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Originally published December 31, 2010 at 7:42 PM | Page modified December 31, 2010 at 8:31 PM

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Fewer banks in region may fail in 2011, but weaker ones may sell out

After a record year of bank failures, conditions are ripe for a wave of privately orchestrated mergers and acquisitions among Pacific Northwest financial institutions.

Seattle Times staff reporter

After bank failures across the nation nearly every Friday for the past two years, bankers and regulators expect to catch their breath in 2011 and maybe start the weekend early for a change.

Instead of regulators seizing banks, conditions are ripe for a wave of privately orchestrated mergers and acquisitions in the Pacific Northwest, experts say.

"Fewer failures, but many mergers," predicts Brad Williamson, director of banks at the Washington Department of Financial Institutions.

Bank failures reached a record high in 2010: Nationally 157 failed, up from 140 in 2009. Eleven banks failed in Washington, up from three in 2009.

Washington ranked fifth among the states in the number of bank failures, behind Florida, Georgia, Illinois and California.

Most of the failed Washington banks were buckling under the weight of loans to developers and builders that defaulted since the housing bubble burst in late 2007.

Frontier Bank, which was owned by Everett-based Frontier Financial, was the biggest bank to fail here since Washington Mutual's collapse in September 2008. Frontier was the fifth-largest bank headquartered in the state and the second largest in the Puget Sound area.

The Federal Deposit Insurance Corp. (FDIC) estimated that Frontier Bank's failure in April will cost the deposit-insurance fund $1.37 billion — more than any bank in state history, and nearly equal to the cost of the 10 other Washington banks combined. (Because of WaMu's corporate structure and the way its takeover was handled, the FDIC says it cost the deposit-insurance fund nothing.)

Two other state banks with more than $1 billion in assets failed in 2010 — Horizon Bank in Bellingham, and City Bank in Lynnwood.

Conditions at Washington community banks are still poor but better compared to the end of 2009, Williamson said.

About 44 percent of banks in Washington were unprofitable as of Sept. 30, according to the FDIC.

That's encouraging because a year ago 65 percent were unprofitable, Williamson said. On the other hand, only 14 percent of banks were losing money at the end of 2007.

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Sara Hasan, an analyst at Seattle brokerage firm McAdams Wright Ragen, said the shakeout will continue in 2011, but more and more of it will come in the form of private transactions rather than FDIC-assisted deals.

Many banks are saddled with high levels of soured real-estate loans and feeling heat from regulators to raise fresh capital. Banks are seeing tepid growth in business loans and thin margins on interest income, she said.

Meanwhile, the costs of complying with the new regulatory reforms is so high it could affect small banks' ability to generate profits for shareholders, Hasan said.

"It is very difficult to be a really small bank," she said.

The sharp drop in housing prices and soaring job losses also took down The Union Credit Union — the first credit union to fail in Washington in 15 years. Members of the tiny Spokane institution mainly were working in the construction industry.

Several healthy banks in the Pacific Northwest grew last year by bidding on failing banks seized by regulators: Seattle-based Washington Federal Savings and Loan picked up Horizon Bank.

Umpqua Bank of Oregon acquired Seattle's Evergreen Bank and Tacoma's Rainier Pacific Bank.

Heritage Bank of Olympia purchased Longview's Cowlitz Bank and Pierce Commercial Bank of Tacoma.

And Whidbey Island Bank absorbed City Bank and Arlington-based North County Bank.

Banks eager to grow likely will have fewer failed banks to bid on in 2011 and more competition from other bidders, Hasan said, spurring some to pursue private deals.

There's already evidence investors see long-term-growth potential in the region's banking sector.

Spokane-based Sterling Savings, the state's second-largest bank, in August announced $730 million in new capital from private equity and institutional investors.

And 58-branch AmericanWest Bank of Spokane was recapitalized with $185 million by California-based SKBHC Holdings, which bought it for $6.5 million after the bank's holding company filed for Chapter 11 bankruptcy protection.

In both cases, earlier shareholders in the struggling banking companies were left with little or nothing.

More consolidation is coming. But it remains to be seen if the buyers will be locally based or larger players from California and elsewhere, as were buyers in some of the FDIC deals.

Hasan, the analyst, said several local banking companies such as Washington Federal, Columbia Banking System and Washington Banking Co. "essentially have money burning a hole in their pockets.

"Now that maybe the worst of the storm has passed, they'll look for an opportunity to deploy that capital," she said.

Sanjay Bhatt: 206-464-3103 or sbhatt@seattletimes.com

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