Sterling Bancshares Inc.'s decision to overhaul its credit approval policies is paying off.

The Houston company, which three years ago had a net chargeoff-to-loan ratio more than three times that of its peers, now boasts a ratio among the industry's best.

On Tuesday, the $4.3 billion-asset company said it had charged off $406,000 of loans in the first quarter, or 0.05% of its average loan portfolio. This was down from the 0.24% of loans it charged off a year earlier and the 1.44% charged off in the first quarter of 2004.

The credit-quality improvement, along with better expense control, helped Sterling achieve strong earnings growth in a quarter during which both net interest and noninterest income declined.

Sterling's net income in the quarter that ended March 31 rose 18.8% from the year earlier, to $11.9 million, and per-share earnings rose 13%, to 17 cents.

In a conference call Tuesday, the chairman, president, and chief executive officer, J. Downey Bridgwater, said that chargeoffs were unusually low in the quarter and that he expects them to rise as the year goes on.

Still, now that Sterling has centralized credit procedures, Barry McCarver, a vice president of research on banks and thrifts at Stephens Inc. in Little Rock, said he is confident that earnings will continue improving - and stockholders will be rewarded.

In heavy trading, Sterling's stock was up more than 7% late Tuesday, to $11.57 a share.

Sterling began revamping its credit-approval procedures about four years ago, after management concluded that the company had become too big to operate "very much like the old Texas bank holding companies," Mr. Bridgwater said.

Sterling was an active buyer in the late 1990s and early this decade; by mid-2003 it had nearly 40 branches in the Houston, Dallas, and San Antonio markets.

Its model then was to let each branch operate pretty much autonomously, but the quality of loans booked was inconsistent at best, and Sterling's credit quality suffered.

So the company set out to centralize the approval process by instituting a credit scoring model for business loans and providing more oversight and guidance for lenders in an effort to build a consistent credit culture.

Until then, "the approval processes, documents, funding, and monitoring were all decentralized," Mr. Bridgwater said in an interview this month. "As banks become larger, they need to provide guidance and oversight of the loan portfolio at a central location to manage and mitigate the perceived risks."

Centralization often leads to improved credit quality and customer service and frees up lenders to spend more time meeting with customers and prospects, said L.T. "Tom" Hall, the director of advisory services at Brintech Inc., a community bank consulting firm owned by United Community Bank in Blairsville, Ga.

"It adds a lot of value," he said. "Just about any bank at $500 million that has acquired other little banks or if they have eight or 10 branches should absolutely want to consolidate their credit processes and centralize their underwriting environment."

Though the centralization began in 2003, Sterling started showing significant improvement last year.

Net chargeoffs dropped from 0.51% of loans at the end of 2005 to 0.19% at the end of 2006, according to Federal Deposit Insurance Corp. data, and nonperformers declined from 0.83% to 0.43%. Potential problem loans dropped by $70 million, to $94 million, in the same period, Mr. Bridgwater said.

"Most of our losses - 75% of chargeoffs - were loans below $250,000, which was our individual loan officers' limit when it was decentralized," he said.

Dan Bass, the managing director at Carson Medlin Co. Investment Bankers in Houston, said that Sterling had needed to change its culture if it wanted to keep growing.

It bought nine banks from 1995 to 2002 but then took a four-year break as it focused on credit quality.

There were "changes that had to be made to take it to the next level," he said.

Sterling is buying banks again. In September it purchased the $320 million-asset Bank of the Hills in Kerrville, Tex., and in March it bought the $184 million-asset Partners Bank of Texas in Humble.

Stephens' Mr. McCarver said that Sterling's automated credit scoring approach has helped it get better information about borrowers, which improves decision-making in the branches.

"In a seamless manner they can set policy and procedures on a daily basis at headquarters, and it trickles down to the branches," he said. "So they still have the power at the branch to make the loan with guidance from headquarters."

Sterling might have benefited from centralizing its credit sooner, but its next step toward improving credit quality will put it a little ahead of the curve, industry watchers said.

Last week, the company adopted a dual risk rating system that Mr. Bridgwater said would improve the accuracy of provisioning, better determine loans to put on the books, and give regulators more detailed information on loans.

Pam Martin, the director of regulatory relations at the Risk Management Association, said most banks with $10 billion of assets or more use the dual risk-rating model but that most smaller banks do not.

"Often, smaller institutions don't have centralized structures because they are small and don't feel the need for that kind of management," she said.

But if institutions such as Sterling "want to continue to grow, [they] must put more formalized risk management structures in place."

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