Doral Financial (DRL) is in an unenviable position as it tries to shake down the Puerto Rican government for funds it desperately needs to satisfy federal regulators.

The $8.5 billion-asset company is scrambling to find ways to raise capital after Puerto Rico's Treasury Department denied Doral's claim to roughly $230 million in overpaid taxes. That decision has depleted Doral's Tier 1 capital, putting the company in violation of a 2012 consent order with the Federal Deposit Insurance Corp.

Management faces a ticking clock. Earlier this month, the FDIC gave Doral 120 days to shore up capital or provide a plan for its sale or liquidation. On one hand, the company has several options to fill the shortfall, but each avenue requires overcoming unique challenges tied to Puerto Rico and Doral's own balance sheet issues.

"None of the alternatives are very good for Doral," says Bert Ely of Ely & Co., a financial institutions and monetary policy consulting firm. "The problem is the Puerto Rican economy has been in bad shape for a number of years."

Here is a look at Doral's options for raising its capital ratios.

Fight for a Refund

Doral's dispute dates back to 2005 when it restated several years of earnings to adjust how it calculated the fair value of its portfolio of floating-rate interest-only strips. The restatements significantly cut into its earnings for 2000 to 2004. Doral has claimed that it overpaid taxes for those years, prompting its demand for a refund.

Doral and the Puerto Rican government reached an accord in 2012 to reclassify the money as a prepaid tax asset rather than an amortizing deferred tax asset in an accounting move that lifted the company's capital levels. The FDIC recently determined that Doral could no longer count Puerto Rican tax receivables toward its Tier 1 capital, and Puerto Rico's Treasury Department has voided the 2012 agreement.

Doral is fighting for the refund, though an amicable and quick resolution seems unlikely. Glen Wakeman, Doral's president and chief executive, wrote in a recent letter to Puerto Rico Treasury Secretary Melba Acosta Febo that the company would "exercise all legal remedies available to it to enforce collection" of the refund.

Febo, in voiding the 2012 agreement, categorically denied Doral's public contention that the government declared the agreement null "due to Puerto Rico's fiscal situation." Still, Puerto Rico's bonds were downgraded earlier this year to junk status as the territory struggles with staggering debt.

Doral is "at the mercy of the Puerto Rican government," says Craig Miller, a partner at Manatt, Phelps & Phillips. The company could file a lawsuit to try and recover the funds but that would tie up resources at a time when management needs capital now, he adds.

Representatives for Febo and Doral declined to comment further and the FDIC declined to discuss matters tied to an open bank.

Try to Recapitalize

Doral could need more capital even if it gets the refund. The FDIC's recent decision also invalidated about $60 million in other tax receivables tied to the Puerto Rican government, equal to about 9% of Doral's Tier 1 capital at Dec. 31.

"Their situation has gone from bad to worse," says Fernando Alonso, a partner at the Miami law firm Hunton & Williams who keeps up with the territory's banks. "Whether or not they get paid by the government, their situation has become very aggravated."

The optimal solution would involve selling common stock, Alonso says.

Doral had been considering strategic options even before the issue with the FDIC surfaced, a source familiar with the company's planning process says. The source asked not to be named given close ties to the company.

Pricing and potential dilution for existing shareholder could also complicate matters. Doral's stock has plummeted more than 70% since it went public on May 1 with the FDIC decision and its need for capital, closing Monday at $2.75 a share.

Sell Assets

Doral had hired an advisor before the latest troubles surfaced with regulators and the Puerto Rican government. Still, pricing could also complicate matters should Doral elect to sell assets, which the source close the company says is also on the table.

The company last week agreed to sell a mainland health care lending division to Triumph Bancorp in Dallas in a deal that was in the works before the FDIC issue arose. Similar deals could be worked out; Ely says the company's mainland assets are the most attractive.

Doral has five branches in Florida that had nearly $500 million in deposits at the end of June, according to FDIC data. The company also has three branches in New York City with $1.1 billion in deposits. But selling the best assets could further cripple Doral's ability to return to profitability.

The company could also sell some of its most desirable assets in Puerto Rico. Good assets are hard to come by on the island so interest could be high, says the person familiar with Doral's thinking. But interest would greatly rely on a potential buyer's risk appetite since the territory remains under duress, experts say.

Doing so would also allow Doral to shrink its balance sheet, which would also require it to hold less capital. But shrinkage also has limitations. A bank "can only sell so much because at some point it has fixed costs" that must be covered, Alonso says.

Management could also unload nonperforming loans and foreclosed property. Noncurrent loans made up nearly 13% of Doral's loan portfolio as of Dec. 31, based on FDIC data. But if Doral sells an asset at a big enough loss, it would only widen its capital hole, Ely warns.

Questions still exist over the company's loan-loss reserving. Doral delayed reporting its 2013 financial results because it is reviewing its process for estimating the loan-loss allowance.

Sell the Entire Company

Despite Puerto Rico's troubles, the territory has "its own thriving market" that could be a good fit for a right buyer looking at long-term potential, Alonso says. Strategic investors may believe the economy has reached bottom.

"There could be interest at the right price because banks benefit from scale," says Christopher Wu, a partner at investment bank Carl Marks. For a newcomer to the market, Doral would provide "access to a dominant franchise in a market. … That is something that would be hard to start from scratch."

Some are skeptical that Doral will find a mainland or foreign white knight. There could be limited interest from outsiders because of continuing economic concerns in the territory, says Taylor Brodarick, an analyst at Guggenheim Partners.

Doral, the island's second-biggest mortgage lender, could also look to sell itself to another Puerto Rican bank. But interest could be limited due to internal issues with potential suitors.

The $35 billion-asset Popular (BPOP) is big enough to absorb Doral, but Brodarick notes that the company remains in the Troubled Asset Relief Program and has been focusing on building up capital to exit the program. The $8.1 billion-asset OFG Bancorp (OFG) also has potential, but such a deal would double OFG's size.

Representatives at OFG and Popular declined to comment.

Doral's significant amount of troubled assets and pricing also present problems. The company lost more than $88 million last year. Puerto Rico's economic recovery has been sluggish and its unemployment rate still hoovers around 14%. Doral would probably have to address its nonperforming assets prior to a sale, concedes the source familiar with the company's planning process.

"The fact that it is so weak could be seen as an opportunity and a chance for growth in Puerto Rico," Miller says. "You could end up with a bargain basement deal."

The company narrowly escaped peril before, industry observers note. The company came close to failing in mid-2007 before an eleventh-hour capital infusion from a group of private equity investors allowed management to pay $625 million in debt.

Doral is focused on managing its daily operations, working with the Puerto Rican government to resolve its tax claims and developing a capital plan to regain compliance. While the company isn't concerned that the bank could fail, the source says Doral's employees have handled a few calls from concerned customers.

"There are a lot of what-ifs" surrounding Doral, Brodarick says.

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