Reputations invested in Sterling are as good as money

Two important partners last week joined the Sterling Financial Corp. recapitalization effort.

When it comes to brands, it’s hard to top the U.S. Department of the Treasury.

Less well known, except within the investment community, Thomas H. Lee Partners also contributed its solid gold reputation. A $134.7 million investment will follow if Sterling can parlay the new endorsements into a complete, $720 million package.

That tall order, made taller by another quarter of gruesome losses, has been unmet since regulators in October ordered the sacking of Sterling management and demanded the Spokane institution bring in new money to offset the loss of the old. Deadlines were imposed, then extended. Tuesday, Lee set a deadline of its own for a Treasury buy-in. Having already signaled its willingness to participate under certain conditions, a quick assent on Thursday was no surprise.

But that could not have been a decision made lightly.

In November 2008, the Treasury committed $303 million from the Troubled Asset Relief Program to Sterling, which was facing enormous real estate and construction loan problems. Under the recapitalization plan, the Treasury will get only $75 million of its investment back – an initial hit to the Treasury of $228 million. The hope for complete recovery lies in the 6.4 million warrants that will entitle the government to buy Sterling common stock at 20 cents per share for the next 10 years.

Only one other bank has received the same relief from the Treasury. Several hundred banks still have TARP obligations, most of them small- or mid-size institutions. Why Sterling, and who made the decision?

Well, bad as Sterling’s balance sheet may be, it still has a wonderful franchise: 178 branches covering states from Northern California to Montana. Retail deposits continued to grow in the first quarter.

Craig Hart, president of Hart Capital Management, suggests Sterling’s size has another positive. A takeover would cost the Treasury its full $303 million and the Federal Deposit Insurance Corp. perhaps $700 million.

“You’re talking about a potential $1 billion loss to those two agencies,” Hart says.

The FDIC has proceeded cautiously with bank takeovers, he says, because of the risk to its insurance fund, which is in the red pending a prepayment of assessments ordered last year. Sterling would be a big pill to swallow.

Last week’s announcements made that unlikely, he says.

“Thomas H. Lee has a very good reputation and respect in the investment community,” Hart says.

The Boston firm’s willingness to participate in Sterling’s recapitalization should bring more investors into the effort, he says, adding, “It’s great for the community. It’s great for Sterling.”

Brad Williamson, who heads the Washington Department of Financial Institutions’ Banking Division, has monitored Sterling’s progress closely.

Neither the Treasury nor Lee would venture their credibility unless they were confident other investors were poised to put more money into the bank, he says.

Also, Williamson says the Treasury would not have gotten involved without someone at the top levels of the department signing off on the deal, a comment a spokesperson would not confirm until all the elements of the recapitalization plan are in place.

“I have a lot of confidence the transaction will, in fact, be fully subscribed,” Williamson says, noting that other Washington banks have recently secured more capital.

Hart and Williamson expect the Sterling reformation to play out within the next few weeks.

A lot of Sterling partnerships, with employees, customers and communities, especially Spokane, ride on the outcome.