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Sterling Financial Corporation (NASDAQ:STSA)

Q2 2008 Earnings Call Transcript

July 23, 2008 11:00 am ET

Executives

Deborah Wardwell – IR

Harold Gilkey – Chairman and CEO

Dan Byrne – EVP and CFO

Analysts

Jeff Rulis – D.A. Davidson

Matthew Clark – KBW

Allen Bortell – Inverness Management

Theodore Kovaleff – Grant Capital [ph]

Nick Gray [ph] – Private Investor

Kit Cole – Investment Advisory Service

Scott Hogan [ph] – Thai Capital [ph]

Kipling Peterson – CVC

Operator

Good day everyone and welcome to the second quarter 2008 earnings conference call. Each of you will be on a 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, www.sterlingfinancialcorporation-spokane.com immediately following the call.

I would now like to turn the call over to Ms. Deborah Wardwell of Sterling Financial Corporation.

Deborah Wardwell

Thank you, Laurel. Good morning and welcome. 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 conference call, Sterling's management will be referencing forward-looking statements that are not historical facts and pertain to our future operating results. These forward-looking statements include but are not limited to statements about our plans, objectives, expectations and intentions, and other statements contained in this report 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 development which may, among other things, increase delinquency risks in Sterling’s loan portfolios, shifts in industries which may lower results, shifts in demand for Sterling's loan and other products, increased costs or lower-than-expected revenues or cost savings in connection with acquisitions, changes in accounting policy, changes in the monetary and fiscal policies of the federal government, and changes in laws, regulations and the competitive environment.

In closing, I would like to highlight two upcoming investor events. Sterling will host an Analyst Day at Hayden Lake, Idaho near its corporate headquarters on August 10th through the 11th of 2008.

In addition Harold and Dan are presenting at the upcoming FTN Midwest Securities Small and Mid-Cap Bank Conference on September 4, 2008 in New York City.

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

Harold Gilkey

Thank you, Deborah. Good morning everyone and welcome to Sterling Financial conference call. We are indeed navigating through a very difficult financial storm. Yesterday, we announced earnings of $0.23 per share for the second quarter of 2008.

During the quarter, Sterling recognized a credit provision of $31 million, $6 million lower than what we reported on the first quarter. We saw our level of classified and problem accounts increase but at a lower rate than we experienced in the last two quarters. This was as expected. Dan might say we had a downturn in the upturn of problem assets. We have, indeed, identified our credit issues and have allocated the necessary resources to manage through this asset-quality cycle. Overall, our construction portfolio declined by approximately $100 million during the quarter.

Our credit administration and portfolio management teams have taken positive steps to reduce the problems in our residential construction portfolio. I want to emphasize that our team has taken a conservative approach towards risk evaluation and are disciplined in the rating of loans according to the appropriate risk. We recognize that we are currently operating in an uncertain environment and believe it’s only prudent to regularly reassess the risks.

Sterling's core business continues to perform solidly, thanks to the focus and dedication of the bank’s leadership and our employees. Our net interest margin is better than projected. Our fee income was higher than projected and we controlled our operating expenses, which were flat compared to the first quarter.

Our business and consumer lending continues to increase and in our subsidiary Golf Savings Bank, residential mortgage originations continue to be above plan despite a very difficult market. Deposits overall rose nearly 5% to almost $8 billion on a year-over-year basis and were up nearly 2% on a linked quarter basis. In other words, we are executing on the things we can control.

Sterling’s capital adequacy and liquidity remained strong. Total capital advanced 5% to $1.18 billion from a year ago. Sterling’s total risk-based capital ratio was 10.9%. The Sterling has cash and cash equivalents and high-grade investment securities of $2.39 billion. Sterling's investment securities provide substantial liquidity and collateral for borrowers. We have additional borrowing capacity of approximately $700 million through the Federal Home Loan Bank of Seattle and access to a little over $2 billion from the Federal Reserve and other resources.

I repeatedly tell our team at Sterling to focus on what we are responsible for and above all stay focused on serving our clients in a hometown helpful manner.

Over the past three quarters, Sterling has managed what it has the power to control and will continue to do so. We cannot control the events at other financial institutions. We can only manage events at Sterling and its subsidiary companies. We are managing our way through this credit disruption.

At all levels of our banks, we are working closely with our customers. We also urge our Sterling team to avoid reacting to the daily barrage of negative headlines that appear in the National Press.

Sterling operates in an area of the United States, the Pacific Northwest, where the economy remains relatively solid and the growth drivers such as population migration and new job creation continue to be favorable.

Housing trends in the Puget Sound region, for example, based on a recent June residential multiple listing data, continued to suggest a pattern of stabilization. The median price for housing has remained stable throughout 2008. The number of closed sales continues to trend upward on a monthly sequential basis.

Inventory levels are trending down as more homes are sold and fewer homes come on to the market. Also reports indicate that Boise is nearing residential stabilization. In other words, the sky is not falling.

The bottom line is that Sterling’s core banking operations continues to perform solidly. Sterling has pretax pre-provision earnings of $47 million in the second quarter or $188 million on annualized pretax earnings. These pretax pre-provision earnings along with our loss reserves and our capital cushion allow us to manage capital issues with the credit elements of our portfolio. As mentioned earlier, identification leads to better decisions in advance of a credit cycle. Time, money and management will be the solution to this cycle.

At this point, I would like to turn the call over to Dan Byrne, our Chief Financial Officer, Dan?

Dan Byrne

Thanks Harold. To supplement the information provided in this press release, I’m going to focus on a few key highlights for the quarter and then provide the opportunity for you to ask specific questions during the Q&A session.

As Harold indicated at the end of the second quarter, Sterling's total assets were virtually unchanged at $12.7 billion and total loans receivable had increased only slightly to $9.2 billion. Sterling's capital position remained strong and we continue to be well capitalized.

Sterling announced yesterday earnings of $11.7 million or $0.23 per diluted share for the quarter. During the quarter, we did have the credit provisions Harold indicated at $31 million which was just a touch higher than our earlier guidance.

As Harold noted, our results reflect relatively strong operating results as our pretax pre-provision profitability was $47.2 million compared to $41.1 million on a linked-quarter basis and $43.9 million in the same quarter of last year. The bank is continuing to do very well as we work through this asset quality cycle.

Net interest income was $94.1 million for the second quarter of 2008, an increase from $92.1 million on a linked-quarter basis and up 6% over the same period of a year ago. The net interest margin on a tax-equivalent basis was down only 1 basis point to 3.23% for the second quarter of 2008 compared to 3.24% on a linked-quarter basis and 3.41% for the same quarter a year ago.

Despite being asset sensitive in the near term, our net interest margin held up much better than we projected. We attribute that to aggressively pricing of our funding sources.

Many thanks to all of our deposit gathering teams in the different delivery channels, the retail branches, the commercial, corporate and private bankers and to our treasury management team who worked very hard to re-price and re-position our borrowings and I think they did quite a successful job at reducing the cost of our overall funding sources. I would also like to highlight the 5% year-over-year rise in our deposit base to a record $7.99 billion.

In the second quarter, you will note a 4% annualized growth in non-interest bearing checking accounts. Much of this is related to C&I lending. We also had an increase in CDs that was influenced by a surge in public entity transaction accounts. But I think the more important point, during the quarter, we had the ability to reduce our cost to deposits by 39 basis points. That is very significant.

Total non-interest income was up approximately 20% in the second quarter compared to the linked quarter and up 3% over the same period of a year ago. We are pleased with the growth in fees and service charge income which was up 17% on a year-over-year basis and 13% on a linked-quarter basis.

Growth in fees and service charge income reflects increases in annualized account fees, loan related fees, transaction fees, financial services conditions, and fees from Sterling’s Balance Shield program, which is an overdraft protection program. The total number of transaction accounts for the second quarter grew at 3% over the second quarter of 2007 and was up almost 1% from the first quarter of 2008.

Mortgage banking operating income for the second quarter of 2008 was $8.2 million compared to $6.2 million in the linked quarter and $9.8 million in the same quarter a year ago. The increase during the second quarter reflects better volume of our sales from Golf Savings Bank, although we did experience lower brokered loan fee income in the commercial real estate division. The decline in broker fees is mostly reflective of the disappearance of the conduit market, coupled with a retreat of life insurance companies, which has slowed down their funding of new loans.

Brokered income on the commercial real estate for the second half of the year was about one-third of what it was in the year ago period. A lower year-to-date comparison of mortgage banking income is also reflective of gains on SBA and portfolio loans sold in the prior period. Because of the declines in prices for the portfolio loan sales, we have backed away from selling some of our SBA and commercial loans in the current period. We felt it is better to hold for the yield than sell at depressed prices.

Golf Savings Bank continues to capture its share of loan originations and improve its profitability. While the level of applications for residential and loans declined a touch from the first quarter, we are encouraged that the mix has shifted to more purchase transactions which we think is an indication of consumers coming back to the housing market.

Our efficiency ratio continued to improve during the quarter as measured by the ratio of non-interest expense to average assets, which dropped to 2.29% in the second quarter of 2008 from 2.33% on a linked-quarter basis, and from 2.45% in the same period a year ago.

Full-time equivalent employees decreased a touch to 2545 from 2612 at the end of the second quarter of last year. We have been working to reduce operating expenses and continually improve our operations.

During the second quarter, total operating expenses of $72.4 million were up 4% on a year-over-year basis, but flat compared with the previous quarter.

At June 30, 2008, gross non-performing loans, that is non-performing assets before specific reserves, were $303.4 million up from $223.1 million last quarter and $135.2 million at the end of 2007. You will know that we have changed our reporting format to provide more transparency by showing both the gross non-performing assets, as well as non-performing assets net of specific impairment reserves.

As we previously identified, the largest component of non-performers are in the residential construction portfolio, accounting for 79% of non-performing assets and about 92% of the increase from the first quarter. The balance of non-performers are in other loan types typical of a growing company and pretty well diversified across our loan portfolio.

Regarding the Puget Sound, which is our largest market with approximately $1 billion in residential construction commitments, this market is still holding up reasonably well. Gross non-performing loans increased a modest $7.6 million to $31 million and represent only 3% of outstanding commitments to this geographic sector. And while it may be too soon to tell, it appears that our asset quality in Boise and Bend is stabilizing.

The Portland market experience more softness this quarter with non-performing assets related to residential construction increasing $38.5 million to over $46 million. This increase is primarily related to four builders with projects in various stages of development.

Residential construction non-performers also increased in the state of Utah, up $14.8 million to $36.2 million. This represents a $21.4 million increase. Now, the good news here is we do not have much of a portfolio in Utah, less than $70 million in total commitments and the economic climate in Utah is still positive.

We experienced additional deterioration in southern California where residential construction non-performing assets increased from $28 million in the previous quarter to $40 million in the current quarter. This is largely attributed to a single borrower with two A and D projects in Orange County.

Regarding non-performing loans that are outside of residential construction, the other loan categories represent 21% of nonperformers and are well distributed across the portfolio.

Classified assets which include all of the non-performing assets were $497.5 million, which is up from $403 million in the previous quarter. Majority of the classified assets also fall into residential construction. I would point out that the increase during the second quarter was slower than the rate that we have seen in the previous two periods. We remain cautious about the outlook for 2008.

During the quarter, our net charge-offs were $13.6 million. Specifically, $11.6 million was related to residential construction and $1.6 million was related to consumer loans and the balance was related to other loan types throughout the portfolio.

During the June quarter, we had partial or total resolution of a number of nonperforming assets. I will tell you that during the quarter, we did have some reductions of $28.5 million. This includes loans by currents, paid off, or sold, representing 14% of the nonperforming asset portfolio at the beginning of the quarter. Of the $28.5 million, our loss experience was only $2.9 million or approximately 10%. I want to emphasize that many of the loans paid off with no loss. The largest discount was taken for a land project in Southern California with a 36% loss.

Additionally, we transferred $16.5 million of loans to OREO. The write-down on OREOs are based on current market values, but these market values vary greatly depending on property type, the level of completion, and geographic location. The total charge-offs at foreclosure was $8.4 million resulting in an increase to OREO of $8.1 million.

During the second quarter, the charge-offs were heavily influenced by two land development loans to one borrower in Southern California, which were written off approximately 50% on one loan and 60% on the other. Again, we do not believe that these two loans in Southern California are indicative of the entire portfolio.

With respect to income taxes, the accrual rate was down a bit in the second quarter to 28% compared to 32.5% in the second quarter of 2007. This is in part due to lower pretax earnings and we continue to capitalize on the availability of tax credits throughout our operational footprint.

Now, looking ahead to the second half of 2008, we are encouraged by the performance of Sterling Savings Bank and at Golf Savings Bank. The recent unsettling news at IndyMac and the uncertainty of Fannie Mae and Freddie Mac provides some headwinds that make the visibility of our guidance a little difficult.

We are maintaining the upper-end of our guidance for 2008 at $1 per share, but we have dropped the lower-end of the range to $0.75 per share. The wider than normal guidance reflects the uncertainties surrounding a couple of factors that will influence our performance. The first will be the level of classified and nonperforming assets over the next two quarters and the severity of charge-offs that we anticipate in these categories. The second is the uncertainty regarding the macro events outside of our control, mainly the economic growth on a national and regional basis, and additional actions the Federal Reserve Board will take or the Congress may take.

With respect to interest rates, we expect the Federal Reserve to maintain the Fed funds rate through 2008 at current levels. We believe the recent yield curve steeping will continue through 2008 and that the relationship of the spread between LIBOR and treasury rates are at risk of increasing. We would expect an improvement of 5 basis points to 10 basis points given what the Fed has done, but we may see our net interest margin under pressure during the third and fourth quarters due to the uncertainty of how we deal with the insurance and deposit shocks and the pricing of deposits. It is a little hard to quantify at this time.

We expect total assets to be flat to down at the end of 2008 as we strategically shift our loan portfolio toward commercial banking and consumer loans, and away from construction loans.

We expect mortgage banking operating income may be impacted by the uncertainty of Freddie Mac and Fannie Mae and be a touch lower in the second half than we saw in the first half. These and service charge income is expected to hold up and is tied to the level of our transaction accounts.

We have implemented a number of programs to increase efficiencies in our operations and expect the increase in operating expenses may not rise as much as our previous guidance. We expect the effective tax rate to below our prior guidance and come in between 26% to 28%.

We have assumed that the economy in the Pacific Northwest will begin to slow but will remain stronger than the national economy and certainly stronger than some of the hard-hit regional sectors and other regions of the country. It is our belief that Boise, Idaho has stabilize somewhat and Portland, Oregon market continues to slow. We believe the Utah economy will be similar to Boise.

Regarding the housing market, we have seen a monthly increase in payoffs, although this level is lower than last year. When it comes to projecting non-performing assets and classified assets, we realize that we have a very fluid situation and we are making assumptions on how quickly loans will be paid off and the ability of our borrowers to carry the inventory until it is sold.

We expect some turnover in nonperforming assets. We expect the composition of nonperforming assets to remain weighted toward the residential construction through the remainder of the year.

That being said, we expect the provision to be a bit lower in the second half of the year compared with the first half of the year. Our earnings guidance assumes provisioning for all of 2008 of between $100 million and $125 million.

We expect to remain well capitalized through 2008. We have core capital ratios improving through the year from expected growth in retained earnings. We do not believe we need to raise capital. We believe earnings are strong enough to absorb the credit costs we see before us.

Additionally, we have evaluated the alternative position that credit costs could be greater. To that position, I would reiterate that our second half 2008 earnings and our capital position are sufficient to absorb an additional $200 million in credit costs when you tax effect the credit costs. We do not believe that the credit costs will be that severe.

Also, in regards to liquidity, at the holding company, we have cash resources of approximately $9 million that are expected to continue to grow through the end of the year and we have $10 million line of credit that remains untapped.

At the bank level, we have sufficient collateral to support additional borrowings from the Federal Home Loan Bank, the Federal Reserve, and other sources if necessary.

With that, I will turn it back to Harold Gilkey.

Harold Gilkey

Thank you, Dan. On the whole, the second quarter of 2008 unfolded as we had anticipated. The core banking operations indeed performed very solidly. We made progress against our goal of emphasizing high-quality lending relationships in the business and consumer segments while deemphasizing our construction exposure.

Fee income grew very nicely up 17% year-over-year. We stabilized our net interest margin. We controlled our overhead expenses and as projected, non-performing assets and classifieds increased over the first quarter of 2008 level, but at a slower rate.

With three quarters of experience in this cycle, our credit team is confident that we have identified most of our credits that are either distressed or could become distressed. Our credit team has tightened its focus on resolving and working off [ph] credits. The resolution process is likely to take several quarters. And most importantly, I am confident in our team and the strengths of preserving the franchise that Sterling has built.

I would like to share with you a few strengths of the Sterling franchise. Our capital and our liquidity positions remained solid. The operations of our core banking business are solid and performing well. We live in an area of the country that is – where the primary economic drivers are constructive; employment levels, job creation and net in-migration.

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

Our credit team is capable and seasoned, and has significant experience in loan resolution and workup. We do have a diversified loan portfolio, and we will continue to build our commercial banking franchise in Sterling and our residential home loan business through Golf Savings Bank.

That being said, I would like to now turn over to Laura to begin our Q&A session. Thank you, Laura.

Question-and-Answer Session

Operator

(Operator instructions) Our first comes from Mr. Jeff Rulis. Your line open sir and please state your company name.

Jeff Rulis – D.A. Davidson

D.A. Davidson. Good morning.

Dan Byrne

Good morning, Jeff. How are you?

Jeff Rulis – D.A. Davidson

Good, how are you?

Dan Byrne

I’m looking forward to seeing you next week.

Jeff Rulis – D.A. Davidson

Okay. Dan, I wanted to clarify the earnings guidance range, I just missed it.

Dan Byrne

I’m sorry?

Jeff Rulis – D.A. Davidson

The earnings guidance range, did you –?

Dan Byrne

Yes, the earnings guidance range we gave was $0.75 to a dollar.

Jeff Rulis – D.A. Davidson

Okay, thanks. And the credit issues you are seeing at Portland, specifically, I’m assuming that’s outside of the metro area, could you comment on sort of the specific areas of problems there?

Harold Gilkey

Well, Jeff, you got it identified well. It’s in the – when we say Portland, we’re talking in a general sense of the Portland metropolitan areas. And as indicated before on a couple of conversations, the Southeast Vancouver has slowed significantly and the Southeast Portland has started to slow.

Jeff Rulis – D.A. Davidson

And what is your total loan commitments in Portland?

Harold Gilkey

I think our total is about 20% of our construction lending, so about $0.5 billion.

Dan Byrne

It is actually a touch lower than that. It’s about $445 million in total.

Jeff Rulis – D.A. Davidson

Great. Okay, and then lastly, just looking for a clarification on the specific reserve on non-performing loans that you use to calculate the net non-performing loan number. That specific reserve, is that included in total reserves of $162 million?

Dan Byrne

Yes, it is.

Jeff Rulis – D.A. Davidson

Okay. Great, thank you.

Operator

Our next question comes from Matthew Clark. Your line is open, sir, and please state your company name.

Matthew Clark – KBW

Sure, KBW. Good morning guys.

Harold Gilkey

Good morning, Matt.

Dan Byrne

Good morning, Matt.

Matthew Clark – KBW

Can you give us the total capital ratio at the bank level at the end of the second quarter?

Dan Byrne

I think it’s in the press release.

Matthew Clark – KBW

I thought I saw the holding capital – I don't know.

Dan Byrne

We showed both – let me just pull that out here real quick.

Matthew Clark – KBW

Sorry about that. I got it 10.8. Thank you.

Dan Byrne

It is 10.8 on a risk-based capital basis.

Matthew Clark – KBW

Is there a level at which you might not want to see that drop to and you might proactively try to do something about it before if it were to you get to a more center [ph] level?

Harold Gilkey

Matt, I think you question is directed at our interspatial [ph] and need for capital and I think I’ve answered that every way I know how. But we believe that the best way to generate capital for this company is through the earnings that our bank provides.

The history of this company, we are a leverage company and I think I know how to manage that leverage well. And we will keep track of it and do what is necessary to maintain the well-capitalized position.

Matthew Clark – KBW

Great, and the 30 to 89 day bucket, at the end of the quarter that we will see in the call report, can you give us where that stood?

Dan Byrne

Matt, I don’t have that but do provide however provide the 60 day plus delinquency and I would just comment that the majority of that 60-day plus are really are 90-day plus basically driven by the non-performing assets.

Matthew Clark – KBW

Okay. And then interest income reverses on new non-accruals this quarter. How much does that cost the margins?

Harold Gilkey

I have to take a look here a little bit. It cost us about 16 basis points in terms of margin.

Matthew Clark – KBW

Okay, that’s it from me for now. Thanks.

Operator

Our next question comes from Allen Bortell. Your line is open and please state your company name.

Allen Bortell – Inverness Management

Yes. Inverness Management. You guys are making me come out of retirement.

Dan Byrne

Welcome back to the working world.

Allen Bortell – Inverness Management

Yes. I am looking at the macro picture here, Congress passing this housing bill with a tax credit for first home buyers which has helped clear away a lot of unsold homes in the past when they have done a credit, I think at least once or maybe two times over the last 20 to 25 years.

Well, I don’t know the exact profile of your builders' loans and how much is standing inventory ready to sell. Could you state how many numbers of homes out there – there are and that are ready to be picked up by consumers?

Dan Byrne

Yes, Allen, I don’t know the exact number of houses if you will, but typically our portfolio has about 60% of vertical, so it is just tax from [ph] the houses, the majority of that is in (inaudible) near completion or at completion.

Allen Bortell – Inverness Management

So, the price points, are they generally in sort of middle income or –

Harold Gilkey

Allen, they tend to be the first-time home buyer up to above the mid range.

Allen Bortell – Inverness Management

Okay, well may be there is some positive done [ph] at this housing bill which might reach all the way out to –

Harold Gilkey

We would view the tax credit for first-time home buyers as a positive and that is one of the things we said in the narrative is that, it’s so hard to judge what the Fed or Treasury or Congress will do. This one seems to be a positive.

Allen Bortell – Inverness Management

Okay. Thanks very much.

Operator

Our next question comes from Theodore Kovaleff. Your line is open, sir, and please state your company name.

Theodore Kovaleff – Grant Capital

Yes, Grant Capital [ph]. Yes, good morning. I realize that this maybe quite previous but given your acquisitive history, I am wondering whether what has happened in California may lead you to look elsewhere in the future for acquisition candidates.

Harold Gilkey

That’s a good question but I think the response will be that the M&A market in the financial industry in the near-term future is really prohibited because of the credit cycle. As in the past, we will always look at acquisitions that fit inside our current footprint, so as to increase our market share.

Theodore Kovaleff – Grant Capital

Okay, fair enough, thank you.

Operator

(Operator instructions) Our next question comes from Nick Gray [ph]. Your line is open and please state your company.

Nick Gray

I’m a private investor.

Dan Byrne

Good morning Nick.

Nick Gray

Good morning, Dan. Could you and Harold give us your perspective of the regulatory environment in general and then specifically whatever information you can give us regarding Sterling specifically as to scheduled exams and or the results of exams that are already under way or have taken place?

Harold Gilkey

As you know, we are prohibited from discussing the exams themselves. We have just completed a safety and soundness exam at Golf Savings Bank and are waiting for the final copy, a final report. I can tell you that I felt comfortable with results of the analysis of their credit review and we are scheduled for a safety and soundness exam at the Sterling Savings Bank. I believe that it begins in the first week or so of October.

With regards to the overall environment from a regulatory standpoint, I have great empathy for them because they appear to be focused on the credit in certain geographic areas particularly in the western district because of the problems in Southern California and Southern Nevada. But at the same time, I find them to be useful in helping us identify the opportunities going forward and the difficulties that we view within the whole credit environment.

One of the things I stated, Nick, is that we can only control our own financial institution and we can't really control others’ financial institutions and the events that are happening there. I think you will find, as regulators find, there is a difference of happenings in various institutions because of management in those various institutions. So I feel reasonably comfortable but until you have the doctor's exam, you never know whether you’re well placed [ph]. Thanks, Nick.

Nick Gray

Thank you.

Operator

Our next question comes from Kit Cole. Your line is open and please state your company name.

Kit Cole – Investment Advisory Service

Good morning. Kit Cole; Investment Advisory Service. I would like to know what percent of the construction portfolio is not residential.

Harold Gilkey

The total construction portfolio is just short of $3 billion and commercial construction portfolio is about $1 billion.

Kit Cole – Investment Advisory Service

And can you give us some color as to how that segment is going?

Harold Gilkey

Yes, I think the best way I can state it to you is that all sections of our credit portfolio with the exception of residential construction is performing as expected. We have not seen any real migration into any difficult area. The only area we have seen is in the indirect automobile and that happened when the construction slowdown happened and if you'd like to buy a pickup, we have a lot of them delivered back to us. Pretty minor function though.

Kit Cole – Investment Advisory Service

And I want to follow up on a question and that is, how do you declare a construction loan non-performing? When the reserve runs out or is there some – do you assess impairment of collateral – what's that process?

Dan Byrne

Generally speaking, their 90 days delinquent is what the non-performing amount is. But I think what you’re really referring to is how we manage the interest reserves and when we have indications of concern regarding a project, we will collapse those interest reserves quickly and not allow them to continue to run up the balance. So I think in our case, we’ve been very proactive and in some cases, maybe accelerated the loans going into non-performing status.

Kit Cole – Investment Advisory Service

One last one and that is, what do you do about the impairment or how do you recognize or assess impairment of collateral?

Dan Byrne

We do an evaluation of the project, generally speaking and look at the build out and cash flows over the time frame it will take to do that.

Kit Cole – Investment Advisory Service

Are you recognizing that impairment in your NPAs?

Dan Byrne

We are. And that’s the reserve, the specific reserve that’s reflected on the schedule for the non-performing assets.

Kit Cole – Investment Advisory Service

Thank you.

Operator

Our next question comes from Scott Hogan [ph], your line is open and please state your company name.

Scott Hogan – Thai Capital

Thai Capital [ph]. Can you hear me?

Dan Byrne

Yes, Scott.

Scott Hogan – Thai Capital

First question, when is your yearly regulatory exam for the Savings Bank?

Harold Gilkey

I think I’ve responded to that, but I think it’s right now scheduled for either the first or second week of October and will be completed by year-end.

Scott Hogan – Thai Capital

And then, I assume you guys are tracking this closer and in one place versus what I could do, what are the inventory days numbers for April, May and June in Seattle, Portland and in any of the other geographies that are important that you are tracking?

Dan Byrne

I am not sure that I have all that right in front me. Scott, can I get back to you on that one?

Scott Hogan – Thai Capital

Yes, that will be great. Thanks.

Operator

Our next question comes from Kipling Peterson. Your line is open and please state your company name, sir.

Kipling Peterson – CVC

Good morning, CVC. A couple of questions. The first one, acknowledging that all of the financial sector has been under pressure, I am just curious with the company having lost 90% of its market value over the last year up until last week, are you finding that you’re having to do more handholding with depositors to assuage them of their fears about maybe what the market is pretending and what the outlook is? That’s question one. And question two, is the Spokane region the most rock-solid market that you’re in?

Harold Gilkey

Kip, you only asked about eight items – let me address a couple of things. First of all, our deposits are up either on a year-over-year basis or at a sequential basis. And I don’t think our stock price had any real adverse effect on the depositor activity. I think the element came more from the closure of IndyMac in California and I must commend our staff in the preparation and the discussions that the IndyMac failure brought about from our depositors and quite frankly, since the IndyMac, our deposits have indeed grown.

Rock solid – I think the whole Pacific Northwest is in pretty good economic conditions and I have indicated several times that banks generally reflect the economies they’re in. And going into the, what I would call, the economic slow down, Eastern Washington, the Inland Empire of the Northwest was well prepared to go in that because of the high commodity prices. Western side, the Boeing, the Microsoft, and the like continue to hire and Boise has a strong inflow and probably has the lead, the lowest unemployment ratio in the northwest. We keep track of all of this and are on top – I don’t find any real strong negative weakness in the Pacific Northwest.

Kipling Peterson – CVC

Thank you.

Dan Byrne

We need to wrap up.

Operator

That does conclude our Q&A session.

Harold Gilkey

Laurel, thank you very much. This will end the Q&A session and I’d like to thank everyone for their participation. We look forward to again talking with you on our third quarter conference call. Earnings release is currently scheduled for Tuesday, October 21 and we will follow that up with an earnings call the next morning at 8 am Pacific Daylight Time.

If you’re interested in attending our Analyst Meeting, please contact Deborah Wardwell in our Investor Relations Department.

In closing, I would say that the second quarter was a solid quarter and our Board of Directors showed the confidence in our future development by authorizing a $0.10 dividend payable in October for the shareholders at September 30.

With that, I’d like to once again thank you for your participation and this concludes our conference call. Thank you.

Operator

A replay for the call will be available in one hour. You may access the replay by dialing 203-369-1244. This concludes today's conference call.

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Source: Sterling Financial Corporation Q2 2008 Earnings Call Transcript
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