UNITED STATES
SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-Q





[X]
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934


For the
quarterly period ended: September 30, 2009


or





[   ]
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934


For the
transition period from ____________ to ____________





Commission
File No. 333-133649





STERLING  BANKS,
INC.


(Exact
name of registrant as specified in its charter)





New Jersey
              
              20-4647587(State
      or other jurisdiction of incorporation or organization)
              
              (IRS
      Employer Identification
Number)


3100 Route 38, Mount Laurel,
New Jersey 08054


(Address
of principal executive offices) (Zip Code)





856-273-5900


(Registrant’s
telephone number, including area code)





N/A


(Former
name, former address and former fiscal year, if changed since last
report)





Indicate by check mark whether the
registrant: (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. 
Yes X                No
___





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).  Yes_____       
No_____





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large
      accelerated filer
              o
              Accelerated
      filer
              oNon-accelerated
      filer
              o
              Smaller
      reporting company
              x(Do
      not check if a smaller reporting company)








Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act):YES     
NO X





Number of shares outstanding of the
registrant’s common stock, par value $2.00 per share, outstanding as of November
24, 2009: 5,843,362























STERLING
BANKS, INC.





FORM
10-Q





FOR
THE QUARTER ENDED SEPTEMBER 30, 2009





INDEX


Part I
              FINANCIAL
      INFORMATION
              PageItem
      1.
              Consolidated
      Financial StatementsBalance
      Sheets
              4Statements
      of Operations
              6Statements
      of Shareholders’ Equity
              7Statements
      of Cash Flows
              8Notes
      to Consolidated Financial Statements
              9Item
      2.
              Management’s
      Discussion and Analysis of Financial Conditionand
      Results of Operations
              29Item
      3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              37Item
      4T.
              Controls
      and Procedures
              37
  Part II
              OTHER
      INFORMATIONItem
      1.
              Legal
      Proceedings
              37Item
      1A.
              Risk
      Factors
              37Item
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              37Item
      3.
              Defaults
      Upon Senior Securities
              37Item
      4.
              Submission
      of Matters to a Vote of Security Holders
              37Item
      5.
              Other
      Information
              37Item
      6.
              Exhibits
              38SIGNATURES
              
              
              
              38






EXHIBITS





Exhibit 31.1Certification
      of Chief Executive Officer pursuant to §302 of the
      Sarbanes-OxleyAct
      of 2002.Exhibit 31.2Certification
      of Chief Financial Officer pursuant to §302 of the
      Sarbanes-OxleyAct
      of 2002.


3





Part I.    Financial Information





Item
1.                                Financial
Statements








STERLING
BANKS, INC. AND SUBSIDIARY


CONSOLIDATED
BALANCE SHEETS


SEPTEMBER
30, 2009 AND DECEMBER 31, 2008





September
      30,
              2009
              (unaudited
      and unreviewed)
            
            
            December
      31,
              2008ASSETSCash
      and cash due from banks
            
            $
            9,071,000
            
            
            $
            13,054,000Federal
      funds sold
            
            
            19,498,000
            
            
            
            472,000Cash
      and cash equivalents
            
            
            28,569,000
            
            
            
            13,526,000Investment
      securities held-to-maturity, at cost (fair value of
      $12,174,000
              at
      September 30, 2009 and $19,992,000 at December 31, 2008)
            
            
            11,802,000
            
            
            
            19,884,000Investment
      securities available-for-sale, at fair value
            
            
            35,340,000
            
            
            
            24,097,000Total
      investment securities
            
            
            47,142,000
            
            
            
            43,981,000Restricted
      stock, at cost
            
            
            2,014,000
            
            
            
            2,448,000Loans
      held for sale
            
            
            -
            
            
            
            2,000Loans
            
            
            296,914,000
            
            
            
            305,626,000Less:
      allowance for loan losses
            
            
            (6,682,000
            )
            
            
            (8,531,000
            )Total
      net loans
            
            
            290,232,000
            
            
            
            297,095,000Core
      deposit intangible asset, net
            
            
            2,077,000
            
            
            
            2,374,000Bank
      premises and equipment, net
            
            
            8,297,000
            
            
            
            8,526,000Branch
      Property Held for Sale
            
            
            505,000
            
            
            
            596,000Accrued
      interest receivable and other assets
            
            
            9,064,000
            
            
            
            10,557,000Total
      assets
            
            $
            387,900,000
            
            
            $
            379,105,000





See
Notes to Consolidated Financial Statements











4








STERLING
BANKS, INC. AND SUBSIDIARY


CONSOLIDATED
BALANCE SHEETS


SEPTEMBER
30, 2009 AND DECEMBER 31, 2008








September
      30,
              2009
              (unaudited
      and unreviewed)
            
            
            December
      31,
              2008LIABILITIES
              
              DepositsNoninterest-bearing
            
            $
            31,367,000
            
            
            $
            35,873,000Interest-bearing
            
            
            311,836,000
            
            
            
            292,721,000Total
      deposits
            
            
            343,203,000
            
            
            
            328,594,000Federal
      Home Loan Bank advances
            
            
            15,250,000
            
            
            
            16,000,000Subordinated
      debentures
            
            
            6,186,000
            
            
            
            6,186,000Accrued
      interest payable and other accrued liabilities
            
            
            1,606,000
            
            
            
            1,204,000Total
      liabilities
            
            
            366,245,000
            
            
            
            351,984,000COMMITMENTS
      AND CONTINGENCIES (Note 2)SHAREHOLDERS'
      EQUITYPreferred
      stock, no par value, 10,000,000 shares authorized, none
issued
              or
      outstanding
            
            
            -
            
            
            
            -Common
      stock,
              $2
      par value, 15,000,000 shares authorized; 5,843,362 issued and
              outstanding
      at September 30, 2009 and December 31, 2008
            
            
            11,687,000
            
            
            
            11,687,000Additional
      paid-in capital
            
            
            29,823,000
            
            
            
            29,767,000Accumulated
      deficit
            
            
            (20,184,000
            )
            
            
            (14,279,000
            )Accumulated
      other comprehensive income (loss)
            
            
            329,000
            
            
            
            (54,000
            )Total
      shareholders' equity
            
            
            21,655,000
            
            
            
            27,121,000Total liabilities and
      shareholders' equity
            
            $
            387,900,000
            
            
            $
            379,105,000





See
Notes to Consolidated Financial Statements







5





5STERLING
BANKS, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF OPERATIONS


THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





(Unaudited
and Unreviewed for 2009)





For
      the three
              months
      ended
              September
      30,
              2009
            
            
            For
      the three
              months
      ended
              September
      30,
              2008
            
            
            For
      the nine
              months
      ended
              September
      30,
              2009
            
            
            For
      the nine
              months
      ended
              September
      30,
              2008INTEREST
      INCOMEInterest
      and fees on loans
            
            $
            4,294,000
            
            
            $
            5,125,000
            
            
            $
            12,799,000
            
            
            $
            15,839,000Interest
      and dividends on securities
            
            
            465,000
            
            
            
            318,000
            
            
            
            1,450,000
            
            
            
            1,093,000Interest
      on due from banks and federal funds sold
            
            
            5,000
            
            
            
            21,000
            
            
            
            17,000
            
            
            
            161,000Total
      interest and dividend income
            
            
            4,764,000
            
            
            
            5,464,000
            
            
            
            14,266,000
            
            
            
            17,093,000INTEREST
      EXPENSEInterest
      on deposits
            
            
            1,632,000
            
            
            
            1,985,000
            
            
            
            5,442,000
            
            
            
            6,994,000Interest
      on Federal Home Loan Bank advances and
              overnight
      borrowings
            
            
            163,000
            
            
            
            31,000
            
            
            
            484,000
            
            
            
            110,000Interest
      on subordinated debentures
            
            
            107,000
            
            
            
            105,000
            
            
            
            316,000
            
            
            
            313,000Total
      interest expense
            
            
            1,902,000
            
            
            
            2,121,000
            
            
            
            6,242,000
            
            
            
            7,417,000Net
      interest income
            
            
            2,862,000
            
            
            
            3,343,000
            
            
            
            8,024,000
            
            
            
            9,676,000PROVISION
      FOR LOAN LOSSES
            
            
            1,075,000
            
            
            
            105,000
            
            
            
            1,465,000
            
            
            
            505,000Net
      interest income after provision for loan losses
            
            
            1,787,000
            
            
            
            3,238,000
            
            
            
            6,559,000
            
            
            
            9,171,000NONINTEREST
      INCOMEService
      charges
            
            
            64,000
            
            
            
            65,000
            
            
            
            194,000
            
            
            
            188,000Gains
      on sales of available-for-sale securities
            
            
            -
            
            
            
            -
            
            
            
            5,000
            
            
            
            95,000Gains
      on sales of fixed assets
            
            
            -
            
            
            
            1,000
            
            
            
            -
            
            
            
            5,000Miscellaneous
      fees and other
            
            
            113,000
            
            
            
            217,000
            
            
            
            383,000
            
            
            
            507,000Total
      noninterest income
            
            
            177,000
            
            
            
            283,000
            
            
            
            582,000
            
            
            
            795,000NONINTEREST
      EXPENSESCompensation
      and benefits
            
            
            1,580,000
            
            
            
            1,719,000
            
            
            
            4,780,000
            
            
            
            5,516,000Occupancy,
      equipment and data processing
            
            
            887,000
            
            
            
            923,000
            
            
            
            2,714,000
            
            
            
            2,751,000Marketing
      and business development
            
            
            125,000
            
            
            
            124,000
            
            
            
            393,000
            
            
            
            419,000Professional
      services
            
            
            336,000
            
            
            
            246,000
            
            
            
            960,000
            
            
            
            681,000FDIC
      insurance
            
            
            371,000
            
            
            
            90,000
            
            
            
            870,000
            
            
            
            303,000Amortization
      of core deposit intangible asset
            
            
            99,000
            
            
            
            86,000
            
            
            
            297,000
            
            
            
            261,000Impairment
      or disposal of fixed assets
            
            
            -
            
            
            
            -
            
            
            
            84,000
            
            
            
            -Losses
      on sales and impairment of repossessed
              property
            
            
            -
            
            
            
            -
            
            
            
            77,000
            
            
            
            -Other
      operating expenses
            
            
            220,000
            
            
            
            194,000
            
            
            
            848,000
            
            
            
            657,000Total
      noninterest expenses
            
            
            3,618,000
            
            
            
            3,382,000
            
            
            
            11,023,000
            
            
            
            10,588,000INCOME
      (LOSS) BEFORE INCOME TAX
              EXPENSE
      (BENEFIT)
            
            
            (1,654,000
            )
            
            
            139,000
            
            
            
            (3,882,000
            )
            
            
            (622,000
            )INCOME
      TAX EXPENSE (BENEFIT)
            
            
            2,856,000
            
            
            
            60,000
            
            
            
            2,023,000
            
            
            
            (217,000
            )NET
      INCOME (LOSS)
            
            $
            (4,510,000
            )
            
            $
            79,000
            
            
            $
            (5,905,000
            )
            
            $
            (405,000
            )NET
      INCOME (LOSS) PER COMMON SHAREBasic
      and Diluted
            
            $
            (0.77
            )
            
            $
            0.01
            
            
            $
            (1.01
            )
            
            $
            (0.07
            )WEIGHTED
      AVERAGE SHARES OUTSTANDINGBasic
            
            
            5,843,362
            
            
            
            5,843,362
            
            
            
            5,843,362
            
            
            
            5,843,362Diluted
            
            
            5,843,362
            
            
            
            5,849,335
            
            
            
            5,843,362
            
            
            
            5,843,362





See
Notes to Consolidated Financial Statements






6





STERLING BANKS, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY


NINE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008


(Unaudited
and Unreviewed for 2009)





Retained
            
            
            AccumulatedAdditional
            
            
            Earnings
            
            
            Other
            
            
            TotalCommon
      Stock
            
            
            Paid-In
            
            
            (Accumulated
            
            
            Comprehensive
            
            
            Shareholders'Shares
            
            
            Amount
            
            
            Capital
            
            
            Deficit)
            
            
            Income
      (Loss)
            
            
            EquityDecember
      31, 2007
            
            
            5,843,362
            
            
            $
            11,687,000
            
            
            $
            29,708,000
            
            
            $
            1,949,000
            
            
            $
            (36,000
            )
            
            $
            43,308,000Comprehensive
      loss:Net
      loss – 2008
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (405,000
            )
            
            
            -
            
            
            
            (405,000
            )Change
      in net unrealized loss onsecurities
      available-for-sale, netof
      reclassification adjustmentand
      tax effects
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (80,000
            )
            
            
            (80,000
            )Total
      comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (485,000
            )Stock
      compensation
            
            
            -
            
            
            
            -
            
            
            
            40,000
            
            
            
            -
            
            
            
            -
            
            
            
            40,000September
      30, 2008
            
            
            5,843,362
            
            
            $
            11,687,000
            
            
            $
            29,748,000
            
            
            $
            1,544,000
            
            
            $
            (116,000
            )
            
            $
            42,863,000December
      31, 2008
            
            
            5,843,362
            
            
            $
            11,687,000
            
            
            $
            29,767,000
            
            
            $
            (14,279,000
            )
            
            $
            (54,000
            )
            
            $
            27,121,000Comprehensive
      loss:Net
      loss – 2009
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (5,905,000
            )
            
            
            -
            
            
            
            (5,905,000
            )Change
      in net unrealized gain (loss)on
      securities available-for-sale,net
      of reclassification adjustmentand
      tax effects
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            383,000
            
            
            
            383,000Total
      comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (5,522,000
            )Stock
      compensation
            
            
            -
            
            
            
            -
            
            
            
            56,000
            
            
            
            -
            
            
            
            -
            
            
            
            56,000September
      30, 2009
            
            
            5,843,362
            
            
            $
            11,687,000
            
            
            $
            29,823,000
            
            
            $
            (20,184,000
            )
            
            $
            329,000
            
            
            $
            21,655,000





See
Notes to Consolidated Financial Statements











7





STERLING BANKS, INC. AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CASH FLOWS


NINE
MONTHS ENDED SEPTEMBER 30, 2009 AND 2008


(Unaudited
and Unreviewed for 2009)


2009
            
            
            2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
            
            $
            (5,905,000
            )
            
            $
            (405,000
            )Adjustments
      to reconcile net loss to net cash (used in) provided by operating
      activities:Depreciation
      and amortization of premises and equipment
            
            
            770,000
            
            
            
            809,000Provision
      for loan losses
            
            
            1,465,000
            
            
            
            505,000Net
      amortization of purchase premium on securities
            
            
            288,000
            
            
            
            27,000Net
      amortization of core deposit intangible
            
            
            297,000
            
            
            
            261,000Stock
      compensation
            
            
            56,000
            
            
            
            40,000Realized
      loss (gain) on sales, write down or retirement of buildings and
      equipment
            
            
            84,000
            
            
            
            (5,000
            )Realized
      loss on sales or write down of repossessed property
            
            
            77,000
            
            
            
            -Realized
      gain on sales of securities available-for-sale
            
            
            (5,000
            )
            
            
            (95,000
            )Realized
      gain on sales of loans held for sale
            
            
            -
            
            
            
            (12,000
            )Proceeds
      from sale of loans held for sale
            
            
            2,000
            
            
            
            1,058,000Originations
      of loans held for sale
            
            
            -
            
            
            
            (1,020,000
            )Changes
      in operating assets and liabilities:Decrease
      in accrued interest receivable and other assets
            
            
            725,000
            
            
            
            135,000Increase
      (Decrease) in accrued interest payable and other accrued
      liabilities
            
            
            403,000
            
            
            
            (198,000
            )Net
      cash (used in) provided by operating activities
            
            
            (1,743,000
            )
            
            
            1,100,000CASH
      FLOWS FROM INVESTING ACTIVITIESPurchases
      of securities available-for-sale
            
            
            (19,826,000
            )
            
            
            (3,995,000
            )Purchases
      of securities held-to-maturity
            
            
            -
            
            
            
            (15,322,000
            )Proceeds
      from sales of securities available-for- sale
            
            
            -
            
            
            
            5,470,000Proceeds
      from maturities of securities available-for-sale
            
            
            4,005,000
            
            
            
            25,900,000Proceeds
      from maturities of securities held-to-maturity
            
            
            169,000
            
            
            
            -Proceeds
      from principal payments on mortgage-backed securities
      available-for-sale
            
            
            5,118,000
            
            
            
            2,090,000Proceeds
      from principal payments on mortgage-backed securities
      held-to-maturity
            
            
            7,728,000
            
            
            
            1,550,000Purchases
      of restricted stock
            
            
            (219,000
            )
            
            
            (2,465,000
            )Proceeds
      from sale of restricted stock
            
            
            653,000
            
            
            
            2,246,000Net
      decrease in loans
            
            
            5,398,000
            
            
            
            9,833,000Proceeds
      from sales of other real estate owned
            
            
            435,000
            
            
            
            -Proceeds
      from sales of equipment
            
            
            -
            
            
            
            46,000Purchases
      of premises and equipment
            
            
            (534,000
            )
            
            
            (392,000
            )Cash
      paid for acquisition
            
            
            -
            
            
            
            (25,000
            )Net
      cash provided by investing activities
            
            
            2,927,000
            
            
            
            24,936,000CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      (decrease) increase in noninterest-bearing deposits
            
            
            (4,506,000
            )
            
            
            1,553,000Net
      increase (decrease) in interest-bearing deposits
            
            
            19,115,000
            
            
            
            (29,028,000
            )Proceeds
      from Federal Home Loan Advances
            
            
            -
            
            
            
            5,500,000Repayments
      of Federal Home Loan Advances
            
            
            (750,000
            )
            
            
            -Net
      cash provided by (used in) financing activities
            
            
            13,859,000
            
            
            
            (21,975,000
            )INCREASE
      IN CASH AND CASH EQUIVALENTS
            
            
            15,043,000
            
            
            
            4,061,000CASH
      AND CASH EQUIVALENTS, JANUARY 1,
            
            
            13,526,000
            
            
            
            11,788,000CASH
      AND CASH EQUIVALENTS, SEPTEMBER 30,
            
            $
            28,569,000
            
            
            $
            15,849,000SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATIONCash:Interest
      on deposits and borrowed funds
            
            $
            6,121,000
            
            
            $
            7,604,000Income
      taxes
            
            $
            -
            
            
            $
            1,000Noncash
      investing activities:Transfer
      of loans to other real estate owned
            
            $
            1,374,000
            
            
            $
            -





See
Notes to Consolidated Financial Statements










8




STERLING BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE
1.  DESCRIPTION OF BUSINESS





Sterling
Banks, Inc. (the “Company”) is a bank holding company headquartered in Mount
Laurel, NJ.  Through its subsidiary, Sterling Bank (the “Bank”), the
Company provides individuals, businesses and institutions with commercial and
retail banking services, principally in loans and deposits.  Sterling
Banks, Inc. was incorporated under the laws of the State of New Jersey on
February 28, 2006 for the sole purpose of becoming the holding company of the
Bank.




The Bank
is a commercial bank, which was incorporated on September 1, 1989, and commenced
opera­tions on December 7, 1990.  The Bank is chartered by the New
Jersey Department of Banking and Insurance and is a member of the Federal
Reserve System and the Federal Deposit Insurance Corporation.  The
Bank maintains its principal office at 3100 Route 38 in Mount Laurel, New Jersey
and has nine other full service branches.  The Bank’s primary deposit
products are checking, savings and term certificate accounts, and its primary
loan products are consumer, residential mortgage and commercial
loans.




NOTE
2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Financial
Statements and Basis of Presentation




Rule 8-03 of Regulation S-X requires that interim
financial statements included in quarterly reports on Form 10-Q be reviewed by
an independent registered public accountant using professional standards and
procedures for conducting such reviews, as established by thegenerally
accepted auditing standards, as may be modified or
supplemented by the Securities and Exchange Commission (“SEC”).  The
Company’s registered public accounting firm, McGladrey & Pullen, LLP
(“McGladrey”) advised the Company that McGladrey was unwilling to provide a
report on its review of the Company’s interim consolidated financial statements
for the three and nine month periods ended September 30, 2009, as required by
Rule 8-03 of Regulation S-X, due to concerns raised about the sufficiency of the
Company’s allowance for loan losses  by the Federal Reserve Bank of
Philadelphia (the “FRB”).  Following a recent examination by the
Company’s regulators, the FRB advised McGladrey orally and preliminarily that
the FRB believed that the Company’s allowance for loan losses as of June 30,
2009 was understated in the approximate amount of $4.5 to $6.0
million.  The examination report has not, however, been issued, and
the FRB’s analysis in coming to this conclusion is not known at this
time.  Once this June 30, 2009 matter has been resolved with the FRB
and McGladrey, the Company intends to file an amended quarterly report on Form
10-Q for the quarter ended September 30, 2009.  Further, depending on
the outcome of discussions with its examiners, the Company may be required to
file an amended quarterly report on Form 10-Q for the quarter ended June 30,
2009.
 
 Because
the required review has not been completed, the Company’s Form 10-Q for the
quarterly periods ended September 30, 2009 is considered deficient. As a result,
the Company is considered not to be timely or current in its filings under the
Securities Exchange Act of 1934.





The
financial statements included herein have not been audited and have not been
reviewed by the Company's independent auditors, except for the balance sheet at
December 31, 2008, which was derived from the audited financial
statements.  Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted; therefore, these financial
statements should be read in conjunction with the audited financial statements
and the notes thereto for the year ended December 31, 2008.  The
accompanying financial statements reflect all adjustments which are, in the
opinion of management, necessary to present a fair statement of the results for
the interim periods presented.  Such adjustments are of a normal
recurring nature.  The results for the three and nine months ended
September 30, 2009 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2009.





The
financial statements include the accounts of Sterling Banks, Inc. and its
wholly-owned subsidiary, Sterling Bank.  Sterling Banks Capital Trust
I is a wholly-owned subsidiary but is not consolidated because it does not meet
the requirements.  All significant inter-company balances and
transactions have been eliminated.





Use
of Estimates





The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period.  Actual results could differ from such
estimates.  Material estimates that are
particularly susceptible to significant change in the near term are the
determination of the allowance for loan losses, the valuation of deferred tax
assets, the valuation of intangible assets and the fair value of financial
instruments.








9





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 2.  SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(continued)





Accounting
Standards Codification





The
Financial Accounting Standards Board’s (“FASB”) Accounting Standards
Codification (“ASC”) became effective on July 1, 2009.  At that date,
the ASC became FASB’s officially recognized source of authoritative U.S.
generally accepted accounting principles (“GAAP”) applicable to all public and
non-public non-governmental entities, superseding existing FASB, American
Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force
(“EITF”) and related literature.  Rules and interpretive releases of
the Securities and Exchange Commission (“SEC”) under the authority of federal
securities laws are also sources of authoritative GAAP for SEC
registrants.  All other accounting literature is considered
non-authoritative.  The switch to the ASC affects the way companies
refer to GAAP in financial statements and accounting policies.  Citing
particular content in the ASC involves specifying the unique numeric path to the
content through the Topic, Subtopic, Section and Paragraph
structure.





Commitments





In the
normal course of business, there are various outstanding commitments to extend
credit, such as letters of credit and unadvanced loan commitments, which are not
reflected in the accompanying financial statements.  Management does
not anticipate any material losses as a result of these
commitments.





Contingencies





The
Company, from time to time, is a party to routine litigation that arises in the
normal course of business.  Management does not believe the resolution
of this litigation, if any, would have a material adverse effect on the
Company’s financial condition or results of operations.  However, the
ultimate outcome of any such matter, as with litigation generally, is inherently
uncertain and it is possible that some of these matters may be resolved
adversely to the Company.





Investments





The
Company has identified investment securities that it has the intent and ability
to hold to maturity considering all reasonably foreseeable events or
conditions.  The securities are classified as
“held-to-maturity.”  The Company has also identified investment
securities that will be held for indefinite periods of time, including
securities that will be used as part of the Company’s asset/liability management
strategy and that may be sold in response to changes in interest rates,
prepayments and similar factors.  These securities are classified as
“available-for-sale” and are carried at fair value, with any temporary
unrealized gains or losses reported as other comprehensive income, net of the
related income tax effect, a separate component of shareholders’
equity.





Allowance
for Losses on Loans





The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to
earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.  The allowance is an amount that management believes will
be adequate to absorb estimated losses relating to specifically identified
loans, as well as probable credit losses in the balance of the loan portfolio,
based on an evaluation of the collectibility of existing loans and prior loss
experience.






10




STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 2.  SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(continued)





The
allowance for loan losses is evaluated on a regular basis by management and is
based upon management’s periodic review of the collectability of loans in light
of changes in the nature and volume of the loan portfolio, overall portfolio
quality and historical experience, review of specific problem loans, adverse
situations which may affect borrowers’ ability to repay, estimated value of any
underlying collateral, prevailing economic conditions, and other factors which
may warrant current recognition.  Such periodic assessments may, in
management’s judgment, require the Company to recognize additions or reductions
to the allowance.





Various
regulatory agencies periodically review the adequacy of the Company’s allowance
for loan losses as an integral part of their examination
process.  Such agencies may require the Company to recognize additions
or reductions to the allowance based on their judgments of information available
to them at the time of their examination.  This evaluation is
inherently subjective, as it requires estimates that are susceptible to
significant revision as more information becomes available.




A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Loans that experience insignificant payment delays and
payment shortfalls generally are not classified as
impaired.  Management determines the significance of payment delays
and payment shortfalls on a case-by-case basis, taking into consideration all of
the circumstances surrounding the loan and the borrower, including the length of
the delay, the reasons for the delay, the borrower’s prior payment record, and
the amount of the shortfall in relation to the principal and interest
owed.  Impairment is measured on a loan by loan basis for commercial
and construction loans by either the present value of expected future cash flows
discounted at the loan’s effective rate, the loan’s obtainable market price or
the fair value of the collateral if the loan is collateral
dependent.




Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment.  Accordingly, the Company does not separately identify
individual residential mortgage and consumer loans for impairment
disclosures.





Impairment
of Long-Lived Assets





The
Company reviews long-lived assets, including property and equipment and definite
lived intangibles, for impairment whenever events or changes in business
circumstances indicate that the carrying amount of the assets may not be fully
recoverable.  An impairment loss would be recognized when estimated
undiscounted future cash flows expected to result from the use of the asset and
its eventual disposition is less than its carrying
amount.  Impairment, if any, is assessed using discounted cash
flows.  During the nine months ended September 30, 2009, impairment
was identified on our former Gaither Road location that is held for sale and a
write down of $82,000 was recorded.  No impairments occurred during
the nine months ended September 30, 2008.











11





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 2.  SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(continued)





Core
Deposit Intangible





Core
deposit intangibles arise from purchase business combinations.  On
March 16, 2007, we completed our merger with the former Farnsworth Bancorp,
Inc.  We were deemed to be the purchaser for accounting purposes and
thus recognized a core deposit intangible asset in connection with the
merger.  The establishment and subsequent amortization of this
intangible asset requires several assumptions including, among other things, the
estimated cost to service deposits acquired, discount rates, estimated attrition
rates and useful lives.  If the value of the core deposit intangible
or the customer relationship intangible is determined to be less than the
carrying value in future periods, a write down would be taken through a charge
to our earnings.  The most significant element in evaluation of these
intangibles is the attrition rate of the acquired deposits.  If such
attrition rate accelerates from that which we expected, the intangible is
reduced by a charge to earnings.  The attrition rate related to
deposit flows is influenced by many factors, the most significant of which are
alternative yields for deposits available to customers and the level of
competition from other financial institutions and financial services
companies.  In connection with our annual impairment testing in the
fourth quarter of 2008, we reassessed the carrying value of the core deposit
intangible, determined that the value of the core deposit relationship had
declined below its carrying value, and charged earnings for $475,000 in the
fourth quarter of 2008.  We further reassessed the estimated useful
life and determined that with changes in the marketplace, a remaining useful
life of six years would be more appropriate.





Income
Taxes





Deferred
income taxes arise principally from the difference between the income tax basis
of an asset or liability and its reported amount in the financial statements, at
the statutory income tax rates expected to be in effect when the taxes are
actually paid or recovered.  Deferred income tax assets are reduced by
a valuation allowance when, based on the weight of evidence available, it is
more likely than not that all or some portion of the net deferred tax assets may
not be realized.




When tax
returns are filed, it is highly certain that some positions taken would be
sustained upon examination by the taxing authorities, while others are subject
to uncertainty about the merits of the position taken or the amount of the
position that ultimately would be sustained.  The benefit of a tax
position is recognized in the financial statements in the period during which,
based on all available evidence, management believes it is more-likely-than not
that the position will be sustained upon examination, including the resolution
of appeals or litigation processes, if any.  The evaluation of a tax
position taken is considered by itself and not offset or aggregated with other
positions.  Tax positions that meet the more-likely-than not
recognition threshold are measured as the largest amount of tax benefit that is
more than 50 percent likely of being realized upon settlement with the
applicable taxing authority.  The portion of benefits associated with
tax positions taken that exceeds the amount measured as described above is
reflected as a liability for unrecognized tax benefits in the balance sheet
along with any associated interest and penalties that would be payable to the
taxing authorities upon examination.  It is the Company’s policy to
recognize interest and penalties related to the unrecognized tax liabilities
within income tax expense in the statements of operations.




During
the quarter ending September 30, 2009, management determined that there was a
need for a valuation allowance of $3.5 million on the Company’s deferred tax
assets because it is more likely than not that this portion of the deferred tax
assets will not be realized as a result of cumulative tax losses and
uncertainties of future taxable income.






12




STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 2.  SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(continued)





Recent
Accounting Pronouncements





FASB ASC
Topic 260, Earnings Per
Share





On
January 1, 2009, FASB ASC Topic 260, Earnings Per
Share  became effective, which provides that unvested share
based payment awards that contain non-forfeitable rights to dividends or
dividend equivalents are considered participating securities and should be
included in the computation of basic Earnings per share using the two class
method.  At September 30, 2009 the Company did not have any shares
which were considered participating securities.





FASB ASC
Topic 820,Fair Value
Measurements and Disclosures(Accounting Standards Update No.
2009-5)





FASB ASC
Topic 820 (Accounting Standards Update No. 2009-5) provides additional guidance
on: a) determining when the volume and level of activity for the asset or
liability has significantly decreased; b) identifying circumstances in which a
transaction is not orderly; and c) understanding the fair value measurement
implications of both (a) and (b).  This new guidance requires several
new disclosures, including the inputs and valuation techniques used to measure
fair value and a discussion of changes in valuation techniques and related
inputs, if any, in both interim and annual periods.  The Company
adopted this new guidance on April 1, 2009.  Adoption of this new
guidance did not have a significant impact on the Company’s financial position
or results of operations.





FASB ASC
Topic 320,Investments - Debt
and Equity Securities





FASB ASC
Topic 320 provides new guidance on the recognition and presentation of an
other-than-temporary impairment (“OTTI”) and requires additional
disclosures.  The recognition provisions within this new guidance
apply only to our debt securities classified as available-for-sale and
held-to-maturity, while the presentation and disclosure requirements within this
new guidance apply to both our debt and equity securities.  An
impaired debt security will be considered other-than-temporarily impaired if we
have the intent to sell or it more likely than not we will be required to sell
prior to recovery of the amortized cost.  In these situations the OTTI
recognized in net income (loss) is equal to difference between amortized cost
and fair value.  If we do not expect recovery of the entire cost
basis, even if we have no intention to sell the security, it will be considered
an OTTI as well.  In this situation the new guidance requires we
recognize OTTI by separating the loss between the amount representing the credit
loss and the amount relating to other factors.  Credit losses will be
recognized in net income and losses relating to other factors will be recognized
in other comprehensive income (“OCI”).  FASB ASC Topic 320 is
effective for interim and annual periods ending after June 15, 2009, with
early adoption permitted for periods ending after March 15,
2009.  FASB ASC Topic 320 requires a cumulative effect adjustment to
the opening balance of retained earnings in the period of adoption with a
corresponding adjustment to accumulated OCI for that portion representing losses
related to factors other than credit quality.  We adopted FASB ASC
Topic 320 effective April 1, 2009.  The change in accounting principle
had no impact on the recorded amounts in the consolidated financial
statements.  The adoption disclosure effects of this new guidance are
depicted in Note 3 – Investment
Securities.








13





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 2.  SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES(continued)





FASB ASC
Topic 825,Financial
Instruments





FASB ASC
Topic 825 requires disclosures about the fair value of financial instruments for
interim periods of publicly traded companies as well as in annual financial
statements.  Fair value information along with the significant
assumptions used to estimate fair value must be disclosed.  The
adoption effects of this new guidance are depicted in Note 8 – Fair Value.





FASB ASC
Topic 855, Subsequent
Events





New
authoritative guidance under FASB ASC Topic 855, establishes general standards
of accounting for and disclosure of events that occur after the balance
sheet date but before financial statements are issued or are available to be
issued (i.e., complete in a form and format that complies with GAAP and approved
for issuance).  However, FASB ASC Topic 855 does not apply to subsequent
events or transactions that are within the scope of other applicable GAAP that
provide different guidance on the accounting treatment for subsequent events or
transactions.





There are
two types of subsequent events to be evaluated under this
Statement:





Recognized
subsequent events - An entity must recognize in the financial statements the
effects of all subsequent events that provide additional evidence about
conditions that existed at the date of the balance sheet, including the
estimates inherent in the process of preparing financial
statements.





Non-recognized
subsequent events - An entity must not recognize subsequent events that provide
evidence about conditions that did not exist at the date of the balance sheet
but that arose after the balance sheet date but before financial statements are
issued or are available to be issued.  Some non-recognized subsequent
events may be of such a nature that they must be disclosed to keep the financial
statements from being misleading.  For such events, an entity must disclose
the nature of the event and an estimate of its financial effect or a statement
that such an estimate cannot be made.





FASB ASC
Topic 855 also requires the disclosure of the date through which an entity has
evaluated subsequent events and the basis for that date - that is, whether that
date represents the date the financial statements were issued or were available
to be issued.





This
guidance applies to both interim financial statements and annual financial
statements.  FASB ASC Topic 855 is effective for interim and annual periods
ending after June 15, 2009, and should be applied prospectively. 
Accordingly, management has evaluated subsequent events through November 25,
2009, the date the financial statements were issued and has determined that no
recognized or non-recognized subsequent events warranted inclusion or disclosure
in the interim financial statements as of September 30, 2009.








14





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE
3.  INVESTMENT SECURITIES





The
following is a summary of the Company's investment in available-for-sale and
held-to-maturity securities as of September 30, 2009:





Gross
            
            
            Gross
            
            
            EstimatedAmortized
            
            
            Unrealized
            
            
            Unrealized
            
            
            FairCost
            
            
            Gains
            
            
            Losses
            
            
            ValueAvailable-for-saleU.S.
      Government agencies and corporations
            
            $
            8,094,000
            
            
            $
            138,000
            
            
            $
            (12,000
            )
            
            $
            8,220,000Residential
      mortgage-backed securities
            
            
            21,756,000
            
            
            
            384,000
            
            
            
            (58,000
            )
            
            
            22,082,000Municipal
      securities
            
            
            4,941,000
            
            
            
            97,000
            
            
            
            -
            
            
            
            5,038,000Total
      securities available-for-sale
            
            $
            34,791,000
            
            
            $
            619,000
            
            
            $
            (70,000
            )
            
            $
            35,340,000Held-to-maturityU.S.
      Government agencies and corporations
            
            $
            100,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            100,000Residential
      mortgage-backed securities
            
            
            11,702,000
            
            
            
            372,000
            
            
            
            -
            
            
            
            12,074,000Total
      securities held-to-maturity
            
            $
            11,802,000
            
            
            $
            372,000
            
            
            $
            -
            
            
            $
            12,174,000





The
Company’s investment securities as of December 31, 2008 were as
follows:




Gross
            
            
            Gross
            
            
            EstimatedAmortized
            
            
            Unrealized
            
            
            Unrealized
            
            
            FairCost
            
            
            Gains
            
            
            Losses
            
            
            ValueAvailable-for-saleU.S.
      Government agencies and corporations
            
            $
            3,995,000
            
            
            $
            33,000
            
            
            $
            -
            
            
            $
            4,028,000Residential
      mortgage-backed securities
            
            
            15,250,000
            
            
            
            76,000
            
            
            
            (29,000
            )
            
            
            15,297,000Municipal
      securities
            
            
            4,941,000
            
            
            
            -
            
            
            
            (169,000
            )
            
            
            4,772,000Total
      securities available-for-sale
            
            $
            24,186,000
            
            
            $
            109,000
            
            
            $
            (198,000
            )
            
            $
            24,097,000Held-to-maturityU.S.
      Government agencies and corporations
            
            $
            100,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            100,000Residential
      mortgage-backed securities
            
            
            19,784,000
            
            
            
            129,000
            
            
            
            (21,000
            )
            
            
            19,892,000Total
      securities held-to-maturity
            
            $
            19,884,000
            
            
            $
            129,000
            
            
            $
            (21,000
            )
            
            $
            19,992,000





The
amortized cost and estimated market value of debt securities classified as
available-for-sale and held-to-maturityat September 30, 2009 by
contractual maturities are shown below.  Expected maturities may
differ from contractual maturities for mortgage-backed securities because the
mortgages underlying the securities may be called or prepaid without any
penalties; therefore, these securities are not included in the maturity
categories in the following maturity schedule.









15




STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 3.  INVESTMENT
SECURITIES(continued)







September
      30, 2009Available-for-sale
            
            
            Held-to-maturityAmortized
            
            
            Estimated
            
            
            Amortized
            
            
            EstimatedCost
            
            
            Fair
      Value
            
            
            Cost
            
            
            Fair
      ValueMaturing
      within one year
            
            $
            -
            
            
            $
            -
            
            
            $
            100,000
            
            
            $
            100,000Maturing
      after one year, but within five years
            
            
            637,000
            
            
            
            645,000
            
            
            
            -
            
            
            
            -Maturing
      after five years, but within ten years
            
            
            9,489,000
            
            
            
            9,621,000
            
            
            
            -
            
            
            
            -Maturing
      after ten years
            
            
            2,909,000
            
            
            
            2,992,000
            
            
            
            -
            
            
            
            -Residential
      mortgage-backed securities
            
            
            21,756,000
            
            
            
            22,082,000
            
            
            
            11,702,000
            
            
            
            12,074,000Total
      securities
            
            $
            34,791,000
            
            
            $
            35,340,000
            
            
            $
            11,802,000
            
            
            $
            12,174,000





The
following table shows the gross unrealized losses and fair value of Company's
investments with unrealized losses that are not deemed to be
other-than-temporarily impaired, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position, at September 30, 2009:





Continuous
      Unrealized Losses
            
            
            Continuous
      Unrealized LossesExisting
      for Less Than 12 Months
            
            
            Existing
      for 12 Months or MoreUnrealized
            
            
            
            
            
            UnrealizedFair
      Value
            
            
            Losses
            
            
            Fair
      Value
            
            
            LossesAvailable-for-sale:U.S.
      Government agencies and corporations
            
            $
            1,988,000
            
            
            $
            (12,000
            )
            
            $
            -
            
            
            $
            -Residential
      mortgage-backed securities
            
            
            3,921,000
            
            
            
            (58,000
            )
            
            
            -
            
            
            
            -Municipal
      securities
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -5,909,000
            
            
            
            (70,000
            )
            
            
            -
            
            
            
            -Held-to-maturity:Residential
      mortgage-backed securities
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      temporarily impaired securities
            
            $
            5,909,000
            
            
            $
            (70,000
            )
            
            $
            -
            
            
            $
            -





U.S. Government and Agency
Obligations.The unrealized losses on the Company’s
investments in U.S. Treasury obligations and direct obligations of U.S.
government agencies were caused by interest rate increases.  The
contractual terms of those investments do not permit the issuer to settle the
securities at a price less than the amortized cost bases of the
investments.  Because the Company does not intend to sell the
investments and it is not more likely than not that the Company will be required
to sell the investments before recovery of their amortized cost bases, which may
be maturity, the Company does not consider those investments to be
other-than-temporarily impaired at September 30, 2009.










16




STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 3.  INVESTMENT
SECURITIES(continued)




Residential Federal Agency
Mortgage-Backed Securities.The unrealized losses on the
Company’s investment in federal agency mortgage-backed securities were caused by
interest rate increases.  The Company purchased those investments at a
discount relative to their face amount, and the contractual cash flows of those
investments are guaranteed by an agency of the U.S.
government.  Accordingly, it is expected that the securities would not
be settled at a price less than the amortized cost bases of the Company’s
investments.  Because the decline in market value is attributable to
changes in interest rates and not credit quality, and because the Company does
not intend to sell the investments and it is not more likely than not that the
Company will be required to sell the investments before recovery of their
amortized cost bases, which may be maturity, the Company does not consider those
investments to be other-than-temporarily impaired at September 30,
2009.





NOTE
4.  EARNINGS PER SHARE





Basic
earnings per common share are computed by dividing net income by the weighted
average number of common shares outstanding.  Shares issued during the
period are weighted for the portion of the period that they were outstanding
during the year.  The weighted average number of common shares
outstanding for the nine months ended September 30, 2009 and 2008 were
5,843,362, respectively.  Diluted earnings per common share consider
common share equivalents (when dilutive) outstanding during each
year.  Shares issuable upon the exercise of stock options were not
considered in the calculation of net loss per share for the three and nine
months ended September 30, 2009 and the nine months ended September 30, 2008, as
their inclusion would be anti-dilutive.  The effect for the three
months ended September 30, 2008 was an additional 5,973 shares for
dilution.




NOTE
5.  STOCK-BASED EMPLOYEE COMPENSATION





The
Company has a stock-based employee compensation plan.  The Company
records compensation expense equal to the fair value of all equity-based
compensation over the vesting period of each award.  The Company uses
the Black-Scholes option pricing model to estimate the fair value of stock-based
awards.




During
the nine months ended September 30, 2009, the Company did not issue any
options.  During the nine months ended September 30, 2008, the Company
issued 175,200 options with an exercise price range of $3.80 to $4.05, to
employees and directors that vest in equal annual installments over ten
years.  The Company uses the Black-Scholes option pricing model to
estimate the fair value of stock-based awards.  For options issued in
2008, the weighted average estimated value per option was $1.60.  The
fair value of options granted in 2008 was estimated at the date of the grant
based on the following assumptions: risk free interest rate of 4.1%, volatility
of 22-23%, expected life of 8-10 years and no expected dividend
yield.  Compensation cost charged to operations for the nine months
ended September 30, 2009 and 2008 was $56,000 and $40,000,
respectively.








17

















STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE
6.  COMMON STOCK





During
the nine months of 2009 and 2008, no stock options were exercised.





During
the nine months of 2009 and 2008, no cash dividends were declared or
paid.





NOTE
7.  CAPITAL RATIOS





The Bank
is subject to various regulatory capital requirements administered by state and
federal banking agencies.  Failure to meet minimum capital
requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company’s financial statements.  Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank’s assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices.  The Bank’s
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other
factors.




Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the following table) of
Total and Tier I capital (as defined in the regulations) to risk-weighted assets
(as defined), and of Tier I capital to average assets (as defined).





At
September 30, 2009, management believes that the Bank is “adequately
capitalized,” as defined by regulatory banking agencies.  Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank’s capital levels do not allow the Bank to accept brokered
deposits without prior approval from regulators.  As of September 30,
2009, the Bank did not have any brokered deposits.  Further, the Bank
is subject to certain interest rate restrictions that can be paid for its
deposits without prior approval from regulators.





The
Bank’s actual capital amounts and ratios are presented in the following tables
(amounts in thousands, except percentages):





For
      Capital
              
              
              To
      Be WellActual
              
              
              Adequacy
      Purposes
              
              
              CapitalizedAmount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              RatioAs
      of September 30, 2009:Total
      Capital (to Risk-Weighted Assets)
              
              $
              27,939
              
              
              
              9.60
              %
              
              $
              ≥23,285
              
              
              
              ≥8.0
              %
              
              $
              ≥29,106
              
              
              
              ≥10.0
              %Tier
      I Capital (to Risk-Weighted Assets)
              
              $
              24,263
              
              
              
              8.34
              %
              
              $
              ≥11,642
              
              
              
              ≥4.0
              %
              
              $
              ≥17,464
              
              
              
              ≥ 
      6.0
              %Tier
      I Capital (to Average Assets)
              
              $
              24,263
              
              
              
              6.26
              %
              
              $
              ≥15,368
              
              
              
              ≥4.0
              %
              
              $
              ≥19,210
              
              
              
              ≥ 
      5.0
              %
 For
      Capital
              
              
              To
      Be WellActual
              
              
              Adequacy
      Purposes
              
              
              CapitalizedAmount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              RatioAs
      of December 31, 2008:Total
      Capital (to Risk-Weighted Assets)
              
              $
              32,134
              
              
              
              10.52
              %
              
              $
              ≥24,428
              
              
              
              ≥8.0
              %
              
              $
              ≥30,535
              
              
              
              ≥10.0
              %Tier
      I Capital (to Risk-Weighted Assets)
              
              $
              28,258
              
              
              
              9.25
              %
              
              $
              ≥12,214
              
              
              
              ≥4.0
              %
              
              $
              ≥18,321
              
              
              
              ≥ 
      6.0
              %Tier
      I Capital (to Average Assets)
              
              $
              28,258
              
              
              
              7.21
              %
              
              $
              ≥15,675
              
              
              
              ≥4.0
              %
              
              $
              ≥19,594
              
              
              
              ≥ 
      5.0
              %
  18


STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE
8.  FAIR VALUE





Effective January 1, 2008, the Company
adopted FASB ASC Topic 820, Fair Value Measurement, which
provides a framework for measuring fair value under generally accepted
accounting principles.  FASB ASC Topic 820 applies to all financial
instruments that are being measured and reported on a fair value
basis.  Nonfinancial assets and nonfinancial liabilities that are
recognized and disclosed at fair value on a nonrecurring basis under FASB ASC
Topic 820 were delayed to fiscal years beginning after November 15,
2008.  Accordingly, effective January 1, 2009, the Company began
disclosing the fair value of Other Real Estate Owned (OREO) previously deferred
under the provisions of this guidance.





FASB ASC
Topic 820 defines fair value as the exchange price that would be received for an
asset or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date.  In determining fair
value, the Company uses various methods including market, income and cost
approaches.  Based on these approaches, the Company often utilizes
certain assumptions that market participants would use in pricing the asset or
liability, including assumptions about risk and or the risks inherent in the
inputs to the valuation technique.  These inputs can be readily
observable, market corroborated, or generally unobservable.  The
Company utilizes techniques that maximize the use of observable inputs and
minimize the use of unobservable inputs.  Based on the observability
of the inputs used in valuation techniques the Company is required to provide
the following information according to the fair value hierarchy.  The
fair value hierarchy ranks the quality and reliability of the information used
to determine fair values.





Financial
assets and liabilities carried at fair value will be classified and disclosed as
follows:





Level 1 Inputs


·
            Unadjusted
      quoted prices in active markets that are accessible at the measurement
      date for identical, unrestricted assets or
  liabilities.


·
            Generally,
      this includes debt and equity securities and derivative contracts that are
      traded in an active exchange market (e.g., New York Stock Exchange), as
      well as certain US Treasury and US Government and agency mortgage-backed
      securities that are highly liquid and are actively traded in
      over-the-counter markets.





Level 2 Inputs


· Quoted
prices for similar assets or liabilities in active markets.


· Quoted
prices for identical or similar assets or liabilities in markets that are not
active.


·
            Inputs
      other than quoted prices that are observable, either directly or
      indirectly, for the term of the asset or liability (e.g., interest rates,
      yield curves, credit risks, prepayment speeds or volatilities) or “market
      corroborated inputs.”


·
            Generally,
      this includes US Government and agency mortgage-backed securities,
      corporate debt securities, derivative contracts and loans held for
      sale.





Level 3 Inputs


·
            Prices
      or valuation techniques that require inputs that are both unobservable
      (i.e. supported by little or no market activity) and that are significant
      to the fair value of the assets or
liabilities.


·
            These
      assets and liabilities include financial instruments whose value is
      determined using pricing models, discounted cash flow methodologies, or
      similar techniques, as well as instruments for which the determination of
      fair value requires significant management judgment or
      estimation.







19





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 8.  FAIR VALUE(continued)





Fair Value on a Recurring
Basis





Certain
assets and liabilities are measured at fair value on a recurring
basis.  The following table presents the assets and liabilities
carried on the balance sheet by caption and by level within the FASB ASC Topic
820 hierarchy (as described above) as of the dates listed.





September
      30, 2009
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalFinancial
      AssetsInvestment
      securities available-for-saleU.S.
      Government agencies and
              corporations
            
            $
            -
            
            
            $
            8,220,000
            
            
            $
            -
            
            
            $
            8,220,000Mortgage-backed
      securities
            
            $
            -
            
            
            $
            22,082,000
            
            
            $
            -
            
            
            $
            22,082,000Municipal
      securities
            
            $
            -
            
            
            $
            5,038,000
            
            
            $
            -
            
            
            $
            5,038,000





December
      31, 2008
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalFinancial
      AssetsInvestment
      securities available-for-saleU.S.
      Government agencies and
              Corporations
            
            $
            -
            
            
            $
            4,028,000
            
            
            $
            -
            
            
            $
            4,028,000Mortgage-backed
      securities
            
            $
            -
            
            
            $
            15,297,000
            
            
            $
            -
            
            
            $
            15,297,000Municipal
      securities
            
            $
            -
            
            
            $
            4,772,000
            
            
            $
            -
            
            
            $
            4,772,000





Securities
Portfolio





The fair
value of securities is the market value based on quoted market prices, when
available, or market prices provided by recognized broker
dealers.  The fair value of securities is the market value based on
quoted market prices, when available, or market prices provided by recognized
broker dealers (Level 1).  When listed prices or quotes are not
available, fair value is based upon quoted market prices for similar or
identical assets or other observable inputs (Level 2) or significant management
judgment or estimation based upon unobservable inputs due to limited or no
market activity of the instrument (Level 3).





Fair Value on a Nonrecurring
Basis





Certain
assets and liabilities are measured at fair value on a nonrecurring basis; that
is, the instruments are not measured on an ongoing basis but are subject to fair
value adjustments in certain circumstances (for example, when there is
impairment).  The following table presents the assets and liabilities
carried on the balance sheet by caption and by level within the FASB ASC Topic
820 hierarchy (as described above) as of the dates listed.





September
      30, 2009
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalFinancial
      AssetsImpaired
      loans
            
            $
            -
            
            
            $
            -
            
            
            $
            25,475,000
            
            
            $
            25,475,000





December
      31, 2008
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalFinancial
      AssetsImpaired
      loans
            
            $
            -
            
            
            $
            -
            
            
            $
            14,892,000
            
            
            $
            14,892,000











20




STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 8.  FAIR VALUE(continued)





September
      30, 2009
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalNon-Financial
      AssetsOther
      real estate owned
            
            $
            -
            
            
            $
            -
            
            
            $
            1,786,000
            
            
            $
            1,786,000





Impaired
Loans





The fair
value of impaired loans is based on the loan’s fair value of the collateral for
collateral dependent loans.  The valuation allowance for impaired
loans is included in the allowance for loan losses in the consolidated balance
sheets.  The valuation allowance for impaired loans at September 30,
2009 was $405,000.  During the nine months ended September 30, 2009,
the valuation allowance for impaired loans decreased $2,397,000 from $2,802,000
at December 31, 2008 as a result of loans being collected or charged off in full
or in part.





Other
Real Estate Owned





Other
real estate owned (OREO) fair value was determined using appraisals which may be
discounted based on management’s review and changes in market conditions (Level
3).





Fair Value of Financial
Instruments (FASB ASC Topic 825 Disclosure)




FASB ASC
Topic 825, Disclosures About
Fair Value of Financial Instruments, requires the disclosure of the
estimated fair value of financial instruments, including those financial
instruments for which the Company did not elect the fair value
option.  The methodology for estimating the fair value of financial
assets and liabilities that are measured on a recurring or nonrecurring basis
are discussed above.




The
following methods and assumptions were used to estimate the fair value under
FASB ASC Topic 825 of each class of financial instruments not previously
discussed.




Cash and Cash
Equivalents:  The carrying amounts of cash and due from banks
and federal funds sold approximate fair value.




Investment Securities
Held-to-Maturity:  The fair value of securities
held-to-maturity is based on quoted market prices, where
available.  If quoted market prices are not available, fair values are
based on quoted market prices of comparable instruments.  These
financial instruments are not carried at fair value.




Restricted
Stock:  The carrying value of restricted stock approximates
fair value based on redemption provisions.




Loans (except collateral
dependent impaired loans):  Fair values are estimated for
portfolios of loans with similar financial characteristics.  Loans are
segregated by type such as commercial, residential mortgage and other
consumer.  Each loan category is further segmented into groups by
fixed and adjustable rate interest terms and by performing and non-performing
categories.




The fair
value of performing loans is typically calculated by discounting scheduled cash
flows through their estimated maturity, using estimated market discount rates
that reflect the credit and interest rate risk inherent in each group of
loans.  The estimate of maturity is based on contractual maturities
for loans within each group, or on the Company’s historical experience with
repayments for each loan classification, modified as required by an estimate of
the effect of current economic conditions.







21




STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 8.  FAIR VALUE(continued)





Fair
value for nonperforming loans that are not collateral dependent is based on the
discounted value of expected future cash flows, discounted using a rate
commensurate with the risk associated with the likelihood of
repayment.




For all
loans, assumptions regarding the characteristics and segregation of loans,
maturities, credit risk, cash flows, and discount rates are judgmentally
determined using specific borrower and other available information.




The
carrying amounts reported for loans held for sale approximates fair
value.




Accrued Interest Receivable
and Payable:  The fair value of interest receivable and payable
is estimated to approximate the carrying amounts.




Deposits:  The
fair value of deposits with no stated maturity, such as noninterest-bearing
demand deposits, savings, NOW and money market accounts, is equal to the amount
payable on demand.  The fair value of time deposits is based on the
discounted value of contractual cash flows, where the discount rate is estimated
using the market rates currently offered for deposits of similar remaining
maturities.




Borrowed
Funds:  The fair value of borrowings is calculated by
discounting scheduled cash flows through the estimated maturity date using
current market rates.




Estimated Fair
Values:  The estimated fair values of the Company’s material
financial instruments as of September 30, 2009 are as follows:





Carrying
      Value
            
            
            Fair
      ValueFinancial
      Assets:Cash
      and due from banks
            
            $
            9,071,000
            
            
            $
            9,071,000Federal
      funds sold
            
            $
            19,498,000
            
            
            $
            19,498,000Investment
      securities, held-to-maturity
            
            $
            11,802,000
            
            
            $
            12,174,000Investment
      securities, available-for-sale
            
            $
            35,340,000
            
            
            $
            35,340,000Restricted
      stock
            
            $
            2,014,000
            
            
            $
            2,014,000Loans,
      net of allowance for loan losses
            
            $
            290,232,000
            
            
            $
            289,719,000Accrued
      interest receivable
            
            $
            1,379,000
            
            
            $
            1,379,000Financial
      Liabilities:Noninterest-bearing
      demand deposits
            
            $
            31,367,000
            
            
            $
            31,367,000Interest-bearing
      deposits
            
            $
            311,836,000
            
            
            $
            306,102,000Borrowed
      funds
            
            $
            21,436,000
            
            
            $
            18,434,000Accrued
      interest payable
            
            $
            547,000
            
            
            $
            547,000











22





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 8.  FAIR VALUE(continued)





The
estimated fair values of the Company’s material financial instruments as of
December 31, 2008 are as follows:




Carrying
      Value
            
            
            Fair
      ValueFinancial
      Assets:Cash
      and due from banks
            
            $
            13,054,000
            
            
            $
            13,054,000Federal
      funds sold
            
            $
            472,000
            
            
            $
            472,000Investment
      securities, held-to-maturity
            
            $
            19,884,000
            
            
            $
            19,992,000Investment
      securities, available-for-sale
            
            $
            24,097,000
            
            
            $
            24,097,000Restricted
      stock
            
            $
            2,448,000
            
            
            $
            2,448,000Loans
      held for sale
            
            $
            2,000
            
            
            $
            2,000Loans,
      net of allowance for loan losses
            
            $
            297,095,000
            
            
            $
            299,648,000Accrued
      interest receivable
            
            $
            1,740,000
            
            
            $
            1,740,000Financial
      Liabilities:Noninterest-bearing
      demand deposits
            
            $
            35,873,000
            
            
            $
            35,873,000Interest-bearing
      deposits
            
            $
            292,721,000
            
            
            $
            288,303,000Borrowed
      funds
            
            $
            22,186,000
            
            
            $
            19,340,000Accrued
      interest payable
            
            $
            427,000
            
            
            $
            427,000





The fair
value of commitments to extend credit is estimated using the fees currently
charged to enter into similar agreements, and, as the fair value for these
financial instruments is not material, these disclosures are not included
above.




Limitations:  Fair
value estimates are made at a specific point in time, based on relevant market
information and information about the financial instruments.  These
estimates do not reflect any premium or discount which could result from
offering for sale at one time the Company’s entire holdings of a particular
financial instrument.  Because no market exists for a significant
portion of the Company’s financial instruments, fair value estimates are based
on judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors.  These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and, therefore, cannot be
determined with precision.  Changes in assumptions could significantly
affect the estimates.








23





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE
9.  LOANS





The
composition of net loans as of September 30, 2009 and December 31, 2008 are as
follows:




September
      30, 2009
            
            
            December
      31, 2008Commercial,
      Financial and Agricultural
            
            $
            30,496,000
            
            
            $
            32,115,000Real
      Estate - Construction
            
            
            46,499,000
            
            
            
            68,278,000Real
      Estate – Mortgage
            
            
            165,049,000
            
            
            
            147,435,000Installment
      loans to individuals
            
            
            49,865,000
            
            
            
            53,827,000Lease
      Financing
            
            
            5,641,000
            
            
            
            4,636,000Unrealized
      Loan Fees
            
            
            (636,000
            )
            
            
            (665,000
            )Total
      loans
            
            
            296,914,000
            
            
            
            305,626,000Less:  allowance
      for loan losses
            
            
            (6,682,000
            )
            
            
            (8,531,000
            )Net
      loans
            
            $
            290,232,000
            
            
            $
            297,095,000





Summaries
of information pertaining to impaired and nonaccrual loans are as
follows:





September
      30, 2009
            
            
            December
      31, 2008Impaired
      loans without a valuation allowance
            
            $
            25,104,000
            
            
            $
            5,813,000Impaired
      loans with a valuation allowance
            
            
            776,000
            
            
            
            11,881,000Total
      impaired loans including troubled debt restructurings
            
            
            25,880,000
            
            
            
            17,694,000Valuation
      allowance related to impaired loans
            
            
            405,000
            
            
            
            2,802,000Average
      investment in impaired loans
            
            
            21,876,000
            
            
            
            10,348,000Total
      non-accrual loans (included in impaired loans)
            
            
            14,056,000
            
            
            
            9,898,000





Impaired loans without a valuation
allowance increased $19.3 million since December 31, 2008 as a result of the
Company designating new loans as impaired where the current appraisal supports
the full amount of the loans, where the Company charged off or partially charged
off $3.4 million during the nine months ended September 30, 2009, based upon
current appraisals obtained by the Company or, serving as a proxy, a 40%
reduction in appraised value on older appraisals.




NOTE
10.  ALLOWANCE FOR LOAN LOSSES





The
allowance for loan losses is calculated under FASB ASC Topic 310, Receivables and FASB ASC
Topic 450, Contingencies.  Nonperforming
and impaired loans are evaluated under FASB ASC Topic 310 using either the fair
value of collateral or present value of future cash flow methods.  The
Company evaluates all nonperforming and impaired loans using the fair value of
collateral method since all non-performing and impaired loans are collateralized
by real estate.  When a loan is evaluated using this method, a new
appraisal of the primary and or secondary collateral is obtained and compared to
the outstanding balance of the loans.  A specific reserve is added to
the allowance for loan losses if a collateral shortfall exists.  On
December 31, 2008, the amount of the specific reserve was $2,802,000 which was
included in the total allowance for loan losses of $8,531,000.  During
the nine months ended September 30, 2009, the Company charged off loans or
portions of loans totaling $3,439,000 from the allowance for loan losses, made a
provision of $1,465,000, including changes in qualitative factors, and had
recoveries of $125,000, resulting in an allowance for loan losses balance of
$6,682,000.







24





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 10.  ALLOWANCE FOR
LOAN LOSSES(continued)





The
following table shows changes in the allowance for loan losses arising from
loans charged off and recoveries on loans previously charged off by loan
category and additions to the allowance that have been charged to expenses for
the periods presented.





For
      the three months ended September 30,2009
            
            
            2008Balance
      at beginning of period
            
            $
            7,041,000
            
            
            $
            2,974,000Charge-offs:Commercial, Financial, Agricultural
            
            
            -
            
            
            
            -Real Estate – Construction
            
            
            (1,504,000
            )
            
            
            -Real Estate – Mortgage
            
            
            (32,000
            )
            
            
            (17,000
            )Consumer Installment loans
            
            
            (19,000
            )
            
            
            (48,000
            )Lease Financing
            
            
            -
            
            
            
            -(1,555,000
            )
            
            
            (65,000
            )Recoveries:Commercial, Financial, Agricultural
            
            
            60,000
            
            
            
            -Real Estate – Construction
            
            
            36,000
            
            
            
            -Real Estate – Mortgage
            
            
            -
            
            
            
            1,000Consumer Installment loans
            
            
            25,000
            
            
            
            -Lease Financing
            
            
            -
            
            
            
            -121,000
            
            
            
            1,000Net
      recoveries (charge-offs)
            
            
            (1,434,000
            )
            
            
            (64,000
            )Provision
      for loan loss
            
            
            1,075,000
            
            
            
            105,000Balance
      at end of period
            
            $
            6,682,000
            
            
            $
            3,015,000Average
      loans outstanding (1)
            
            $
            296,464,000
            
            
            $
            301,035,000Net
      charge-offs as a percentage of average loans (2)
            
            
            1.92
            %
            
            
            0.08
            %(1)
      Includes loans held for sale and non-accruing loans(2)
      Annualized














25





STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 10.  ALLOWANCE FOR
LOAN LOSSES(continued)





For
      the nine months ended September 30,2009
            
            
            2008Balance
      at beginning of period
            
            $
            8,531,000
            
            
            $
            2,891,000Charge-offs:Commercial,
      Financial, Agricultural
            
            
            (238,000
            )
            
            
            (32,000
            )Real
      Estate – Construction
            
            
            (2,939,000
            )
            
            
            -Real
      Estate – Mortgage
            
            
            (182,000
            )
            
            
            (238,000
            )Consumer
      Installment loans
            
            
            (80,000
            )
            
            
            (124,000
            )Lease
      Financing
            
            
            -
            
            
            
            -(3,439,000
            )
            
            
            (394,000
            )Recoveries:Commercial,
      Financial, Agricultural
            
            
            61,000
            
            
            
            2,000Real
      Estate – Construction
            
            
            36,000
            
            
            
            -Real
      Estate – Mortgage
            
            
            1,000
            
            
            
            3,000Consumer
      Installment loans
            
            
            27,000
            
            
            
            8,000Lease
      Financing
            
            
            -
            
            
            
            -125,000
            
            
            
            13,000Net
      charge-offs
            
            
            (3,314,000
            )
            
            
            (381,000
            )Provision
      for loan loss
            
            
            1,465,000
            
            
            
            505,000Balance
      at end of period
            
            $
            6,682,000
            
            
            $
            3,015,000Average
      loans outstanding (1)
            
            $
            302,571,000
            
            
            $
            308,421,000Net
      charge-offs as a percentage of average loans (2)
            
            
            1.46
            %
            
            
            0.17
            %(1)
      Includes loans held for sale and non-accruing loans(2)
      Annualized





The
charge offs as of September 30, 2009, were a result of the Company analyzing its
impaired loans with collateral deficiencies and charging off portions of loans
not covered by the Company’s collateral as a result of new real estate
appraisals obtained.  Even though a portion of individual loans were
charged off, management will continue to obtain and convert the collateral and
pursue the borrower(s) for full collection of the entire loan, including the
partial charge off amount.




As noted
in Note 1 above, the FRB may require the Company to restate its financial
statements for the quarter ended June 30, 2009 as a result of the FRB’s analysis
of the Company’s allowance for loan losses.  The FRB has orally and preliminarily indicated that it
believes that the Company’s allowance for loan losses as of June 30, 2009 was
understated in the approximate amount of $4.5 to $6.0
million.  Such an increase to the allowance for loan losses
could be material to the Company.  The
examination report of the FRB has not, however, been issued.


NOTE
11.  OTHER COMPREHENSIVE INCOME (LOSS)
 
 Accounting
principles generally require that recognized revenue, expenses, gains and losses
be included in net income.  However, certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities are reported as a separate component of the equity section of the
balance sheet.  Such items, along with net income, are components of
comprehensive income.


26







STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 11.  OTHER
COMPREHENSIVE INCOME (LOSS)(continued)





The
components of other comprehensive income (loss) and related tax effects for the
nine months ended September 30, 2009 and 2008 are as follows:





For
      the three
              months
      ended
              September
      30,
              2009
            
            
            For
      the three
              months
      ended
              September
      30,
              2008
            
            
            For
      the nine
              months
      ended
              September
      30,
              2009
            
            
            For
      the nine
              months
      ended
              September
      30,
              2008Unrealized
      holding gains (losses)
              on
      available-for-sale securities
            
            $
            550,000
            
            
            $
            (85,000
            )
            
            $
            643,000
            
            
            $
            (38,000
            )Reclassification
      adjustment for
              gains
      realized in income
            
            
            -
            
            
            
            -
            
            
            
            (5,000
            )
            
            
            (95,000
            )Net
      unrealized gains (losses)
            
            
            550,000
            
            
            
            (85,000
            )
            
            
            638,000
            
            
            
            (133,000
            )Tax
      effect
            
            
            (220,000
            )
            
            
            34,000
            
            
            
            (255,000
            )
            
            
            53,000Net-of-tax
      amount
            
            $
            330,000
            
            
            $
            (51,000
            )
            
            $
            383,000
            
            
            $
            (80,000
            )





NOTE
12.  WRITTEN AGREEMENT





On July
28, 2009, the Company and the Bank entered into a Written Agreement (the
“Agreement”) with the Federal Reserve Bank of Philadelphia and the New Jersey
Department of Banking and Insurance (collectively, the
“Regulators”).  The Agreement is based on findings of the Regulators
identified in an examination of the Bank that commenced on January 5,
2009.




Under the
terms of the Agreement, the Bank agreed, among other things, to engage, within
30 days of the Agreement, an independent consultant acceptable to the Regulators
to assess the Bank’s staffing needs and the qualifications and performance of
all senior executive officers of the Bank and to prepare a written report.
Within 45 days of receipt of such report, the Bank agreed to submit to the
Regulators a written management plan addressing the findings of the
report.  In addition, within 60 days of the Agreement, the Bank will
submit to the Regulators written plans to: strengthen board oversight of the
management and operation of the Bank; strengthen the Bank’s management of
commercial real estate; strengthen lending and credit administration, which
includes a prohibition on the capitalization of interest; improve the periodic
review and grading of the Bank’s loan portfolio; improve the Bank’s position
regarding past due loans, problem loans, adversely classified loans; improve the
Bank’s internal audit program; maintain sufficient capital at the Bank; improve
the Bank’s earnings; improve management of the Bank’s liquidity position; and
correct criticisms detailed in the Regulators’ examination report of the Bank’s
compliance with all federal laws relating to anti-money laundering. The Bank has
also agreed to maintain an adequate allowance for loan and lease losses;
charge-off or collect assets classified as “loss” in the Regulators’ examination
report that have not been previously collected or charged off, and not to extend
or renew any credit to or for the benefit of any borrower who is obligated to
the Bank on an extension of credit that has been charged off or classified as
“loss” in the Regulators’ examination report.  Under the Agreement,
neither the Company nor Bank is permitted to declare or pay any
dividends.  The Company has also agreed not to distribute any
interest, principal or other sums on trust preferred securities; issue, increase
or guarantee any debt; nor purchase or redeem any shares of the Company’s
stock.







27








STERLING
BANKS, INC. AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited
and Unreviewed)





NOTE 12.  WRITTEN AGREEMENT(continued)




The Board
of Directors of the Company and the Bank are also required to appoint a joint
Compliance Committee to monitor and coordinate the Company’s and the Bank’s
compliance with the provisions of the Agreement, obtain prior approval for the
appointment of new directors, the hiring or change in responsibilities of senior
executive officers, and to comply with restrictions on severance payments and
indemnification payments to institution affiliated parties. Failure to comply
with the provisions of the Agreement could subject the Company and/or the Bank
to additional enforcement actions. We believe that the Company and or the Bank
have already implemented or are acting in accordance with most of the
requirements of the Agreement, and we intend to take such actions as may be
necessary to enable the Company and or the Bank to comply with the remaining
requirements of the Agreement.  However, there can be no assurance
that the Company and or the Bank will be able to comply fully with the
provisions of the Agreement, or that efforts to comply with the Agreement will
not have adverse effects on the operations and financial condition of the
Company or the Bank.




The
Agreement does not affect the Bank’s ability to continue to conduct its banking
business with customers in a normal fashion.  The Bank’s deposits will
remain insured by the FDIC to the maximum limits allowed by law.  The
Agreement will remain effective and enforceable until stayed, modified,
terminated or suspended in writing by the Regulators.













28





ITEM 2.   MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS





Forward-Looking
Statements





The
Company may from time to time make written or oral “forward-looking statements”,
including statements contained in the Company’s filings with the Securities and
Exchange Commission (including this Quarterly Report on Form 10-Q), in its
reports to shareholders and in other communications by the Company, which are
made in good faith by the Company pursuant to the “safe harbor” provisions of
the Private Securities Litigation Reform Act of 1995.





These
forward-looking statements involve risks and uncertainties, such as statements
of the Company's plans, objectives, expectations, estimates and intentions,
which are subject to change based on various important factors (some of which
are beyond the Company’s control).  The following factors, among
others, could cause the Company's financial performance to differ materially
from the plans, objectives, expectations, estimates and intentions expressed in
such forward-looking statements: the strength of the United States economy in
general and the strength of the local economies in which the Company conducts
operations; the effects of, and changes in, trade, monetary and fiscal policies
and laws, including interest rate policies of the Board of Governors of the
Federal Reserve System; the effect that maintaining regulatory capital
requirements could have on the growth of the Company; inflation; changes in
prevailing short term and long term interest rates; national and global
liquidity of the banking system; changes in loan portfolio quality; adequacy of
loan loss reserves; changes in the rate of deposit withdrawals; changes in the
volume of loan refinancings; the timely development of and acceptance of new
products and services of the Company and the perceived overall value of these
products and services by users, including the features, pricing and quality
compared to competitors' products and services; the impact of changes in
financial services laws and regulations (including laws concerning taxes,
banking, securities and insurance), including the increase in the cost of FDIC
insurance; technological changes; changes in consumer spending and saving
habits; findings of the Bank’s recent examination by the FRB; changes in the
local competitive landscape, including the acquisition of local and regional
banks in the Company’s geographic marketplace; possible impairment of intangible
assets, specifically core deposit premium from the Company’s acquisition of
Farnsworth; the ability of our borrowers to repay their loans; the uncertain
credit environment in which the Company operates; the ability of the Company to
manage the risk in its loan and investment portfolios; the ability of the
Company to reduce noninterest expenses and increase net interest income, its
growth, results of possible collateral collections and subsequent sales; and the
success of the Company at managing the risks resulting from these
factors.




The
Company cautions that the above-listed factors are not exclusive.  The
Company does not undertake to updateany
forward-looking statement, whether written or oral, that may be made from time
to time by or on behalf of the Bank.





Readers
should carefully review the risk factors described in other reports the Company
files from time to time with the Securities and Exchange Commission, including
the Company’s Form 10-K for the year ended December 31, 2008, and its subsequent
quarterly reports on Form 10-Q and current reports on Form 8-K.





General





Our
principal source of revenue is net interest income, which is the difference
between the interest income from our earning assets and the interest expense of
our deposits and borrowings.  Interest-earning assets consist
principally of loans, investment securities and federal funds sold, while our
interest-bearing liabilities consist primarily of deposits and
borrowings.  Our net income is also affected by our provision for loan
losses, noninterest income and noninterest expenses, which include salaries,
benefits, occupancy costs and charges relating to non-performing and other
classified assets.







29





Consolidated
Results of Operations


Three
Months Ended September 30, 2009 and 2008


(Unaudited
and Unreviewed)





The
following discussion compares the results of operations for the three months
ended September 30, 2009 (unaudited and unreviewed) to the results of operations
for the three months ended September 30, 2008 (unaudited and
unreviewed).  This discussion should be read in conjunction with the
accompanying financial statements (unaudited and unreviewed) and related notes,
as well as statistical information included in this Form 10-Q.





Net Loss. For the three
months ended September 30, 2009, the net loss totaled $4,510,000, compared to
net income of $79,000 for the three months ended September 30,
2008.  Decreased earnings for the three months ended September 30,
2009 were attributable primarily to management’s determination that there was a
need for a valuation allowance of $3,477,000 on the Company’s deferred tax
assets, a decrease in net interest income after provision for loan losses of
$1,451,000, a decrease in noninterest income of $106,000 and an increase in
noninterest expenses of $237,000.  Basic and diluted income (loss) per
share for the three months ended September 30, 2009 and 2008 totaled ($0.77) and
$0.01, respectively.





Net Interest Income. Net
interest income for the three months ended September 30, 2009 totaled
$2,862,000, a decrease of 14.4% from $3,343,000 for the three months ended
September 30, 2008.  This decrease is primarily as a result of a
decrease in the net interest margin, from 4.00% for the three months ended
September 30, 2008 to 3.24% for the three months ended September 30, 2009, or
$626,000, including lost interest income on nonaccrual loans of approximately
$152,000, partially offset by an increase in interest earning assets of $145,000
in 2009.





Interest
income decreased by $700,000 for the three months ended September 30, 2009 from
the same period in 2008, attributable to a 122 basis point decrease in the yield
on average earning assets from 6.61% in 2008 to 5.39% in 2009, partially offset
by an increase in average interest earning assets of $17.8
million.  Average interest earning loans outstanding decreased by
$12.8 million while average investment securities increased $20.0 million and
due from banks and federal funds sold increased $10.6 million.  The
decrease in average interest earning loans outstanding is attributable primarily
to an increase in average nonaccrual loans of $7.5 million, an increase in
repossessed property of $1.6 million and normal monthly payments and/or payoffs,
while the increase in average investment securities and federal funds sold was
attributable to management’s efforts to decrease the Bank’s general level of
risk on the balance sheet.  Interest expense decreased by $219,000
from the same time period in 2008.  Average interest-bearing
liabilities increased by $35.4 million, which was attributable to an increase in
borrowed funds of $12.3 million in an effort to increase the Bank’s net interest
income by borrowing at a lower cost and investing in higher yielding assets and
an increase in interest bearing deposits.  The average rate paid on
interest-bearing liabilities decreased to 2.28% for the three months ended
September 30, 2009 from 2.85% for the same period of 2008.




Provision for Loan Losses.Provision for loan losses was $1,075,000 and $105,000 for the three
months ended September 30, 2009 and 2008.





Noninterest
Income.  Noninterest income decreased $106,000, or 37.5%, for
the three months ended September 30, 2009 to $177,000 compared to $283,000 for
the same period of 2008, primarily as a result of decreased prepayment penalties
for early loan payoffs of $61,000, a decrease in late charges of $16,000, and a
decrease in miscellaneous fees of $10,000.





Noninterest
Expenses.  For the three months ended September 30, 2009,
noninterest expenses increased by $236,000, or 7.0%, to $3,618,000, compared to
$3,382,000 for the same period of 2008, primarily as a result of an increase in
FDIC insurance of $281,000 and an increase in loan workout and repossessed
property expenses of $128,000, which were partially offset by decreases in
personnel costs of $139,000, reflecting the effect of staff and benefit
reductions, including as a result of the closure of one of our branch locations
in November 2008.








Income Taxes.  We
recorded income tax expense of $2,856,000 on loss before taxes of $1,654,000 for
the three months ended September 30, 2009.  During this quarter,
management determined that there was a need for a valuation allowance of
$3,477,000 on the Company’s deferred tax assets.  Based on forecasts
of the Company’s future profitability, management concluded full recognition of
these tax assets was unlikely because it is more likely than not that this
portion of the deferred tax assets will not be realized as a result of
cumulative tax losses and uncertainties of future taxable
income.  During the three months ended September 30, 2008, we recorded
an income tax expense of $60,000 on income before taxes of $139,000, resulting
in an effective tax rate of 43.2% for the 2008 period.






30





Consolidated
Results of Operations


Nine
Months Ended September 30, 2009 and 2008


(Unaudited
and Unreviewed)





The
following discussion compares the results of operations for the nine months
ended September 30, 2009 (unaudited and unreviewed) to the results of operations
for the nine months ended September 30, 2008 (unaudited and
unreviewed).  This discussion should be read in conjunction with the
accompanying financial statements (unaudited and unreviewed) and related notes,
as well as statistical information included in this Form 10-Q.





Net Loss. For the nine months
ended September 30, 2009, the net loss totaled $5,905,000, compared to net loss
of $405,000 for the nine months ended September 30, 2008.  Decreased
earnings for the nine months ended September 30, 2009 were attributable
primarily to management’s determination that there was a need for a valuation
allowance of $3,477,000 on the Company’s deferred tax assets, a decrease in net
interest income after provision for loan losses of $2,612,000, a decrease in
noninterest income of $213,000 and an increase in noninterest expenses of
$435,000.  Basic and diluted loss per share for the nine months ended
September 30, 2009 and 2008 totaled $1.01 and $0.07, respectively.




Net Interest Income. Net
interest income for the nine months ended September 30, 2009 totaled $8,024,000,
a decrease of 17.1% from $9,676,000 for the nine months ended September 30,
2008.  This decrease is primarily as a result of a decrease in the net
interest margin, from 3.74% for the nine months ended September 30, 2008 to
3.04% for the nine months ended September 30, 2009, or $1,837,000, including
lost interest income on nonaccrual loans of approximately $457,000, partially
offset by an increase in interest earning assets of $185,000 in
2009.





Interest
income decreased by $2,827,000 for the nine months ended September 30, 2009 from
the same period in 2008, attributable to a 122 basis point decrease in the yield
on average earning assets from 6.62% in 2008 to 5.40% in 2009, partially offset
by an increase in average interest earning assets of $8.1
million.  Average interest earning loans outstanding decreased by
$13.0 million while average investment securities increased $14.5 million and
due from banks and federal funds sold increased $6.6 million.  The
decrease in average interest earning loans outstanding is attributable primarily
to an increase in average nonaccrual loans of $7.1 million, an increase in
repossessed property of $1.5 million and normal monthly payments and/or payoffs,
while the increase in average investment securities and federal funds sold was
attributable to management’s efforts to decrease the Bank’s general level of
risk on the balance sheet.  Interest expense decreased by $1.2 million
from the same time period in 2008.  Average interest-bearing
liabilities increased by $23.7 million, which was attributable to an increase in
borrowed funds in an effort to increase the Bank’s net interest income by
borrowing at a lower cost and investing in higher yielding assets and an
increase in interest bearing deposits.  The average rate paid on
interest-bearing liabilities decreased to 2.52% for the nine months ended
September 30, 2009 from 3.22% for the same period of 2008.





Provision for Loan Losses.Provision for loan losses was $1,465,000 and $505,000 for the nine months
ended September 30, 2009 and 2008.





Noninterest
Income.  Noninterest income decreased $213,000, or 26.8%, for
the nine months ended September 30, 2009 to $582,000 compared to $795,000 for
the same period of 2008, primarily as a result of a decrease in gains on sales
of available-for-sale securities and fixed assets of $95,000, a decrease in
prepayment penalties on early loan payoffs of $27,000, a decrease in mortgage
origination revenue of $13,000, a decrease in late charges of $11,000 in 2009,
and a one time fee of $30,000 for the sale of branch rights in
2008.





Noninterest
Expenses.  For the nine months ended September 30, 2009,
noninterest expenses increased by $435,000, or 4.1%, to $11,023,000, compared to
$10,588,000 for the same period of 2008.  Increases in FDIC insurance
of $587,000, including a one time special assessment of $183,000, in loan
workout and repossessed property expenses of $431,000, a partial write down on
the Company’s former Gaither Road office of $82,000 and losses on sales of or
partial write downs on repossessed property of $77,000, were partially offset by
decreases in personnel costs of $736,000, reflecting bonuses expensed in 2008
and the effect of staff and benefit reductions, including as a result of the
closure of one our branch locations in November 2008.





Income Taxes.  We
recorded income tax expense of $2,023,000 on loss before taxes of $3,882,000 for
the nine months ended September 30, 2009.  During the quarter ended
September 30, 2009, management determined that there was a need for a valuation
allowance of $3,477,000 on the Company’s deferred tax assets.  Based
on forecasts of the Company’s future profitability, management concluded full
recognition of these tax assets was unlikely because it is more likely than not
that this portion of the deferred tax assets will not be realized as a result of
cumulative tax losses and uncertainties of future taxable
income.  During the nine months ended September 30, 2008, we recorded
an income tax benefit of $217,000 on loss before taxes of $622,000, resulting in
an effective tax rate of 34.9% for the 2008 period.






31





Consolidated
Financial Condition


At
September 30, 2009 and December 31, 2008


(Unaudited
and Unreviewed for 2009)







The
following discussion compares the financial condition at September 30, 2009
(unaudited and unreviewed) to the financial condition at December 31,
2008.  This discussion should be read in conjunction with the
accompanying financial statements (unaudited and unreviewed) and related notes
as well as statistical information included in this Form 10-Q.





Total Assets. Total assets
increased $8.8 million, or 2.3%, to $387.9 million at September 30, 2009,
compared to $379.1 million at December 31, 2008.  This was due to
management’s efforts to increase the Bank’s net interest margin and
liquidity.





Loans.Loans outstanding
decreased $8.7 million, or 2.9%.  The decrease in loans was due
primarily to normal contractual loan payments and/or payoffs in the loan
portfolio and a decrease in originations of residential mortgage construction
loans.





Allowance for Loan
Losses.  The allowance for loan losses was $6.7 million at
September 30, 2009 as compared to $8.5 million at December 31,
2008.  This decline was due primarily to the charging off of certain
loans that were impaired.  The ratio of the allowance for loan losses
to total loans was 2.3% and 2.8% at September 30, 2009 and December 31, 2008,
respectively.  The Company’s management has considered nonperforming
assets and other assets of concern in establishing the allowance for loan
losses.  The Company continues to monitor its allowance for possible loan
losses and will make future additions or reductions in light of the level of
loans in its portfolio and as economic conditions dictate.








32




The table
below recaps loans accruing but past due 90 days or more, non-accrual loans,
OREO (Other Real Estate Owned), and troubled debt restructurings as of the dates
listed.




September
      30, 2009
            
            
            December
      31, 2008Restructured
      loans:Real
      Estate – Construction
            
            $
            1,012,000
            
            
            $
            642,000Real
      Estate – Mortgage
            
            
            4,039,000
            
            
            
            -Total
      restructured loans
            
            
            5,051,000
            
            
            
            642,000Loans
      accruing, but past due 90 days or more:Commercial,
      Financial and Agricultural
            
            
            75,000
            
            
            
            92,000Real
      Estate – Construction
            
            
            2,006,000
            
            
            
            2,360,000Real
      Estate – Mortgage
            
            
            454,000
            
            
            
            178,000Consumer
      Installment loans
            
            
            41,000
            
            
            
            77,000Total
      loans accruing, but past due 90 days or more
            
            
            2,576,000
            
            
            
            2,707,000Nonaccrual
      Loans:Commercial,
      Financial and Agricultural
            
            
            245,000
            
            
            
            -Real
      Estate – Construction
            
            
            12,523,000
            
            
            
            9,840,000Real
      Estate – Mortgage
            
            
            1,288,000
            
            
            
            55,000Total
      nonaccrual loans
            
            
            14,056,000
            
            
            
            9,895,000Total
      nonperforming loans
            
            
            21,683,000
            
            
            
            13,244,000Other
      Real Estate Owned
            
            
            1,786,000
            
            
            
            923,000Total
      nonperforming assets
            
            $
            23,469,000
            
            
            $
            14,167,000Non-performing
      loans/Total loans (1)
            
            
            7.30
            %
            
            
            4.33
            %Non-performing
      assets/Total assets
            
            
            6.05
            %
            
            
            3.74
            %Allowance
      for loan losses/Total non-performing loans
            
            
            30.82
            %
            
            
            64.41
            %


(1)
Includes loans held for sale.





During
2009, to conform to bank regulatory reporting requirements and general practices
within the banking industry for impaired collateral dependent loans where
repayment is expected solely from the underlying collateral, we reduced the
carrying value through a partial charge-off of certain loans as shown in the
table below:





Real
      Estate:
            
            Loan
              Balance
            
            
            Direct
      charge-
              off
            
            
            Adjusted
      Loan
              Balance
            
            
            %
      Charged-
              offConstruction
            
            $
            14,748,000
            
            
            $
            2,941,000
            
            
            $
            11,807,000
            
            
            
            19.94
            %Mortgage
            
            
            182,000
            
            
            
            182,000
            
            
            
            -
            
            
            
            100.00$
            14,930,000
            
            
            $
            3,123,000
            
            
            $
            11,807,000
            
            
            
            20.92
            %





The
current level of the allowance for loan losses is the result of management’s
assessment of the risks within the portfolio based on the information revealed
in credit monitoring processes.  The Company utilizes a risk-rating
system on all commercial, business, agricultural, construction and multi-family
and commercial real estate loans, including purchased loans.  A
quarterly risk analysis is performed on all types of loans to establish the
necessary reserve based on the estimated risk within the
portfolio.  This assessment of risk takes into account the composition
of the loan portfolio, historical loss experience for each loan category,
previous loan experience, concentrations of credit, current economic conditions
and other factors that in management’s judgment deserve
consideration.








33


Although
management believes that it uses the best information available to determine the
allowance, unforeseen market conditions could result in adjustments and net
earnings could be significantly affected if circumstances differ substantially
from the assumptions used in making the final determinations.  Future
additions to the Company’s allowance may result from periodic loan, property and
collateral reviews and thus cannot be predicted in advance.





The
allowance for loan losses is calculated under FASB ASC Topic 310 and FASB ASC
Topic 450.  Non-performing and impaired loans are evaluated under FASB
ASC Topic 310, using either the fair value of collateral or present value of
future cash flows method.  In our case, all non-performing and
impaired loans are evaluated using the fair value of collateral method since all
the non-performing and impaired loans are collateralized by real
estate.  When a loan is evaluated using this method, a new
appraisal(s) of the primary and secondary collateral is obtained and compared to
the outstanding balance of the loan.  A specific reserve is added to
the allowance for loan losses, if a collateral shortfall exists.





The
Company had $14.1 million and $9.9 million, respectively, in loans on nonaccrual
status at September 30, 2009 and December 31, 2008.  This increase is
the result of 30 loans that the Company placed on nonaccrual status during the
first nine months of 2009, less 4 that were transferred to other real estate
owned, less 2 that were paid in full, less 1 that was sold.  Of the 30
loans that were placed on nonaccrual status during the first nine months of
2009, 15 were deemed impaired as of December 31, 2008 and no additional
valuation reserve was needed for these loans during the first nine months of
2009.  The remaining 15 were classified impaired and put on nonaccrual
status during the first nine months of 2009, and required $319,000 in valuation
reserves.  Impaired loans increased by $8.2 million, or 46%, between
December 31, 2008 and September 30, 2009; however, as a result of the charge
offs or partial charge offs, the valuation reserve decreased by $2,397,000, or
86%.





The Company utilizes a risk rating
system on all unimpaired loans which takes into account loans with similar
characteristics and historical loss experience related to each
group.  In addition, qualitative adjustments are made for levels and
trends in delinquencies and nonaccruals, downturns in specific industries,
changes in credit policy, experience and ability of staff, national and local
economic conditions, and concentrations of credit within the
portfolio.  The total loans outstanding in each group of loans with
similar characteristics is multiplied by the sum of the historical loss factors
and the qualitative factors (for that group), to produce the allowance for the
unimpaired loan loss balance required.





Unimpaired commercial real estate loans
analyzed decreased $27.0 million, or 20%, between December 31, 2008 and
September 30, 2009 due to payments and payoffs and loans characterized as
impaired.  Unimpaired spot lot construction loans, a component type
within the real estate - construction portfolio, had their qualitative
adjustment factors increased an average of 88% due to the risk present in this
portfolio segment and the increasing historical charge off qualitative
factor.  As a result of the above mentioned activity during the first
nine months of 2009, management concluded that a provision for loan losses of
$1,465,000 was needed during the first nine months of 2009.





Deposits.Deposits
totaled $343.2 million at September 30, 2009, increasing $14.6 million, or 4.4%,
from the December 31, 2008 balance of $328.6 million.  The increase in
deposits resulted primarily from management’s efforts to increase the bank’s net
interest margin and liquidity.





Federal Home Loan Bank Advances and
Other Borrowings.Federal Home Loan Bank advances and other borrowings
totaled $21.4 and $22.2 million at September 30, 2009 and December 31, 2008,
respectively.





Shareholders’
Equity.Shareholders’ equity decreased by $5.5 million, or
20.2%, mainly as a result of our net loss, partially offset by a decrease in
other comprehensive loss.








34





Comparative
Average Balances, Interest and Yields:





Three Months EndedSeptember 30, 2009
            
            
            September 30, 2008Average
              Balance
            
            
            Interest
              Income/Expense
            
            
            Annual
              Yield/Cost
            
            
            Average
              Balance
            
            
            Interest
              Income/Expense
            
            
            Annual
              Yield/CostAssetsLoans,
      net (1)
            
            $
            285,952,000
            
            
            $
            4,294,000
            
            
            
            5.96
            %
            
            $
            298,773,000
            
            
            $
            5,125,000
            
            
            
            6.90
            %Investment
      securities (2)
            
            
            49,003,000
            
            
            
            465,000
            
            
            
            3.77
            
            
            
            28,955,000
            
            
            
            318,000
            
            
            
            4.41Due
      from banks and Federal funds sold
            
            
            15,435,000
            
            
            
            5,000
            
            
            
            0.12
            
            
            
            4,852,000
            
            
            
            21,000
            
            
            
            1.72Total
      interest-earning assets
            
            
            350,390,000
            
            
            
            4,764,000
            
            
            
            5.39
            
            
            
            332,580,000
            
            
            
            5,464,000
            
            
            
            6.61Allowance
      for loan losses
            
            
            (8,370,000
            )
            
            
            
            
            
            
            
            
            
            
            (3,006,000
            )Other
      assets
            
            
            48,972,000
            
            
            
            
            
            
            
            
            
            
            
            48,636,000Total
      assets
            
            $
            390,992,000
            
            
            
            
            
            
            
            
            
            
            $
            378,210,000Liabilities
      and shareholders’ equityTime
      deposits
            
            $
            200,451,000
            
            
            $
            1,407,000
            
            
            
            2.79
            %
            
            $
            181,059,000
            
            
            
            1,636,000
            
            
            
            3.59
            %NOW/MMDA/savings
      accounts
            
            
            108,937,000
            
            
            
            225,000
            
            
            
            0.64
            
            
            
            105,213,000
            
            
            
            349,000
            
            
            
            1.32Borrowed
      funds
            
            
            22,121,000
            
            
            
            270,000
            
            
            
            4.83
            
            
            
            9,821,000
            
            
            
            136,000
            
            
            
            5.48Total
      interest-bearing liabilities
            
            
            331,509,000
            
            
            
            1,902,000
            
            
            
            2.28
            
            
            
            296,093,000
            
            
            
            2,121,000
            
            
            
            2.85Noninterest-bearing
      demand deposits
            
            
            33,175,000
            
            
            
            
            
            
            
            
            
            
            
            37,971,000Other
      liabilities
            
            
            638,000
            
            
            
            
            
            
            
            
            
            
            
            1,430,000Shareholders’
      equity
            
            
            25,670,000
            
            
            
            
            
            
            
            
            
            
            
            42,716,000Total
      liabilities and shareholders’ equity
            
            $
            390,992,000
            
            
            
            
            
            
            
            
            
            
            $
            378,210,000Net
      interest income
            
            
            
            
            
            $
            2,862,000
            
            
            
            
            
            
            
            
            
            
            $
            3,343,000Interest
      rate spread (3)
            
            
            
            
            
            
            
            
            
            
            3.11
            %
            
            
            
            
            
            
            
            
            
            
            3.76
            %Net
      interest margin (4)
            
            
            
            
            
            
            
            
            
            
            3.24
            %
            
            
            
            
            
            
            
            
            
            
            4.00
            %





Nine Months EndedSeptember 30, 2009
            
            
            September 30, 2008Average
              Balance
            
            
            Interest
              Income/Expense
            
            
            Annual
              Yield/Cost
            
            
            Average
      Balance
            
            
            Interest
              Income/Expense
            
            
            Annual
              Yield/CostAssetsLoans,
      net (1)
            
            $
            288,230,000
            
            
            $
            12,799,000
            
            
            
            5.94
            %
            
            $
            301,245,000
            
            
            $
            15,839,000
            
            
            
            7.02
            %Investment
      securities (2)
            
            
            48,930,000
            
            
            
            1,450,000
            
            
            
            4.47
            
            
            
            34,412,000
            
            
            
            1,093,000
            
            
            
            4.24Due
      from banks and Federal funds sold
            
            
            16,122,000
            
            
            
            17,000
            
            
            
            0.14
            
            
            
            9,479,000
            
            
            
            161,000
            
            
            
            2.27Total
      interest-earning assets
            
            
            353,282,000
            
            
            
            14,266,000
            
            
            
            5.40
            
            
            
            345,136,000
            
            
            
            17,093,000
            
            
            
            6.62Allowance
      for loan losses
            
            
            (7,951,000
            )
            
            
            
            
            
            
            
            
            
            
            (2,866,000
            )Other
      assets
            
            
            46,614,000
            
            
            
            
            
            
            
            
            
            
            
            48,393,000Total
      assets
            
            $
            391,945,000
            
            
            
            
            
            
            
            
            
            
            $
            390,663,000Liabilities
      and shareholders’ equityTime
      deposits
            
            $
            201,309,000
            
            
            $
            4,743,000
            
            
            
            3.15
            %
            
            $
            194,283,000
            
            
            
            5,926,000
            
            
            
            4.07
            %NOW/MMDA/savings
      accounts
            
            
            107,584,000
            
            
            
            699,000
            
            
            
            0.87
            
            
            
            103,211,000
            
            
            
            1,068,000
            
            
            
            1.38Borrowed
      funds
            
            
            22,215,000
            
            
            
            800,000
            
            
            
            4.81
            
            
            
            9,882,000
            
            
            
            423,000
            
            
            
            5.72Total
      interest-bearing liabilities
            
            
            331,108,000
            
            
            
            6,242,000
            
            
            
            2.52
            
            
            
            307,376,000
            
            
            
            7,417,000
            
            
            
            3.22Noninterest-bearing
      demand deposits
            
            
            33,333,000
            
            
            
            
            
            
            
            
            
            
            
            38,422,000Other
      liabilities
            
            
            1,143,000
            
            
            
            
            
            
            
            
            
            
            
            1,856,000Shareholders’
      equity
            
            
            26,361,000
            
            
            
            
            
            
            
            
            
            
            
            43,009,000Total
      liabilities and shareholders’ equity
            
            $
            391,945,000
            
            
            
            
            
            
            
            
            
            
            $
            390,663,000Net
      interest income
            
            
            
            
            
            $
            8,024,000
            
            
            
            
            
            
            
            
            
            
            $
            9,676,000Interest
      rate spread (3)
            
            
            
            
            
            
            
            
            
            
            2.88
            %
            
            
            
            
            
            
            
            
            
            
            3.40
            %Net
      interest margin (4)
            
            
            
            
            
            
            
            
            
            
            3.04
            %
            
            
            
            
            
            
            
            
            
            
            3.74
            %


________________________________


(1) Includes loans
held for sale.  Also includes loan fees, which are not
material.  Does not include loans on nonaccrual.


(2) Yields
are not on a tax-equivalent basis.


(3) Interest
rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.


(4) Net
interest margin represents net interest income as a percentage of average
interest-earning assets.








35








Liquidity





Liquidity describes our ability to meet
the financial obligations that arise out of the ordinary course of
business.  Liquidity addresses the Company’s ability to meet deposit
withdrawals on demand or at contractual maturity, to repay borrowings as they
mature, and to fund current and planned expenditures.  Liquidity is
derived from loan and investment securities repayments and income from
interest-earning assets.  Our loan to deposit ratio was 86.5% and
93.0% at September 30, 2009 and December 31, 2008, respectively.





The
Company seeks to rely primarily on core deposits from customers to provide
stable and cost-effective sources of funding to support growth.  The
Company also seeks to augment such deposits with longer term and higher yielding
certificates of deposit.  To the extent that retail deposits are not
adequate to fund customer loan demand, liquidity needs can be met in the
short-term funds market.  As of September 30, 2009, the Company
maintained lines of credit with correspondent banks of $39.2
million.  Longer term funding requirements can be satisfied through
advances from the Federal Home Loan Bank.





As of
September 30, 2009, the Company’s investment securities portfolio included $33.5
million of mortgage-backed securities that provide significant cash flow each
month.  The majority of the investment portfolio is classified as
available-for-sale, is readily marketable, and is available to meet liquidity
needs.  The Company’s residential real estate portfolio includes
loans, which are underwritten to secondary market criteria, and provide an
additional source of liquidity.





Capital
Resources





The Company is subject to various
regulatory capital requirements.  Regulatory capital is defined in
terms of Tier I capital (shareholders’ equity adjusted for unrealized gains or
losses on available-for-sale securities), Tier II capital (which includes a
portion of the allowance for loan losses) and Total capital (Tier I plus Tier
II).  Risk-based capital ratios are expressed as a percentage of
risk-weighted assets.  Risk-weighted assets are determined by
assigning various weights to all assets and off-balance sheet associated
risk.  Regulators have also adopted minimum Tier I leverage ratio
standards, which measure the ratio of Tier I capital to average
assets.





At
September 30, 2009, management believes that the Bank is “adequately
capitalized,” as defined by regulatory banking agencies.  The
Company’s long term goal is to ensure that the Bank is “well capitalized” under
the applicable regulatory standards.  To assist in this goal, the
Company issued $6.0 million of trust preferred securities (the “Securities”) on
May 1, 2007.  The Securities bear interest at 6.744% for the first
five years.  Subsequently, the interest rate will be adjusted
quarterly based on a three month LIBOR rate plus 1.70%.  The
Securities are callable by the Company after five years with a final maturity of
May 1, 2037.  The Company contributed $4.5 million of the proceeds of
the Securities to the capital of the Bank as Tier I capital.  If the
Company determines that there is a need to preserve capital or improve
liquidity, the ability exists to defer interest payments for a maximum of five
years.  During the second and third quarters of 2009, the Company
elected to defer the interest payments due.  Further, pursuant to the
terms of the Agreement with the Regulators, the Company will not make any
interest payments in the future without prior approval from the
Regulators.





Off-Balance
Sheet Arrangements





The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its
customers.  These financial instruments include commitments to extend
credit, including unused portions of lines of credit and standby letters of
credit.  The Company has also entered into long-term lease obligations
for some of its premises and equipment, the terms of which generally include
options to renew.  The above instruments and obligations involve, to
varying degrees, elements of off-balance sheet risk in excess of the amount
recognized in the balance sheets.  None of these instruments or
obligations have or are reasonably likely to have a current or future effect on
the Company's financial condition, revenues or expenses, results of operations,
liquidity, capital expenditures or capital resources that is material to
investors.







36




As of September 30, 2009, commitments to extend credit and
unused lines of credit amounted to approximately $35.8 million and standby
letters of credit were approximately $4.2 million.  See Note 8 to the
Notes to Financial Statements included in the Company’s Annual Report on Form
10-K for the year ended December 31, 2008 for additional information regarding
the Bank’s long-term lease obligations.








ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





Not
Applicable.








ITEM
4T.  CONTROLS AND PROCEDURES





Disclosure
Controls and Procedures





As of
September 30, 2009, management of the Company, under the supervision and with
the participation the Company’s principal executive officer and principal
financial officer, evaluated the effectiveness of the design and operation of
the Company’s disclosure controls and procedures as contemplated by Rule 13a-15
under the Securities Exchange Act of 1934 (the “Exchange Act”).  Based
on that evaluation, the principal executive officer and principal financial
officer concluded that the Company’s disclosure controls and procedures were
effective as of September 30, 2009, in ensuring that information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported within the required time
periods.




Changes
in Internal Control over Financial Reporting





The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting.  During the period covered
by this Quarterly Report, there was no change in the Company’s internal control
over financial reporting that has materially affected, or is reasonably likely
to materially affect, the Company's internal control over financial
reporting.





PART
II.  OTHER INFORMATION





ITEM
1.                      Legal
Proceedings.





Not Applicable.





ITEM
1A.                    Risk
Factors.





Not
Applicable.





ITEM
2.                      Unregistered
Sales of Equity Securities and Use of Proceeds.





Not
Applicable.





ITEM
3.                      Defaults
Upon Senior Securities.





None.





ITEM
4.                      Submission
of Matters to a Vote of Security Holders.





None.





ITEM
5.                      Other
Information.





None.








37





ITEM 6.
              Exhibits.The
      following are filed as exhibits to this report:31.1
              Certification of Chief Executive Officer pursuant to
      §302 of the Sarbanes-Oxley
                Act of 2002.31.2
              Certification of Chief Financial Officer pursuant to
      §302 of the Sarbanes-Oxley
                Act of 2002.










SIGNATURES
 
 In accordance with the requirements of
the Securities Exchange Act of 1934, the registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 STERLING
      BANKS, INC.Date:
      November 25, 2009
              By:
      /s/ Robert H.
      KingRobert
      H. KingPresident
      and Chief Executive OfficerDate:
      November 25, 2009
              By:
      /s/ R.
      Scott HornerR.
      Scott HornerExecutive
      Vice President and ChiefFinancial
      Officer