Private Equity Bank Deal Struggling - TheStreet



) -- A proposed private equity-led deal to recapitalize Spokane, Wash.-based bank

Sterling Financial

(STSA) - Get Report

has run into trouble, and the parties involved are concerned regulators could step in and find a new plan to fix the struggling bank.

Under an agreement announced May 24,

Thomas H. Lee Partners


Warburg Pincus

would each invest $139 million in exchange for a 20.5% stake in Sterling. However, the deal is contingent upon Sterling raising at least another $442 million, a feat that has proved difficult. Sterling first announced a proposed investment by TH Lee April 27, before later announcing a modified deal adding Warburg Pincus to the mix on May 24.

One source close to potential investors in the deal says the difficulty is the result of the stock market sell-off in May. Prior to the selloff, many publicly-listed banks were trading at a healthy premium to book value. That made an investment in Sterling look attractive at what would have been a price equal to book value. As publicly-listed banks have cheapened, however, the private deal looks comparatively less attractive, this source said.

Another person who has eyed the deal but is less closely involved believes the difficulty lies in too-aggressive assumptions related to a deferred tax benefit. Like many banks, including


(C) - Get Report


Bank of America

(BAC) - Get Report

, Sterling hopes to make use of its past losses to avoid taxes on future profits. The potential for making use of those losses is known as a deferred tax asset, but in order to make use of the asset companies need to have profits to offset.

Citigroup sparked controversy for what some argued was a too-aggressive use of its deferred tax asset,

but the bank now looks to have largely won the argument


If Sterling cannot put a deal together, regulators may step in and sell the bank outright, according to the source close to potential investors.

JPMorgan Chase

(JPM) - Get Report

which has a strong retail presence in the Pacific Northwest following its 2008 acquisition of Washington Mutual, might be a logical candidate if the government is willing to make the deal attractive enough by bearing a greater share of Sterling's losses.

Cara Coon, a spokeswoman for Sterling, says the bank expects the deal with the private equity firms to be completed before a Sept. 1 deadline, though she says that deadline could be extended.

Added sweeteners to the deal to attract new buyers could come from either the Federal Deposit Insurance Corp. or the U.S. Treasury, which invested $303 million in Sterling under the Troubled Asset Relief Program. As part of currently proposed deal, the Treasury has agreed to sell its stake in Sterling at a discount, as it did when

TD Bank Financial

(TD) - Get Report

bought failing lender

The South Financial Group( TSFG)


Not helping the situation is a difficult environment for private equity-led

bank deals

. Such transactions were challenged from the outset, since there are strict limits on how much control over a bank a private equity firm is allowed to have. Further regulatory changes, as well as generally stiffer resistance to private equity from regulators than many initially expected, have made investing in banks even less appealing for buyout firms.

Still, some firms, including

J.C. Flowers & Co .


The Carlyle Group


The Blackstone Group

(BX) - Get Report

have made bank investments in the past year and a half. So has

Warburg Pincus

, which took a $115 million stake in

Webster Bank

(WBS) - Get Report

nearly a year ago.

But those deals are the exceptions. Tom Chen, head of the investment banking unit at Piper Jaffray that advises on deals in the financial industry, estimates at one point 90% of private equity firms were interested in bank investments, but he guesses the number is now closer to 35-40% as several firms have decided it isn't worth the hassle for what are likely to be relatively modest returns.

"At the end of the day, it's just a bank," Chen says. "It's not like you're buying the next


(GOOG) - Get Report



(AAPL) - Get Report



Written by Dan Freed in New York