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Capitol Bancorp 10-K 2009
form10_k.htm




 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

T
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
   
 
For the fiscal year ended December 31, 2008
   
 
OR
   
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission File Number:  001-31708

CAPITOL BANCORP LTD.
(Exact name of registrant as specified in its charter)

MICHIGAN
 
38-2761672
(State or other jurisdiction of
 
(IRS Employer
incorporation or organization)
 
Identification Number)
Capitol Bancorp Center
   
200 N. Washington Square
   
Lansing, Michigan
 
48933
(Address of principal executive offices)
 
(Zip Code)

517-487-6555
(Registrant's telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock, no par value per share
 
New York Stock Exchange
     
8.50% Cumulative Trust Preferred Securities,
$10 Liquidation Amount
 
 
New York Stock Exchange
     
10.5% Cumulative Trust Preferred Securities,
$10 Liquidation Amount
 
 
New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes    o                           No    x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes    o                           No    x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes    x                          No    o


 
 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
Large accelerated filer  o
 
Accelerated filer  x
 
Non-accelerated filer  o
 
Smaller Reporting Company  o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes    o                           No    x

As of June 30, 2008, the aggregate market value of the registrant's common stock held by non-affiliates of the registrant was:  $119,302,283.  (Such amount was computed based on shares held by non-affiliates as of January 31, 2008 and the common stock closing price reported by the New York Stock Exchange on June 30, 2008.  For purposes of this computation, all executive officers, directors and 5% shareholders have been assumed to be affiliates.  Certain of such persons may disclaim that they are affiliates of registrant.)

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class
 
Outstanding at February 24, 2009
Common Stock, no par value per share
 
17,290,623 shares


DOCUMENTS INCORPORATED BY REFERENCE

Document
 
Parts Into Which Incorporated
Annual Report to Shareholders for the Year Ended
December 31, 2008 (Annual Report)
 
 
Parts I, II, and IV
Portions of Proxy Statement for the Annual Meeting of
Shareholders to be held April 22, 2009 (Proxy Statement)
 
Part III


 
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CAPITOL BANCORP LTD.
Form 10-K
Fiscal Year Ended: December 31, 2008
Cross Reference Sheet

Item of Form 10-K
Part I
Incorporation by Reference From:
Item 1.  Business
Pages F-7 – F-11, F-22 – F-31, F-42 – F-45 and F-58 – F-59,
Financial Information Section of Annual Report
 
Item 1A.  Risk Factors
Page F-33, Financial Information Section of Annual Report
 
Item 2.  Properties
Pages F-42 – F-43 and F-56, Financial Information Section of Annual
Report
 
Part II
 
Item 5.  Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer
Purchases of Equity Securities
 
Pages F-2 – F-6, F-59 – F-61 and F-69 – F-70 , Financial Information
Section of Annual Report
Item 6.  Selected Financial Data
Page F-2, Financial Information Section of Annual Report
 
Item 7.  Management's Discussion and Analysis of
Financial Condition and Results of
Operations
 
Pages F-7 – F-33, Financial Information Section of Annual Report
 
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk
Pages F-6 and F-26 – F-31, Financial Information Section of
Annual Report
 
Item 8.  Financial Statements and Supplementary
Data
Pages F-2 and F-38 – F-72, Financial Information Section of
Annual Report
 
Item 9A. Controls and Procedures
Pages F-34 – F-36, Financial Information Section of Annual Report
 
Part III
 
Item 10. Directors, Executive Officers and Corporate
Governance
 
Proxy Statement
Item 11. Executive Compensation
Proxy Statement
 
Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related
Stockholder Matters
 
Proxy Statement
Item 13. Certain Relationships and Related
Transactions and Director Independence
 
Proxy Statement
Item 14. Principal Accountant Fees and Services
 
Proxy Statement
 
Part IV
 
Item 15. Exhibits and Financial Statement Schedules
Pages F-34 – F-72, Financial Information Section of Annual Report

Key:
"Annual Report"
means the 2008 Annual Report of Capitol provided to Shareholders and the Commission pursuant to Rule 14a-3(b).  Capitol's 2008 Annual Report is divided into two sections:  a Financial Information Section and a Marketing Section and is filed as Exhibit 13 with this Form 10-K report.

"Proxy Statement"
means the Proxy Statement of Capitol for the Annual Meeting of Shareholders to be held April 22, 2009.

Note:
The page number references herein are based on the paper version of the referenced documents.  Accordingly, those page number references may differ from the electronically filed versions of those documents.

 
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CAPITOL BANCORP LTD.

2008 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

 
PART I
 
Page
ITEM  1.   Business
6
 
ITEM 1A.  Risk Factors
24
 
ITEM 1B.  Unresolved Staff Comments
31
 
ITEM  2.   Properties
31
 
ITEM  3.   Legal Proceedings
32
 
ITEM  4.   Submission of Matters to a Vote of Security Holders
33
 
PART II
 
 
ITEM  5.   Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
 
34
 
ITEM 6.   Selected Financial Data
35
 
ITEM  7.   Management's Discussion and Analysis of Financial Condition and Results of Operations
35
 
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
35
 
ITEM  8.   Financial Statements and Supplementary Data
35
 
ITEM  9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
35
 
ITEM 9A. Controls and Procedures
35
 
ITEM 9B. Other Information
36
 
PART III
 
 
ITEM 10.  Directors, Executive Officers and Corporate Governance
37
 
ITEM 11.  Executive Compensation
37
 
ITEM 12.  Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
 
37
 
ITEM 13.  Certain Relationships and Related Transactions and Director Independence
37
 
ITEM 14.  Principal Accountant Fees and Services
37
 
PART IV
 
 
ITEM 15.  Exhibits and Financial Statement Schedules
38


 
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FORWARD-LOOKING STATEMENTS

Some of the statements contained or incorporated by reference in this annual report on Form 10-K that are not historical facts may constitute forward-looking statements.  Those forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, are subject to known and unknown risks, uncertainties and other factors which may cause the actual future results, performance or achievements of Capitol and/or its subsidiaries and other operating units to differ materially from those contemplated in such forward-looking statements.  The words "intend," "expect," "project," "estimate," "predict," "anticipate," "should," "will," "may," "believe" and similar expressions also identify forward-looking statements.  Important factors which may cause actual results to differ from those contemplated in such forward-looking statements include, but are not limited to: (i) the results of Capitol's efforts to implement its business strategy, (ii) changes in interest rates, (iii) legislation or regulatory requirements adversely impacting Capitol's banking business and/or strategy, (iv) adverse changes in business conditions or inflation, (v) general economic conditions, either nationally or regionally, which are less favorable than expected and that result in, among other things, a deterioration in credit quality and/or loan performance and collectability, (vi) competitive pressures among financial institutions, (vii) changes in securities markets, (viii) actions of competitors of Capitol's banks and Capitol's ability to respond to such actions, (ix) the cost of and access to capital, which may depend in part on Capitol's asset quality, prospects and outlook, (x) changes in governmental regulation, tax rates and similar matters, (xi) availability of funds under the U.S. Treasury's Capital Purchase Program, (xii) changes in management and (xiii) other risks detailed in Capitol's other filings with the Securities and Exchange Commission.  If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.  The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make certain estimates and assumptions, many of which are based on assumptions relating to the above-stated forward-looking statements, that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results will differ from those estimates because of the inherent subjectivity and inaccuracy of any estimation.  All subsequent written or oral forward-looking statements attributable to Capitol or persons acting on its behalf are expressly qualified in their entirety by the foregoing factors.  Investors and other interested parties are cautioned not to place undue reliance on such statements, which speak as of the date of such statements.  Capitol undertakes no obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events.







[The remainder of this page intentionally left blank]
 
 
 

 
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PART I

Item 1. Business.

a.           General development of business:

Incorporated by reference from Pages F-7 – F-11, Financial Information Section of Annual Report, under the captions "Summary and Overview" and "Capitol's Approach to Community Banking" and Pages F-42 – F-45, Financial Information Section of Annual Report, under the caption "Note A—Nature of Operations, Basis of Presentation and Principles of Consolidation."

b.           Financial information about segments:

Incorporated by reference from Pages F-10 – F-13, Financial Information Section of Annual Report (excerpt from management's discussion and analysis of financial conditions and results of operations) and Pages F-42 – F-45, Financial Information Section of Annual Report, under the caption "Note A—Nature of Operations, Basis of Presentation and Principles of Consolidation."

c.           Narrative description of business:

Incorporated by reference from Pages F-7 – F-11, Financial Information Section of Annual Report, under the caption "Summary and Overview," and "Capitol's Approach to Community Banking," Pages F-42 – F-45, Financial Information Section of Annual Report, under the caption "Note A—Nature of Operations, Basis of Presentation and Principles of Consolidation," Pages F-22 – F-26, Financial Information Section of Annual Report, under the caption "Liquidity, Capital Resources and Capital Adequacy" and Pages F-26 – F-31, Financial Information Section of Annual Report, under the caption "Trends Affecting Operations."

At December 31, 2008, Capitol and its subsidiaries employed approximately 1,580 full time equivalent employees.

Capitol Trust I and Capitol Trust XII were formed in 1997 and 2008, respectively; each is a Delaware statutory business trust.  The business and affairs of Capitol Trust I and Capitol Trust XII are conducted by their respective property trustee, a Delaware trustee, and administrative trustees who are employees and officers of Capitol.  Capitol Trust I and Capitol Trust XII exist for the sole purpose of issuing and selling its preferred securities and common securities, using the proceeds from the sale of those securities to acquire subordinated debentures issued by Capitol and certain related services.  During 2001, Capitol formed Capitol Trust II and Capitol Statutory Trust III, in conjunction with private placements of trust-preferred securities.  Capitol Trust IV was similarly formed in 2002, Capitol Trust VI, Capitol Trust VII and Capitol Statutory Trust VIII were formed in 2003, Capitol Trust IX was formed in 2004 and Capitol Trust X and Capitol Trust XI were formed in 2007.  Each of these securities has similar terms.  Additional information regarding trust-preferred securities is incorporated by reference from Pages F-58 – F-59, Financial Information Section of Annual Report, under the caption "Note I—Subordinated Debt."

Supervision and Regulation:

General:
The banking industry is subject to extensive state and federal regulation and continues to undergo significant change, particularly during the current severe economic recession.  Proposals to change the laws and regulations governing the banking industry are currently being discussed in Congress, in state legislatures and before the various bank regulatory agencies, in addition to direct investment in some financial institutions by the U.S. government.  The likelihood and timing of any changes and the impact such changes might have on Capitol are impossible to determine with any certainty.  A change in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations and earnings of Capitol.  Although Congress in recent years had sought to reduce the regulatory burden on financial institutions with

 
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Item 1. Business – continued.

respect to the approval of specific transactions, Capitol expects that the financial services industry will remain heavily regulated and that additional laws or regulations may be adopted.  The following discussion summarizes certain aspects of the banking laws and regulations that affect Capitol.  To the extent that the following information describes statutory or regulatory provisions, it is qualified entirely by reference to the particular statutory or regulatory provision.

In October 2008, Capitol applied to its primary federal regulator and the FDIC for up to $142 million of preferred stock to be purchased by the U.S. Treasury pursuant to the Capitol Purchase Program (CPP) under the Troubled Asset Relief Program (TARP).  If the U.S. Treasury purchases such preferred stock from Capitol, Capitol would also issue warrants up to 4.5 million in shares of its common stock, which would be immediately exercisable.  The preferred stock issued under CPP bears a 5% annual dividend for the first five years, increasing to 9% thereafter, and would be treated as permanent tier 1 capital for regulatory purposes.  Entering into a CPP stock purchase agreement with the U.S. Treasury under TARP restricts the issuer of preferred stock from increasing its dividends on common stock and repurchasing its common stock, places restrictions on executive compensation and has other evolving conditions and reporting obligations. There is no certainty Capitol will be approved for the CPP or, if approved, whether Capitol will choose to participate.

On February 25, 2009, the U.S. Treasury announced its new Capital Assistance Program (CAP) under which U.S. banking organizations may apply for a U.S. Treasury investment in mandatorily convertible preferred stock in an amount of up to 1% or 2% of risk-weighted assets.  The purpose of the CAP is to provide eligible banking organizations with capital in the form of a preferred security which is convertible into common equity.  Participating banking organizations would also issue warrants to the U.S. Treasury.  Eligibility will be consistent with the criteria and deliberative process established under the TARP/CPP.  The CAP is open immediately and the application deadline for participation is in May 2009.  Capitol has not yet determined whether it will submit a CAP application.

Capitol is a bank holding company registered with the Board of Governors of the Federal Reserve and is subject to regulation under the Bank Holding Company Act of 1956, as amended (Bank Holding Company Act).  The Bank Holding Company Act requires the Federal Reserve Board's prior approval of an acquisition of assets or of ownership or control of voting shares of any bank or bank holding company, if the acquisition would give the acquiring institution more than 5% of the voting shares of such bank or bank holding company.  It also imposes restrictions, summarized below, on the assets or voting shares of nonbanking companies that Capitol may acquire.

Consistent with the requirements of the Bank Holding Company Act, Capitol's lines of business provide its customers with banking, trust and other financial services and products.  These services include commercial banking through 64 subsidiary banks (as of December 31, 2008), as well as trust services, mortgage origination and servicing, equipment leasing, brokerage and investment advisory services, property and casualty insurance, life insurance and annuity products, and portfolio management services through subsidiary banks and other subsidiaries.

Under Federal Reserve Board policy, a bank holding company is expected to serve as a source of financial strength to its subsidiary banks and to stand prepared to commit resources to support each of them.  There are no specific quantitative rules on a holding company's potential liability.  If one of Capitol's subsidiary banks were to encounter financial difficulty, the Federal Reserve Board could invoke the doctrine and require a capital contribution from Capitol.  In addition, and as a separate legal matter, a holding company is required to guarantee the capital plan of an undercapitalized subsidiary bank.  See "Capital Adequacy and Prompt Corrective Action" below.

Capitol's subsidiary banks are subject to the provisions of the banking laws of their respective states of organization, the National Bank Act or national thrift regulations.  They are under the supervision of, and are subject to periodic examination by, their respective state banking departments (in the case of state-chartered banks), the Office of the Comptroller of the Currency (OCC) (in the case of national banks) or the Office of Thrift Supervision (OTS) (in the case of federal savings banks) and are subject to the rules and regulations of the OCC, the OTS, the Federal Reserve Board and the Federal Deposit Insurance Corporation (FDIC).  As of December 31, 2008, 56 of Capitol's banking subsidiaries were state-chartered banks and therefore subject to supervision, regulation and examination by state banking

 
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Item 1. Business – continued.

regulators and the FDIC.  Seven of Capitol's depository institution subsidiaries, as of December 31, 2008, were chartered as federal savings banks and are subject to regulation and examination by the OTS and FDIC; one bank subsidiary was a national bank, subject to regulation by the OCC and FDIC.  Additionally, non-bank subsidiaries are supervised and examined by the Federal Reserve Board and various other federal and state agencies.

Capitol's insured depository institution subsidiaries are also subject to cross-guaranty liability under federal law.  This means that if one FDIC-insured depository institution subsidiary of a multi-institution bank holding company fails or requires FDIC assistance, the FDIC may assess "commonly controlled" depository institutions for the estimated losses suffered by the FDIC.  Such liability could have a material adverse effect on the financial condition of any assessed subsidiary institution and on Capitol as the common parent.  While the FDIC's cross-guaranty claim is generally junior to the claims of depositors, holders of secured liabilities, general creditors and subordinated creditors, it is generally superior to the claims of shareholders and affiliates.

Payment of Dividends:
There are various statutory restrictions on the ability of Capitol's banking subsidiaries to pay dividends or make other payments to Capitol.  Each of the state-chartered banking subsidiaries is subject to dividend limits under the laws of the state in which it is chartered.  Federal Reserve Board policy provides that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the holding company's capital needs, asset quality and overall financial condition.

Dividends from a national banking association may be declared only from the bank's undivided profits, and until the bank's surplus fund equals its common capital, no dividends may be declared unless at least 10% of the bank's net income for a given time period has been carried to the surplus fund, depending on the frequency of dividend payments in a given year.  The OCC's approval is required if the total of all dividends declared in any calendar year exceeds the sum of the bank's net income of that year combined with its retained net income of the preceding two years.

OTS regulations limit capital distributions by federal savings banks, including the payment of cash dividends.  A federal savings bank must file an application with the OTS for prior approval if a capital distribution in a calendar year will exceed the sum of the institution's net income for that year to date plus retained net income for the preceding two years, or if such distribution would violate prior OTS agreements or OTS-imposed conditions or would otherwise raise safety and soundness concerns.

Capitol has several series of trust-preferred securities outstanding which are interest bearing.  Under certain conditions, Capitol may defer payment of interest on the related subordinated debentures for periods of up to five years.  The documents governing the trusts restrict Capitol's right to pay a dividend on its common stock under certain circumstances and give holders of the securities preference on liquidation over the holders of Capitol's common stock.

Capital Adequacy and Prompt Corrective Action:
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires federal regulators to take prompt corrective action against any undercapitalized institution.  FDICIA establishes five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.  "Well capitalized" institutions significantly exceed the required minimum level for each capital measure (currently, risk-based and leverage).  "Adequately capitalized" institutions include depository institutions that meet the required minimum level for each capital measure.  "Undercapitalized" institutions consist of those that fail to meet the required minimum level for one or more relevant capital measures.  "Significantly undercapitalized" characterizes depository institutions with capital levels significantly below the minimum requirements.  "Critically undercapitalized" refers to depository institutions with minimal capital and at serious risk for government seizure.


 
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Item 1. Business – continued.

Under certain circumstances, a well-capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category.  A depository institution is generally prohibited from making capital distributions, including paying dividends or fees to a holding company, if the institution would thereafter be undercapitalized.  Institutions that are adequately but not well capitalized cannot accept, renew or roll over brokered deposits except with a waiver from the FDIC, and are subject to restrictions on the interest rates that can be paid on such deposits.  Undercapitalized institutions may not accept, renew or roll over brokered deposits.

The banking regulatory agencies are permitted or, in certain cases, required to take certain actions with respect to institutions falling within one of the three undercapitalized categories.  Depending on the level of an institution's capital, the agencies' corrective powers include, among other things:

· 
prohibiting the payment of principal and interest on subordinated debt;
 
· 
prohibiting the holding company from obtaining distributions from the institution without prior regulatory approval;
 
· 
placing limits on asset growth and restrictions on activities;
 
· 
placing additional restrictions on transactions with affiliates;
 
· 
restricting the interest rate the institution may pay on deposits;
 
· 
prohibiting the institution from accepting deposits from correspondent banks; and
 
· 
in the most severe cases, appointing a conservator or receiver for the institution.

A banking institution that is undercapitalized is required to submit a capital restoration plan, and such a plan will not be accepted unless, among other things, the banking institution's holding company guarantees the plan up to a certain specified amount.  Any such guarantee from a depository institution's holding company is entitled to a priority of payment in bankruptcy.

FDICIA also contains a variety of other provisions that may affect Capitol's operations, including reporting requirements, regulatory standards for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days' prior notice to customers and regulatory authorities before closing any branch.

Information concerning capital adequacy guidelines for Capitol and its banking subsidiaries including their regulatory capital position at December 31, 2008 is incorporated by reference from Pages F-69 – F-70, Financial Information Section of Annual Report, under the caption "Note P—Dividend Limitations of Subsidiaries and Other Capital Requirements."

FDIC Insurance Assessments:
On November 30, 2006, the FDIC adopted a new rule for calculating deposit insurance based on a risk-weighting. The new rule took effect on January 1, 2007, and increased the assessment amount for all insured institutions for payments due June 30, 2007 and thereafter.  The new minimum annual assessment rate is 0.05% for a well capitalized bank, while the maximum annual rate is 0.43%.  The FDIC retains the ability to increase regular insurance assessments and to levy special additional assessments.

FDIC deposit insurance premium levels became a much more significant expense in 2008 ($3.2 million) and 2007 ($2.0 million) compared to 2006 ($362,000), and will increase in future periods as a result of the FDIC imposing a risk-based matrix approach for assessment of premiums for deposit insurance, as it seeks to replenish its insurance fund from the costs of bank failures and address higher deposit insurance coverage.


 
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Item 1. Business – continued.

During 2008, bank failures, coupled with deteriorating economic conditions, significantly reduced the FDIC's reserve ratio.  As of June 30, 2008, the designated reserve ratio was 1.01% of estimated insured deposits at March 31, 2008.  As a result of this reduced reserve ratio, in December 2008, the FDIC issued a ruling raising assessment rates uniformly by seven basis points for the first quarter of 2009.  The FDIC also recently modified the way its assessment system differentiates for risk beginning April 1, 2009, resulting in corresponding changes in assessment rates beginning with the second quarter of 2009.

In conjunction with the October 2008 enactment of the Emergency Economic Stabilization Act of 2008 (EESA), the limit on FDIC insurance coverage was increased to $250,000 for all accounts through December 31, 2009.  That legislation, along with the rate increases, will cause significant increases to FDIC insurance premiums incurred by Capitol's bank subsidiaries in 2009.

In early March 2009, the FDIC announced a special assessment to be charged equal to 20 basis points on deposits as of December 31, 2008, on June 30, 2009, payable September 30, 2009.  The FDIC subsequently indicated the possibility of reducing that special assessment to 10 basis points if Congress increases the FDIC's credit facility available from the U.S. Treasury.

In 2006, the FDIC merged the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) into a single fund called the Deposit Insurance Fund.  As a result of the merger, the BIF and the SAIF were abolished.  The merger of the BIF and the SAIF into the Deposit Insurance Fund does not affect the authority of the Financing Corporation (FICO) to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the Federal Savings and Loan Insurance Corporation.  The bonds issued by the FICO are due to mature in 2017 through 2019.  For the quarter ended December 31, 2008, the annualized FICO assessment was equal to 1.10 basis points for each $100 in domestic deposits maintained at an institution.

Temporary Liquidity Guarantee Program:
On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (TLG Program).  The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by the U.S. Treasury, as an initiative to counter the system-wide crisis in the nation's financial sector.  Under the TLG Program, the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions and (ii) provide full FDIC deposit insurance coverage for noninterest bearing transaction deposit accounts, Negotiable Order of Withdrawal Accounts (commonly known as NOW accounts) paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts (commonly known as IOLTA) held at participating FDIC-insured institutions through December 31, 2009.  Coverage under the TLG Program was available for the first 30 days without charge.  The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt.  The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000.  Capitol elected to participate in both guarantee programs.

American Recovery and Reinvestment Act of 2009:
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was enacted.  The ARRA, commonly known as the economic stimulus or economic recovery package, includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health and education programs.  In addition, ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients, which would include Capitol (if Capitol is approved to receive and agrees to receive TARP funds), until the institution has repaid the U.S. Treasury, which is now permitted under ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasury's consultation with the recipient's appropriate regulatory agency.  The executive compensation standards are more stringent than those currently in effect under the CPP or those previously proposed by the U.S. Treasury, but it is not yet clear how these executive compensation standards will relate to the

 
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Item 1. Business – continued.

similar standards announced by the U.S. Treasury in its guidelines on February 4, 2009, or whether the standards will be considered effective immediately or only after implementing regulations are issued by the U.S. Treasury.  The new standards include (but are not limited to) (i) prohibitions on bonuses, retention awards and other incentive compensation, other than restricted stock grants which do not fully vest during the TARP period up to one-third of an employee's total annual compensation, (ii) prohibitions on so-called golden parachute payments upon departure from a company, (iii) an expanded claw-back of bonuses, retention awards and incentive compensation if payment is based on materially inaccurate statements of earnings, revenues, gains or other criteria, (iv) prohibitions on compensation plans that encourage manipulation of reported earnings, (v) retroactive review of bonuses, retention awards and other compensation previously provided by TARP recipients if found by the U.S. Treasury to be inconsistent with the purposes of TARP or otherwise contrary to public interest, (vi) required establishment of a company-wide policy regarding “excessive or luxury expenditures” and (vii) inclusion in a participant's proxy statements for annual shareholder meetings of a nonbinding “say on pay” shareholder vote on the compensation of executives.

Future Legislation:
Various legislation affecting financial institutions and the financial industry is, from time to time, introduced in Congress.  Such legislation may change banking statutes and the operating environment of Capitol and its subsidiaries in substantial and unpredictable ways and could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance, depending upon whether any of this potential legislation will be enacted and, if enacted, the effect that it or any implementing regulations would have on the financial condition or results of operations of Capitol or any of its subsidiaries.  With the recent enactments of EESA and ARRA, the nature and extent of future legislative and regulatory changes affecting financial institutions is very unpredictable.

Interstate Banking:
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Riegle-Neal Act), as amended, a bank holding company may acquire banks in states other than its home state, subject to any state requirement that the bank has been organized and operating for a minimum period of time (not to exceed five years) and the requirement that the bank holding company not control, prior to or following the proposed acquisition, more than 10% of the total amount of deposits of insured depository institutions nationwide or, unless the acquisition is the bank holding company's initial entry into the state, more than 30% of such deposits in the state, or such lesser or greater amount set by the state.  The Riegle-Neal Act also authorizes banks to merge across state lines, thereby creating interstate branches.  Banks are also permitted to acquire and to establish de novo branches in other states where authorized under the laws of those states.

Transactions with Affiliates:
Transactions between Capitol's subsidiary banks and their affiliates are governed by Regulation W of the Federal Reserve Act and substantially similar regulations of the FDIC.  The affiliates of the banks include Capitol and any entity controlled by Capitol.  Generally, Regulation W (i) limits the extent to which the subsidiary banks may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and maintain an aggregate limit on all such transactions with affiliates to an amount equal to 20% of the bank's capital stock and surplus, (ii) require that a bank's extensions of credit to such affiliates be fully collateralized (with 100% to 130% collateral coverage, depending on the type of collateral), (iii) prohibit the bank from purchasing or accepting as collateral from an affiliate any "low quality assets" (including non-performing loans) and (iv) require that all "covered transactions" be on terms substantially the same, or at least as favorable, to the bank or its subsidiary as those provided to a non-affiliate.  The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and other types of similar transactions.

Loans to Insiders:
The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal stockholders of banks.  Under Section 22(h) of the Federal Reserve Act and its implementing regulations, loans to a director, an executive officer and to a principal shareholder of a bank, and some affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities,

 
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the bank's loan-to-one-borrower limit.  Loans in the aggregate to insiders and their related interests as a class may not exceed the bank's unimpaired capital and unimpaired surplus.  Section 22(h) and its implementing regulations also prohibit loans, above amounts prescribed by the appropriate federal banking agency, to directors, executive officers and principal shareholders of a bank or bank holding company, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the bank with any "interested" director not participating in the voting.  Section 22(h) generally requires that loans to directors, executive officers and principal shareholders be made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons.

Community Reinvestment Act:
Under the Community Reinvestment Act (CRA) and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate income areas, consistent with safe and sound banking practice.  The CRA requires the adoption by each institution of a CRA statement for each of its market areas describing the depository institution's efforts to assist in its community's credit needs.  Depository institutions are periodically examined for compliance with CRA and are periodically assigned ratings in this regard.  Banking regulators consider a depository institution's CRA rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution.  An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiary.

Fair Lending and Consumer Laws:
In addition to the Community Reinvestment Act, other federal and state laws regulate various lending and consumer aspects of the banking business.  Governmental agencies, including the Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that, in some cases, prospective borrowers experience unlawful discrimination in their efforts to obtain loans from depository and other lending institutions.  These agencies have brought litigation against some depository institutions alleging discrimination against borrowers.  Many of these suits have been settled, in some cases for material sums, short of a full trial.

Those governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act.  These factors include evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral nondiscriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity.

Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations.  These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of certain loans to customers.

Gramm-Leach Bliley Act of 1999:
The Gramm-Leach-Bliley Act of 1999 (GLBA) covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies.  The following description summarizes some of its significant provisions.

The GLBA repeals sections 20 and 32 of the Glass-Steagall Act, thus permitting unrestricted affiliations between banks and securities firms.  It also permits bank holding companies to elect to become financial holding companies.  A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, investment, merchant banking, insurance underwriting, sales

 
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Item 1. Business – continued.

and brokerage activities.  In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed and have at least a satisfactory Community Reinvestment Act rating.  Capitol has determined not to become certified as a financial holding company at this time, but may reconsider this determination in the future.

The GLBA provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities.  Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in specific areas identified under the law.  The federal bank regulatory agencies adopted insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.

The GLBA repeals the broad exemption of banks from the definitions of "broker" and "dealer" for purposes of the Securities Exchange Act of 1934, as amended.  It also identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a "broker," and a set of activities in which a bank may engage without being deemed a "dealer."  Additionally, the law makes conforming changes in the definitions of "broker" and "dealer" for purposes of the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended.

The GLBA also contains extensive customer privacy protection provisions.  Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution's policies and procedures regarding the handling of customers' nonpublic personal financial information.  The law provides that, except for specific limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to "opt out" of such disclosure.  An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes.  The GLBA also provides that the states may adopt customer privacy protections that are more strict than those contained in the GLBA.

Anti-Money Laundering and the USA Patriot Act of 2001:
In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (Patriot Act). The Patriot Act is designed to deny terrorists and criminals the ability to obtain access to the United States' financial system and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money.  The Patriot Act mandates that financial services companies implement policies and procedures with respect to additional measures designed to address the following matters: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions and currency crimes.  The Patriot Act also substantially broadened existing anti-money laundering legislation, imposed new compliance and due diligence obligations, created new crimes and penalties and compelled the production of documents located both inside and outside the United States.  The U.S. Treasury Department has issued a number of regulations that apply some of these requirements to financial institutions such as Capitol's banking subsidiaries.  The regulations impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.  Pursuant to the Patriot Act and the related regulations, Capitol and its banking subsidiaries have established anti-money laundering compliance and due diligence programs that include, among other things, the designation of a compliance officer, employee training programs and an independent audit function to review and test the program.


 
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Item 1. Business – continued.

Capitol maintains an Internet web site at http://www.capitolbancorp.com that includes links to Capitol's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports (SEC Reports).  The SEC Reports are available without charge as soon as reasonably practicable following the time they are filed with or furnished to the SEC.  Information on Capitol's web site is not incorporated into this Form 10-K or Capitol's other securities filings and is not a part of those filings.  The public may read and copy any materials Capitol files with the SEC at the SEC's Public Reference Room at 100 F. Street, NE, Washington, DC 20549.  The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC also maintains an Internet site that contains information regarding issuers that file electronically with the SEC.  That address is http://www.sec.gov.  In addition, Capitol makes available on its web site at http://www.capitolbancorp.com, under the heading "Governance," its:  (i) Code of Ethics; (ii) Governance Guidelines; and (iii) the charters of Capitol's Board committees, and also intends to disclose any amendments to its Code of Ethics, or waivers of the Code of Ethics on behalf of its Chief Executive Officer and other senior financial officers, on its web site.  These corporate governance materials are also available free of charge in print to shareholders who request them in writing to:  Capitol Bancorp Ltd., Attention:  Secretary, Capitol Bancorp Center, 200 N. Washington Square, Lansing, Michigan 48933.

The following tables (Tables A to G, inclusive), present certain statistical information regarding Capitol's business.












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DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY (TABLE A)
                                   
CAPITOL BANCORP LIMITED
                                                     
                                                       
                                                       
Net interest income, the primary component of earnings, represents the difference between interest income on interest-earning assets and interest expense on interest-
 
bearing liabilities. Net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the rates earned or paid on them. This
 
table shows the daily average balances for the major asset and liability categories and the actual related interest income and expense (in $1,000s) and average
 
yield/cost for the years ended December 31, 2008, 2007 and 2006.
                                     
                                                       
   
2008
   
2007
   
2006
 
         
Interest
   
(1)
         
Interest
   
(1)
         
Interest
   
(1) 
 
   
Average
   
Income/
   
Average
   
Average
   
Income/
   
Average
   
Average
   
Income/
   
Average
 
   
Balance
   
Expense
   
Yield/Cost
   
Balance
   
Expense
   
Yield/Cost
   
Balance
   
Expense
   
Yield/Cost
 
ASSETS
                                                           
  Money market and interest-bearing deposits
  $ 127,311     $ 1,218       0.96 %   $ 23,912     $ 1,120       4.68 %   $ 33,123     $ 1,403       4.24 %
  Federal funds sold
    220,128       3,822       1.74 %     205,294       10,687       5.21 %     171,445       8,703       5.08 %
  Investment securities -- U.S. Treasury,
                                                                       
    government agencies, mutual funds and other
    44,691       1,812       4.05 %     39,330       1,699       4.32 %     42,277       1,806       4.27 %
  Loans held for sale
    10,774       774       7.18 %     24,427       2,133       8.73 %     36,306       2,740       7.55 %
  Portfolio loans (2)
    4,621,247       296,689       6.42 %     3,840,526       314,800       8.20 %     3,236,538       264,701       8.18 %
        Total interest-earning
                                                                       
           assets/interest income
    5,024,151       304,315       6.06 %     4,133,489       330,439       7.99 %     3,519,689       279,353       7.94 %
  Allowance for loan losses (deduct)
    (79,554 )                     (50,316 )                     (44,000 )                
  Cash and due from banks
    133,039                       153,042                       150,782                  
  Premises and equipment, net
    60,160                       56,925                       50,656                  
  Other assets
    234,342                       159,855                       119,987                  
                                                                         
                         Total assets
  $ 5,372,138                     $ 4,452,995                     $ 3,797,114                  
                                                                         
                                                                         
LIABILITIES AND STOCKHOLDERS' EQUITY
                                                                       
  Interest-bearing deposits:
                                                                       
    Savings deposits
  $ 89,025     $ 1,496       1.68 %   $ 83,632     $ 2,291       2.74 %   $ 59,985     $ 981       1.64 %
    Time deposits under $100,000
    1,029,914       36,759       3.57 %     569,773       28,060       4.92 %     429,108       17,983       4.19 %
    Time deposits $100,000 and over
    1,199,988       50,099       4.17 %     1,031,011       52,828       5.12 %     889,769       38,115       4.28 %
    Other interest-bearing deposits
    1,236,841       24,016       1.94 %     1,227,480       40,981       3.34 %     1,066,109       31,550       2.96 %
  Notes payable and short-term borrowings
    408,521       15,067       3.69 %     220,996       11,048       5.00 %     173,719       8,169       4.70 %
  Subordinated debentures
    162,453       13,029       8.02 %     143,390       11,954       8.34 %     100,999       8,788       8.70 %
        Total interest-bearing
                                                                       
           liabilities/interest expense
    4,126,742       140,466       3.40 %     3,276,282       147,162       4.49 %     2,719,689       105,586       3.88 %
  Noninterest-bearing demand deposits
    661,578                       628,345                       614,529                  
  Accrued interest on deposits and
                                                                       
    other liabilities
    49,230                       31,640                       25,305                  
  Minority interests in consolidated subsidiaries
    163,563                       133,170                       110,060                  
  Stockholders' equity
    371,025                       383,558                       327,531                  
                        Total liabilities and
                                                                       
                           stockholders' equity
  $ 5,372,138                     $ 4,452,995                     $ 3,797,114                  
                                                                         
Net interest income
          $ 163,849                     $ 183,277                     $ 173,767          
                                                                         
Interest Rate Spread (3)
                    2.66 %                     3.50 %                     4.06 %
                                                                         
Net Yield on Interest-Earning Assets (4)
                    3.26 %                     4.43 %                     4.94 %
                                                                         
Ratio of Average Interest-Earning
                                                                       
   Assets to Interest-Bearing Liabilities
    1.22                       1.26                       1.29