Capitol Bancorp in Michigan Blames FDIC for Its Bankruptcy Delay

Capitol Bancorp (CBCRQ) of Lansing, Mich., is blaming the Federal Deposit Insurance Corp. for its need to reschedule a crucial bankruptcy hearing.

The $1.75 billion-asset company was supposed to attend the confirmation hearing — where a judge determines if its bankruptcy plan is feasible — on Tuesday, but late last month it requested a delay until late January. It blamed a weeks-long tussle with the FDIC over its ability to cover its equity partner's due-diligence costs.

"The debtors [Capitol] have acted expeditiously and in good faith to obtain approval for the expenditure of funds necessary to complete due diligence from their regulator," a Nov. 26 filing with the U.S. Bankruptcy Court for the Eastern District of Michigan says. "However, the process has been time-consuming."

Time is not something Capitol has to spare. The goal of the bankruptcy is to simplify the company's debt-heavy capital structure, which should pave the way for new capital to enter and be used to recapitalize its deeply troubled banks across the country. The confirmation hearing has been rescheduled at least twice; the new date has not been set.

In the meantime, however, the New Mexico Regulation and Licensing Department has notified Capitol that its Sunrise Bank of Albuquerque unit is operating with an unsafe level of capital and if it not fixed by Dec. 20, the agency has the authority to seize it. The failure of any of Capitol's dozen bank units could unravel the entire organization given the FDIC's ability to put the cost of failures on related banks.

Capitol did not comment. The FDIC does not comment on open institutions, an agency spokesman said.

Sometimes troubled banks cover due-diligence costs for potential equity investors, industry observers say.

"It is like paying someone to kick your tires," says Lawrence Kaplan, a partner at Paul Hastings. "But new investors are not willing to take any chances. They don't want to spend a lot of money and then have the bank fail and it all is for naught."

The FDIC does not have any rules preventing banks from covering due-diligence costs, although in July it issued a special memo to bank executives warning them to be careful in dealing with advisors who were requesting them to pay for due diligence and other fees with promises of connections to new equity. That guidance, however, was to protect struggling banks against fraudsters, not to stand in the way of new equity.

Still, regulators can require struggling banks to get approval before making such expenditures, says Philip K. Smith, president of law firm and consultancy Gerrish McCreary Smith.

As part of its bankruptcy reorganization, Capitol is expecting to cram down all existing stakeholders to a 53% equity stake, with new investors taking a 47% stake in exchange for $70 million to $115 million in capital. In October, ValStone Partners, a Michigan private-equity firm, agreed to invest $50 million and buy $207 million of Capitol's problem assets.

In the Nov. 26 filing, Capitol said that on Sept. 26 the FDIC said it has to approve payment of any due-diligence fees. Capitol's first request in early October was denied. In the following weeks, Capitol made several additional attempts, including a trip to Chicago to visit with the regional director of the FDIC. After several denials and appeals, the FDIC finally approved certain payments on Nov. 21.

Capitol's equity partners should be able to finish their investigation by Jan. 25, the company said in its filing.

Capitol, which once operated more than 60 banks across the country, was particularly hard hit by the downturn as the portfolios of its older banks soured and it was still dealing with startup costs of it young banks. In 2009, it began selling banks to recapitalize itself. It had 12 banks at the end of the third quarter.