Bailout Nation

To find a sobering example of how precarious Washington states relatively healthy banking sector is, one need look no further than Sterling Financial.

The Spokane-based bank, one of the states largest independent financial institutions, received $303 million in federal money last year, the most of any of the half dozen or so banks that have thus far cued up for a cash infusion.

The money comes from the acronym-friendly U.S. Department of Treasurys Troubled Assets Relief Programs Capital Purchase Program, sometimes called CPP, but better known as TARP.

For his part, Sterling Financial chairman and CEO Harold Gilkey says the federal cash will add liquidity and inject capital into financial institutions [and] benefit the industry as a whole. One of the things this capital injection with TARP is going to provide [is] significantly fortressed balance sheets.

Unfortunately, Gilkey later found out that the money may also be needed to stanch his own bleeding balance sheet. On Jan. 13 of this year, Sterling Financial suspended payment of its dividend. Later that same day, the bank announced that, because of worsening economic conditions, Sterling Financial would record a loss for all of 2008.

The news probably shouldnt have been a shocker. After all, Sterling Financial had stated earlier in the year that it was facing worsening financial conditions due to bad construction and housing loans. But shareholders responded to the January bombshell by dumping the banks stock and pushing its share price down by about 67 percent in one week, to $2.14.

The question that continues to loom over Washingtons banking sector is: If relatively healthy banks such as Sterling Financial are facing tough times, what is the situation like for the rest of the sector this year?

DON’T CALL IT A BAILOUT

Aside from the spectacular implosion (and eventual acquisition) of Washington Mutual, most Northwest banks hadnt fared too badly in 2008 compared to those in other parts of the country.

But that picture may change in 2009. Of the 83 Washington-based banks, it is not known how many applied for the federal cash. At the beginning of this year, at least 11 institutions had received nearly $830 million via the CPP (see chart). Everett-based Frontier Financial and Spokanes AmericanWest Bancorporation have also applied to TARP for an additional combined total of about $173 million in CPP funds.

The purchase program funds represent about $250 billion of the overarching $700 billion TARP package, which was allocated by Congress to stabilize the nations teetering financial system. This first tranche of funds is being used to purchase shares in bankslarge and small, troubled and relatively healthythroughout the nation.

In return for the money, the federal government is receiving preferred stock in the participating banks, upon which the banks will pay 5 percent in dividends for the next five years (after which, the rate increases to 9 percent). The wide-ranging amounts awarded to various banks are based on the program guideline that each participating bank can offer to have the government purchase no less than 1 percent and no more than 3 percent of risk-weighted assets.

The TARP program continues to receive blistering criticism from observers who describe it as little more than a handout to an industry that has effectively driven itself into the ground, mainly through poorly managed or risky lending practices. The apparent secrecy that is surrounding how these banks are using the money has only added fuel to the fire.

But bank officials accepting the money through CPP defend the program. The CPP money is not bailout money, says Randy Fewel, president and CEO of Spokanes Inland Northwest Bank, which applied for funds. Its an investment in the banks, the idea being to stimulate lending. We believe the government will make money on this [plan].

Inland Northwest is not projecting growth for 2009, but Fewel says that if the institution gets TARP money (which it had not been notified of at presstime), the bank will amend the budget and make more commercial and consumer loans.

Megan Clubb, president and CEO of Walla Walla-based Baker Boyer Bank, which is not participating in the TARP program, agrees that the plan will get the dysfunctional markets moving and help them become healthy again.

The government has stepped in to recapitalize the banks, she says, [but] the government will get repaid.

HELPING THE STRONG SURVIVE

In hopes of making sure to have the best chance of getting repaid, the U.S. Treasury Department seems to be stacking the deck, in a senseoffering TARP money to many banks that are in relatively sound or strong positions. The aim is to bolster those banks that have the best chance of surviving the ongoing purge. While few banks in Washington state have gone under, the numbers may increase this year. Along with Washington Mutual, the financial meltdown has snared The Bank of Vancouver, which the FDIC closed in January.

A prime example of the Treasurys plan is Washington Federal. The Seattle-based bank had no immediate need for TARP funds, according to Roy M. Whitehead, the banks chairman, president and CEO. Nonetheless, the bank accepted an invitation from the Treasury Department in the third week of October 2008 to apply for the TARP program.

Whitehead says it makes sense to offer financial support to banks like top-rated, well-capitalized thrift Washington Federalwhich he describes as a banking industry Rock of Gibraltarwith a proven track record and the greatest potential to overcome the ongoing industry adversity, rather than those more imperiled institutions that have less chance of survival.

If youre going to make an investment in the economy, who are you going to give that money to? Whitehead asks. The Treasury [Department] does want to get their money back, and [theyre putting money] where it can do the most good.

And despite Sterling Financials announced losses in 2008, the largest of the Washington-based TARP recipients still maintains it is in good shape to weather this financial storm. While the Spokane bank took some big hits throughout last year, especially in its residential construction portfolio, it is well capitalized with large financial reserves.

Still, not all local banks are opting to be part of TARP. Case in point: Baker Boyer Bank, which formally announced in mid-December that it would not participate in the CPP.

In a release at the time, Clubb was quoted as saying, We understand clearly that Baker Boyer would be eligible to participate in the CPP plan, but after careful review of the program and customers needs, we have determined our strong capital base and earnings will allow us, without taxpayers assistance, to be a reliable source of loans to customers who want to grow and operate their businesses or to purchase cars or homes.

The community bank, which focuses on wealth management and small-business clients, has withstood the recent financial storm really well … by sticking to banking fundamentals, Clubb says.

Specifically, Baker Boyer avoided subprime lending and focused more than 80 percent of its business locally in the Walla Walla Valley. She adds, We didnt put excess deposits into risky toxic investments.

LENDING FREEZE CONTINUES

Now that local banks are getting money to help them get back on their feet, or at least steady their stance, it remains to be seen whether these institutions will use the federal funds to help their customers turn things around financially.

Nationwide, TARP-receiving banks came under fire in December when it was widely reported that many of them adamantly refused to share details about how they planned to spend their taxpayer-funded aid. This incident underscored ongoing concerns that banks would simply use their TARP aid to help improve their financial situation and beef up liquidity, while still keeping their purse strings tightly closed to potential borrowers.

While Clubb says her lending business has remained normal, and deposits at Baker Boyer have grown 12 percent in the past year, she believes that, with the credit freeze youre seeing, banks that arent in our position … are finding themselves with concerns about demands of depositors. The banks are hoarding their cash and investments that are highly liquid. With the disastrous examples of IndyMac and Bear Stearns fresh in their minds, she adds, many banks will hold onto their assets more aggressively.

A November 2008 story in The New York Times also suggested that Cascade Financial, which was financially scarred by investments in Fannie Mae and Freddie Mac, plans to use its government funding to bolster its own balance sheet before it will consider lending.

Brad Williamson, director of the Division of Banks at Washingtons Department of Financial Institutions, agrees. Banks in Washington will be cautious and make sure theyre looking to high-quality borrowers, he says.

But some bankers point out that part of the problem is that, in the current economic climate, there simply arent as many opportunities to make those high-quality loans.

Businesses have been affected because of tightening of credit markets, says Dennis A. Long, CEO of Aberdeens Bank of the Pacific. Community banks want to do commercial and industrial loans. However, he adds, building and land acquisition, home construction, and residential home purchases have suffered declines.

Customers recognize its a harder business out there, says Gilkey of Sterling Bank. Many of them arent looking for loans yet. The normal sources for permanent loans have slowed down.

Likewise, Washington Federal is finding that good borrowers are a relatively scarce commodity. There hasnt been a day as bankers when we didnt want to make every good loan we could find, Whitehead says. But consumers are trying to repay debt right now. And with some rare exceptions, most businesses are not looking to [expand] or buy equipment.

IMPROVING FINANCIAL HEALTH?

So, most banks are looking ahead, while preparing for a bumpy and slow-going ride through the next year.

They hope 2009 will give way to a financially healthier (if more consolidated) industry. Inland Northwest Bank has grown an awful lot in the last two years, says Fewel. That rapid growth outstripped our ability to earn profits. Now we just need to digest.

Like most bankers, Fewel also sees this year as a poor one for profits and expects more banks to go out of business. At least 25 banks in the United States failed in 2008, according to the FDIC. Most analysts expect that figure to rise considerably in the coming months.

Were hunkering down and riding this out, Fewel says. Its just part of the business cycles ebb and flow, and this is a correction that needed to happen.