Sterling's Turnaround Is a Fair Play for Investors: Street Whispers

NEW YORK ( TheStreet) -- Sterling Financial Corp. ( STSA) of Spokane, Wash., is shaping up to be an attractive turnaround play for long-term investors.

Sterling had been saddled with a high level of nonperforming assets and associated expenses, but several recent developments underscore what can now become a focus growth.

The company in July announced that it had recaptured its entire deferred tax asset valuation allowance of $288.8 million, feeding second-quarter earnings of $320.9 million, or $5.13 a share, raising the company's tangible book value to $18.92 a share as of June 30, from $13.71 the previous quarter, and increasing its tangible common equity ratio to a very strong 12.3%.

Then, the U.S. Treasury on Tuesday announced an offering of the 5,738,637 Sterling Financial common shares held by the government, which the Treasury received in exchange for $303 million in Sterling Financial preferred shares in August 2010, as part of Sterling's recapitalization. The Treasury had originally provided $303 million in bailout assistance to the company through the Troubled Assets Relief Program, or TARP, in December 2008. Sterling Financial's shares on Wednesday rose slightly to close at $20.43.

Looking more deeply at the company's second-quarter results, there were several positive developments, beyond the DTA recapture and share sale:
  • Sterling Financial had $9.6 billion in total assets as of June 30. Nonperforming assets declined to $321.1 million, or 3.35% of total assets as of June 30, improving from 3.68% the previous quarter, and 5.38% a year earlier. Repossessed real estate declined to $55.8 million as of June 30, from $70.4 million in March, and $101.4 million, in June 2011.
  • Total loans increased to $6.1 billion as of June 30, from $6.0 billion in March, and $5.6 billion in June 2011. Second-quarter portfolio loan originations (excluding loans held for sale) totaled $458.6 million, from $347.5 million the previous quarter, and $425.9 million a year earlier. Multifamily originations increased 36% sequentially to $62.3 million in the second quarter.
  • Second-quarter net interest income totaled $78.9 million, increasing from $74.4 million in the first quarter, and $74.8 million, a year earlier. Sterling Financial's net interest margin -- the difference between the average yield on loans and investments and the average cost for deposits and borrowings -- was a tax-adjusted 3.56%, increasing from 3.38% the previous quarter, and 3.31% a year earlier, bucking the trend for most banks in the prolonged low-rate environment.
  • Sterling defines its operating efficiency ratio as "noninterest expense, excluding repossessed real estate costs and amortization of core deposit intangibles, divided by net interest income (tax equivalent) plus noninterest income, excluding gain on sales of securities, other-than-temporary impairment losses on securities and charge on prepayment of debt." The efficiency ratio is, essentially, the number of pennies of overhead for every dollar of revenue. The company's second-quarter efficiency ratio was 66%, improving from 80% the previous quarter, and 74% a year earlier. CEO Greg Seibly during the company's earnings conference call on July 27 reiterated Sterling's "goal of achieving an efficiency ratio of 60% by the end of 2013," and said that "there are several actions that are currently under way that we believe will enhance our efficiency moving forward," including cost savings from the further integration of First Independent Bank -- acquired in February -- and the sale of Sterling's Montana operations.

FBR analyst Paul Miller -- whose firm, along with Sandler O'Neil, is a joint book running manager for the Treasury's offering -- rates Sterling Financial "Outperform," with a $24 price target, saying after the company announced its second-quarter results that "expense saves, stronger core operations, and a lower interest expense as deposits reprice, should position the company well for further earnings growth."

Miller estimates that Sterling will earn $1.35 a share during 2013.

The analyst said that "Sterling continues to de-risk the balance sheet by reducing its exposure to securities and improving its loan-to-deposit ratio, from 100%-plus in 2009 to 87% as of 2Q12," and that "the company has also made significant progress in working through problem assets, and we believe that it has reached an inflection point with regard to credit."

Sterling Financial's have returned 23% year-to-date, following a 12% decline during 2011.

STSA Chart STSA data by YCharts

The shares trade for 1.1 times tangible book value, and 16 times the consensus 2013 earnings estimate of $1.29, among analysts polled by Thomson Reuters.

Miller said that "given our expectation for Sterling to continue strengthening its core operating earnings and deploying excess capital, we believe shares should trade closer to 1.3x tangible book value, and that "if credit metrics reach normal levels and the run-rate efficiency ratio gets closer to the company's goal of 60%, we would expect the stock to trade closer to peers at 1.5x TBV."

On Wednesday, Miller said "we view last night's sale as a positive, as it removes an overhang on the stock and provides increased liquidity to the shares. Coupled with the DTA coming back on the balance sheet, the sale could allow the company to more aggressively manage capital," through dividends or share buybacks.


-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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