CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
We make statements in this Report, and we may from time to time make other statements, regarding our outlook or expectations for earnings, revenues, expenses and/or other financial, business or strategic matters regarding or affecting Sterling Bancorp that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Forward-looking statements are typically identified by words such as "believe," "expect," "anticipate," "intend," "outlook," "estimate," "forecast," "project" and other similar words and expressions or future or conditional verbs such as "will," "should," "would," "could," or "may." These statements are not historical facts, but instead represent our current expectations, plans or forecasts and are based on the beliefs and assumptions of management and the information available to management at the time that these disclosures were prepared. You should read these statements carefully. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made. We do not assume any duty and do not undertake to update our forward-looking statements. Because forward-looking statements are subject to assumptions and uncertainties, actual results or future events could differ, possibly materially, from those that we anticipated in our forward-looking statements . Although we believe the expectations reflected in these statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements and future results could differ materially from our historical performance. The factors described in our annual report on Form 10-K under Item 1A, Risk Factors, or otherwise described in our filings with the
Securities and Exchange Commission, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations expressed in our forward-looking statements, including but not limited to: • our Company's ability to successfully implement growth, expense reduction
and other strategic initiatives and to integrate and fully realize cost
savings and other benefits we estimated in connection with the Merger;
• a deterioration in general economic conditions, either nationally,
internationally, or in our market areas, including extended declines in the
real estate market and constrained financial markets;
• our use of estimates in determining fair value of certain of our assets,
which estimates may prove to be incorrect and result in significant declines in valuation; and
• our Company's ability to successfully implement growth, expense reduction
and other strategic initiatives and to complete merger and acquisition
activities and realize expected strategic and operating efficiencies associated with such matters.
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
The following commentary presents management's discussion and analysis of financial condition and results of operations and is intended to assist the reader in understanding our financial condition and results of operations. The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and the accompanying notes included in Part I, Item I of this Report and with our audited consolidated financial statements and the accompanying notes and Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2013 Annual Report on Form 10-K. Operating results discussed herein are not necessarily indicative of the results of any future period. Tax-equivalent adjustments are the result of increasing income from tax-exempt securities by an amount equal to the federal taxes that would be paid if the income were fully taxable based on a 35.0% marginal effective income tax rate.
Overview and Management Strategy
Sterling Bancorp, of which the principal subsidiary is the Bank, specializes in the delivery of service and solutions to business owners, their families and consumers within the communities we serve through teams of dedicated and experienced relationship managers. The Bank offers a complete line of commercial, business and consumer banking products and services. Our financial condition and results of operations are discussed herein on a consolidated basis with the Bank and certain other subsidiaries. References to we, us, or the Company may signify the Bank, depending on the context. We focus our efforts on generating core deposit relationships, and originating high quality commercial and industrial, commercial real estate, residential mortgage and other consumer loans mainly for our held-for-investment portfolio. We also utilize excess funding to purchase and hold investment securities. Our ability to gather low cost, core deposits allows us to compete for, and originate loans at, an interest rate spread 47
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over our cost of funding that allows us to generate attractive risk-adjusted returns. Our strategic objectives include growing revenues and earnings by procuring new clients, expanding existing client relationships, improving asset quality and increasing operating efficiency. To achieve these goals, we are focusing on specific target markets, which include small and middle market commercial clients and consumers, expanding our delivery and distribution channels, creating a high productivity performance culture, closely monitoring operating costs and proactively managing enterprise risk. Our goal is to create a full service commercial bank that achieves top-tier performance on key metrics including return on equity, return on assets and earnings per share. The Bank targets the following geographic markets: the New York Metro Market, which includes
Manhattanand the boroughs, Long Island, the New York Suburban Market, which consists of Rockland, Orange, Sullivan, Ulster, Putnam, Westchesterand other counties in New Yorkand Bergen Countyand other counties in northern New Jersey. Our specialty lending businesses, which include asset-based lending, factoring, payroll finance, equipment finance and residential mortgage banking also generate loans and deposits in other markets across the United States. We believe the Bank operates in an attractive footprint that presents us with significant opportunities to execute our strategy. Based on data from Oxxford Information Technology, we estimate the total number of small-to-middle market businesses in our immediate footprint exceeds 550,000. Recent Developments We successfully completed the Merger on October 31, 2013. See Note 1. Basis of Presentation for details on the transactions and events that comprised the Merger. Legacy Sterling results since November 1, 2013are included in the results from operations in this Report on Form 10-Q; therefore, the results included in this Report on Form 10-Q for the nine months ended June 30, 2014include eight months of operations of legacy Sterling and nine months of operations of the Company. See Note 2. Acquisitions for disclosure on the impact of the Merger with legacy Sterling. The Merger is consistent with our strategy of expanding in the greater New Yorkmetropolitan region and beyond and building a diversified company with significant commercial and consumer banking capabilities. We believe the Merger created a larger, more efficient organization by combining our differentiated team-based distribution channels with legacy Sterling's diverse lending businesses and capabilities. We anticipate that the Merger will allow us to accelerate loan growth, increase our ability to gather low cost core deposits and generate substantial cost savings and revenue enhancement opportunities. As a result of the Merger, we have a diversified loan portfolio composition which as of June 30, 2014consisted of approximately 43.8% of commercial and industrial loans, 37.6% of commercial real estate loans and 15.9% of residential mortgage and other consumer loans. Further, the Merger provides us with a greater, more diversified non-interest income stream. For the quarter ended June 30, 2014, non-interest income was $13.5 million, which represented 18.7% of total revenue (net interest income plus non-interest income). Our goal is to increase this percentage to 20% or more of total revenue over time. As of June 30, 2014, the Company had 21 commercial relationship teams and 36 financial centers. During the nine months ended June 30, 2014, the Company consolidated 10 financial centers and announced its intention to consolidate three additional locations in 2014. The Company intends to continue executing its differentiated, single point of contact distribution strategy to deliver our full suite of lending and deposit products to our core target of small and middle market commercial and consumer clients. We anticipate we will continue to grow our number of commercial relationship teams by 3 - 5 teams annually. In connection with the Merger, we announced a target of achieving $34.0 millionof cost savings upon full integration of the legacy companies. Our operating results in the quarter ended June 30, 2014reflect the positive impact of the Merger on our operating efficiency. During the quarter, our core operating efficiency ratio was 57.8%, which represented an improvement of 366 basis points relative to the prior quarter. We anticipate we will continue to identify and execute additional operating efficiencies related to the Merger in the future.
Critical Accounting Policies
The accounting and reporting policies followed by the Company conform, in all material respects, to GAAP and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company generally bases its estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
The Company defines "critical accounting policies" as those involving significant judgments and difficult or complex assumptions by management, often as a result of the need to make estimates about matters that are inherently uncertain or variable, which have, or could have, a material impact on the carrying value of certain assets or the results from operations.
The Company evaluates the appropriateness of its critical accounting policies on a quarterly basis. There were no material changes to the Company's critical accounting policies in the quarter ended
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include the allowance for loan losses, accounting for goodwill and other intangible assets, accounting for income taxes and the recognition of interest income. Allowance for Loan Losses. The methodology for determining the allowance for loan losses is considered by the Company to be a critical accounting policy due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for changes in the economic environment that could result in changes to the amount of the allowance for loan losses considered necessary. We evaluate our loans at least quarterly, and review their risk components as a part of that evaluation. See our Annual Report on Form 10-K, "Notes to Consolidated Financial Statements Note 1, Basis of Financial Statement Presentation and Summary of Significant Accounting Policies" for a discussion of the risk components. We consistently review the risk components to identify any changes in trends. Goodwill and Other Intangible Assets. The Company accounts for goodwill and other intangible assets in accordance with GAAP, which, in general, requires that goodwill not be amortized, but rather that it be tested for impairment at least annually at the reporting unit level using the two step approach. Testing for impairment of goodwill and intangible assets is performed annually and involves the identification of reporting units and the estimation of fair values. The Company tests its goodwill and other intangible assets for impairment in the fourth quarter of the fiscal year and at other reporting period ends when conditions warrant. The estimation of fair values involves a high degree of judgment and subjectivity in the assumptions used. Changes in the local and national economy, the federal and state legislative and regulatory environments for financial institutions, the stock market, interest rates and other external factors (such as natural disasters or significant world events) may occur from time to time, often with great unpredictability, may materially impact the fair value of publicly traded financial institutions and could result in an impairment charge at a future date. We also use judgment in the valuation of other intangible assets. A core deposit intangible asset has been recorded for core deposits (defined as checking, money market and savings deposits) that were acquired in acquisitions that were accounted for as purchase business combinations. The core deposit intangible asset has been recorded using the assumption that the acquired deposits provide a more favorable source of funding than more expensive wholesale borrowings. An intangible asset has been recorded for the present value of the difference between the expected interest to be incurred on these deposits and interest expense that would be expected if these deposits were replaced by wholesale borrowings, over the expected lives of the core deposits. If we determine these deposits have a shorter life than was estimated, we will write down the asset by expensing the amount that is impaired. Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change. Interest income. Interest income on loans, securities and other interest-earning assets is accrued monthly unless the Company considers the collection of interest to be doubtful. Loans are placed on non-accrual status when payments are contractually past due 90 days or more, or when we have determined that the borrower is unlikely to meet contractual principal or interest obligations, unless the assets are well secured and in the process of collection. At such time, unpaid interest is reversed by charging interest income for interest in the current fiscal year or the allowance for loan losses with respect to prior year income. Interest payments received on non-accrual loans (including impaired loans) are not recognized as income unless future collections are reasonably assured. Loans are returned to accrual status when collectibility is no longer considered doubtful. 49
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SELECTED FINANCIAL DATA The following summary data is based in part on the consolidated financial statements and accompanying notes, and other information appearing elsewhere in this Form 10-Q. For the three months ended June 30, For the nine months ended June 30, 2014 2013 2014 2013 Per Common Share Data Earnings, basic $ 0.18 $ 0.15 $ 0.14 $ 0.46 Earnings, diluted 0.18 0.15 0.14 0.45 Book value 11.40 10.83 11.40 10.83 Tangible book value (1) 6.20 7.01 6.20 7.01 Dividends declared per share (2) 0.07 0.06 0.14 0.18 Performance Ratios (annualized) Return on average assets 0.85 % 0.68 % 0.23 % 0.70 % Return on average equity 6.37 5.18 1.71 5.40 Return on average tangible equity (1) 11.86 7.88 3.15 8.26 Core operating efficiency (1) 57.8 59.1 61.2 62.2 Balance Sheet Data (dollars in thousands) Total assets
$ 7,250,729 $ 3,824,429 $ 7,250,729 $ 3,824,429Total securities 1,730,980 1,065,724 1,730,980 1,065,724 Total loans 4,558,624 2,336,534 4,558,624 2,336,534 Allowance for loan losses (36,350 ) (28,374 ) (36,350 ) (28,374 ) Total goodwill and other intangible assets 435,185 169,318 435,185 169,318 Deposits 5,102,457 2,739,214 5,102,457 2,739,214 Borrowings 1,061,777 552,805 1,061,777 552,805 Stockholders' equity 953,433 480,165 953,433 480,165 Tangible equity (1) 518,248 310,847 518,248 310,847 Statement of Operations Data (dollars in thousands) Net interest income $ 58,451 $ 28,317 $ 158,355 $ 84,059 Provision for loan losses 5,950 3,900 13,750 9,450 Non-interest income 13,471 6,581 35,084 21,092 Non-interest expense 44,904 21,789 164,647 67,674 Net income 15,011 6,376 11,341 19,925 Capital Ratios Tangible equity as a % of tangible assets (1) 7.60 % 8.50 % 7.60 % 8.50 % Asset Quality (dollars in thousands) Non-performing loans (NPLs): non-accrual $ 53,153 $ 27,244 $ 53,153 $ 27,244 Non-performing loans (NPLs): still accruing 3,645 4,216 3,645 4,216 Other real estate owned 5,017 4,376 5,017 4,376 Non-performing assets (NPAs) 61,815 35,836 61,815 35,836 Net charge-offs 1,615 3,070 6,277 9,358 Net charge-offs as a % of average loans (annualized) 0.15 % 0.54 % 0.21 % 0.57 % NPLs as a % of total loans 1.25 1.35 1.25 1.35 NPAs as a % of total assets 0.85 0.94 0.85 0.94 Allowance for loan losses as a % of NPLs 64.0 90.2 64.0 90.2 Allowance for loan losses as a % of total loans 0.80 1.21 0.80 1.21
(1) See reconciliation of non-GAAP financial measures on page 60. (2) In connection with the Merger, the Company accelerated the declaration of a
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Key highlights as of and for the nine months ended
• Total loans reached
• Commercial and industrial loans represented 43.8% of our loan portfolio at
June 30, 2014compared to 18.2% at September 30, 2013. Commercial real estate loans represented 37.6% of our loan portfolio at June 30, 2014compared to 52.9% at September 30, 2013.
• The allowance for loan losses was
• Total deposits were
• Return on average tangible equity, a non-GAAP financial measure, was 3.15%
for the nine months ended
non-GAAP financial measure). This ratio was impacted by the Merger-related
expense and other charges discussed below.
• Return on average assets was 0.23% for the nine months ended
compared to 0.70% for the nine months ended
impacted by the Merger-related expenses and other charges discussed below. • The core operating efficiency ratio, a non-GAAP financial measure, was 61.2% for the nine months ended
June 30, 2014compared to 62.2% for the nine months ended June 30, 2013. Results from operations for the nine months ended June 30, 2014were impacted by costs associated with the Merger and other charges, which were partially offset by gains as follows:
• We incurred
professional advisory fees and legal fees, a portion of change-in-control
payments, costs associated with changing signage at various office and financial center locations and other merger-related items. These items were recorded in our statement of operations as Non-interest expense - Merger-related expenses. • We recognized a charge of
$25.4 millionfor asset write-downs and compensation items. Approximately $14.6 millionof the total amount consisted of charges to reduce the carrying value of premises and
equipment as the Company intends to consolidate several office locations
and financial centers in fiscal 2014. Other charges consisted of an
the payment of an early termination fee to our current service provider of
compensation; and a write-off of the naming rights to
Ballpark. The banking systems conversion will allow us to fully integrate
the information technology systems of legacy Provident and legacy Sterling
and better position the Company for sustained and profitable growth. These
items were recorded in our statement of operations as Other non-interest
expense - Charge for asset write-downs, banking systems conversion, retention and severance compensation. • We recognized a charge of
$4.2 millionrelated to the settlement of a portion of the Company's defined benefit pension plans and ESOP. A
significant portion of the charge represented the acceleration of future
amortization of pension plan expense included in accumulated other
comprehensive loss on the Company's balance sheet. This charge was
recorded in our income statement in Non-interest expense - Compensation
and employee benefits.
• We recognized the following gains:
• A gain on the sale of investment securities of