Bert Caldwell: Sterling, feds are getting reacquainted

Les Weatherhead and Carol Friend saw each other for the first time in 17 years Thursday morning. The pleasantries were brief.

Weatherhead, as attorney for Sterling Financial Corp., was questioning Friend about her actions as a former assistant director of the U.S. Office of Thrift Supervision Seattle office.

Friend was an overseer of Sterling during a critical period following the 1989 enactment of legislation — the Financial Institutions Reform Recovery Enforcement Act, or FIRREA — intended to halt the implosion of the savings and loan industry. Long-term, low-interest mortgages were killing thrifts forced to pay higher interest rates on short-term deposits. Also, many thrift executives were reckless, or worse, making non-mortgage investments offering higher returns.

Bailing the industry out ultimately cost U.S. taxpayers more than $125 billion.

Sterling helped bail by taking over three other Washington thrifts with the help of some federal cash, and agreements that the gap between the value of a failing institution’s assets and its liabilities could be carried on Sterling’s books as capital. How much a bank or thrift can lend depends on how much capital it has.

How wisely it may lend is another matter. One of the loans on the woeful books of Tri-Cities Savings, taken over by Sterling in 1988, was made to a museum in Scottsdale, Ariz. It’s no small trick for a Kennewick banker to get underwater on a loan in the middle of the Arizona desert.

Taking over Tri-Cities, Lewis Federal Savings & Loan, and Central Evergreen Savings and Loan was a stretch for Sterling, one that had the Spokane thrift in a precarious capital position when FIRREA was passed. Probably nothing could have put the company in more peril. A $10.5 million offering of preferred stock had been planned to shore up the balance sheet, but OTS ruled the shares could not carry a dividend.

No dividend, no sale.

Friend and her fellow OTS regulators refused to back off, instead insisting on an alternative capital plan, or a sale of Sterling.

Bids were entertained, three buyers showed interest. Only one, Washington Mutual, followed up with a due diligence review of Sterling’s books.

By then — spring 1990 — Sterling officers were so concerned nervous employees would bolt if they became aware of a pending sale, that they insisted Washington Mutual perform its review away from Sterling’s downtown offices. The examination took place at the airport Ramada Inn.

They had cause to be gun-shy. Key loan officers had already left. More ominously, Chairman Harold Gilkey early on found himself confronted in his office by a stranger who said he was going to close Sterling and put Gilkey in jail. That was not the only threat made as he and other Sterling officers declined to hand the keys over to OTS.

At one point, Friend and other OTS types went before Sterling’s board of directors to convey, face-to-face, the urgency of the thrift’s plight.

Washington Mutual never made an offer. Sterling turned to the courts for relief. On May 29, the thrift obtained a temporary restraining order barring OTS from seizing Sterling.

The U.S. Supreme Court subsequently ruled FIRREA had improperly abrogated contracts that dozens of thrifts had negotiated with their regulators. Since then, the feud between Sterling and OTS has boiled down to damages, with the government asserting it’s a small matter of $900,000, and Sterling looking for something more like $63 million.

But for the government’s reneging on its commitments, Gilkey testified, Sterling might the twice the $11.4 billion regional banking powerhouse it has become since 1991, when it was finally able to raise new capital.

So far — its witnesses, except for Friend, do not take the stand until this week — the government has questioned the damage caused by Sterling’s weakened capital position, and argues that executives had a much freer hand to run Sterling as they saw fit after regulators were enjoined from enforcing restrictions they had imposed on the bank.

Friend said regulators had little discretion under FIRREA, and that she had no animosity toward Sterling.

You’ll excuse Sterling officials for not taking that pleasantly.