A fundraising that regulators have required Sterling Savings Bank to perform could end up totaling $600 million, rather than $300 million, two of the Spokane bank's top executives say.
The amount of equity capital Sterling will need to raise is subject to change, and as of Dec. 31, it was at about $600 million, says Dan Byrne, executive vice president and chief financial officer of Sterling Financial Corp., the bank's holding company.
"It looks like it will be on the upper end," Byrne says.
The amount of regulatory capital, or so-called Tier 1 capital, that the bank has, which is defined as shareholder's equity plus reserves set aside for loan losses, had fallen at year-end as Sterling Financial's shareholders' equity plunged to $323 million from $666 million on Sept. 30.
"Tier 1 capital is a function of the balance sheet size," Byrne says.
On Oct. 15, Sterling Financial said that Sterling Savings, which is its biggest subsidiary, had reached an agreement with regulators to raise $300 million in equity capital by Dec. 15. Sterling Savings didn't meet that deadline, but its management team says the regulators have given the bank leeway on the deadline.
By specifying earlier that Sterling would raise $300 million, the Federal Deposit Insurance Corp. wanted "to establish an amount that would get us into the capital market," says Ezra Eckhardt, chief operating officer of the bank and the bank-holding company and president of Sterling Savings. "They wanted to create an impetus for action."
A second way to address lagging regulatory capital is to reduce assets, and Sterling has done that by cutting its assets to $10.9 billion from $12.8 billion in 2009, Eckhardt says. Yet, he says, the regulators "didn't want us just to reduce our assets; they wanted us to raise capital." He adds, "We believe we have adequate access to the capital markets." Typically, a bank's loans make up more than half of its assets, and Sterling says it "deleveraged," or reduced its reliance on borrowed money, when it reduced its assets.
All along, it has been important for Sterling Savings to raise an amount of equity capital that would allow it not just to satisfy regulatory guidelines, but to meet its long-term business goals, "not to scrape by, but to be adequately capitalized" so it could be competitive and do well, Eckhardt says.
While Sterling expects that its capital-raising efforts will include a stock offering, it also believes the effort will include multiple financing sources. Eckhardt and Byrne say Sterling offered to pay 20 cents on the dollar when it announced on Feb. 1 an effort to purchase $238 million in trust preferred securities, on which Sterling had accrued, rather than paid, dividends. In trust preferred offerings, banks issue debentures and establish trusts to issue the securities.
Asked why the owners of those securities would accept 20 cents on the dollar in payment, Eckhardt says that if they already have written down the securities to market value, payment at the reduced valuecoupled with the tax break they would realize by selling the securities at such a lossmight provide the holders of the securities with the best possible return.
Although Sterling would sell stock to raise money to buy the trust preferred securities at a discount, the holders of the securities wouldn't receive stock, says Byrne.
"It's a cash tender offer," he says. "Our investment banker told us it's easier for them to take cash rather than common stock." The purchase of the trust preferred securities is subject to regulatory approval, as is the public offering that Sterling would conduct to raise funds to buy the securities. Sterling says the holders of the securities have 20 business days to decide whether to accept the offer.
As part of Sterling's restructuring of its capital position, it also hopes to persuade the U.S. Department of the Treasury to accept common stock in exchange for the preferred stock the government received when it provided $303 million in capital to Sterling through the Troubled Asset Relief Program. Byrne says there's some precedent for Treasury to accept common stock for the preferred. At year-end, Sterling owed the government $17.4 million in unpaid dividends on the preferred shares.
While Sterling hasn't said when it expects to complete the capital raising, it does say it expects that its hiring of a new chief credit officer to replace Steve Page, who retired in January, will happen in 45 to 100 dayseither in connection with the capital raising or after the capital raising is completed.
Last week, Sterling Financial reported that it had lost $855.5 million, or $16.48 a share, in 2009, and $336.7 million, or $6.51 a share, in the fourth quarter.
Sterling's results were hurt when it took a charge of $340.3 million in the fourth quarter for funds it had set aside to cover potential loan losses. On a full-year basis, Sterling set aside a total of $681.4 million for that reason.
Asked whether Sterling is done making quarterly announcements that it has set aside large amounts of money to cover potential loan losses, Byrne says, "We sure would hope so."
He adds, "We have reviewed and discounted a sizable portion of our residential construction portfolio. There's not much left. The rest seems to be performing."
Sterling wrote off $272.1 million in bad loans in the fourth quarter, up from $182.5 million in the year-earlier period. As of Dec. 31, its allowance for credit losses, or the running total of amounts set aside to cover potential loan losses minus charge-offs, was $355.4 million. That's the equivalent of 4.62 percent of total loans, up from 2.55 percent a year earlier.
Eckhardt says Sterling logged good results during the year, for example by increasing its number of checking accounts by 3 percent. In the fourth quarter alone, it boosted total checking account balances by 10 percent. Both those achievements serve its strategy of attracting core deposits and were accomplished through solid efforts by the bank's employees, Eckhardt says. Checking accounts are a low-cost source of funds, he says.
While deposits declined by 7 percent during the year, Sterling reduced by 27 percent its reliance on brokered deposits, which are placed by brokers, and are totally rate dependent and transitory. It originated $844.8 million in loans in the fourth quarter, up 17 percent from the fourth quarter of 2008.
The bank's liquidity, as measured by its net loans-to-deposits ratio, improved by 11 percentage points in 2009, ending the year at 94 percent for the best ratio in Sterling's history, Eckhardt says. When a bank has more loans than deposits, it has to borrow funds from sources such as the Federal Home Loan Bank, he says.
Meanwhile, the bank slashed its deposit-funding costs during 2009 by almost a full percentage point, to 1.76 percent from 2.7 percent in 2008, when high certificate of deposit rates offered by now-defunct Washington Mutual Bank and a higher interest rate environment pushed those costs up.
In the fourth quarter, Sterling's noninterest income increased 28 percent, reflecting in part higher income from mortgage banking operations.
"We feel strongly that the general performance of the organization is good," Eckhardt says. "The performance of 2,700 employees is overshadowed by the focus on credit quality."
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