Nearly out of capital, CIB Marine Bancshares Inc. in Pewaukee, Wis., is pursuing an unusual route for a bank parent: bankruptcy.

The $830 million-asset company has proposed filing under Chapter 11 and swapping its trust-preferred securities, on which it has defaulted, for preferred stock.

The swap would eliminate trust-preferred debt and add capital — making CIB Marine a more appealing target for a buyer.

"It would clean up and eliminate debt on the balance sheet," said John Hickey Jr., CIB Marine's chairman and chief executive officer. "It would make us a more attractive partner to another company. Instead of buying one with a lot of debt, you would buy one with a lot of equity on its books."

The trust-preferred holders rejected a similar exchange proposal this year that, unlike the current one, did not include a prepackaged bankruptcy plan. CIB Marine has also sweetened the offer this time: Once the company emerges from bankruptcy and finds a buyer, a portion of the preferred stock could be converted to common shares, giving the investors 50% ownership and a chance for some upside.

"I will be fascinated to see the outcome," said James Rockett, the co-chairman of the financial institutions corporate and regulatory group in the San Francisco office of Bingham McCutchen LLP. "It may be a signal that [trust-preferred] holders are going to have to make some difficult economic decisions. This might be a reasonable way to resolve the position they are in."

If the trust-preferred holders reject the latest offer, CIB Marine warned, it could end up having to liquidate its bank subsidiary, or regulators could seize the unit. (In such situations, common shareholders and trust-preferred investors typically end up with nothing.)

CIB Marine is believed to be the first banking company to defer interest payments on trust-preferred securities for the full five years.

Industry watchers also said it is rare to see a bank holding company go bankrupt while the bank subsidiary is still solvent.

Sanford Brown, the managing partner in Bracewell & Giuliani's Dallas office, said he has seen bank holding companies file for bankruptcy protection twice in his career. "There have been a few instances where the subsidiary bank was not so bad off that it was going to be declared insolvent but the holding company had crushing amounts of debt," he said.

He cited the $36 million-asset Surety Capital Corp.'s decision to file for bankruptcy protection in late 2007. The Fort Worth company did so to clear a path to sell its Surety Bank without shareholder opposition.

Typically, a banking company issuing trust-preferred securities is allowed to defer interest payments for up to five years before default occurs. CIB Marine ran up against the default deadline on March 22, and lacked enough cash to pay the $36.7 million in deferred interest that was due. As of June 30, the company owed more than $100 million of principal and interest to the trust-preferred holders, and had $7.1 million in liquid assets.

CIB Marine's last profitable year was 2002, when it made $8.8 million. Since then, problems, including construction loans, have produced losses totaling $209 million.

Michael Iannoccone, the president and managing partner of MDI Investments Inc., said the exchange offer has little upside for trust-preferred holders.

"They would have to make the $4.2 million interest payment for the next 25 years just for you to get your money back," he said. The trust-preferred shareholders, he said, are probably thinking, " 'My chances of collecting anything out of bankruptcy are nil, but why would I convert to a security where I have no redemption value or maturity date? With seven years of negative history, I have no chance of collecting a dividend in the future. Why would I settle?' "

CIB Marine and its bank subsidiary are operating under regulatory orders. The bank is under a cease-and-desist order issued by the Federal Deposit Insurance Corp. that requires it to maintain a 10% Tier 1 leverage ratio. The holding company is under an agreement with the Federal Reserve to maintain a Tier 1 leverage ratio of 4%.

The company's total risk-based capital ratio was 3.94% at June 30, compared to 14.59% the year earlier. The Tier 1 risk-based capital ratio was 1.97%, compared to 7.23%, and the leverage ratio was 1.54%, compared to 5.33%. But Hickey said that, under the proposed exchange, its total risk-based capital ratio would rise to 18%, its Tier 1 risk-based capital ratio would be 17%, and its leverage ratio would be 13%.

He said the company has been working with regulators on the proposal. (The bank unit is adequately capitalized under regulatory definitions.)

The company had originally specified an Aug. 17 deadline for holders of the trust-preferreds to vote but extended it to Sept. 9. This offer has garnered a more positive response than the previous one but not quite enough "yes" votes, Hickey said.

"The vote was close but not close enough," he said. "We are taking the next three weeks to talk to individual holders and might try to convince some to come along. … It's hard to talk to all these folks. We don't know who all of them are."

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