To Score Capital, Washington's Sterling Digs into Playbook

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 drum up capital 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. There isn't [just] one fix, but this is not a time to hold back if you start really struggling. Everybody and every part of the bank should be sharing in this solution."

Likewise, 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.

For Sterling, the question is: How much will the merger help fill its capital hole? Jeffrey Rulis, an analyst at D.A. Davidson & Co., said the answer is unclear.

"They're shrinking the balance sheet, and some of the nonperforming loans have been written down, so maybe they need less money," he said. "But on the flip side, if you look at tangible common equity, that negative balance continues to grow, so there's a bigger hole."

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%. As of June 30, its leverage ratio was 2%, down from 8.7% 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% 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. Spokesmen for Warburg Pincus and Thomas H. Lee would not comment on the status of the capital-raising efforts, but a person familiar with them, who did not want to be identified, said the lead investors may increase their initial commitments.

A spokeswoman for Sterling would not comment on the status of the efforts last week, citing a quiet period.

In a press release last month announcing the company's second-quarter results, Sterling CEO 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."

Still, some reasons exist for optimism regarding Sterling's future. For one, the company's size would make it appealing to private-equity investors despite the question marks, Rabatin said.

Furthermore, a new management team has been significantly more aggressive in addressing asset-quality issues.

On an annualized basis, the company charged off 12.7% of its loan portfolio in the fourth quarter, 6.8% in the first quarter and 5.5% in the second quarter. It has reduced its construction loans — its most troubled portfolio — by 25% since the first quarter.

Rulis said these could be signs that the company has turned a corner. But as Sterling said in its own press release, raising capital has been difficult.

"There's clearly some doubt that it will get done, and that's sort of reflected in the share price," Rulis said. "But I'm not ruling it out."

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%.

Jeffrey Hare, a partner at DLA Piper 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.

"The argument is that the sum is better than its parts," Hare said.

Several large companies, including Synovus Corp., Capitol Bancorp Ltd. and People's United in Bridgeport, Conn., have consolidated multiple bank charters during the economic downturn.

And Moeling, the Atlanta lawyer, said he expects more "multibanks" to contemplate the strategy as the economy turns around. "Today, it really is driven by cost savings and risk management control," he said. "This is just not a time where you can afford the luxury of not changing things."