Capitol Bancorp Keeps Hanging On, But for How Much Longer?

Capitol Bancorp could soon hit the wall after a long run that has cheated the odds.

It once operated dozens of banks across the country under its signature strategy of partnerships with local investors. But the financial crisis dealt Capitol a severe blow because it was heavy into states such as Arizona, Michigan and Nevada that suffered the most. It has been busy slimming down since then.

"I tip my hat to them," says Eliot Stark, a managing director at Headwaters MB, a Denver investment bank. "They've gone through this liquidation process without going into conservatorship. It is really pretty amazing; no one would have thought in 2008 that they would still be alive in 2012."

The company, however, might be running out of options.

Capitol made an abrupt about-face in April 2009, abandoning aspirations of chartering 100 banks. It hired KBW to help unload healthy banks and used the proceeds to prop up the strugglers. Three years later the company has whittled its franchise to 14 banks, from a peak of 64, through sales and consolidations. So far, Capitol has managed to keep all of its banks out of the hands of the Federal Deposit Insurance Corp.

Most of its remaining banks are deeply troubled despite periodic capital injections. The holding company has $108 million of negative equity and is saddled with debt from trust-preferred securities.

Capitol has four pending bank sales that would reduce its assets by $235 million and raise about $6 million. If it completes the sales, the company would have 10 banks. Seven of those banks are dangerously close to becoming critically undercapitalized, a level at which regulators are typically compelled to step in and shutter an institution.

"It really comes down to those remaining troubled banks and what is left in those portfolios," says Terry Keating, a managing director at Amherst Partners in Chicago. "Have they been repaired to a point of breakeven? They wouldn't be able to sustain substantial losses again without a source of capital."

Late last month the company reported consolidated nonperforming assets of $324.6 million, down nearly a quarter from a year earlier. Though the amount remains high for the $2.2 billion-asset company, the decrease was positive.

None of Capitol's banks have failed, but the FDIC has asserted that the company controlled Commerce Bank of Southwest Florida, which failed in late 2009. Capitol has maintained that it did not own an interest in the bank, which cost the Deposit Insurance Fund $23.6 million.

Calls to Capitol were not returned. Investment bankers say there still might be a few other levers left to pull but they are either longshots or too incremental.

There are still a few banks that could fetch a premium, Stark says, particularly the $154 million-asset Capitol National Bank. Based in Lansing, Mich., it is the franchise's patriarch and the only one of its banks with a national charter. Capitol National is among the healthier of the remaining banks; it was adequately capitalized at Dec. 31, with a total risk-based capital ratio of 9.03%.

"It is still a small gem that could be sold," Stark says. "Maybe it brings in $15 million and keeps them going for awhile."

The benefit of hanging on this long is that others' appetite for troubled banks has improved, Keating says, such that even significantly undercapitalized banks could attract some prospective buyers. Capitol can attest to that: it has deals to sell two significantly undercapitalized banks in North Carolina.

Investors are trying to focus on the upside potential, while putting money that was initially raised to buy failed banks to work, Keating says. "On the whole, investors are expecting the market to improve and are trying to get their money in," Keating says.

In its annual filing with the Securities and Exchange Commission, Capitol says it is seeking new capital. Given the company's insolvency and debt, that is the least likely outcome, industry observers say. Investors are likely unwilling to invest enough money to pull the company out of its capital hole and then refill its coffers.

"I don't see anyone stepping in to recapitalize the company," Stark says. "It would take $100 million just to get it to zero."

Chip MacDonald, a partner at the law firm Jones Day, says the company could potentially look to recapitalize its struggling banks by filing for bankruptcy, though that would be extremely difficult.

"You have to have a really solid plan with somebody coming in with capital," MacDonald says. "It is hard to recap banks and holding companies that do not have a core strategy."

Regulators have been gracious in working with Capitol, MacDonald adds. Its most-troubled banks are its biggest ones, and the failure of any of those particular banks could jeopardize the whole company by piling the cost of the failure onto the remaining banks.

Also, Capitol owned 51% stakes in many of its younger banks, with local investors owning the rest. Many of the local investors have managed to buy their banks outright, and the FDIC has given them waivers for any liability for Commerce Bank of Southwest Florida. Should any of the remaining banks fail, Capitol would face a much easier resolution process compared with a two years ago.

"Kudos to the company for being able to keep it going," MacDonald says. "But the FDIC deserves a lot of credit for hanging in there and allowing them to get it resolved on their own."