Capitol Bancorp Ltd.'s latest divestiture deal underscores just how far the company has retreated from its original strategy.
The $5.8 billion-asset Capitol announced Wednesday that it had agreed to sell its 51% stake in Bank of Belleville in Illinois to the local partners who helped Capitol start the bank in 2005. In better times, the pattern at Capitol was to buy out its partners in start-up banks after three years — not the other way around.
"This is clearly not our traditional business model," said Michael Moran, the company's chief of capital markets. "We are re-engineering the community model."
Analysts called the deal Capitol's starkest departure yet.
The company, which has dual headquarters in Lansing, Mich., and Phoenix, is getting hammered both by credit-quality deterioration at its older banks and by the cost of carrying dozens of start-ups on its books.
"This really is a major change. This is a bank development company that is moving into retrenchment mode," said Daniel Cardenas, an analyst with Howe Barnes Hoefer & Arnett Inc. "And as they've said, I think we will continue to see the divestiture of assets."
Capitol's long-standing model was to invest with local partners in start-ups, usually banks with a single office.
In 2006, the company turbo-charged this strategy by setting a goal of reaching 100 charters by 2011.
A year ago, the company's charters peaked at 64, but after consolidations in Michigan and Arizona, it shrank to 53.
It also announced in April that it had hired KBW Inc.'s Keefe, Bruyette & Woods to help it shrink further.
Capitol struck its first deal under KBW's tutelage weeks later with the still-pending sale of Yuma Community Bank in Arizona to Foothills Bank for $10.5 million in cash.
While not a term of the agreements, the expectation of the local investors used to be that Capitol would buy them out somewhere around the third year, paying them, in Capitol stock, roughly 1.5 times the bank's book value. That was another practice it suspended last year.
Kevin Pesko, the president of Bank of Belleville and one of its local shareholders, said they approached Capitol about buying the company out last summer when it became clear that Capitol was not going to buy them out.
"If they had done what was expected, we would have gone along with it, but the world just changed," Pesko said. "And there was some interest among shareholders to increase their stake, so we thought, 'Why don't we just reverse the process?' "
Capitol said it would get 1.42 times the bank's book value for its shares.
The deal is expected to close next quarter and Capitol would continue to provide data processing and other back-office services to the bank.
Pesko said the local partners are raising roughly $5 million from current and new shareholders to complete the deal.
"Being independent is just attractive to us right now," Pesko said.
The $70 million-asset Bank of Belleville turned its first profit last year and had no nonperforming loans at the end of the first quarter, according to data from the Federal Deposit Insurance Corp.
Pesko said that was still the case at the end of the second quarter, and despite a loss in the first quarter, it was in the black for the first half.
Capitol, on the other hand, lost $15.7 million in the first quarter, compared with earnings of $2.2 million a year earlier, and 5.53% of its assets were nonperforming as of March 31.
Though the nonperforming assets are primarily in the company's Michigan and Arizona banks (its oldest ones), the company is also being weighed down by the younger subsidiaries, which are struggling to achieve profitability.
"They lost money on a preprovision basis," said Brad Milsaps, a managing director at Sandler O'Neill & Partners LP. "Their margin has gotten crushed. Its expenses are sky-high as they aggressively opened new banks, so they are looking to streamline where they can."
Moran said that there has been interest in other Capitol subsidiaries, but that the company does not have a set goal of the number of banks it needs to shed.
The company's total risk-based capital ratio was a healthy 11.36% at the end of the first quarter, but analysts said they are concerned that if its credit remains weak it will find itself in a capital pinch.
Capitol applied for $142 million under the Treasury Department's Troubled Asset Relief Program, but said this week that it "has no current plans to participate." When asked if its application was ever approved, Moran said, "To my knowledge it has never been acted upon."
Given the company's stock price, which has fallen 78% since a year earlier to $1.93 Thursday, a capital raise would be unlikely, Moran said.
Instead, Capitol is focusing inward.
Analysts pointed out that both the Yuma and Belleville subsidiaries are healthy banks that are being sold to preserve capital.
"It is a step in the right direction and they are going to have to execute on several more of these deals to right-size the company, but at some point they will have to replace that earnings power," Milsaps said.
"Right now, they are selling off profitable pieces of the franchise to help pieces of the franchise that are struggling."
Cardenas said he would like to see the company try to shed some of its banks with credit-quality problems, but realizes that selling the healthy pieces is the "easiest scenario."
"These kinds of deals really have minimal impact other than a slight boost to capital," Cardenas said.
"If they sold one of the bigger banks with credit problems, they could shrink the balance sheet, reduce the nonperforming assets and boost capital. But I think right now they are looking at everything and they should entertain all offers."
