An M&A situation playing out in Puerto Rico is shining a light not only on the banks involved, but also on the U.S. government's strategy for salvaging its endangered Tarp investments.

Doral Financial Corp., spurned in its bid to buy bigger competitor First BanCorp, has sent a message: it's ready to take chances if that's what it takes to grow.

First BanCorp showed it would rather partner, so to speak, with the U.S. government than with a competing Puerto Rican bank.

Over at the Treasury Department, a willingness to significantly amend a capital-raising requirement for First BanCorp signals that the government, when faced with dire circumstances, will make ever-increasing concessions to maximize returns from the Troubled Asset Relief Program.

Industry observers said that taken together, the efforts show all parties are willing to make gutsy moves in one of the nation's weakest markets.

"None of this would have happened if First BanCorp wasn't vulnerable," said Kip Weissman, a lawyer at Luse Gorman. "There always are odd offers [with the Treasury], but there never has been many and it is usually a specialty situation. … The fact that they got the Treasury to go in on it is huge."

Analysts said the Treasury is likely to negotiate for such deals — as it has done with a few other banks — but that its actions should not be misconstrued; such behavior will be spotty as the industry gets healthier.

"Through the capital-raising process we have seen distressed banks pay back Tarp," said Brett Scheiner, an analyst at FBR Capital Markets & Co. "Tarp repayment discounts have often come with a significant dilution of the current equity position."

First BanCorp said Thursday that it had amended its Tarp agreement with the Treasury, lowering its planned capital raise to $350 million from $500 million. The agency is set to then convert preferred stock it obtained through Tarp into common stock.

Treasury also agreed to reduce the discount rate to 25% from 35% while increasing First BanCorp's shares of common stock issued to 438.7 million after the conversion from 380.2 million.

Many banks have raised capital partially or entirely related to Tarp funds and some had to lower their amount for commitments. In late September, Virginia Commerce Bancorp Inc. in Arlington announced plans to raise up to $21.4 million in capital through several institutional investors. The $2.8 billion-asset company had withdrawn a $75 million public offering in July. Virginia Commerce has said it would use some of the proceeds to repay a portion of its $71 million tied to Tarp.

But few companies have won so much from the Treasury as First BanCorp has. Not only was it able to persuade the Treasury to convert Tarp shares at a discount, but analysts said it is even more uncommon to get the government to agree to the terms it did.

Sterling Financial Corp. in Spokane, Wash., is among the better-known examples. The $10 billion-asset company has been on an extensive capital-raising campaign, securing $730 million in August while getting the Treasury to agree to a 75% discount on its $303 million Tarp investment.

The "Treasury is run by investment banker types, who know how to play 'Let's Make a Deal,' " said Walter Moeling 4th, a lawyer at Bryan Cave in Atlanta. He contrasted that style with the Federal Deposit Insurance Corp., which "feels constrained by statute from doing 'Open Bank Assistance.' "

Still, analysts said huge concessions are rare because the Treasury must view a restructuring as the best and only likely option left for Tarp to succeed. Most of the small banks that voluntarily applied for Tarp were approved because they were in decent financial condition to begin with, analysts said.

First BanCorp's FirstBank Puerto Rico has seen nonperforming assets rise to 10.6% of total assets at Sept. 30, from 5.29% when it received Tarp in January 2009.

The $16.7 billion-asset company said in its latest Tarp restructuring that it had reduced risk by slashing assets by 12%, or $2.2 billion, mainly in nonperforming assets, during the past six months that ended Sept. 30.

As a smaller company, it did not need as much capital, which is why the parties were able to agree on a reduced capital raise, Aurelio Aleman, First BanCorp's president and chief executive, said in an e-mailed response.

Raising the funds could be a quicker process now. The Treasury knows this, too, observers said.

The "Treasury is willing to negotiate in order to give a little and get a lot more than it might get if the bank fails," Moeling said. "The key is that Treasury is not doing this to help the bank. Treasury is doing this to maximize the certainty and amount of its recovery."

This was not the only option for First BanCorp based on a bid proposed Dec. 2 by the $9 billion-asset Doral Financial Corp. Doral offered a stock exchange valued at 30 cents per share. The offer included plans to raise $550 million and secure a conversion agreement with the Treasury.

The latest Tarp conversion with the Treasury will be highly dilutive to First BanCorp's investors, especially with an increase in the volume of shares offered. Most analysts said it's better than nearly obliterating its long-built pride, however. That Doral has also felt distress in its marketplace made it easier for First BanCorp's board to reject the offer, Weissman said.

"Doral still has to raise the money," Weissman added. "Doral also obviously has been through hell the last few years … so there are contingencies on all sides."

Aleman declined to discuss why the company rejected Doral's bid, instead referring to its press release. When asked if they would consider other bids, he said, "we would consider what we understand is best for our shareholders."

For First BanCorp's investors, the company can remain the second-biggest Puerto Rican bank without selling to a competitor half its size in a small and competitive market. The move will be closely watched, observers said.

"Doral has thrown its head in the ring, and they'll certainly be waiting in the wings," Weissman said. Should First BanCorp fail, "then they will have to crawl back on their knees to Doral, and it will be ugly because there will be no leverage."

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