Demise of Two Units Threatens Capitol Bancorp's Rescue Plan

The complex structure of Capitol Bancorp (CBCRQ) is morphing from its saving grace to an albatross.

As a multibank holding company that once had dozens of units across the country, Capitol's breadth had been viewed as the key to its survival. Though its troubles run deep, regulators have given the Lansing, Mich., company ample time to wind itself down. It sold some banks to raise the capital ratios of others, to slightly above critically undercapitalized levels.  

But regulators seemed to lose patience Friday, closing two of the $1.6 billion-asset company's 11 bank units. The failures will undoubtedly tighten regulatory supervision of Capitol, and they may also give frustrated investors an advantage in an increasingly tense bankruptcy restructuring.

Capitol had spent the past four years trying to avoid this scenario. The Federal Deposit Insurance Corp. has the ability to bill its nine surviving units for the failures of Pisgah Community Bank in Asheville, N.C., and Sunrise Bank in Valdosta, Ga., which are expected to cost the Deposit Insurance Fund $26.2 million.

"This occurrence is going to heighten the concern of the regulators and is going to put the company under much more scrutiny," says Ernest Panasci, a partner at Stinson Morrison Hecker in Denver.

Additional regulatory scrutiny is tough to imagine. Capitol is operating under an enforcement order from the Federal Reserve, and nearly all of its banks are under prompt corrective action directives or notifications from regulators and are undercapitalized.

Additionally, the FDIC already has hit the company and its units with a cross-guarantee claim related to the 2009 failure of a Florida bank that had ties to its founder and chief executive, Joseph Reid.

Capitol did not return calls for comment.

Though the regulators will ratchet up their oversight, they won't assert any liability claims immediately, observers say.

The FDIC can exercise its powers a few ways. For instance, it can fail surviving banks with the goal of selling them. It can also seek a monetary settlement or demand the proceeds of a sale.

It has two years to assert such claims, and the deadline can be extended. The FDIC will have to determine the least costly method before acting.

The FDIC declined to comment, saying it doesn't speak about individual institutions.

The failures could also alter the course of Capitol's bankruptcy proceedings.

In August the company — which is in a negative equity position and is burdened with trust-preferred securities — announced it would attempt to restructure itself by filing for Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the Eastern District of Michigan.

Its plan called for all of its existing equity and debt holdings to be restructured into a 53% equity stake in the company, with a new investor taking a 47% stake in exchange for $70 million to $115 million in capital.

One investor emerged in September, but later backed out. Investors may have been spooked by the potential for one bank failure to unravel the entire company. Now that two failures didn't result in immediate doom for the combined organization, Capitol could potentially woo other investors. Those investors, observers say, could likely get waivers for the cross-guarantee liability because they would be saving the other nine banks.

However, the failures coincided with a pivotal point in the bankruptcy proceedings.

Until now, Reid and his fellow executives have had exclusive rights — without interference from creditors — to submit and execute a plan. That right expires Thursday, but no plan has not been confirmed.

The judge could extend the deadline, but attorneys familiar with the proceedings say that the judge and the creditors have grown increasingly agitated by delays and the company's inability to secure the needed investment.

The failures certainly won't help. Once the deadline passes, the creditors and others will be able to submit plans for how they think the company should be restructured.

"There has been a lot of bickering," one attorney said on condition of anonymity. "It could soon get into a messier zone once the creditors start submitting alternate plans."

Several attorneys cautioned, however, not to discount the pluck of Reid, along with his daughter Cristin K. Reid, who serves as corporate president. Although Capitol has been troubled for more than four years, the Reids have fought tirelessly to keep the company afloat, consolidating their once 64-bank empire to less than a dozen.

"The closures were not good news," another of the attorneys said on condition of anonymity. "But Joe [Reid] has been a master at dodging the collapse."

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