To Score Capital, Community Banks Dig into the Playbook

US Banker | August, 2010

When Sterling Financial Corp. in Spokane, Wash., merged its two bank units last week, few may have noticed, but many community bankers could relate.

Companies that cannot get their hands on fresh capital are scrambling for a Plan B these days.

Not everyone has the option to boost their capital ratios through a consolidation, as Sterling did when it combined Sterling Savings Bank and Golf Savings Bank. But they all are searching for any move they can make — or several of them.

"In this kind of market, the most successful banks that deal with their problems don't just take one approach, they pull out the playbook," said Walter Moeling 4th, a partner in the Bryan Cave law firm in Atlanta. "My most successful clients have cut expenses, sold branches, consolidated charters, disposed of nonbank activities.”

The $9.7 billion-asset Sterling's consolidation was not a panacea but an incremental move to stay afloat. The company, which has acknowledged doubts about its viability, has lost nearly $1 billion in the past 18 months and needs to raise $725 million by Sept. 1 to comply with a regulatory order.

Like many banks in the Pacific Northwest, Sterling has wrestled with a huge concentration of nonperforming construction loans. It has been operating under an enforcement order since last year requiring it to boost its leverage ratio to at least 10 percent. As of June 30, its leverage ratio was 2 percent, down from 8.7 percent a year earlier.

Working in its favor, the company has capital commitments from two private-equity investors. Thomas H. Lee Partners LP and Warburg Pincus have each pledged $139 million, contingent upon Sterling's raising an additional $447 million.

As a condition of the transactions, the Treasury Department has agreed to take a 75 percent haircut on its $303 million investment through the Troubled Asset Relief Program, accepting $75.8 million worth of common equity.

Under the agreements, Sterling has until the end of August to close a deal.

In a press release last month announcing the company's second-quarter results, Sterling Chief Executive Greg Seibly said, "The recapitalization process has been challenging and complex. Although there can be no assurance of success, we are leveraging our resources in an effort to bring the recapitalization to a successful conclusion."

Brett Rabatin, an analyst at Sterne Agee & Leach, said investors may be having a hard time seeing the value in such an investment.

Sterling's share price has not risen above $1 for months, and the stock was delisted from the Nasdaq in June.

The capital raising effort would be extremely dilutive to shareholders, increasing the company's shares outstanding to about 4 billion, including the TARP covenants and warrants, Rabatin said. Sterling had 52.2 million shares outstanding at June 30.

"The value might be there, but it's difficult to see normalized earnings several years out that would substantiate this being a great investment," Rabatin said. "I think that's what private equity has struggled with.”

Meanwhile, regulators gave Sterling the go-ahead to merge the $558.3 million-asset Golf Savings Bank into Sterling Savings. Golf, which has operated as a traditional thrift, is to be Sterling's home loan division.

Though smaller than Sterling, Golf's capital ratios are much stronger. As of March 31, it had a total risk-based capital ratio of 20.7 percent, more than twice the level regulators typically require.

Jeffrey Hare, a partner at the DLA Piper law firm in Washington, said consolidating charters can allow a holding company to reduce duplication of processes or personnel at its subsidiaries, lead to better risk management and ultimately save money. Combining a weaker bank with a healthier one also could produce better performance ratios.