Free Proposed Findings of Fact and Conclusions of Law - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

PLAINTIFFS IN ALL WINSTAR-RELATED CASES AT THE COURT Court No. 95-829c Plaintiffs, vs. THE UNITED STATES, Defendant. (Chief Judge Smith)

STERLING'S POST-TRIAL MEMORANDUM OF CONTENTIONS OF FACT AND LAW

WITHERSPOON, KELLEY, DAVENPORT & TOOLE, P.S. 1100 US BANK BUILDING 422 W. RIVERSIDE SPOKANE, WA 99201 Tele: (509) 624-5265 WILLIAM D. SYMMES LESLIE R. WEATHERHEAD September 21, 2007

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

STERLING SAVINGS ASSOCIATION, a state-chartered savings association, STERLING FINANCIAL CORPORATION, a Washington Corporation, Plaintiffs, vs. UNITED STATES OF AMERICA, Defendant.

Court No. 95-829-C (Judge Wheeler)

STERLING'S POST-TRIAL MEMORANDUM OF CONTENTIONS OF FACT AND LAW

I. INTRODUCTION AND SUMMARY OF ARGUMENT Via the enactment, implementation and enforcement of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), the United States breached two contracts with Sterling Savings Association ("Sterling") that were made at the Government's request to help the Government remedy a nationwide thrift crisis. The issue before the Court is the appropriate damages due to Sterling resulting from that breach. The evidence and expert testimony presented at trial demonstrate that the lost profits measure of damages most appropriately compensates Sterling for the losses it suffered because of the breach, and Sterling, therefore, requests entry of an award of $63.327 million representing lost profits and wounded bank damages. Sterling has always been a profitable business, run by well-respected and experienced bankers. It has grown from $2.1 million in assets in 1983 to over $10 billion today. Throughout its existence, -1-

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it has been managed by the same team of executive officers. When the savings and loan crisis threatened the thrift industry, the Government sought out healthy thrifts like Sterling and induced them to acquire failing thrifts. Sterling, a highly-rated institution with strong management, was approached several times by the Government, and eventually acquired three failing thrifts. In exchange for taking the failing thrifts off of the Government's hands, Sterling was given cash assistance, credits to its regulatory net worth and forbearances from adverse action by the Government for specified terms. The consideration paid to Sterling was a mere fraction of what it would have otherwise cost the Government to liquidate these three thrifts. Months after the last transaction closed, however, the newly-enacted FIRREA legislation and regulations issued under the Act rendered the contracts, in the Government's eyes, void. The Government turned on the very thrifts it had looked to in a crisis for help, including Sterling, and decided those thrifts were the problem. The Government foreclosed nearly all avenues of profitability for Sterling, regulating it almost out of existence and, finally, planned to shut it down because of a perceived negative capital ratio that resulted from Sterling's acquisitions of the failing thrifts and from the Government's refusal to recognize the contractual capital credits in favor of Sterling. A temporary restraining order kept Sterling open, but the Government persevered in threatening Sterling with more sanctions should it venture outside of the limited activity allowed by the Government and attempt to regain the progressive growth that it had enjoyed prior to the breach. Ultimately, Sterling raised capital and got a reprieve from the regulatory death sentence against it and has since remained a profitable institution, despite the breach. But it has never cured the damage done by the Government's broken promises.

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During the three-week trial, the Government proffered two theories: (1) that Sterling fully mitigated the breach two years after it occurred and should only be compensated for its transaction costs; and, alternatively (2) that if Sterling did not fully mitigate, it is at fault for failing to do so and should recover nothing. Stated differently, the Government wants this Court to permit it to use the fact that Sterling has prospered in spite of the Government's breach to elide, via accounting, the harm its breach wrought. This should be rejected for two reasons. The United States Government's promise had value which would have been cumulative to the success Sterling enjoyed and black letter contract law requires a party who breaches a contract to pay the costs occasioned by his or her breach: Much of law and legal liability turns on fault, on the notion of wrong-doing, and of providing retribution for and discouraging such conduct. Contract law, and the consequences of breach of contract, do not. When parties enter into a contract, and promise each other that they will perform in accordance with the terms of their agreement, they retain a choice: when the time comes they can perform, and accept whatever benefits and losses the contract gives them, or they can refuse to perform and pay the consequences. Glendale Federal Bank, FSB v. United States, 239 F.2d 1374, 1379-80 (Fed. Cir. 2001) (emphasis added). The Government is not excepted from this rule. Whether FIRREA was justified as sound legislation is immaterial. The Government's breach may well have been an "efficient breach", but the Government must pay damages for the efficiency it gained. The Government breached a valid and binding contract and it is obliged to substitute its performance with money damages.

II. ISSUES PRESENTED 1. What is the amount of damages to which Sterling is entitled for breach of contract?

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2.

Whether the lost profits measure of damages reflect the actual harm done to Sterling by

the Government's breach? 3. In the event the Court determines that the lost profits analysis should not be applied, what

amount for the cost of replacement capital is the appropriate award of damages?

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III. PROPOSED FINDINGS OF FACT A. STERLING HAS ALWAYS EMPLOYED A GROWTH STRATEGY AND IN IMPLEMENTING THAT STRATEGY HAS GROWN FROM A TWO MILLION DOLLAR INSTITUTION TO AN INSTITUTION WITH ASSETS IN EXCESS OF TEN BILLION DOLLARS AS OF 2007. 1. 1. Sterling Constantly Increases Assets, Profits And Capital. Sterling opened its doors on April 4, 1983, with $2.1 million in capital. (Gilkey, Tr. 68,

lines 19-25; Gilkey, Tr. 70, lines 13-16; see also Joint Stipulation of Facts ("JSF") #1) 2. For every year of its operations, Sterling has been profitable. (Gilkey, Tr. 153, lines

3-19; Horvitz, Tr. 2036, lines 7-18, 2528, line 20 through 2529, line 5). In its entire history, Sterling has only shown a loss in one single quarter; this occurred in 1996, because of an extraordinary SAIF premium being imposed upon Sterling by the Government. (Byrne, Tr. 684, line 7 through 687, line 2) 3. From the very beginning, Sterling intended to grow quickly and has been successful in

this strategy. (Gilkey, Tr. 78, line 18 through 79 line 9; Gilkey, Tr. 82, line 3 through 83, line 13) 4. Sterling's strategy has been to grow the company by internal or organic growth at an

equal proportion to the growth by acquisition and to use leverage risk for the company's benefit. (Gilkey, Tr. 83, lines 3-19). 5. Sterling's growth plan recognizes that rural farm communities lack loan opportunities,

and accordingly Sterling took deposits from rural communities and used those funds to make loans in metropolitan market areas through its mortgage company operations, specifically, in Spokane, Boise, Portland, and Seattle. (Gilkey, Tr. 76 line 15 through 77 line 14) 6. Sterling has always sought ways to add capital through acquisitions or public offerings.

(Gilkey, Tr. 147, lines 16-20)

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7.

Sterling has always grown through acquisitions, and has, over time, acquired

approximately 20 banks or thrifts. (Gilkey, Tr. 83, lines 11-13; P-503; Gilkey, Tr. 398, line 25 through 399, line 11) 8. Sterling's business strategy for growth had always consistently included calculated

leverage risk. (Gilkey, Tr. 77, line 15 through 78 line 7). 9. Sterling's planned operation as a highly-leveraged company has historically placed it in

the lowest 10 percent for capital ratio among its peers. (Gilkey, Tr. 148, lines 5-15; Hamm, Tr. 3975, lines 20-22; Hamm, Tr. 3976, lines 5-6) 10. As a consequence of Sterling's capital ratios, its regulators have consistently taken the

position that Sterling needs additional capital. (Gilkey, Tr. 147, line 3 through 148, line 15; DX-263 (SG0053028)) 11. During Sterling's history, it never encountered difficulty adding assets except for

immediately after the implementation of FIRREA. (Gilkey, Tr. 156, lines 7-12). 12. After the Lewis & Clark acquisition, Sterling had roughly $4 million in capital; within a year, after leveraging that $4 million, Sterling grew to approximately $100 million. (Gilkey, Tr. 82, line 14 through 83, line 2) 13. Even facing competitive markets, Sterling grew from an initial capital input of

approximately $2 million to an asset size of over $10 billion with 3,000 employees spread over nine states as of 2007. (Barnett, Tr. 1180, lines 7-17) 14. As of 2007, Sterling is well over $10 billion in size, and has branches in Washington,

Idaho, Montana, Oregon, California, Nevada, Colorado, Utah and Arizona. (Gilkey, Tr. 153, line 20 through 154, line 4; P-501)

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15.

Sterling currently intends to continue to make more acquisitions, and requires more

capital to do so. (Gilkey, Tr. 442, lines 1-12) 16. But for the breach, Sterling would have been between a $25 billion and $50 billion

institution. (Gilkey, Tr. 405, lines 1-21) 17. Sterling still intends to grow, and eventually become an institution with a value in excess

of $50 billion. (Gilkey, Tr. 440, line 20 through 441, line 14) 18. Since 1991, Sterling has raised capital every year but two. (Gilkey, Tr. 290, lines 1-7

and 13-19; P-501; P-505; Gilkey, Tr. 418, line 24 through 419, line 2) 2. Sterling's Corporate Management And Geographic Location Have Contributed To Its Continued And Near Constant Growth. Sterling was formed by managers with commercial banking backgrounds, which gave

19.

the Government great confidence in its ability to succeed. (Faulstich, Tr. 344, line 7 through 345, line 25; Horvitz, Tr. 2042, line 10 through 2043, line 8). 20. Since opening Sterling Savings Bank, its management has formed a number of related

companies contributing to Sterling's market success: (1) In 1992 a holding company called Sterling Financial Corporation ("SFC") was formed. (Gilkey, Tr. 73, line 24 through 74, line 4; (Gilkey, Tr. 74, lines 5-11); (2) Action Mortgage Company, a Sterling subsidiary of Sterling in the business of residential mortgage construction, headquartered in Spokane, opened in 1988. (Gilkey, Tr. 72, lines 11-25; Gilkey, Tr. 123, line 24 through 124 line 5); (3) Intervest Mortgage Investment, another Sterling subsidiary in the business of commercial mortgages and concentrating both in construction and permanent loans for income-producing property, headquartered in Lake Oswego, Oregon (a suburb of Portland), opened in 1987. (Gilkey, Tr. 72, lines 13-22; Gilkey, Tr. 124, lines 5-7) 21. In the thrift industry, $5 of equity or capital will translate to approximately $100 of assets -7-

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using leverage. (Gilkey, Tr. 78 lines 10-17; Horvitz, Tr. 2022, lines 17-21) 22. The economy in the Pacific Northwest during the early 1990s was positive, with growth in the population, personal income, employment, and agricultural economy. (Gilkey, Tr. 284 lines 3-12; Faulstich, Tr. 343, line 20 through 344 line 6; Conerly, Tr. 885, lines 5-10; P-268, p. 9) 23. In addition to its corporate form and organization, Sterling's growth was aided by the fact

that from 1985 through 2000, the Washington, Oregon and Idaho economies were consistently growing, in contrast to other parts of the country and the overall U.S. economy. (Conerly, Tr. 888, line 2 through 891, line 4; Conerly, Tr. 894, line 21 through 899, line 18; Conerly, Tr. 917, line 11 through 919, line 13; Conerly, Tr. 922, line 18 through 926, line 6; Conerly, Tr. 931, line 20 through 934, line 6; Conerly, Tr. 942, line 17 through 944, line 9; Conerly 946, line 19 through 948, line 1; Conerly, Tr. 957, line 24 through 959, line 2; P-514; P-515; P-516; P-517; P-518; P-519A; P-521; P-268, p. 9) 24. A company operating in the Northwest would be in a favorable environment compared

to a comparable company operating in another part of the country. (Conerly, Tr. 959, line 23 through 960, line 13) 25. 21-25) 26. It is more likely that a financial institution will grow in a growing economy. (Conerly, Sterling's market area enjoyed stronger growth than most states. (Conerly, Tr. 963, lines

Tr. 984, lines 20-23; Conerly, Tr. 986, line 20-987, line 9) 3. Sterling's Pre-FIRREA Relationship With Government Regulators Was Uniformly Positive. The Government knew from the very beginning of Sterling's existence that it intended

27.

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(Faulstich, Tr. 340, lines 5-23) 28. From 1983 to 1988 Sterling's examination and supervisory ratings, which provide a snapshot of an institution's safety and soundness regulatory condition, were "exceptionally positive" and reflected good management. (Faulstich, Tr. 352, line 2 through 353, line 15; Horvitz, Tr. 2049, lines 21-23, 2051, lines 12-14; P-45, pp. 6-7; P-541) 29. Prior to the enactment of FIRREA, Sterling's relationship with its regulators was one of

mutual respect. (Gilkey, Tr. 141, lines 1-8.) 30. 31. In 1988, the FHLB of Seattle noted that Sterling's management was strong. (P-40, p. 1) The President of the FHLB of Seattle never considered Sterling to be a troubled thrift and,

indeed, thought of it as an ally because of its good management and willingness to acquire troubled thrifts which aided the FHLBB. (Faulstich, Tr. 320, line 21 through 321, line 15) 32. Mr. James Faulstich never believed Sterling was being mismanaged or run in an unsafe

or unsound manner prior to the enactment of FIRREA. (Faulstich, Tr. 354, line 20 through 355, line 1; see also Faulstich, Tr. 363, lines 5-12) 33. Prior to the enactment of FIRREA and its corresponding regulations, Sterling was in full

capital compliance. (Gilkey, Tr. 183, lines 3-8) 34. Before FIRREA, the Federal Home Loan Bank of Seattle never considered Sterling to be

a troubled thrift. (Faulstich, Tr. 230, lines 21-24) 35. Before FIRREA, the Federal Home Loan Bank of Seattle considered Sterling to be an ally

in resolving troubled thrift issues. (Faulstich, Tr. 231, lines 3-15) 36. At the time of the Tri-Cities acquisition the Federal Home Loan Bank of Seattle had "no

supervisory concerns with" Sterling. (P-24; p. 8).

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37.

The Federal Home Loan Bank of Seattle viewed Sterling's business plan after the

Tri-Cities acquisition as "an ambitious one," but consistent with Sterling's prior growth trends. (Faulstich, Tr. 336, lines 13-20; P-24, p. 9). 38. Mr. Faulstich, the principal supervisory agent for the Federal Home Loan Bank of Seattle,

had high regard for Sterling's management. This opinion was validated by Mr. Gilkey's high degree of competence and by Sterling's success. (Faulstich, Tr. 344, lines 4-19) 39. As of November 7, 1988 the Federal Home Loan Bank of Seattle considered Sterling to

have "a proven success record in demonstrating it can successfully integrate acquired institutions and/or offices into its operations while maintaining profitability and meeting minimum regulatory capital requirements." (P-45, p. 6) 40. As of November 7, 1988 the Federal Home Loan Bank of Seattle believed that "[p]art of

the reason for continued favorable examination ratings, despite its rapid growth, is due to its careful strategic planning. Sterling has indicated that it also prepares for growth by hiring capable personnel prior to consummation of the mergers to avoid potential operational problems." (P-45, p. 7) 41. As of November 7, 1988 the Federal Home Loan Bank of Seattle wrote of Sterling,

"[s]ince its opening in 1983, Sterling has experienced four examinations and received satisfactory ratings in all areas. The institution continues to be well-managed with positive earnings, good asset quality, and acceptable capital level." (P-45, p. 46) 4. 42. Early In Sterling's Existence, Government Regulators Looked To It For Assistance. Before Sterling even opened for business, it was approached by state regulators and asked

to enter negotiations to acquire Lewis & Clark Savings ("Lewis & Clark") located in Clarkston, Washington. (Gilkey, Tr. 75, lines 4-16; Gilkey, Tr. 87, lines 4-13)

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43. lines 4-22) 44.

Sterling agreed and acquired Lewis & Clark on or about June 30, 1983. (Gilkey, Tr. 87

Sterling's acquisition of Lewis & Clark was consistent with its business plan of taking

deposits in rural communities in order to make loans in metropolitan areas. (Gilkey, Tr. 76, lines 12-18) 45. After the Lewis & Clark acquisition, regulators from the state and the Federal Home Loan

Bank asked Sterling's management team to consider other acquisitions and to given them opinions as to the specific problems facing the failing thrifts. (Gilkey, Tr. 88, line 21 through 89, line 15). B. CONSISTENT WITH ITS PLANS, AND IN EXCHANGE FOR SIGNIFICANT PROMISES, STERLING ACCEPTED THE GOVERNMENT'S INVITATION TO CONTRACT TO ACQUIRE THREE FAILED THRIFTS. 1. Sterling Acquired Lewis Federal Savings & Loan In 1985. a. The Government Approached Sterling And Asked It To Investigate An Acquisition Of Lewis Federal.

46.

In early 1984, Ed Hedlund, the branch supervisor for the Federal Home Loan Bank of

Seattle ("FHLB of Seattle"), asked Sterling to look into acquiring the Lewis Federal Savings and Loan Association ("Lewis Federal"), a failing Washington State thrift. (Gilkey, Tr. 90, line 15 through 91, line 17) 47. Unless Lewis Federal was acquired, the Government would have been obliged to pay an

expected $6.049 million to liquidate the thrift. (P-1, p. 1) 48. By the time Sterling was contacted, the FHLB of Seattle had placed Lewis Federal into

conservatorship and asked for bids. (Gilkey, Tr. 93, line 23 through 24, line 2) 49. Sterling bid on Lewis Federal and was selected to acquire the thrift; this transaction closed in early 1985. (Gilkey, Tr. 93, line 23 through 94, line 2; P-18; P-19) -11-

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50

In November 1985, Sterling acquired Lewis Federal Savings and Loan Association

("Lewis Federal"), a thrift with negative regulatory net worth. 51. When Sterling acquired Lewis Federal, Lewis Federal's liabilities were greater than the

assets and it had a negative net worth. (Gilkey, Tr. 101, line 16 through 102, line 1) b. Sterling Bargained For And Received Contractual Provisions And Incentives Before Agreement To The Acquisition.

52.

In negotiating the acquisition of Lewis Federal, Sterling requested that the Government

grant it certain regulatory forbearances, in order to allow Sterling appropriate time to evaluate and reform problem assets and deal with unanticipated problems. (Gilkey, Tr. 94, 16-23; P-3) 53. The FHLB agreed to grant Sterling a forbearance from adverse action, arising from its

failure to meet net worth requirements, which resulted from Sterling's acquisition of Lewis Federal. (Sterling Savings Assoc. v. USA, 53 Fed. Cl. 599, 610-11 (2002), amended on other grounds, 72 Fed. Cl. 404 (2003), vacated in part on rehearing by 72 Fed. Cl. 404 (2006); Horvitz, Tr. 2024, line 20 through 2026, line 25; P-20, p. 2) 54. This forbearance meant that Sterling could subtract Lewis Federal from its total assets in

determining Sterling's net worth for regulatory purposes or, alternatively, could subtract Lewis Federal's deficiency capital. (Gilkey, Tr. 99, lines 3-18; Horvitz, Tr. 2099, line 9 through 2101, line 24; P-549) 55. This forbearance was designed to protect Sterling from any damaging consequences as

a result of its acquisition of Lewis Federal, for a period of five years. (Gilkey, Tr. 99, lines 8-18) 56. In addition to the forbearance discussed above, Sterling received $1.75 million in cash

assistance from Federal Savings and Loan Insurance Corporation ("FSLIC"), which the Assistance Agreement stated would be credited to Sterling's net worth account. (Gilkey, Tr. 108, lines 13-23; -12-

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P-19, p. 6; JSF #3) 57. The acquisition of Lewis Federal provided Sterling with additional capital to leverage,

and fit within Sterling's business plan of gathering rural deposits for metropolitan lending. (Gilkey, Tr. 114, line 19 through 116 line 6) 2. Sterling Acquired Tri-Cities Savings & Loan In 1988. a. Following The Acquisition Of Lewis Federal, The Government Approached Sterling Regarding Tri-Cities.

58.

After Sterling's successful acquisition of Lewis Federal, the managing officer of Tri-Cities

Savings and Loan Association ("Tri-Cities") contacted Sterling and asked if it would be interested in acquiring Tri-Cities. (Gilkey, Tr. 125, lines 16-25) 59. Sterling and Tri-Cities entered into a letter of intent, permitting Sterling to conduct due

diligence and evaluate a proposed private acquisition. (Gilkey, Tr. 125, lines 16-25) 60. After only three hours of conducting due diligence, Sterling opted not to acquire Tri-Cities

where problems were significant; Sterling's decision was confirmed by Federal Regulators who expressed surprise that Sterling would even consider acquiring such a troubled thrift. (Gilkey, Tr. 126, lines 1-15) b. The Tri-Cities Acquisition Was Directly Linked To Sterling's Acquisition Of Central Evergreen.

61.

Hilton Hewitt, Federal Home Loan Bank of Seattle supervisory agent to Central Evergreen

Savings and Loan Association ("Central Evergreen") called Mr. Gilkey and asked if he wanted to be the "King of Chehalis" by acquiring Central Evergreen. (Gilkey, Tr. 126, line 16 through 127, line 8) 62. Mr. Gilkey declined, on behalf of Sterling, stating that Central Evergreen was too big, too

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problematic, and did not have capital. (Gilkey, Tr. 127, lines 1-8) 63. Two days after Sterling declined to acquire Central Evergreen, Mr. Hewitt again called

and informed Sterling that if it acquired Tri-Cities, Sterling would have sufficient capital to acquire Central Evergreen. (Gilkey, Tr. 127, lines 9-17) 64. Sterling conducted due diligence on both Central Evergreen and Tri-Cities and bid on an

assisted acquisition of Tri-Cities, however Sterling was not the original low bidder on Tri-Cities. (Gilkey, Tr. 127, lines 18-22; Gilkey, Tr. 158, line 22 through 159, line 6) 65. Upon learning that it was not the successful bidder on Tri-Cities, Sterling contacted Mr.

Hewitt who told Sterling not to worry about the other bidder and that Sterling would win the bid. (Gilkey, Tr., 127, line 4 to 128, line 1; Gilkey, Tr. 159, lines 12-22) 66. Shortly after Mr. Gilkey's conversation with Mr. Hewitt, Sterling "magically" became the

low bidder on Tri-Cities, and started the process for that acquisition and for acquisition of Central Evergreen. (Gilkey, Tr. 160, lines 3-16) 67. Sterling acquired Tri-Cities on April 8, 1988; and in doing so was able to obtain the

capital to acquire Central Evergreen. (P-37; Gilkey, Tr. 733, line 12 through 734, line 8; Barnett, Tr. 1207, lines 19-22; Horvitz, Tr. 2049, lines 3-23; see also P-391; JSF #4) 68. Shortly after the Tri-Cities acquisition, Sterling's MACRO ratings were at "2", the highest

level typically awarded in practice. (Gilkey, Tr. 143, lines 10-18; Faulstich, Tr. 352, line 8 through 353, line 10; Horvitz, Tr. 2050, lines 8-20; P-40; P-268, p. 6) c. Sterling Bargained For And Received Contractual Provisions And Incentives Before Agreeing To The Acquisition.

69.

As with Lewis Federal, Sterling contracted for forbearances in connection with the Tri-

Cities acquisition. (Sterling Savings, 53 Fed. Cl. at 610-11.; Gilkey, Tr. 129, lines 2-6; Horvitz, Tr. -14-

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2099, linen 9 through 2101, line 24; P-549) 70. Sterling's need for a forbearance in the Tri-Cities acquisition was even stronger than in

the Lewis Federal transaction because Tri-Cities faced significant problems, including defalcation by the executive officer and the directorship and numerous problem assets which would take time for Sterling to resolve. (Gilkey, Tr. 132, line 22 through 133, line 15) 71. As part of the Tri-Cities acquisition, the Federal Home Loan Bank Board ("FHLBB")

agreed that the initial cash contribution made pursuant to the Assistance Agreement would be a credit to Sterling's regulatory capital. (Sterling Savings, 53 Fed. Cl. at 610-11; P-28, ¶ 4) 72. The FHLBB also agreed to forbear from regulatory action for any failure by Sterling to

meet capital requirements, for a five year period following the acquisition. (Sterling Savings, 53 Fed. Cl. at 610-11; P-28, ¶ 1) 73. Sterling received $11,730,128 in cash assistance from FSLIC. (Sterling Savings, 53 Fed.

Cl. at 610-11; P-38, p. 17; JSF #5) 74. Sterling viewed the Tri-Cities acquisition as beneficial because of the capital it brought

to Sterling. (Gilkey, Tr. 140, lines 6-12) d. Following The Acquisition Of Tri-Cities, Sterling Had Sufficient Capital To Acquire Central Evergreen.

75.

The Office of Thrift Supervision ("OTS") and Sterling understood that Sterling lacked

sufficient capital to acquire Central Evergreen without the Government's cash assistance from the Tri-Cities transaction. (Friend, Tr. 2285, line 13 through 2286, line 12) 76. Recognizing the realities regarding Sterling's capital, Ed Hedlund, the OTS regulator for

Central Evergreen, stated that Sterling's acquisition of Central Evergreen transaction was "subject to Sterling getting Tri-Cities." (P-375) -15-

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77.

On July 1, 1988, Mr. Gilkey met with a representative of the OTS, and George Godding

, president of Central Evergreen, to discuss Sterling's potential acquisition of Central Evergreen. (P-391) 78. The FHLBB obtained internal confirmation that Sterling could leverage FSLIC assistance,

and at that meeting Sterling was told that the capital would be counted in such a way as to permit Sterling to acquire Central Evergreen. (Gilkey, Tr. 733, line 12 through 735, line 11; Gilkey, Tr. 739, line 15 through 740, line 4; P-390, P-391, P-392, P-393, P-399) C. FIRREA WAS IMPLEMENTED AND THE GOVERNMENT ENFORCED ITS REGULATIONS ON STERLING IN BREACH OF THE CONTRACTS. 1. 79. The Enactment of FIRREA And Adoption Of Regulations Led To Breach. FIRREA was enacted in August 1989, and became effective in November 1989. (JSF #9)

80. FIRREA changed the computation of the capital ratio required to support assets. (Byrne, Tr. 1340, line 7 through 1342, line 10) 81. After FIRREA, an institution was required to meet a three-tier measurement: (1) tangible

capital at 1½ percent of tangible assets; (2) core capital divided by adjusted tangible assets at 3%; and (3) risk-based capital at 6.4% (which graduated over time to 8%). (Byrne, Tr. 1341, line 18 through 1342, line 10; Byrne, Tr. 1346, lines 7-12) 82. (JSF #8) 83. However, even before FIRREA became effective, in July 1989, Sterling's "composite Before FIRREA, Sterling had total assets of $731 million and deposits of $519 million.

rating" was reduced to a "3" because of its anticipated capital deficiencies under the pending FIRREA legislation: The unassisted acquisition of Central Evergreen...at year-end 1988 has resulted in -16-

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an increase in Sterling's overall level of risk. The primary concern is a currently low level of capital adequacy and increasing future capital requirements due to proposed legislative action increasing capital requirements and precluding, over a period of time, the inclusion of goodwill as capital. (Horvitz, Tr. 2050, lines 15-20; Horvitz, Tr. 2053, line 9 through 2054, line 7; P-407, p. 1) 84. The OTS recognized that Sterling's perceived capital deficiency was a direct result of

FIRREA, and was not a result of poor management or operations: "[t]he lack of capital compliance is due to the implementation of FIRREA versus unsafe and unsound operating procedures." (P-268, p. 8) 85. After the adoption of regulations following the enactment of FIRREA, Sterling's

regulators (now OTS) formally instructed Sterling that, contrary to its contracts, it would not permit Sterling to treat the Government's cash assistance and supervisory goodwill as regulatory capital; as a direct result, the Government began to treat Sterling as an undercapitalized, troubled thrift, in Thrift Bulletin 38-2: The Office of Thrift Supervision is applying the new capital standards to all savings associations, including those associations that have been operating under previously granted capital and accounting forbearances. Section 5(t) of HOLA as amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) eliminates these forbearances. All savings associations presently operating with these forbearances, therefore, should eliminate them in determining whether or not they comply with the new minimum regulatory capital standards. (Any FSLIC capital contribution that resulted in the creation of goodwill will be subject to the requirements for goodwill established to the capital regulation). Office of Thrift Supervision, Capital Adequacy: Guidance on the Status of Capital Accounting Forbearances and Capital Instruments Held by a Deposit Insurance Fund, Thrift Bulletin No. 38-2, 1990 WL 309397 (Jan. 9, 1990). 2. Sterling Tried in Vain To Obtain Relief From The Government's New Restrictions Under FIRREA.

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86.

After FIRREA's enactment, the Government informed Sterling that the Government was

no longer obliged to comply with the terms of its contracts with Sterling, however the Government also informed Sterling that Sterling was obliged to comply with the same contracts. (Byrne, Tr. 1451, lines 6-11) 87. Holding Sterling to the contracts it had just disclaimed, the OTS maintained that Sterling "had a legal obligation" to raise capital under the Central Evergreen agreement. (Friend, Tr. 2309, line 24 through 2310, line 8; Friend, Tr. 2311, lines 8-14; Friend, Tr. 2019, line 18-23) 88. The OTS maintained that the Government's contracts with Sterling had no relevance to

Sterling's demand for capital under the regulations; the Government also maintained that despite the fact that Sterling's capital-deficiency was a direct result of the Government's breach, FIRREA's regulations needed to be enforced and Sterling must enter a conservatorship. (Friend, Tr. 2335, line 1 through 2338, line 18) 89. With the enactment of FIRREA the Government ceased viewing Sterling as an ally and

began to see it as a problem: We were perceived, up until the time of FIRREA, as a savior for the savings and loan industry because of how we were approached by the Government to take over these failing thrifts. We saw it as a business opportunity. The Government saw it as a way to handle some issues that they really didn't want to handle. But when FIRREA came along, the interpretation of FIRREA, I believe, by the OTS and those contracts, how they interpreted the contracts, which negated the net worth and put us in an undercapitalized position in the eyes or the law of FIRREA, that's what happened. Now, because we were deemed to be an undercapitalized thrift that was in trouble at that time based on the fact that the capital that we had was taken away from us and based upon the law of FIRREA which basically said you have to have X capital, we didn't have it because it was taken away, the OTS applied restrictions to us . . . (Barnett, Tr. 1198, line 16 through 1199, line 11) 90. Viewing Sterling as an undercapitalized troubled thrift, on November 9, 1989, OTS -18-

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ordered Sterling to cease to grow its assets beyond growth incidental to interest credited to existing deposit accounts. (P-247) 91. The Government also hamstrung Sterling's ability to grow through acquisitions; for

example, the Government refused to permit Sterling to purchase two branches of Great American Bank ("Great American") until Sterling was in compliance with FIRREA's new capital requirements. (Gilkey, Tr. 212, lines 15-24; Friend, Tr. 2307, line 19 through 2308, line 15; P-413; DX-388) 92. The Government also discouraged Sterling from accepting or renewing uninsured

deposits, or deposits that exceeded the $100,000 insured by the FDIC. (Gilkey, Tr. 231, line 16 through 232, line 21; P-256) 93. Additionally, the Government imposed a $500,000 lending limitation, which forced

Sterling to discontinue its commercial real estate lending. (Gilkey, Tr. 237, line 3 through 239, line 6; P-258) 94. The Government also denied Sterling the right to accept, renew or rollover brokered

deposits, again based upon Sterling's capital position. (P-285; P-288) 95. As a result of this Government action, Sterling was severely limited in the amount of loans

it could make; this in turn curtailed its profitability. (Gilkey, Tr. 232, lines 9-21; Gilkey, Tr. 233, line 6 through 236 line 10) 96. Sterling was unable to grow between November 1989 and November 1991 due to

FIRREA's impact on its capital levels and the OTS' resulting operating restrictions. (Byrne, Tr. 1965, line 14 through 1966, line 6) 3. In Accordance With Its Business Plan, Sterling Attempted To Raise Capital In 1989 That Would Have Brought It Into Compliance With FIRREA's Regulations. In July 1989, the Government knew that Sterling intended to raise capital of up to $20 -19-

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million through a public stock offering. (Gilkey, Tr. 178, lines 1-17; P-407, p. 2; P-246A, p. 2) 98. Mr. Potthast, an OTS field manager, stated the obvious, but fundamental: "You have to

have capital to grow." (Potthast, Tr. 3250, lines 20-22; see also P-268, p. 6) 99. In or about August 1989, the Government told Sterling it was still obligated to complete

the offering under its contracts, even though the Government was in breach after FIRREA. (Gilkey, Tr. 186, line 25 through 187, line 10) 100. Sterling entered into an agreement with its investment bankers, Dain Bosworth, to proceed with a public offering of $18 million. (P-408, p. 1) 101. In October 1989, the offering amount was reduced to $10 million. The reduction was necessary in order to preserve a net operating loss tax benefit that benefitted both to Sterling and the Government. (Gilkey, Tr. 190, line 8 through 192, line 16; Friend, Tr. 2220, line 20 through 2221, line 6; P-306; P-411) 102. Because Sterling did not then meet FIRREA's capital ratios (without the benefit of its contracts), on advice of its investment bankers, Sterling sought: . . .assurance with respect to Sterling's ability to continue to pay dividends, notwithstanding temporary noncompliance with the capital requirements under FIRREA. Specifically, we ask that you indicate that the Office of Thrift Supervision - Twelfth District would not object to Sterling's payment of dividend on the Preferred Stock in the future assuming that Sterling continued its operations in a safe and sound manner and that funds for the payment of such dividends were legally available, notwithstanding noncompliance with the capital requirements under FIRREA. (Gilkey, Tr. 196, lines 4-16; Welch, Tr. 1575, line 4 through 1578, line 6; see also P-268, p. 6; P-342) 103. Sterling had strong investor support for the 1989 offering, which was oversubscribed. (Byrne, Tr. 1433, lines 4-20; Gilkey, Tr. 195, line 4 through 196, line 3) 104. The OTS knew that the offering could not succeed without its non-objection to Sterling -20-

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paying future dividends on the stated conditions. (Friend, Tr. 2316, line 16 through 2317, line 14; Friend, Tr. 2323, line 14 through 2324, line 10) 105. The OTS indicated that it was in the Government's and Sterling's best interests for Sterling to raise capital, and that it therefore would be illogical to deny Sterling's request. (Byrne, Tr. 1962, line 21 through 1963, line 24; P-345; see also DX-373) 106. This statement encouraged Sterling to proceed with the road shows and other preludes to the offering. (Byrne, Tr. 1962, line 21 through 1963, line 24) 107. On December 12, 1989, Mr. Gilkey and Mr. Byrne met with Donald Dochow, the second in command of the OTS in Washington, D.C., to discuss the need for the acceleration of the process for review of the dividend issue. (Gilkey, Tr. 198, line 7 through 199, line 18; P-253) 108. After hearing of Sterling's plans to regain capital compliance, Mr. Dochow indicated that if any institution was worthy of an exemption from FIRREA's capital requirements, Sterling appeared to qualify. (Gilkey, Tr. 203, lines 1-12; P-253) 109. Sterling was not granted an exemption. Instead the OTS denied the request for nonobjection to future payment pay dividends because Sterling was not in compliance with the capital ratios of FIRREA; the OTS never granted FIRREA requirements. (Friend, Tr. 2413, lines 5-21; Friend, Tr. 2309, lines 1-23; P-254) 110. The planned stock offering was cancelled because OTS refused to state its nonobjection. (Byrne, Tr. 1445, lines 15-23; Horvitz, Tr. 2094, lines 12-19; James, Tr. 2891, line 16 through 2892, line 6; P-268, p. 6; see also JSF #10) 111. Sterling incurred costs paid to Dain Bosworth and for printing costs and road shows as a result of the Government's refusal to allow dividends and resulting cancellation of the offering.

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(Gilkey, Tr. 208, line 10 through 209, line 5) 112. The Government knew its position "would be death to a new offering." (Gilkey, Tr. 211, line 25 through 212, line 7) 113. On November 9, 1989, while Sterling was in the process of promoting the offering described above, the Government notified Sterling that it believed that Sterling would fail to meet FIRREA's capital requirements and that Sterling was therefore obliged to submit a capital restoration plan; this required Sterling to limit its expected growth by seventy-five percent (75%). (Byrne, Tr. 1430, line 6 through 1431, line14; P-247, p. 1; Gilkey, Tr. 227, line 1 through 228, line 6; P-247, p. 2) 4. Sterling Attempted To Mitigate The Harm Caused By Its FIRREA Non-Compliance. a. Sterling Shrank Its Assets To Meet Required Capital Ratios.

114. Having been denied the benefit of its contracts with the Government, Sterling's regulatory capital fell short of FIRREA's requirements; due to the OTS' restriction of Sterling as a capitalnoncompliant thrift, Sterling was wholly unable to grow from January 26, 1990 to November 1991. (Byrne, Tr. 1538, lines 12-20; Page, Tr. 1125, lines 15-24) 115. Sterling could not raise capital because of the regulators' refusal to state that they would not object to endorse dividends so long as Sterling was in compliance. (Gilkey, Tr. 211, line 25 through 212, line 7) 116. Due to the Government order that it cease growing and in light of the Government's refusal to honor its contractual capital promises and forbearances, Sterling attempted to shrink its assets to reduce the regulatory threat. (See P-280, 281) Sterling was forced to stop making most types of construction loans, one of Sterling's most profitable markets; Sterling was also unable to renew

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active loans, thereby further reducing its profitability. (Byrne, Tr. 1462, line 19 through 1463, line 12; P-280, P-281) 117. Between 1989 and 1991, Sterling reduced its assets from approximately $730 million to approximately $590 million. (Gilkey, Tr. 278, line 8 through 279, line 2; see JSF#11) 118. Sterling had not planned to shrink in 1990 or 1991. (Page, Tr. 1144, lines 7-9) b. Sterling Obtained A TRO And An Injunction.

119. By April 11, 1990, the Government began the process of closing Sterling by sending its Board of Directors a letter for consent to an appointment of a conservator; Sterling's Board refused to consent to a conservatorship, pointing out that any capital deficiency was caused by the Government's breach of the contracts. (P-269; P-270) 120. OTS regulators invited themselves to a Sterling board meeting to impress upon the directors that the directors were obligated to agree to a conservatorship. (Friend, Tr. 2335, line 1 through 2338, line 18) 121. Sterling met with the OTS in Seattle to convey its concerns about the proposed conservatorship; the OTS stated, regardless of the contracts, "the FIRREA legislation has made these contracts null and void." (P-274) 122. The day after this meeting, the Government sent correspondence insisting that Sterling sign the agreement. (P-271) 123. Contemporaneously, the head of the Seattle office of the OTS and Ed Hedlund, Sterling's regulator, stated that despite the OTS's intent to shut Sterling down, there were no problems with Sterling's management. (P-274, p. 7) 124. Sterling appealed to the Director of the OTS, again asking that its contracts be honored.

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(P-272) 125. The Government imposed more restrictions through a letter sent to the Board of Directors at their homes; these regulations effectively shut down any profitable business. (Gilkey, Tr. 247, lines 3-15; P-273) 126. These letters were implied threats that if the board did not acquiesce to the OTS's desires the directors would be individually and personally liable. (Barnett, Tr. 1186, lines 5-21) 127. OTS personnel appeared at board meetings and made similar threats to both the individual members and the company; again the Government threatened Sterling's directors with personal liability if they did not surrender the company. (Barnett, Tr. 1187, lines 13-20) 128. The Government ordered Sterling to execute a Capital Directive, which would end Sterling's remaining business opportunities and waive Sterling's right to judicial review. (P-275A) 129. Sterling again met with the OTS in an attempt to find a solution to the capital deficiency caused by the Government's breach, however the OTS refused to provide Sterling time to raise the necessary capital. (P-276, pp. 2-7) 130. Sterling offered several capital plans with alternatives to gain the necessary capital, including shrinking the company, selling branches, returning Tri-Cities and Central Evergreen to the Government and reviving the offering that failed in November 1990. (Byrne, Tr. 1474, line 16 through 1476, line 3) 131. Despite Sterling's efforts, the Government maintained that the only option was to sell Sterling Savings Bank. (Byrne, Tr. 1476, lines 7-11) 132. At this point Sterling faced Government Regulators intent on closing it down and had no choice but to, on May 29, 1990, petition the Court for a temporary restraining order ("TRO"), which

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it obtained. (Gilkey, Tr. 249, lines 21-23; JSF #13) i. Despite The Injunction, The Government Continued To Regulate Sterling As A Capital-Deficient Thrift.

133. Six days after Sterling obtained the TRO, the OTS imposed a new restriction, this time requiring Sterling to provide weekly reports of any actions not in compliance with the previous restrictions. (P-277) 134. Sterling objected, noting that in its view this new restriction violated the terms of the temporary restraining order. The OTS stated, via reply letter, that the TRO in no way impacted the concerns it had regarding Sterling, and rephrased the basis for its concern in terms of "safety and soundness": We fully recognize that, until the Temporary Restraining Order is dissolved or the court orders otherwise, we may not enforce the restrictions set forth in our letters of January 26th, March 9th and May 11th. We intend to strictly obey the court's order. However, as our earlier letters indicated, we have significant Supervisory concerns about the condition of Sterling and the soundness of some aspects of its operations. (P-278; P-279) 135. Sterling understood the OTS' letter to indicate that, despite the TRO, the Government would not be dissuaded from shutting Sterling down under the aegis of "safety and soundness" "concerns": They use the words safety and soundness to open the doors to regulatory activity. To me, it meant big trouble. (Gilkey, Tr. 252, lines 9-22) 136. The Government's expressions of "concerns" about "safety and soundness" were driven by Sterling's perceived capital deficiency. (P-268; P-284, P-464) 137. Despite the Government's expression of concern about Sterling's "safety and -25-

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soundness", it internally recognized that there were, in fact, no safety and soundness grounds to sanction Sterling and that its problem was solely capital deficiency after FIRREA: The lack of capital compliance is due to the implementation of FIRREA versus unsafe and unsound operating practices. Lending restrictions imposed by RB 3a are in place. With the acceptance or rejection of this capital plan, a formal enforcement document will be executed. (P-268, p. 9) 138. Sterling did believe and was told numerous times that the restrictions were still operative, despite the TRO. (Byrne, Tr. 1822, lines 2-12; Byrne, Tr. 1501, lines 17-24; ; P-281 DX-441) 139. Despite the TRO, the OTS continued to indicate that Sterling was subject to such restrictions. (Friend, Tr. 2352, line 18 through 2356, line 10; P-281) 140. Given the OTS' continued restrictions in spite of the TRO, Sterling decided to comply with the reporting restriction to avoid further regulatory punishment. (Gilkey, Tr. 254, line 12 through 256, line 18; P-280) 141. On June 20, 1990, while the TRO was in full effect, the Government re-confirmed that Sterling was permitted no growth; Sterling continued to report variances from restrictions imposed upon Sterling. (P-282; Gilkey, Tr. 257, lines 12-22; P-281) 142. On June 25, 1990, the Government explained that the restrictions were justified independently of any problems resulting from the Government's breach; Sterling concluded that the only protection the TRO afforded was that the Government could not close Sterling unless it established a violation of one of the restrictions that the Government claimed was unaffected by the TRO. ( Gilkey, Tr. 258, line 19 through 259, line 7; P-283; Gilkey, Tr. 258, line 25 through 259, line 7) 143. Notwithstanding that Sterling's capital deficiency was due to the Government's breach, -26-

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and the Court's Order restraining the it from taking action inconsistent with the terms of the contracts, the Government conducted an examination focused on Sterling's capital position and assigned a "5" rating ­ the lowest possible. (P-284; P-287) ii. The Court Issued A Preliminary Injunction Continuing The Terms Of The TRO, But The Government Persisted In Unlawful Enforcement.

144. On August 8, 1990, the Court issued a preliminary injunction continuing the terms of the TRO; subsequent to that Order, the Government sought, and received, an order clarifying that the TRO/injunction did not forbid it to regulate on the basis of "safety and soundness". (Gilkey, Tr. 263, lines 7-12; DX-460; Gilkey, Tr. 741, line 24 through 742, line 16; JSF #13, JSF #14, JSF #15) 145. In September 1990, Sterling invested $35 million in mortgaged-backed securities, funding the investment with borrowings from the FHLB of Seattle; even though the FHLB was involved, the OTS "came down with both feet" and responded with examiners and requests for documentation. (Gilkey, Tr. 263, line 13 through 264, line 13; Gilkey, Tr. 264, lines 14-20; Gilkey, Tr. 627, lines 17-24; P-289) 146. By that time the Government had disclaimed any duty to comply with its contracts with Sterling; however, the Government nonetheless demanded that Sterling provide documentation showing that the above transaction complied with the Business Plan "included with the Central Evergreen Agreement." (P-289) 147. The Government again sent letters to Sterling's Board members at their homes; again imposed additional restrictions; and again threatened the board with individual liability and civil monetary penalties. (Gilkey, Tr. 265, line 3 through 266, line 22; P-290) 148. Sterling considered seeking a contempt order on the grounds that the OTS was not complying with the Court's injunctions, but decided that, in view of its desire to run a business, -27-

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initiating further litigation would only harm the thrift. (Gilkey, Tr. 267, line 17 through 269, line 1; Gilkey, Tr. 753, lines 6-14; P-291) 149. After Sterling reminded the OTS of the preliminary injunction, the OTS retreated somewhat, but reiterated its intent to regulate Sterling as a troubled thrift but requesting more information for its evaluation. (P-292) 150. Sterling responded: (1) that the OTS was treating Sterling as a troubled institution because of the capital deficiency caused by the Government's breach; (2) that OTS regulators were present at the Board meeting at which the above transaction was approved and yet waited until the transaction was completed to question it; and (3) by demonstrating that the transaction complied with the Business Plan of the Central Evergreen agreement. (P-293) 151. For its part, the FDIC acknowledged that Sterling would meet its capital requirements if the Government were to honor the contracts. Thus, on September 7, 1990, FDIC reversed its designation that Sterling was capital-deficient. (P-288) Despite this acknowledgment, the OTS did not lift the operating restrictions on Sterling until April 1992. (Gilkey, Tr. 622, lines 9-14; Gilkey, Tr. 726, line 14 through 727, line 8 P-288; P-299B) 152. The Government appealed the preliminary injunction; Sterling continued to report to the Government regarding the restrictions during the pendency of the appeal. (Gilkey, Tr. 273, lines 13-23; P-297) On April 14, 1992, the 9th Circuit Court of Appeals vacated the injunction. (JSF #17) 153. The injunction did not enable Sterling to grow as it had planned to grow prior to the breach; specifically, the remaining restrictions left Sterling without the capacity to increase its lending business either from a regulatory or management standpoint. (Gilkey, Tr. 284, line 17 through 285, line 12; Gilkey, Tr. 284, line 17 through 285 line 12)

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154. In fact, the OTS steadfastly refused to deviate from the restrictions, even when Sterling requested permission to fund a risk-free loan. (Neely, Tr. 1025, line 16 through 1028, line 12) 155. Sterling continued to lose customers both during and after the injunction. (Beil, Tr. 1307, lines 3-13) c. Sterling Ultimately Raised Capital.

156. In November 1991, Mr. Hedlund told Sterling's investment banker that if capital was raised, the regulatory problems would disappear. (Welch, Tr. 1575, line 4 through 1578, line 6) 157. In November 1991, Sterling raised approximately $23 million through a public offering of common stock and the conversion of $2.1 million in preferred stock to common stock. (JSF #16) 158. Sterling's public offering raised enough capital to put it into capital compliance under FIRREA. (Gilkey, Tr. 274, lines 16-21) 159. As a result, on April 8, 1992, the Government lifted the operating restrictions imposed by Sterling prior to and during the term of the injunction. (P-299A; P-299B) 160. This capital raising, however, did not make Sterling whole from the breach. (Gilkey, Tr. 291, lines 12-15; Gilkey, Tr. 390, line 19 through 391, line 10) 161. Sterling had lost people, assets, deposits and income and, on a going-forward basis, had lost the capital that could be invested in profitable assets over time. (Gilkey, Tr. 291, line 25 through 292 line 5) D. STERLING SUFFERED HARM AS A RESULT OF THE GOVERNMENT'S ACTIONS. 1. Sterling Lost Valuable Assets And Was Precluded From Seeking Others. a. Sterling Lost Valuable Business Customers.

162. The harm to Sterling was not limited to the business Sterling had to direct to competitors

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because of these restrictions: By declaring us a capital deficient company, we lost the capital that we contracted for and had sought out forbearances to match the time frames we needed to solve the problems. So we lost capital. We lost people in significant numbers, high quality portfolio group of good bankers, good mortgage bankers. We lost loans. And we lost deposits. I might parenthetically add here, that's what a bank is, is capital, loans, deposits, and -- and its people make it up. But for me personally, the thing that added to that was the reputation was substantially tainted. And a banker banks on his reputation. (Gilkey, Tr. 220, line 14 through 221, line 9) 163. Business clients look to both the stability and reputation of an institution and the relationship with the individual banker. (Beil, Tr. 1298, lines 2-13; Beil, Tr. 1298, line 19 through 1299, line 4) 164. FIRREA and the restrictions caused uncertainty among employees and customers, causing several customers to leave. (Neely, Tr. 1036, lines 7-10; Neely, Tr. 1047, line 16 through 1048, line 20) 165. Such uncertainty was devastating, particularly to relationships with business customers. (Beil, Tr. 1301, lines 6 -14) 166. In mid-1990, Sterling customers and the business community exhibited concern because of the growing media attention as to the impact of FIRREA on Sterling. (Neely, Tr. 1017, line 24 through 1019, line 22) 167. Sterling's reputation in the community was affected. (Beil, Tr. 1305, lines 1-7) 168. Customers, in some instances, followed loan officers who left Sterling to new institutions. (Neely, Tr. 1029, line 22 through 1030, line 3) 169. Sterling literally walked one customer across the street so he could open a $1.7 million account with a competitor because Sterling could not take the uninsured deposit. (Gilkey, Tr. 235, -30-

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lines 6-12) 170. Almost twenty years later, people still ask Sterling about FIRREA and this lawsuit. (Stanley, Tr. 1281, lines 6-13) b. Experienced Employees Left Sterling Following The Breach.

171. The shrinkage did not just affect Sterling's assets, but affected the entire organization of the bank: We lost people, good friends, people that were capable of becoming superior bankers. We lost customers that I had had for years that went to other companies. And I never saw them again from a customer standpoint. We lost deposits which we were never able to recover. And reputation-wise, it was a very difficult time both ­ even after the ­ the offering, our competitors, others questioned our capability and our reputation. (Gilkey, Tr. 280, line 24 through 281, line 12) 172. Sterling had significantly higher turnover in its staff after the passage of FIRREA and attendant imposition of restrictions. (Stanley, Tr. 1256, line 21 through 1259, line 6) 173. Staff left because of concerns that they would lose their jobs and the constraints limiting the amount of business that could be done at Sterling. (Stanley, Tr. 1264, line 19 through 1265, line 5) 174. The OTS restrictions affected staff morale. (Neely, Tr. 1020, line 22 through 1021, line 8) 175. Key employees, including Cajer Neely, left Sterling because customers were leaving and Sterling did not have the capability of creating new business to replace what had been lost. (Neely, Tr. 1024, line 20 through 1025, line 3) c. The Government's Regulations Precluded Sterling From Pursuing Business Banking.

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176. On March 9, 1990, the Government allowed Sterling to engage in limited business banking lending, but imposed restrictions that made profitable lending impossible. (Gilkey, Tr. 240, line 5 through 241, line 9; Gilkey, Tr. 242, line 25 through 244, line 10; P-266) 177. Specifically, the Government required Sterling to reduce its business banking loans, which can only be accomplished by not renewing loans that come due and by asking customers to take their loans elsewhere. (Gilkey, Tr. 240, lines 5-14; P-266) 178. The Government also barred Sterling from issuing letters of credit. (Gilkey, Tr. 240, line 15 through 241, line 9; P-266) 179. The effect of barring letters of credit was twofold: (1) Sterling lost the fee income from issuing such letters; and (2) to accommodate its customers, Sterling was forced to take the customers to competitors to obtain letters, "effectively...saying to the customers [that] we can no longer manage your business." (Gilkey, Tr. 240, line 15 through 241, line 9) 180. The commercial banking department could not increase customers and could not make additional extensions to existing customers, affecting its ability to make loans. (Neely, Tr. 1045, lines 6-14) 2. Two Profitable Subsidiaries Faced Severely Restricted Business Activities. a. Intervest

181. The effect of the Government's "loans to one borrower" restriction virtually closed down Intervest which, at that time, averaged $5 million per loan. (Gilkey, Tr. 216, line 10 through 217, line 10) 182. During 1989 through 1992, Intervest's profits went from $600,000 per year to zero. (Gilkey, Tr. 218, line 21 through 219, line 7)

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183. After FIRREA, Intervest was forced to stop lending and ceased to grow. (Harlow, Tr. 805, lines 16-24) 184. Intervest was able to honor its existing contracts, but could not originate new loans and was forced to reduce the staff of loan officers from eleven to one and total staff was reduced to three people. (Harlow, Tr. 807, line 18 through 808, line 19) 185. Intervest's core business is financing commercial real estate construction and purchase. (Crithfield, Tr. 1062, line 23 through 1063, line 3) 186. Loan producers are critical for the success of Intervest because of their expertise and their personal relationships with customers. (Harlow, Tr. 783, lines 1-22) 187. Intervest grows its business through hiring good loan producers. (Harlow, Tr. 783, line 23 through 784, line 22) 188. Loan officers were let go because there was no more work after FIRREA. (Crithfield, Tr. 1064, lines 16-20) 189. Loan officers were forced to tell valued customers that Intervest could not lend. (Crithfield, Tr. 1066, line 4 through 1067, line 7) 190. At that point, no person at Intervest was producing loans. (Harlow, Tr. 808, lines 20-25) 191. In 1990, Intervest did $21 million in lending. (Harlow, Tr. 812, lines 8-15) 192. In 1991, the volume was $0. (Harlow, Tr. 812, lines 15-17) 193. Since Sterling came into capital compliance in 1991, Intervest's trend has been dramatically positive. (Harlow, Tr. 822, lines 16-18) 194. By 1994, Intervest's loan production was $104 million. (Harlow, Tr. 817, lines 6-13) 195. In 2006, Intervest's loan production was $1.5 billion. (Harlow, Tr. 822, lines 22-25)

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196. Sterling did not plan for or have a business reason to take Intervest's lending to 0 in 1991. (Harlow, Tr. 823, line 4 through 824, line 1) 197. But for the constraints imposed upon Intervest in late 1989 and early 1990, Intervest's growth would have continued in 1990, 1991, and to the present day. (Harlow, Tr. 824, lines 4-11; Harlow, Tr. 825, line 3 through 826, line 5; Harlow, Tr. 858, lines 5-11) 198. FIRREA cost lost profits for Intervest because of forgone loans. (Harlow, Tr. 850, lines 13-16) b. Action Mortgage

199. The restriction also severely limited the business of Action Mortgage Company ("Action"). (Gilkey, Tr. 217, line 22 through 218, line 20) 200. Sterling lost its residential construction lenders, the backbone of Action, because its customers could not be serviced under the OTS restrictions. (Gilkey, Tr. 218, lines 2-20) 201. Action lost 35 to 40 loan officers. (Stanley, Tr.1269, line 25 through 1270, line 5) 3. Following The Lifting Of The Restrictions And Sterling's Return To Capital Compliance, Sterling Began To Grow Again But Was Never Able To Attain The Growth It Would Have Had If It Not Been Restricted After FIRREA. a. Sterling Is A Smaller Bank Than It Would Have Been But-For The Breach.

202. But for the Government's breach and Sterling's resultant shrinkage, Sterling would have been approaching $1 billion in size on September 30, 1990. (Gilkey, Tr. 281, line 13 through 282 line 7) 203. The shrinkage affected Sterling's growth even after 1991, and Sterling has never caught up to where it would be but-for the breach: A: ...[I]t decreased our base of capital from which to grow from. So it's like taking a piece out of a puzzle that we had to replace before we could continue our -34-

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growth pattern. Q: Do you have any belief as to ­ as chief credit officer for Sterling Savings as to whether but for the occurrences in early 1990, you would have been a bigger bank in 1990 in terms of loans receivable on the books? * A: Q: A: Q: A: Q: A: Q: A: * *

Absolutely. Is there any doubt in your mind about that? None whatsoever. How about 1990? There's no doubt. No doubt about what? That we would have grown. Larger than you actually were? Absolutely.

Q: And then once you started to grow again, do you believe that Sterling has grown into the position it would have occupied if none of this had ever happened? Did you get it all back in the marketplace yet? * * *

A: I don't' think you ever replace that. That's a piece of the puzzle that is ­ is ­ would have been additive to the whole growth pattern of our company. I don't' know how you ­ it's gone. Q: A: Q: A: Do you believe you would be a bigger bank today but for the breach? Absolutely. Is there any doubt in your mind about that? None whatsoever.

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Case 1:95-cv-00829-TCW

Document 284

Filed 09/22/2007

Page 37 of 100

(Page, Tr. 1144, line 18 through 1147, line 1 (objections overruled and omitted)) b. Sterling Could Have Used The Additional Capital It Lost As A Result Of The Breach To Support Additional Assets.

204. Sterling could have and would have utilized the supervisory goodwill taken by the breach. (Page, Tr. 1103, lines 2-9; Welch, Tr. 1598, lines 11-19) 205. Sterling could have used the additional assets that would have been supported by the capital lost from the breach. (Gilkey, Tr. 282, lines 11-19; James, Tr. 2830, lines 20-25) 206. Sterling had not experienced any problem growing prior to the breach, and did not expect any difficulty doing so after the breach. (Gilkey, Tr. 283, line 7 through 284, line 1) 207. Since 1991, Sterling has raised capital in every year but two. (Gilkey, Tr. 290, lines 1-7 and 13-19; Gilkey, Tr. 418, line 24 through 419, line 2; Welch, Tr. 1628, lines 21-25; P-501; P-505) 208. On an ongoing basis, Sterling seeks additional capital in order to pursue value enhancing growth. (Gilkey, Tr. 290, lines 8-12; Gilkey, Tr. 416, lines 4-7) 209. In the early 1990s and mid-1990s, Sterling's core capital slightly exceeded the minimum; later, the cushion expanded. (Byrne, Tr. 1347, lines 8-23; Bajaj, Tr. 4141, lines 1-18; P-513) 210. However, Sterling's risk-based capital has remained just above the well-capitalized threshold. (Byrne, Tr. 1347. lines 8-23; P-513) 211. Sterling has never voluntarily turned down an opportunity to raise capital. (Gilkey, Tr. 291, lines 8-11; Gilkey, Tr. 416, lines 4-7) c. Sterling's Profits Continued To Grow Even As It Acquired More Assets.

212. Sterling's return on average assets, or the earnings generated from those assets, was not compromised or lowered as a result of Sterling's rapid expansion. (Gilkey, Tr. 157, lines 7