Sterling Financial Corp. in Lancaster, Pa., is known for producing consistent earnings, and its equipment-financing subsidiary has been a big part of its success, contributing roughly 40% to Sterling's bottom line over the past three years.
But Sterling said Monday that the results of an ongoing internal investigation into contract irregularities at Equipment Finance LLC would force it to restate earnings for 2004 through 2006 and possibly earlier.
The $3.3 billion-asset parent company said that the financial impact is still unknown, and that it might need to raise additional capital.
Sterling did not say what irregularities have been discovered, and officials would not discuss the matter Monday. Two of the subsidiary's senior executives have been put on leave, because of the investigation's preliminary results.
J. Roger Moyer Jr., Sterling's president and chief executive officer, said in a press release that immediate action would be taken to strengthen the leasing subsidiary's management and internal controls. He appealed to shareholders "for patience and continued loyalty as we complete our investigation."
Sterling has also postponed its annual shareholder meeting, which had been scheduled for May 8.
News of Sterling's trouble surfaced April 19, when the company announced that contract irregularities at the unit would delay its first-quarter earnings report, and that it had hired accounting and legal experts to conduct an independent investigation.
Sterling said Monday that it does not expect to finalize the first-quarter earnings in time to file its 10-Q report with the Securities and Exchange Commission by the May 10 deadline.
Analysts said Monday that they had few details to go on for gauging the nature or impact of the troubles at Equipment Finance, which provides commercial financing for the soft-pulp logging and land-clearing industries, mostly in the Southeast. Sterling acquired the specialty lender in 2002.
Any assessment of the restatement's effect would be "speculation at this point," said Mac Hodgson, an analyst at SunTrust Capital Markets Inc. In a worst-case scenario, the unit's $42 million of earnings over the past three years would be wiped out, but "I'm assuming that's not going to happen."
According to Damon DelMonte of KBW Inc.'s Keefe, Bruyette & Woods Inc., the subsidiary accounted for 40.6% of Sterling's $41.6 million of profits last year.
Sterling has a reputation for being "consistent and conservative," and its troubles are "surprising," he said.
Richard D. Weiss of Janney Montgomery Scott LLC wrote in a research note that the unit accounted for nearly 16% of Sterling's loans as of Dec. 31, and that the average yield on those loans was 14.5% last year.
The typical loan is for about $130,000, includes a 20% down payment, and has a term of 36 to 48 months, he wrote.
Sterling's shares fell nearly 20% Monday, to $16.65.
Matthew C. Schultheis of Ferris Baker Watts Inc. wrote in a research note that even though the shares might seem cheap, investors should not buy them "until the company quantifies the magnitude of the situation."
He said he suspects employee-related fraud is to blame.
Mr. Schultheis said in an interview that Sterling had a capital ratio of 12.63% as of Dec. 31. If it wanted to reduce that to 10%, its excess capital would be $71.6 million, he said.
That would be enough to absorb a sizable earnings hit, but perhaps not enough if Sterling ends up having to write down loans, Mr. Schultheis said. "That leaves them a little bit of room, but not as much as you'd like to see."
