Capitol Bancorp Ltd. has spent years expanding into growth markets to offset the sputtering Michigan economy. But now Capitol, sputtering itself, is practically dumping its home state.

In an unusual move that neither regulators nor shareholders have to approve, the $5.7 billion-asset company, which has dual headquarters in Lansing, Mich., and Phoenix, announced this week that it plans to spin off its Michigan Commerce Bancorp Ltd.

Michael Moran, Capitol's chief of capital markets, said the split would benefit its stock price and likely make raising capital easier. That's because the company could get more credit for having operations in 17 states once it is free of Michigan's shadow.

However, Michigan Commerce will not be so lucky, several observers said. It will start life as an independent company with 9.34% of its assets nonperforming, and its market area is one of the most battered in the country.

"Clearly, they will still have significant challenges ahead of them," Moran conceded. "But by isolating that operation, we feel there are opportunities that could be presented to them." He did not elaborate.

Capitol recently bulked up Michigan Commerce by rolling together 10 of its Michigan banks.

By spinning it off, Capitol would shrink its own asset size by 22% and reduce nonperforming loans by more than a third.

Moran said that he does not expect any regulatory hurdles to completing the deal because Michigan Commerce is an existing holding company, its bank is already chartered, and current Capitol shareholders would own the new company. (The ratio for distributing shares in Michigan Commerce has not been determined.)

"Nothing has changed to the regulatory oversight," Moran said, adding that Capitol will continue to serve as a source of strength to Michigan Commerce until the split sometime in the next six months.

But observers said that regulators could intervene, even if technically no particular facet of the deal requires their formal review. In fact, scrutiny could be particularly tough, because Michigan Commerce is operating under a formal agreement with the Federal Deposit Insurance Corp. and the Michigan Office of Financial and Insurance Regulation.

"If regulators see a safety and soundness issue, they could raise supervisory questions," said Frank Bonaventure Jr., a principal at the law firm Ober, Kaler, Grimes & Shriver PC in Baltimore.

"Once it is spun out, regulators could no longer force the original holding company to do anything," Bonaventure said. "That could cause some kind of supervisory push where regulators say, 'We don't want another problem bank out there without the strength of the holding company, even if it benefits shareholders.' "

Eliot R. Stark, a Michigan-based managing director at the investment bank Capital Insight Partners Inc., said that regulators could at least require Capitol to strengthen Michigan Commerce before cutting ties, since the new company would be hard pressed to find capital on its own.

"They will no longer have Capitol to support it and any kind of capital raise will be tough to do because they have no track record to support it," Stark said.

According to filings with the Securities and Exchange Commission, regulators ordered Michigan Commerce Bank to have a leverage ratio of 9% and a total risk-based capital ratio of 12%.

At June 30, Michigan Commerce's leverage ratio was 8.46%. Its total risk-based capital ratio was not disclosed.

Cristin K. Reid, Capitol's president of corporate operations, said that the bank will continue to work toward those capital ratios and that its being below them should not weigh on the deal.

The spinoff is the latest in a series of recently announced changes at Capitol. Though it once aspired to have 100 bank charters, it has been struggling lately with the capital drain of having not only loan trouble, but a slew of start-up banks to support.

Since hiring KBW Inc.'s Keefe, Bruyette & Woods in April, Capitol has announced the sale of five of its subsidiary banks.

The company announced Thursday a second-quarter loss of $18.7 million, compared with earnings of $623,000 a year earlier, as its provision for loan losses increased nearly sixfold, to $35.8 million.

Even following the split, Capitol will continue to face credit problems and a capital crunch. Based on second-quarter data adjusted for the split, nearly 5.63% of Capitol's assets were nonperforming.

However, Moran said the hope is that the deal will clean up the murkiness created by its operations in Michigan, which, in turn, could make access to capital easier.

"This brings clarity, which should result in better valuation in the capital markets, which potentially improves our access to additional sources of funds," he said.

Capitol needs approval from the Securities and Exchange Commission and the Internal Revenue Service to complete the deal.

Terry McEvoy, an analyst with Oppenheimer & Co. agreed with Moran, saying that the company's reputation has been skewed by its Michigan headquarters. "Investors have been hesitant to own a part of Michigan," he said.

"It might have been 40% of the company, but it was 100% of the stock price," he added. "Now it will be a company in the West and the Rockies and the Southwest; that sounds a lot better than a company in Michigan."

Following the split, Michigan will make up 10% of Capitol's assets. It has three remaining bank units there. Two of those are strategic moves — Capitol's only national bank charter and its trust company. The other is a newer subsidiary, of which Capitol owns 51%.

Capitol is not the only company to distance itself from the Wolverine State. In 2007, the $63.3 billion-asset Comerica Inc. ditched Detroit as its headquarters in favor of Dallas.

But regardless of how the spinoff goes, observers said few other companies are likely to copy Capitol. "There aren't that many multibank holding companies, because many of them have consolidated," Bonaventure said.

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