Mercantile Bancorp is tantalizingly close to putting three years of headaches behind it, though it may take roughly $17 million to reach that point.

State regulators failed Royal Palm Bank of Naples in Florida and Heartland Bank in Leawood, Kan., last week. The banks were units that the $707 million-asset Mercantile had spent recent years trying to salvage by selling other banks. Mercantile even resorted to a last-ditch effort to sell the banks' healthiest parts.

The efforts were also geared toward mitigating a potential threat to the company's flagship Mercantile Bank, a $510 million-asset institution in Quincy, Ill., that was well-capitalized at March 31.

The failures are expected to cost the Deposit Insurance Fund $16.6 million. In banking, you are your brother's keeper, meaning that the Federal Deposit Insurance Corp. could look to Mercantile to cover at least part of the hit to the fund.

Mercantile's executives did not return a call for comment, but industry observers say that the issue of the cross-guarantee liability has undoubtedly come up in conversations between the company and its regulators.

"The good news is that [the amount] is modest by comparison. It is hard to imagine two failures where the loss is only $16 million. That is amazing," says Walter G. Moeling 4th, a partner at Bryan Cave in Atlanta. "My guess is that there will be a negotiated settlement."

Congress gave the FDIC the authority to charge surviving banks the cost of their failed affiliates as part of the Financial Institutions, Reform, Recovery and Enforcement Act of 1989.

The most notable example of this power during the current cycle took place in October 2009, when the FDIC seized all nine banks of FBOP, though not all of the banks were undercapitalized. Several industry observers say the FDIC acted wisely in not seizing Mercantile Bank on Friday.

"I think it was in the best interest of the FDIC to leave the existing bank alone for now and maybe allow the parent company to work their way out of the liability," says Gregory Dingens, an executive vice president and the head of investment banking at Monroe Securities, a Chicago advisory firm.

Mercantile hasn't mentioned the potential liability. In a press release issued Friday, the company went to great lengths to dissociate Mercantile Bank from the two failed banks.

"Although Mercantile Bank, Royal Palm Bank and Heartland Bank were all owned by the company, each is a separate entity and each is separately operated, the company said. "Mercantile Bank continues to be owned by the company and its operations are not affected by the closing of the two banks."

The FDIC has a few years to exact its penalty, but Moeling says that failing Mercantile Bank is the least likely scenario. "Nothing is well served by doing that," he says.

Lawyers and advisors say there is a myriad of ways that the FDIC can recoup some of the loss. In addition to a settlement, the agency could also push Mercantile to sell its flagship bank. The FDIC could also determine that the least costly solution involves waiving the claim from Mercantile to avoid standing in the way of a possible recapitalization.

"While the FDIC has the power to assess the cross-guarantee, it doesn't have to assess it," says Henry M. Fields, a partner at Morrison & Foerster who is familiar with cross-guarantee issues but does not specifically follow Mercantile.

After years of trying to stem the losses at Heartland and Royal Palm, Mercantile Bancorp is still ailing. At Sept. 30, 2011, Mercantile Bancorp's last quarterly report before it delisted, the company had $17 million of negative equity. It also had $72 million of trust-preferred securities that are in deferral.

Given Mercantile Bank's apparent health and the holding company's negative equity position, several advisors say the company would likely only find a buyer in a bankruptcy restructuring.

The bankruptcy route would allow the holding company to settle its debt with proceeds from the sale of the bank coming from an auction. Separately, the FDIC could strike a deal with the new owners to settle the liability claim against the bank.

"The holding company could put itself into bankruptcy and allow the court to order the sale of the bank," Fields says. "It sounds to me that if the holding company is insolvent, but the bank is fairly healthy, there is likely a buyer for the bank that is willing to step up."

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