Big strategic conversations are "front and center" at Sterling Bancorp in Southfield, Michigan, Chairman and CEO Thomas O'Brien said.
First, there's the issue of Sterling's quirky geography, with a corporate headquarters in suburban Detroit, about 2,000 miles east of the California markets where the bulk of the bank's client base operates.
"It's an odd construct," O'Brien said. "I would argue your executive management should be close to the employees, to customers and markets, especially in a community bank. Remoteness in and of itself is a risk. … From my perspective, it's very hard to have the CEO 2,000 miles away from the business."
Then there's the proverbial elephant in the room: The sale of the company. While O'Brien was mum on the issue in a recent interview, observers and analysts believe the $2.4 billion-asset Sterling is taking a hard look at the possibility of striking a deal.
Ben Gerlinger, who covers Sterling for Hovde, wrote in a research note June 20 that the company "will ultimately be well-positioned to find a partner later this summer," especially after its decision to redeem $65 million in high-interest subordinated debt the company sold in 2016 and 2017, prior to its ill-fated initial public offering.
Gerlinger characterized redemption of the subordinated debt — which was completed July 15 — as a "shareholder friendly" decision that should result in a substantial boost to Sterling's net interest margin at a time when many banks are battling compression. In a subsequent research note July 27, Gerlinger suggested interest in Sterling would solidify as the banking market normalizes. "Ultimately, Sterling could offer...both bootstrapped earnings and excess capital, depending on deal structure, while also expanding/deepening into California," where 26 of Sterling's branches are located, Gerlinger wrote.
O'Brien, in a June 15 press release, referred to the redemption as a "watershed moment" for Sterling. He added that the subordinated notes "have been an expensive drag on earnings, carrying an interest rate in excess of 12%."
To be sure, moving the corporate headquarters to the West Coast, redeeming tens of millions of dollars in subordinated debt and potentially selling Sterling are weighty issues to consider. O'Brien, for his part, said he was delighted to be mulling them over — instead of the problems that confronted him when he agreed to join the company in June 2020.
"It's certainly wonderful not to be talking about punitive stuff and more about strategic things," O'Brien said.
Three years ago, when Sterling hired him, the message O'Brien delivered was starkly different. O'Brien warned Sterling's board the survival of the company was at stake. Regulators at the Office of the Comptroller of the Currency had identified serious issues in Sterling's biggest business line, its Advantage Loan program. Those revelations led to a wide-ranging criminal investigation by the Department of Justice and ultimately a guilty plea to securities fraud. There was also a parallel investigation by the Securities and Exchange Commission, as well as the looming threat of lawsuits by angry shareholders.
It was enough to overwhelm what was, after all, a small thrift. Sterling had been chartered in 1984 as a federal savings bank. "I can understand the description of this as an existential threat, because relative to the size of the bank, the penalties were quite large," said David Sewell, a partner at Freshfields Bruckhaus and Deringer and a former counsel and assistant vice president at the Federal Reserve Bank of New York.
"The kinds of multi-agency investigations and actions, including a criminal action — that's far more common at the higher end of the asset-size spectrum," Sewell added. "For a relatively small thrift, it's a lot to handle."
Banks in deep trouble
O'Brien, who is 72, built a reputation as perhaps the preeminent community bank turnaround wizard during a 45-year banking career.
State Bancorp in Jericho, New York, hired O'Brien as CEO in November 2006. His arrival came less than a year after a court ordered the company to pay $44 million to a mortgage warehouse lender that claimed State's subsidiary, State Bank of Long Island, helped a depositor, Island Mortgage Network, misappropriate millions of dollars in borrowed funds. The judgment resulted in a $36.5 million loss in 2005.
O'Brien quickly righted the ship at State. He guided the company through the financial crisis and in April 2011, negotiated its sale to Valley National Bancorp for $222 million, a sum equal to nearly two times State's tangible book value.
Engineering State's turnaround and sale marked O'Brien as a CEO who could be called on by troubled institutions. "It kind of opens doors for you," O'Brien said. "I believe that. I've seen it. Somebody looks at your resume and says, 'This guy's been through that, they've experienced it and done it successfully.'"
"You fix one and all the sudden there's another one," he added.
Sure enough, a new struggling institution, Sun Bancorp in Vineland, New Jersey, turned to O'Brien in April 2014, naming him chairman and CEO. Sun had steered free of legal entanglements, but asset quality problems along with questionable business decisions had generated a staggering $314 million in losses in the four years prior to O'Brien's arrival.
Once on the job, O'Brien embarked on a painful restructuring program, selling branches, shuttering Sun's mortgage lending operation and disposing of nearly $100 million in problem loans. Sun returned to profitability in the first quarter of 2015. O'Brien negotiated its sale to OceanFirst Financial in Toms River, New Jersey, for $487 million in cash and stock in 2017.
After the OceanFirst deal closed, O'Brien joined a healthy bank, New York-based Emigrant Bancorp, as vice chairman, but his experience with State, followed by his record at Sun, made it almost inevitable another troubled bank would come calling.
"Any sophisticated board goes out of the way to find somebody who is experienced," former Comptroller of the Currency Eugene Ludwig said. "Second, the [regulatory] agencies typically — in every case I know — have scrutinized that person because you have a troubled bank and they want somebody who is capable and experienced dealing with that kind of a situation, somebody they have respect for because it is a specialty."
Turnarounds "can be done with somebody who is capable, and Tom is capable," Ludwig, who is currently a managing partner at Canapi Ventures and CEO of Ludwig Advisors, added.
A reluctant Midwesterner
O'Brien didn't exactly jump at the chance to sign on with Sterling when the company first contacted him. For one thing, O'Brien was born and raised in central New York and had spent his entire career at banks in New York and New Jersey. O'Brien was reluctant to move to Southfield, which borders Detroit to the north.
His sense of hesitancy was reflected in the press release announcing his hire. "This was not an opportunity that I actively sought," O'Brien stated in the release.
"I think I said no three times before I said yes," O'Brien added in an interview.
Then, there was the seriousness of the company's problems.
Sterling had entered into a formal agreement with the OCC in July 2019, about a year before O'Brien took over as CEO. It was clear, though, that Sterling remained the subject of investigation by multiple agencies.
O'Brien's job involved responding to those various probes, as well as complying with a far-reaching OCC formal agreement.
"The entire information technology platform, anti-money laundering department, risk management all had to be built from the ground up," O'Brien said.
"In the beginning, there were a lot of 60- and 80-hour work weeks," O'Brien said.
You don't get bored. Every day, you come in for action. You're not underutilized.
A sports fan, O'Brien said he never got to see the local teams, Lions, Tigers, Red Wings and Pistons, play a game. "I got to play one round of golf," he added.
The bank's problems originated in its Advantage Loan program, a low-documentation initiative introduced around 2011 to provide home loans, mainly to Chinese nationals and recently arrived Chinese immigrants. Ostensibly, Advantage was a notable success, generating $5 billion in originations and driving outsize profits, including a whopping $63.5 million in 2018. Sterling highlighted Advantage as the centerpiece of its 2017 initial public offering, which raised $85.6 million for the company.
According to the Department of Justice, however, Sterling had cooked the books, resorting to widespread falsification of the documentation required to establish borrowers' income and ability to repay their loans.
Sterling's prospectus advertising the IPO "contained materially false and misleading statements that touted the soundness of the ALP loans," the Department of Justice stated in a March 15 press release. "In truth, the ALP was rife with fraud."
Beyond complying with the OCC order, O'Brien's plan to remedy Sterling's ills involved offering to buy back all Advantage loans the company had sold to investors along with complete cooperation with authorities.
"I just tried to give them whatever they wanted as quickly and as comprehensively as I could," O'Brien said. In the case of the Justice Department, that amounted to more than 6 million documents during the course of its investigation.
The strategy paid dividends as one-by-one Sterling announced the settlement of legal and regulatory issues. In September, the company settled a major class-action lawsuit, agreeing to pay investors $12.5 million. A few days later, the OCC terminated the formal agreement, levying a $6 million civil money penalty. Hefty payouts notwithstanding, O'Brien characterized the twin announcements "one of the best weeks for me personally, one of the best board meetings we've ever had, you name it."
Sterling's biggest domino fell in March, when it pled guilty to securities fraud. The agreement required Sterling to pay an additional $27.2 million in restitution to non-insider shareholders, but it could have been significantly worse for the company, since the Justice Department did not impose any additional fines.
According to Sewell and other analysts, few community banks have endured the level of scrutiny Sterling received. "It is quite significant and unusual to see ... what effectively looked like supervisory issues surface in a criminal process. That does not happen every day," Sewell said. "When you consider everything this bank went through, it adds up to quite a significant package of penalties — especially relative to its size," Sewell added.
Like Sewell, Jeremy Babener, founder of Structured Consulting in Portland, Oregon, called it "highly unusual" for a bank the size of Sterling to draw the attention of the Department of Justice and other large law-enforcement agencies, though he added its experience "can show how serious banking fraud is."
Indeed, where fraud is involved "size doesn't matter," said Eric Young, a compliance expert who serves as senior managing director at Guidepost Solutions in New York. "The DOJ has said that."
Next moves
For Sterling, concerns about fraud and the attendant repercussions are fast fading into the past.
The SEC concluded its investigation earlier this year announcing it did not intend to recommend further enforcement actions against Sterling. Redemption of the subordinated debt may have represented the last loose end in need of tying.
As a result of its repurchase commitment, Sterling reported about $825 million of Advantage loans on its books as of March 31. In May, it announced the sale of 84 nonperforming real estate credits, primarily Advantage loans, in a deal that cleared up a significant portion of its asset-quality issues.
Sterling's last remaining legal issue is the lawsuit it filed against former CEO Scott Seligman. The lawsuit alleges a breach of fiduciary duty connected to the Advantage Loan program. Seligman has denied the allegations.
Sterling reported a $14.2 million loss for 2022, due mainly to the DOJ settlement, which was accounted for in the company's fourth-quarter earnings. For the first quarter, Sterling essentially broke even, reporting a loss of $500,000. Sterling returned to profitability in the second quarter, reporting net income totaling $2.5 million. In the wake of the May loan sale, nonperforming assets totaled $2.1 million, or 0.08% of total assets.
More importantly, Sterling reported shareholder equity totaling $317.7 million on June 30, giving it more than enough resources to work with as it plots a future course, according to O'Brien.
"We have the unique opportunity of being able to say we can do anything now," O'Brien said. "We're not wedded to one business or another; we've got the systems; we've got liquidity. It's kind of a blank canvas.
"At this point, there is virtually no more remedial work to do," O'Brien added.
With Sterling's recovery phase winding down, O'Brien has pondered his next career move. While he didn't rule out staying, there are factors working against a longer tour at Sterling. For one, if the board does act on his advice to relocate its headquarters, it is unlikely O'Brien would want to move with the company to California.
"I'm not a West Coast guy," he said.
O'Brien said he would welcome a post that provided more opportunity to weigh in on broader industry issues, particularly the future of deposit insurance.
"From a policy perspective, we have to re-think the entire way the [Federal Deposit Insurance Corp.] operates and insures and how they charge, because it just doesn't work," O'Brien said. "It's a 1933 concept in a world that is just so radically different.
"There are appropriate solutions here," O'Brien added. "I think they deserve to be kicked around and thought about, maybe discarded because they don't work. A real serious attempt at not going through this again ... I probably would enjoy being part of those conversations."
Another role O'Brien refused to rule out is that of turnaround CEO at some other troubled institution. Given the prevailing economic headwinds, he fears there will likely be no shortage of candidates in the near future.
"If I could be a value-add, I guess I'd have to think about it," O'Brien said.
Though he called working with clients to craft solutions to credit and other financial needs "the best part of the banking business," O'Brien acknowledged an "adrenaline rush" that accompanies turnaround situations.
"You don't get bored," O'Brien said. "Every day, you come in for action. You're not underutilized."
Like O'Brien, Ludwig predicted an economic downturn would produce a new crop of problem banks. "I'm sorry to say we'll probably find a couple more troubled situations that can use Tom's talents," he said. O'Brien's willingness to jump back into the fray came as no surprise," Ludwig added.
"If you're a specialist … you like the opportunity to practice your craft," Ludwig said. "People like Tom are special. They have a genuinely unique talent, part experience, part intuitive, with a strong dose of numerical rigor."
