. We had some other expenses; combined it was about $2 million.


(Operator Instructions.) Your question is from Daniel Cardenas - Howe Barnes.

Daniel Cardenas - Howe Barnes

Can you talk a little bit about your capital levels, do you feel that they’re adequate at the current times or do some building up here through any capital raises?

Harold B. Gilkey

If you followed my career, you would find that I think we have more capital than necessary. We have substantially increased our capital ratios, particularly our tangible capital ratio, over the last four-five years from about a little north of 2% to a little north of 6%. So we have made it a conscious effort to increase our tangible capital ratio, and during this last year, we made a substantial increase of our overall total capital.

We feel that we’re adequately capitalized. The review of our position for reserves, we believe that we’re currently adequately reserved appropriately, but we always have some secondary plans in case we have substantial amounts of assets that are highly liquid.

So, we could increase the capital ratio if necessary. We still have a shelf offering, albeit it’s not an attractive way to get capital at this stage, but we have some secondary sources.

Daniel G. Byrne

And Dan, I would just say that we’re committed to maintain well capitalized status for the organization. Harold’s right, I think we’ve got very good sources for capital we need already on our balance sheet. So, I don’t think we need to be looking at other forms of raising capital, but we’ll remain opportunistic if opportunities present themselves.


Our next question comes from Fred Cummings - Elizabeth Park Capital Management.

Fred Cummings - Elizabeth Park Capital Management

Couple of follow-up questions on credit quality. Could you tell us what is the average LTV of your current book of nonperformers? I know you said that origination, the average LTV was 75%, but after this extensive review, where does that number sit?

Daniel G. Byrne

It tends to vary a little bit by projects. Our feeling is they have gone up on the nonperformings, but we’ve done a very good job, I think, of trying to identify where those valuations are overall and try to address it ultimately with the provision that we did in the fourth quarter.

Fred Cummings - Elizabeth Park Capital Management

And as relates to your reserve, I don’t know if you disclosed how much of that would be specific versus unallocated out of that $111 million?

Daniel G. Byrne

I don’t think we did disclose that.

Fred Cummings - Elizabeth Park Capital Management

And would you anticipate having a higher level of OREO as you work through some of these residential construction projects?

Harold B. Gilkey

I think that’s a given Fred that what you do is you try to work with the contractors themselves to complete their projects and go through that process. But in addition to that, there are times where you would take other aggressive action and take deeds into foreclosure.

So, our expectation is that we will move things either off our balance sheet, or develop an appropriate workout plan, or to add to our OREO. So, my feeling is that that always happens, but I don’t see it as significant drag. It will be there probably for most of ‘08.

Fred Cummings - Elizabeth Park Capital Management

And then, lastly, can you tell us when your next scheduled regulatory exam is? Because I think, for the industry, the one risk factor may be the regulators weighing in and concluding that some of these reserve levels are not adequate. You can even give me your thoughts on that hypothesis of mine.

Harold B. Gilkey

There is risk at all levels. We’re scheduled for a safety and soundness exam at Golf Savings Bank, I think, in the second quarter and I feel very comfortable with that portfolio because it’s substantially residential loans that are well underwritten and that’s why I feel comfortable with that position.

I think we have one delinquency and one OREO in that portfolio now, so I feel very comfortable with that position. And the last exam that was on that portfolio, they met our expectations; what we did was accepted by them.

I think that our next safety and soundness exam for Sterling Savings Bank is scheduled for the latter part of this year or the first part of next year, and so I believe that your thesis may have some validity but by the time that we get there, the cycle will have clearly identified.

And in our last exam, which was latter part of last year, was after the subprime crisis was notified, and we had minimal changes in evaluations. Over time, the regulators have felt very comfortable with our process and discipline in the credit quality.

And Fred, given the history of our company being the highly leveraged company, we have stressed that credit administration to be conservative because you just can’t afford to have significant problem areas. And that led us to the diversified portfolio that we have by product line and by geographic marketplace.

While there is some stress in certain areas, I feel much more comfortable then if we had all of our eggs in one basket − Southern California or Florida.


Your next question comes from Brian Hagler - Kennedy Capital.

Brian Hagler - Kennedy Capital

Just a couple of questions. One, maybe a follow-up to Fred’s question; can you tell us, after reviewing all these different construction projects, what the average mark was you took this quarter?

Daniel G. Byrne

Mark-to-market adjustments?

Brian Hagler - Kennedy Capital

No, no. I mean, did you writedown the value of those construction projects by 10% on average, 15%?

Daniel G. Byrne

The way our classification system works it’s really a matter of applying an allowance allocation based on the risk in that portfolio. And so it does very much vary by project and also overall by types of loans, and depending on how severely classified they are. So, it does vary a little bit in that respect.

Brian Hagler - Kennedy Capital

The ones that were maybe the most severely classified, what kind of marks or write downs did you take on those on a percentage basis?

Daniel G. Byrne

Let me see if I’ve got the information on a classification report, Brian. I don’t have it right at my fingertips. You have another question?

Brian Hagler - Kennedy Capital

Yes. And then my second question just has to do with your balance sheet. Historically, I’ve kind of viewed you as one of the little more liability sensitive than a lot of your peers, and unfortunately here it seems to have maybe changed a little bit.

Is that due to acquisitions that you’ve made or did you make some changes in your balance sheet that’s led to that in the short term or? Just a little more detail on that would be great.

Daniel G. Byrne

Actually, it’s because of the change in the mix of our portfolio toward more asset sensitive, commercial banking. Residential construction lending has all kind of pushed us in that direction, Brian.

But I would tell you that our asset sensitivity is generally out to about 90 days, and then we start to become more liability sensitive by the end of the year. So, initially as rates trend down, we do see a little bit more of the asset re-pricing faster than liabilities, and then it starts to turn around.

Obviously, we’re still playing catch-up with the Fed drop last week that will have an impact, and we’re still catching up from the last 100 basis points. So at some point when the Fed is done with the decline in the interest rates, we will start seeing that pick up again.

Brian Hagler - Kennedy Capital

It will take some time to cycle through your deposit in your CD portfolio, but were you able to cut your deposit rates by a meaningful amount?

Daniel G. Byrne

We were trying to decrease that portion that was re-pricing, primarily in the CDs, we ran out brokered and wholesale deposits from a price sensitivity standpoint; that’s one of the reasons why we did show a decline in overall deposit balances right at the end of the year. And then we saw the rise in the advances from the Federal Home Loan Bank and others.

We were trying to be aggressive and move our posture where we had been more maybe competitive at the upper end of the scale to more middle of the pack. And we’ve been trying to be aggressive in that area to try to cut our cost of funds as the revenue side has been declining.

Harold B. Gilkey

But the other might be valuable, if you were to talk a little about the TRUP we paid off.

Daniel G. Byrne

That’s one area that we expect to see sizable benefit on that $24 million. At the time that we initiated it, we thought we had about a 500 basis point improvement in the overall cost, and obviously it has gotten even larger and the benefit into the future better as a result of the drop in interest rates.

Brian Hagler - Kennedy Capital

Okay. And can follow up on my first question offline?

Daniel G. Byrne

Soon as we grab it, we’ll provide it to you.


Your next question comes from Matthew Clark, with KBW.

Matthew Clark - KBW

Couple of quick follow-ups. Can you isolate the reserve that you have attributed to the construction loan portfolio now? I think it was somewhere in (80?) or so basis point range at least maybe a couple of quarters ago. I was just curious where that stands today?

Daniel G. Byrne

I’m sorry, the reserves specific to the residential construction portfolio, is that what you’re asking?

Matthew Clark - KBW

Or even construction in total? Either one.

Daniel G. Byrne

I may have to follow up on that. I am not sure I’ve got that right at our finger tips, Matt.

Matthew Clark - KBW

Okay. And then lastly, can you update us on the communication you’ve had with the FDIC since the North Valley deal has fallen apart. What progress you’ve made along the lines of the internal audit function. I think that you added a Board member with some related experience. I just wanted to get an update there.

Harold B. Gilkey

I can tell you that we’ve made progress during all exams. They leave you with a list of things that are deficient; all of those deficiencies have been addressed to a 100% portion. The open areas are some additional staffing, which we’ve identified and have plugged in, and there is some expanded training that probably will take on a roll for the whole year.


And at this time I show no further questions.

Daniel G. Byrne

I do have one follow-up response to one of the questions in terms of the residential construction reserves in the allocation. It does amount to about $30 million of the total reserve in our classification process, and I think the ratio is about 164 basis points.


And I show no further question.

Harold B. Gilkey

In that case let’s complete the Q&A session, and I would like to thank everyone for your participation this morning. We look forward to talking with you again at the end of the first quarter of 2008. Our earnings release is currently scheduled for Monday, April 21, and the following morning we will have a conference call again at 8:00 AM Pacific Standard Time.

Once again, thank you.

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