Once Endangered, Washington's Sterling Bank Now Ready to Compete in Pacific Northwest

What's the difference between struggling to survive and vying for first place in your market? For Sterling Financial Corp. in Spokane, Wash., the answer is exactly $730 million.

Less than a month after completing that recapitalization, the $9.7 billion-asset company cleared another major hurdle Monday as regulators rescinded a year-old cease-and-desist order. Although there is still rebuilding work to do, analysts say the order's suspension puts Sterling on a path to become a major player in the Pacific Northwest once again.

"A recapitalized, healthy Sterling is a force to be reckoned with," said Joseph Fenech, an analyst with Sandler O'Neill & Partners LP.

The region has been plagued by problem construction loans, of which many community banks, including Sterling, had huge concentrations. Yet analysts predict that as more banks fail and survivors look to sell themselves, Sterling will be able to take advantage of the opportunities.

"I think we'll be thoughtful, we'll be opportunistic [and] we'll look at things that represent a good strategic fit," said Greg Seibly, Sterling's chief executive officer.

Seibly stressed that before shopping for acquisitions, Sterling must finish some cleanup chores.

The company started this work well before receiving the fresh capital.

As of June 30, the company had reduced gross loans by $2.3 billion, or 26%, since June 2009. It shrank its construction loan portfolio by 25% in the second quarter, and lowered its concentration of residential construction loans to 6%, from 14% a year earlier. And nonperforming loans declined 8%, to $884 million.

"What we saw with the second-quarter results was a clear emergence of the fact that the things we've been working so hard on were really starting to come to fruition," Seibly said.

The fact that the order was lifted so soon after the capital injection signals that regulators think Sterling has addressed most of its asset-quality issues, said Brett Rabatin, an analyst with Sterne, Agee & Leach. Further, the action implies that the $730 million infusion — which boosted the leverage ratio to 10.4% — is enough for Sterling to deal with any remaining problems, he said.

Without the burden of the order, Sterling can turn its attention back to banking, Rabatin said.

"It takes them out of the penalty box in terms of doing things like making new loans and actually trying to be a 'normal' bank, and be out in the market competing with other players," he said. "So it's pretty amazing how things have changed over the past six months."

Indeed, six months ago Sterling acknowledged doubts about whether it would remain viable.

Then, on April 29, the company announced that the Treasury Department had agreed to take a 75% haircut on its $303 million investment in the company via the Troubled Asset Relief Program.

That paved the way for investments from private equity firms Thomas H. Lee Partners LP and Warburg Pincus, which agreed to inject a combined $342 million, for a 45% stake. Sterling sold another $388 million in common stock through a private placement, which closed Aug. 26.

Analysts said Sterling's size makes it a formidable competitor in the region. Sterling Savings Bank, its main subsidiary, became a commercial bank in 2005 and is the largest such institution in Washington by far, even after trimming its balance sheet. (Washington Federal Inc., a thrift company, has $13.7 billion of assets.)

Sterling has "the scale, plus now they have the capital, to … deal with their own problems," said Richard S. Cupp, a former bank CEO and turnaround adviser. "And obviously they're going to have some investors that are going to expect not just repairing damage, but growing the bank."

Sterling's management would not provide a timeline for such growth. Fenech said he expects the company will not be ready to pursue acquisitions until mid to late 2011. By then, the pipeline of failures may have dried up in the region. "I would guess that by the time they get to the stage where they're ready to do a deal, it would be more of a traditional M&A-type deal."

When the time is right, Seibly said, Sterling will seek to expand in its market. The company's chief operating officer, Ezra Eckhardt, put it this way: "We'd like to become one of the dominant regional community banks across the country, [though] we have our work cut out for us right there."

Eckhardt said Sterling will continue to focus on improving asset quality, establishing a high-quality deposit base, and rebuilding relationships with business customers. "Mostly, we're just happy to get back in the game," he said.