Capitol Bancorp's Bankruptcy Plan Faces Ticking Clock

Capitol Bancorp (CBCRQ) has skillfully avoided collapse for several years, but the next few weeks could provide the biggest tests to its survival.

The Lansing, Mich., company's recapitalization — and perhaps its fate — lies in the balance on two key December dates. A bankruptcy confirmation hearing is set for Dec. 4, though the court session has already been pushed back twice, indicating to some industry observers that Capitol is struggling to find the equity necessary to make the plan work.

A more ominous deadline is set for Dec. 20. That is when the New Mexico Regulation and Licensing Department reserves the right to shutter the company's Sunrise Bank of Albuquerque unless Capitol addresses the bank's capital woes.

Unfortunately for Capitol, bankruptcy protection does not prevent a regulator from closing a bank, banking lawyers say. Given regulators' ability to charge related banks for a failure, the seizure of the New Mexico bank could be enough to pull Capitol under.

"You'll often hear in non-banking contexts that bankruptcy allows companies to enjoy the protection of the automatic stay," says Rob Klingler, a partner at Bryan Cave in Atlanta. "The bankruptcy of a bank holding company does not limit in any way the state regulators or the OCC from closing a bank."

Industry observers expect bankruptcies of banking companies, through asset sales or reorganizations, to become a major trend in coming years. Capitol's predicament with the state regulator in New Mexico exposes a kink in the strategy.

Bankruptcy attorneys also note that complications may arise when banking companies file for bankruptcy without the necessary levels of new equity lined up.

"In at least a couple of cases, debtors have attempted to obtain confirmation first, and seek required capital later," says Van C. Durrer 2nd, a partner at Skadden, Arps, Slate, Meagher & Flom. "This obviously puts pressure on their ability to prove the feasibility of their exit from Chapter 11."

Durrer says he is not overly familiar with Capitol's case, but he was a part of a team involved in the 2010 bankruptcy of AmericanWest Bancorp and the related auction of its AmericanWest Bank.

The $1.75 billion-asset Capitol filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Eastern District of Michigan in August after failing to persuade debtholders to convert their interests into equity outside of court. The bankruptcy plan would convert all of Capitol's existing debt and equity into a 53% equity stake; new investors would infuse $70 million to $115 million into the company for the remaining 47% stake.

In October, ValStone Partners, a private-equity firm in Michigan, agreed to invest $50 million in Capitol and buy $207 million of the company's nonperforming assets. The agreements are contingent on the approval of the bankruptcy plan and they give ValStone significant leeway to call off the deals without a penalty.

Representatives for Capitol did not return calls for comment, but the company noted in its quarterly filing with the Securities and Exchange Commission on Nov. 14 that securing outside capital was important to its turnaround.

"The anticipated equity infusion … is a critical component of the likelihood of success" of the reorganization, the filing said. "If Capitol is unable to raise capital from new investors, or raise less than the amount currently anticipated, it may be forced to operate in the Chapter 11 cases for an extended period."

Capitol has other banks that are in danger of possible seizure. The company also disclosed in its regulatory filing that Central Bank of Arizona, Sunrise Bank of Arizona and Pisgah Community Bank were critically undercapitalized at Sept. 30, with leverage ratios "below 2% before rounding to the nearest one-hundredth."

Such a classification gives regulators the legal authority to close banks, but Capitol said it plans to push the banks' ratios above the threshold by the end of this month. It would do so with the proceeds it expects from selling High Desert Bank in Bend, Ore.

Capitol has relied on a strategy of selling banks to prop up others since April 2009. At the onset of the economic downturn, the company had 64 banks. Through consolidations and sales, that company operated a dozen banks at Sept. 30.

The company's financial condition improved modestly in the third quarter; its quarterly loss of $5.7 million compared to a loss of $22.8 million a year earlier. Nonperforming assets fell 26% from the end of last year, to $231.8 million.