Time Is Running Out for Doral Financial

Doral Financial is facing an increasingly cloudy future — and a deadline to raise capital or sell itself — as regulators exert more pressure on the San Juan, Puerto Rico, company.

The Federal Deposit Insurance Corp. recently hit Doral and its $5.9 billion-asset bank with a prompt corrective action directive, ordering them to quickly resolve longstanding capital woes without relying on a $230 million tax refund from the Puerto Rican government. Doral also moved out of its corporate office in a high-end part of Miami; it is unclear if the move was part of a self-initiated cost-cutting exercise or the result of FDIC pressure.

PCAs are often considered one of the last public warnings before a bank goes into receivership, which Doral acknowledged was a possibility in a recent regulatory filing, and industry experts warned that the company is quickly running out of options.

"I think the likelihood that Doral could raise sufficient capital is as close to zero as you can possibly get," said Bert Ely at consulting firm Ely & Co. "I don't think Doral will be able to continue as an independent organization."

Doral did not respond to requests for comment, and Puerto Rico's Treasury Department declined to comment. An FDIC spokesman said the agency does not comment on open institutions.

Here is a rundown of Doral's situation and the company's options in coming weeks.

How did Doral get into such dire straits?

The company restated several years of earnings prior to the financial crisis to adjust how it calculated the fair value of floating-rate interest-only strips. The restatement cut into several years of profit, prompting Doral to claim it overpaid taxes. In addition, Doral's bank has lost nearly $950 million in the last seven years, according to FDIC call reports.

Doral and Puerto Rico's Treasury Department reached an accord in 2012 to reclassify $230 million of the overpayment as a prepaid tax asset, which raised the company's capital levels. But the FDIC determined last year that Doral could no longer count the funds toward Tier 1 capital. Making matters worse, Puerto Rico voided the 2012 agreement.

Doral won a legal victory in October when Puerto Rico's Court of First Instance ruled that the territory's government had to repay the funds over five years. But the government appealed that decision and Doral is still unable to count the money towards capital levels.

What are Doral's prospects?

Though it is rare for a bank to overcome a PCA, "it is not completely unheard of," said Lorraine Buerger, a lawyer at Schiff Hardin. Doral has a few options, including raising capital, but this could be tricky given its unresolved refund and uncertain future, experts said.

"A lot will depend on how investors evaluate Doral's ability to recover the money from the government," said Craig Miller, a lawyer at Manatt, Phelps & Phillips. Recapitalizing "is still possible, but it will be expensive and at a significant dilution."

It is becoming more likely that the company will have to find an institution to buy certain assets or the entire bank, industry observers said. Typically a deal would be in the works before a bank was put under a PCA, Buerger said.

Doral is also likely trying to settle with the Puerto Rican government for at least a portion of the tax refund. However, "time is not their friend," Miller said.

The company could also be dealing with the loss of key employees and important customers, experts said. Nancy Reinhard, who had been Doral's principal accounting officer and interim chief financial officer, abruptly resigned last month to "pursue other opportunities."

During a crisis, mid-level executives who lack an equity stake in the company are likely to look for other employment, said Rod Taylor, president of Atlanta executive recruiting firm Taylor & Co. Making loans can also become problematic when regulatory problems exist, so senior lenders could also be circulating their resumes.

Competitors may also "take advantage of the situation" by hiring a bank's best employees, typically those with a large book of business, said Carlos Arboleda, a managing director at COI Access, an executive recruiting firm in Miami.

Which banks have the capacity to buy Doral?

Finding a buyer could be challenging for Doral due to the weakness of Puerto Rico's economy, Ely said. The territory's unemployment rate in October was 14%, compared to 5.8% nationally, according to the U.S. Bureau of Labor Statistics.

Potential buyers would also need to take a hard look at how Doral is reserving against potential loan losses, Ely said. "The big question is who wants to establish a major presence in Puerto Rico, or which of the few players already operating there are willing to increase their exposure," he added.

Still, a bank with a large presence along the East Coast or South Florida — or an international institution — could be interested since a deal would instantly provide scale on the island, Miller said.

The $34 billion-asset Popular Inc. and the $7.6 billion-asset OFG Bancorp were previously mentioned as potential buyers. It is unclear if OFG would have an interest in digesting such a large institution, and Popular recently divested its retail operations in several markets to help it exit the Troubled Asset Relief Program. An OFG representative declined to comment, and efforts to reach Popular were unsuccessful.

What could happen if Doral fails?

Doral warned in January about the potential of going into receivership, and its lawsuit against Puerto Rico's Treasury Department depicted a worst-case scenario that involved its disappearance from the territory's economy.

Under that scenario, the FDIC may simply be able to find a buyer, which is usually seen as the least costly option, Buerger said. But, once again, Puerto Rico's economic condition could cause complications, Ely said.

The FDIC found buyers in April 2010 for Eurobank, R-G Premier Bank of Puerto Rico and Westernbank when those banks failed. OFG, Scotiabank and Popular were the respective buyers, taking on a combined $17.9 billion in assets — with substantial loss-sharing agreements — and $14.8 billion in deposits.

The FDIC could again try to entice buyers with loss sharing, industry experts said. However, "all indications are that the FDIC prefers new transactions without loss-sharing," Buerger said, though there is nothing barring the agency from revisiting the practice if necessary.

Additionally, the FDIC could sell pieces of Doral to different buyers, observers said. This could include holding onto problem assets deemed unattractive to most bidders for future disposition, Buerger said.

Finally, the FDIC could decide to the run the bank itself for a period, Ely said. The agency would be disinclined to pursue that option since doing so "is perceived as increasing the cost to the insurance fund," Buerger said.

What about Doral's refund claim?

Doral's claim could still remain viable if the company changes hands, Miller said. While continuing the litigation would be expensive, an acquirer would likely pursue it because so much money is at stake, Buerger said.

The Puerto Rican government is likely weighing the pros and cons of settling with another entity instead of Doral, industry observers said. A buyer could be willing to accept less money than Doral, especially if it did not face the same capital pressures.

"An acquirer would spend a lot of time looking at the lawsuit and the viability of the claim," Miller said. "They would then put that into the valuations of an acquisition."