Capitol Bancorp 10-K 2011
Documents found in this filing:
For the transition period from ____________ to ____________
Commission File Number: 001-31708
CAPITOL BANCORP LTD.
(Exact name of registrant as specified in its charter)
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act: None
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).
(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, 2010, the aggregate market value of the registrant's common stock held by non-affiliates of the registrant was: $16,993,884. (Such amount was computed based on shares held by non-affiliates as of January 31, 2010 and the common stock closing price reported by the New York Stock Exchange on June 30, 2010. 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.
DOCUMENTS INCORPORATED BY REFERENCE
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CAPITOL BANCORP LTD.
Fiscal Year Ended: December 31, 2010
Cross Reference Sheet
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2010 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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Some of the statements contained in this document, including Capitol's consolidated financial statements, Management's Discussion and Analysis of Financial Condition and Results of Operations and in documents incorporated into this document by reference that are not historical facts, including, without limitation, statements of future expectations, projections of results of operations and financial condition, statements of future economic performance and other 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," "could," "believe," "may," "might" and similar expressions also are intended to 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 operating 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 banking subsidiaries 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) changes in management, (xii) consummation of pending sales of certain banking subsidiaries, (xiii) completion of Capitol's selective bank divestiture activities, (xiv) other risks detailed in Capitol's other filings with the Securities and Exchange Commission and (xv) the following, among others:
· Capitol's ability to continue as a going concern;
· The impact on Capitol's financial results, reputation and business if it is unable to comply with all applicable federal and state regulations and applicable formal agreements, consent orders, other regulatory actions and any related capital requirements;
· The risk that, if economic conditions worsen or regulatory capital requirements are modified, Capitol may be required to seek additional liquidity and/or capital from external sources, if available;
· Management's ability to effectively manage interest rate risk and the impact of interest rates in general on the volatility of Capitol's net interest income;
· The effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009, the implementation by the Department of the U.S. Treasury and federal banking regulators of a number of programs to address capital and liquidity issues within the banking system and additional programs that may apply to Capitol in the future, all of which may have significant effects on Capitol and the financial services industry;
· The decline in commercial and residential real estate values and sales volume and the likely potential for continuing illiquidity in the real estate market;
· The risks associated with the high concentration of commercial real estate loans within Capitol's portfolio;
· The uncertainties in estimating the fair value of developed real estate and undeveloped land relating to collateral-dependent loans and other real estate owned in light of declining demand for such assets, falling prices and continuing illiquidity in the real estate market;
· Negative developments and disruptions in the credit and lending markets, including the impact of the ongoing credit crisis on Capitol's business and on the businesses of its customers as well as other banks and lending institutions with which Capitol has commercial relationships;
· A continuation of unprecedented volatility in the capital markets;
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· The risks associated with implementing Capitol's business strategy, including its ability to preserve and access sufficient capital to execute its strategy;
· Continued unemployment and its impact on Capitol's customers' savings rates and their ability to service debt obligations;
· Fluctuations in the value of Capitol's investment securities;
· The ability to attract and retain senior management experienced in banking and financial services;
· The sufficiency of the allowance for loan losses to absorb the amount of actual losses inherent within the loan portfolio;
· Capitol's ability to adapt successfully to technological changes to compete effectively in the marketplace;
· Credit risks and risks from concentrations (by geographic area and by industry) within Capitol's consolidated loan portfolio and individual large loans;
· The effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds, and other financial institutions operating in Capitol's market or elsewhere or providing similar services;
· The failure of assumptions underlying estimates for the allowance for loan losses and estimation of values of collateral or cash flow projections related to collateral-dependent loans;
● Volatility of rate sensitive deposits;
· Operational risks, including data processing system failures or fraud;
· Liquidity risks;
· The ability to successfully acquire deposits for funding and the pricing thereof;
· The ability to successfully execute strategies to increase noninterest income;
· Changes in the economic environment, competition or other factors that may influence loan demand and repayment, deposit inflows and outflows, and the quality of the loan portfolio and loan and deposit pricing;
· The impact from liabilities arising from legal or administrative proceedings on the financial condition of Capitol;
· The current prohibition of Capitol's banking subsidiaries to pay dividends to Capitol without prior written authorization from regulatory agencies;
· The current prohibition of Capitol's payment of cash dividends on its common stock without prior written regulatory authorization;
· Administrative or enforcement actions of banking regulators in connection with any material failure of Capitol or its banking subsidiaries to comply with banking laws, rules or regulations or formal agreements with regulatory agencies;
· Capitol's compliance with the terms of its written agreement with the Federal Reserve Bank, amendments thereto or subsequent regulatory agreements;
· The continued availability of credit facilities provided by Federal Home Loan Banks to Capitol's banking subsidiaries;
· The uncertainties of future depositor activity regarding potentially uninsured deposits;
· The possibility of the FDIC assessing Capitol's banking subsidiaries for any cross-guaranty liability;
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· Governmental monetary and fiscal policies, as well as legislative and regulatory changes, that may result in the imposition of costs and constraints on Capitol through higher FDIC insurance premiums, significant fluctuations in market interest rates, increases in capital requirements and operational limitations;
· Changes in general economic or industry conditions, nationally or in the communities in which Capitol conducts business;
· Changes in legislation or regulatory and accounting principles, policies, or guidelines affecting the business conducted by Capitol;
· The impact of possible future material impairment charges;
· Acts of war or terrorism;
· Capitol's ability to manage fluctuations in the value of its assets and liabilities and maintain sufficient capital and liquidity to support its operations;
· The concentration of Capitol's nonperforming assets by loan type in certain geographic regions and with affiliated borrowing groups;
· The risk of additional future losses if the proceeds Capitol receives upon the liquidation of assets are less than the carrying value of such assets;
· Restrictions or limitations on access to funds from subsidiaries and potential obligations to contribute additional capital to Capitol's subsidiaries, which may restrict its ability to make payments on its obligations;
· The availability and cost of capital and liquidity on favorable terms, if at all;
· The risk that the realization of deferred tax assets may not occur;
· The risk that Capitol will not be able to complete its various proposed divestitures, mergers and consolidations of certain of its banking subsidiaries or, if completed, realize the anticipated benefits of the proposed mergers and/or consolidations;
· The costs and effects of litigation, investigations, inquiries or similar matters, or adverse facts and developments related thereto;
· The risk that Capitol could have an "ownership change" under Section 382 of the Internal Revenue Code, which could impair its ability to timely and fully utilize its net operating losses for tax purposes and so-called built-in losses that may exist if such an "ownership change" occurs;
· Other factors and other information contained in this document and in other reports and filings that Capitol makes with the SEC under the Exchange Act, including, without limitation, under the caption "Risk Factors"; and
· Other economic, competitive, governmental, regulatory and technical factors affecting Capitol's operations, products, services and prices.
For a discussion of these and other risks that may cause actual results to differ from expectations, you should refer to the risk factors and other information in this Annual Report on Form 10-K and Capitol's other periodic filings, including quarterly reports on Form 10-Q and current reports on Form 8-K, that Capitol files from time to time with the SEC. All written or oral forward-looking statements that are made by or are attributable to Capitol are expressly qualified by this cautionary notice. You should not place undue reliance on any forward-looking statements, since those statements speak only as of the date on which the statements are made. Capitol undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made to reflect the occurrence of new information or unanticipated events, except as may otherwise be required by law.
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Item 1. Business.
a. General development of business:
Incorporated by reference from Pages F-11 – F-14 Financial Information Section of Annual Report, under the captions "Summary and Overview" and "Capitol's Approach to Community Banking," Pages F-36 – F-39, Financial Information Section of Annual Report, under the caption "Certain Regulatory Matters," Pages F-39 – F-41, Financial Information Section of Annual Report, under the caption "Going-Concern Considerations," Pages F-45, Financial Information Section of Annual Report, under the caption "Divestitures of Banks" and Pages F-59 – F-61, Financial Information Section of Annual Report, under the caption "Note A—Nature of Operations, Basis of Presentation and Principles of Consolidation."
Capitol was incorporated in 1988.
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-81 – F-82, Financial Information Section of Annual Report, under the caption "Note J—Subordinated Debt."
b. Financial information about segments:
Incorporated by reference from Pages F-13 – F-17, Financial Information Section of Annual Report (excerpt from Management's Discussion and Analysis of Capitol's Business, Financial Condition and Results of Operations) and Pages F-59 – F-61, 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-11 – F-14, Financial Information Section of Annual Report, under the captions "Summary and Overview" and "Capitol's Approach to Community Banking," Pages F-30 – F-36, Financial Information Section of Annual Report, under the caption "Liquidity, Capital Resources and Capital Adequacy," Pages
F-35 – F-36, Financial Information Section of Annual Report, comparative analysis of each banking subsidiaries' regulatory capital position, Pages F-36 – F-39, Financial Information Section of Annual Report, under the caption "Certain Regulatory Matters," Pages F-41 – F-44, Financial Information Section of Annual Report, under the caption "Trends Affecting Operations," Pages F-45, Financial Information Section of Annual Report, under the caption "Divestitures of Banks" and Pages F-59 – F-61, Financial Information Section of Annual Report, under the caption "Note A—Nature of Operations, Basis of Presentation and Principles of Consolidation."
At December 31, 2010, Capitol and its subsidiaries employed approximately 1,002 full time equivalent employees.
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Item 1. Business – continued.
Supervision and Regulation:
Incorporated herein by reference from Pages F-36 – F-39 and F-97 – F-100, Financial Information Section of Annual Report, under the caption "Certain Regulatory Matters" and "Capitol Requirements and Related Regulatory Matters."
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 Capitol's business, financial position and results of operations. 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.
Capitol has not received any so-called "bailout" funds from any governmental sources and is not currently expecting to participate in the various capital programs offered by the U.S. government as an economic stimulus during the current severe recession.
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 community banking subsidiaries provide their customers with banking, trust and other financial services and products. These services include commercial banking through 23 banking subsidiaries (as of December 31, 2010), 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 banking subsidiaries and other subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to serve as a source of financial strength to its banking subsidiaries 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 to its banking subsidiaries. In its sole judgment, the Federal Reserve Board could invoke the source-of-strength doctrine and require capital contributions from Capitol to its banking subsidiaries. In addition, and as a separate legal matter, a holding company is required to guarantee the capital plan of an undercapitalized banking subsidiary. See "Capital Adequacy and Prompt Corrective Action" below.
Capitol's banking subsidiaries 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, 2010, 18 of Capitol's banking subsidiaries were state-chartered banks and, therefore, subject to supervision, regulation and examination by state banking regulators and the FDIC. Four of Capitol's depository institution subsidiaries, as of December 31, 2010, were
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Item 1. Business – continued.
chartered as federal savings banks and, accordingly, are subject to regulation and examination by the OTS and FDIC; and one banking subsidiary was a national bank, subject to regulation by the OCC and FDIC. Additionally, nonbank subsidiaries of Capitol are supervised and examined by the Federal Reserve Board and various other federal and state agencies. As part of the financial and regulatory overhaul for the U.S. financial institutions, via certain provision of the Dodd-Frank Act, the OCC must acquire the operations and some employees from the OTS by July 21, 2011.
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; due to operating losses and a written agreement between the Federal Reserve and Capitol, Capitol is currently prohibited from payment of dividends.
As of December 31, 2010, Capitol's banking subsidiaries were prohibited from making dividend payments to Capitol without prior regulatory approval. Capitol is similarly prohibited from making dividend payments without prior regulatory approval.
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. In April 2009, Capitol commenced deferral of interest payments on such subordinated debentures and, pursuant to the written agreement between the Federal Reserve and Capitol, may not make interest payments thereon without prior written approval from the Federal Reserve. 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 FDIC 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.
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
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Item 1. Business – continued.
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.
Most of Capitol's banking subsidiaries are subject to regulatory agreements which, among other things, preclude classification of the bank at a level higher than adequately-capitalized.
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:
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.
Several of Capitol's banking subsidiaries have recently received Prompt Corrective Action Notifications (PCAN) and four banking subsidiaries have received Prompt Corrective Action Directives (PCAD) from the FDIC. For each banking subsidiary which has received a PCAN, capital restoration plans have been requested by the FDIC, prepared and resubmitted for regulatory review and approval. For banks in receipt of a PCAD, those institutions are striving to develop and implement capital restoration plans which may be subsequently acceptable to the FDIC.
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, 2010, is incorporated by reference from Pages F-30 – F-39, Financial Information Section of Annual Report, under the captions "Liquidity, Capital Resources and Capital Adequacy" and "Certain Regulatory Matters" and Pages F-97 – F-100, Financial Information Section of Annual Report, under the caption "Note Q—Capital Requirements and Related Regulatory Matters."
FDIC Insurance Assessments:
FDIC deposit insurance premium levels remained a significant expense in 2010 ($14.8 million) compared to 2009 ($12.1 million) and 2008 ($2.6 million). FDIC insurance premiums currently range from .07% to .78% of average domestic deposits, depending on an institutions' risk classification and other factors. Effective April 1, 2011, banks will be charged FDIC insurance premiums based on net assets (defined by the FDIC for assessment purposes as quarter-to-date average
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Item 1. Business – continued.
daily total assets less the corresponding amount of Tier 1 capital) rather than based on average deposits. Initial base assessment rates range from .05% to .35% of "net assets" and may be adjusted for certain factors. Assuming that Capitol's banking subsidiaries remain in their current risk category, this new FDIC assessment methodology may result in a decrease in this expense item in the future. Future assessment rates and methodology are difficult to predict.
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. During 2009 and 2010, bank failures, coupled with deteriorating economic conditions, significantly reduced the FDIC's insurance fund reserve ratio. The FDIC also 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. From December 31, 2010 through December 31, 2012, all noninterest-bearing transaction deposit accounts are fully insured regardless of the amount and account ownership, separate from and in addition to the FDIC insurance coverage provided from the depositors' other accounts.
On June 30, 2009, the FDIC charged a special assessment equal to 10 basis points on assets as of December 31, 2008, payable September 30, 2009. Future special assessments by the FDIC to bolster its insurance fund are possible. As a means to help improve the reserve ratio of the FDIC's insurance fund, it charged many banks, in December 2009, including some of Capitol's banking subsidiaries, an amount approximating three-years' of annual assessments.
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, 2010, the annualized FICO assessment was equal to 1.04 basis points for each $100 in domestic deposits maintained at an institution.
Temporary Liquidity Guarantee Program:
In November 2008, the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (TLG Program). The TLG Program was an initiative to counter the system-wide crisis in the nation's financial sector in 2008. 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 (changing to 15-25 basis points per annum in 2011) on amounts in covered accounts exceeding $250,000. Capitol elected to participate in both guarantee programs.
The FDIC's TLG Program provides an unlimited guarantee of certain demand deposits and ended effective June 30, 2010. The Dodd-Frank Act was subsequently enacted, which provides a substantially similar unlimited guarantee of all noninterest-bearing deposits through December 31, 2012. Capitol estimates $516.9 million of deposits at its banking subsidiaries would become uninsured, based on balances as of December 31, 2010. The effect of depositor activity upon termination of such unlimited deposit insurance is not determinable.
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Item 1. Business – continued.
American Recovery and Reinvestment Act of 2009:
In February 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 Troubled Asset Relief Program (TARP) recipients, 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 previously proposed by the U.S. Treasury, but it is not yet clear how these executive compensation standards will relate to the similar standards announced by the U.S. Treasury in its guidelines on February 4, 2009, or when the standards will be considered effective 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.
On July 21, 2010, the Dodd-Frank Act (DFA) was signed into law, which significantly changes future regulation of financial institutions and the financial services industry. The DFA includes provisions affecting large and small financial institutions, including several provisions that will profoundly affect how community banks, thrifts and smaller bank holding companies will be regulated in the future. Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of FDIC insurance coverage and impose new capital requirements on bank holding companies, including removing trust-preferred securities as a permitted component of a holding company's Tier 1 capital after a three-year phase-in period beginning January 1, 2013. The DFA also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Additionally, the DFA includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and prepayments. Management is reviewing the provisions of the DFA and assessing its probable impact on the Corporation's business, financial condition and results of operations. However, the ultimate effect of the DFA on the financial services industry in general, and on the Corporation in particular, is currently uncertain.
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 enactments of EESA, ARRA and DFA, the nature and extent of future legislative and regulatory changes affecting financial institutions is very unpredictable.
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Item 1. Business – continued.
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 banking subsidiaries 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 banking subsidiaries 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 nonperforming 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 nonaffiliate. 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, 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 practices. 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 CRA, 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
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Item 1. Business – continued.
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 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 CRA 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
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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.
Evolving Legislation and Regulatory Action:
Legislators and regulators in the United States are currently considering a wide range of proposals that, if enacted, could result in major changes to the way banking operations are regulated. Some of these major changes may take effect as early as 2011, and could materially impact the profitability of Capitol's banking business, the value of assets Capitol holds or the collateral available for Capitol's banking subsidiaries' loans, require changes to business practices or force Capitol to discontinue businesses and expose Capitol to additional costs, taxes, liabilities, enforcement actions and reputational risk.
Capitol maintains an Internet website 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 website 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. 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 website 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 website. 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 and excludes discontinued operations.
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Item 1A. Risk Factors.
An investment in Capitol's common stock, Series A preferred stock and/or its trust-preferred securities are subject to the risks inherent to Capitol's business. The material risks and uncertainties that Capitol believes affect it are described below. The risks and uncertainties described below are not the only ones Capitol faces. Additional risks and uncertainties that Capitol is not aware of or focused on, or risks currently deemed immaterial, may also impair business operations. This Annual Report on Form 10-K is qualified in its entirety by these risk factors. If any of the following risks actually occur, Capitol's financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of Capitol's common stock could decline significantly, and shareholders could lose all or a portion of their investment.
Capitol's ability to continue as a going concern is uncertain.
Capitol has experienced a significant deterioration in asset quality and incurred significant operating losses resulting in an equity deficit and a regulatory capital classification as "less than adequately capitalized." As a result, Capitol and most of its banking subsidiaries have become subject to increased regulatory oversight and compliance requirements. Those factors, among others, raise some level of doubt (potentially "substantial doubt") as to Capitol's ability to continue as a going concern. If Capitol becomes unable to operate as a going concern, it is likely that its common shareholders could lose all or substantially all of their investment in Capitol. Such substantial doubt is discussed in the Report of Independent Registered Public Accounting Firm set forth on page F-53 of the Financial Information Section of Capitol's 2010 Annual Report.
Capitol has commenced several initiatives and other actions to mitigate these going-concern considerations and to improve the Corporation's financial condition, equity, regulatory capital and regulatory compliance. Capitol's ability to continue as a going concern is contingent on the successful achievement of those initiatives. There can be no assurance that the exploration of those capital strategies will result in any transaction, or that any transaction will allow any of Capitol's shareholders to avert a loss of all or substantially all of their investment in Capitol. The pursuit of strategic alternatives may also involve significant expenses and management's time and attention.
Capitol needs to raise additional capital that may not be available to it.
Regulatory authorities require Capitol and its banking subsidiaries to maintain adequate levels of capital to support their operations. As reported by Capitol, many of Capitol's banking subsidiaries are "significantly-undercapitalized" or otherwise classified as less than adequately-capitalized as of December 31, 2010 and have an immediate need to raise capital. Two of Capitol's banking subsidiaries had capital levels resulting in regulatory classification as "critically-undercapitalized" at December 31, 2010; however, each of these subsidiaries received additional capital from Capitol in January 2011 to improve their classifications to "significantly-undercapitalized." In addition, even if Capitol succeeds in raising capital, it may need to raise additional capital in the future due to additional losses from operations or regulatory requirements. The ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside Capitol's control, and on Capitol's financial performance. Accordingly, any such additional capital may not be raised, if and when needed, on terms acceptable to Capitol, or at all. If Capitol cannot raise additional capital when needed, Capitol's ability to increase its capital ratios could be materially impaired and Capitol could face additional adverse regulatory challenges. In addition, if Capitol issues additional equity capital, it may be at a lower price and Capitol's existing shareholders' interest may be diluted.
If Capitol's banking subsidiaries continue to suffer significant loan losses, it may be difficult to continue to operate as a going concern.
Capitol has incurred net losses of $225.2 million and $195.2 million during the years ended December 31, 2010 and 2009, respectively. Future significant losses may make it difficult for Capitol and its banking subsidiaries to continue in operation.
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Item 1A. Risk Factors – continued.
Capitol's losses have largely resulted from provisions for loan losses and impairment losses related to other real estate owned. Since January 1, 2008, Capitol has recorded total provisions for loan losses of $407.9 million (excluding discontinued operations). While such losses exclude charges to establish and maintain a valuation allowance against the realization of Capitol's deferred tax assets of $190.3 million, which are not deemed more-likely-than-not realizable, these latter charges would not have been required had Capitol not incurred the losses on loans.
However, substantial risks remain in Capitol's and its banking subsidiaries' loan portfolios. As of December 31, 2010, approximately 98.4% of Capitol's bank loan portfolio consisted of loans secured by real estate and commercial loans secured by business assets other than real estate. Those consolidated subsidiaries' types of loans are typically larger than other loans which made up the remaining portion of Capitol's and its banking subsidiaries' portfolio loans. Further, deterioration of any or a few of those loans may lead to a significant increase in nonperforming loans and potential loan losses. Any additional increases in nonperforming loans could result in a decrease in interest income from those loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on Capitol's financial condition and results of operations.
The market price of Capitol's common stock has been and continues to be volatile.
Stock price volatility may make it more difficult for stockholders to sell their shares of Capitol's common stock when desired and at an attractive market value. Capitol's common stock price fluctuates significantly in response to a variety of factors including, but not limited to:
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions and interest rate changes or credit loss trends, could also cause Capitol's stock price to decrease regardless of operating results.
Stock markets in general and Capitol's common stock in particular have experienced significant volatility over the past couple of years (or more), and continue to experience significant price and volume volatility. As a result, the market price of Capitol's common stock may continue to be subject to similar market fluctuations that may be unrelated to Capitol's operating performance or prospects. Increased volatility could result in a decline in the market price of Capitol's common stock. On January 19, 2011, NYSE Regulation, Inc. notified Capitol of its intent to delist all of Capitol's securities. No assurance can be made that Capitol will meet the listing standards of the NYSE or another exchange in the near future.
Capitol's business has been adversely affected by conditions in the financial markets and economic conditions.
Since December 2007, the United States has been in a deep recession. Business activity across a wide range of industries and regions is greatly reduced, and local governments and many businesses are experiencing serious difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. Unemployment has increased significantly.
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Item 1A. Risk Factors – continued.
Since mid-2007, the financial services industry and securities markets generally have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all asset classes, including equity securities. Global markets have been characterized by substantially increased volatility, short-selling and an overall loss of investor confidence, initially in financial institutions, but more recently in companies in a number of other industries and in the broader markets.
Market conditions have also led to the failure or merger of a number of prominent financial institutions. Financial institution failures or near-failures have resulted in further losses as a consequence of defaults on securities issued by them, and defaults under contracts entered into with such entities as counterparties. Furthermore, declining asset values, defaults on mortgages and consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to increase credit-default swap spreads, to cause rating agencies to lower credit ratings, and to otherwise increase the cost and decrease the availability of liquidity, despite very significant declines in Federal Reserve borrowing rates and other government actions. Some banks and other lenders, including Capitol, have suffered significant losses and many institutions have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining asset values on the value of collateral. The foregoing has significantly weakened the strength and liquidity of some financial institutions worldwide. The U.S. government, the Federal Reserve Board and other regulatory agencies have taken numerous steps to increase liquidity and to restore investor confidence, including investing billions in the equity of other banking organizations, but asset values have continued to decline and access to liquidity continues to be very limited.
In response to the adverse economic conditions affecting the banking system and financial markets, and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 (EESA) was signed into law in October 2008. Among other things, EESA authorizes the U.S. Treasury (Treasury) to spend up to $700 billion to inject capital into financial institutions by purchasing non-voting preferred shares directly from such institutions and to purchase mortgage-backed and other non-performing assets from financial institutions for the purpose of stabilizing the financial markets.
Capitol's financial performance generally, and in particular the ability of its banks' borrowers to pay interest on and repay the principal of outstanding loans and the value of collateral securing those loans, is highly dependent on the business environment in the markets where Capitol operates and in the United States as a whole. The current severe recession is characterized by declines in economic growth, business activity or investor or business confidence; limitations on the availability of, or increases in the cost of, credit and capital; falling commercial and residential real estate values; inactive or nonexistent markets for the sale of real estate; or a combination of these or other factors.
It is expected that the business environment in the United States will continue to be weak and may deteriorate further for the foreseeable future. There can be no assurance that these conditions will improve in the near term. Such conditions have and could continue to adversely affect the credit quality of Capitol's loans, results of operations and financial condition.
Capitol's ability to achieve and maintain required capital levels and adequate sources of funding and liquidity may be adversely affected by market conditions.
Capitol is required to maintain certain capital levels in accordance with banking regulations with which it is currently less than adequately-capitalized. Many of Capitol's banking subsidiaries are also less than adequately-capitalized. Capitol and its banking subsidiaries must also maintain adequate funding sources in the normal course of business to support their lending and investment operations and repay outstanding liabilities as they become due. Capitol's ability to maintain capital levels, as well as sources of funding and liquidity could be impacted by future adverse operating results and deteriorating economic and market conditions.
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Item 1A. Risk Factors – continued.
Failure by Capitol or its banking subsidiaries to meet any applicable guideline or capital requirement otherwise imposed upon them or to satisfy certain other regulatory requirements could subject them to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities that include prohibitions on their ability to pay future dividends, the issuance by regulatory authorities of a capital directive to increase capital and the termination of deposit insurance by the FDIC.
Noncompliance with capital requirements could have a material adverse effect on Capitol's operations and financial position.
Capitol and many of its banking subsidiaries are less than adequately-capitalized and regulatory agencies may require Capitol and/or its individual banking subsidiaries to maintain a higher level of capital than Capitol currently anticipates, which could adversely affect Capitol's liquidity at the parent company level and require it to raise additional capital.
While Capitol must meet certain regulatory requirements on a consolidated basis, regulatory agencies having authority over each of Capitol's banking subsidiaries may require that those subsidiaries maintain a higher level of capital than Capitol currently anticipates, which would require that Capitol maintain a consolidated capital position that is well beyond what Capitol presently anticipates and could be in excess of the levels of capital used in the assumptions underlying Capitol's management and estimation of its capital needs. Several of Capitol's banking subsidiaries are currently required to maintain regulatory capital levels in excess of minimum requirements. Further, as a holding company with obligations and expenses separate from Capitol's banking subsidiaries, and because many of Capitol's banking subsidiaries are currently prohibited from making dividend payments to Capitol, Capitol must maintain a level of liquidity that is sufficient to address those obligations and expenses. The maintenance of adequate liquidity at Capitol may limit its ability to make further capital investments in banking subsidiaries, which could adversely impact Capitol and require it to raise additional capital. Even if Capitol is successful in implementing its current divestiture and charter consolidation initiatives, there can be no assurance that Capitol and its banking subsidiaries would not be required by the regulatory agencies to have a higher level of capital than Capitol may anticipate.
At December 31, 2010, Capitol and certain banking subsidiaries were classified as less than adequately-capitalized based on their respective regulatory capital ratios. Banks less than adequately-capitalized may become subject to increased regulatory enforcement pursuant to the prompt-corrective-action or other provisions of the FDIC and other bank regulatory agencies. Capitol intends to augment the capital levels of those institutions through allocation of proceeds from the further divestiture of some of its banking subsidiaries, although there is no assurance that amounts contributed to banking subsidiaries' capital will become sufficient to achieve regulatory compliance.
Capitol's and its banking subsidiaries' allowances for loan losses may prove inadequate to absorb actual loan losses, which may adversely impact results of operations.
Capitol believes that its consolidated allowance for loan losses is maintained at a level adequate to absorb inherent losses in the loan portfolio at the balance-sheet date. Management's determination of the allowance is based on evaluation of the portfolio (including potential impairment of individual loans and concentrations of credit), past loss experience, current economic conditions, the volume, amount and composition of the portfolio and other factors. These estimates are subjective and their accuracy depends on the outcome of future events. Actual future losses may differ from current estimates. Depending on changes in economic, operating and other conditions, including changes in fair value of collateral that are generally beyond Capitol's control, actual loan losses could increase significantly. As a result, such losses could exceed current allowance estimates. No assurance can be provided that the allowance will be sufficient to cover actual future loan losses should such losses be realized.
Loan loss experience, which is helpful in estimating the requirements for the allowance for loan losses at any given balance sheet date, has been minimal at some of Capitol's younger banking subsidiaries. Conversely, some of Capitol's mature banking subsidiaries, particularly those located in Michigan, Arizona and Nevada, have recently experienced significantly elevated levels of loan losses due to adverse economic conditions. Because many of Capitol's
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Item 1A. Risk Factors – continued.
banking subsidiaries are young, they do not have seasoned loan portfolios and it is likely that the ratio of the allowance for loan losses to total loans may need to be further increased in future periods as the loan portfolios become more mature and loss experience evolves. If it becomes necessary to increase the ratio of the allowance for loan losses to total loans, such increases would be accomplished through higher provisions for loan losses, which may adversely impact results of operations and could result in larger net losses on a consolidated basis.
The domestic economy in the markets in which Capitol's banking subsidiaries operate is in a severe recession and Capitol's levels of nonperforming loans and related loan losses and levels of foreclosed assets and other real estate owned (OREO) have increased significantly. It is anticipated that levels of nonperforming loans and related loan losses will continue to increase as economic conditions, locally and nationally, continue to deteriorate for the foreseeable future. Capitol's level of OREO increased dramatically in 2009 and remained elevated, causing a corresponding increase in carrying costs and other operating expenses. Continued elevation of OREO could have a negative material impact on Capitol.
In addition, regulatory agencies, as an integral part of their supervisory functions, periodically review the adequacy of the allowance for loan losses. Regulatory agencies may require Capitol or its banking subsidiaries to increase their provision for loan losses or to recognize further loan charge-offs based upon judgments different from those of management. Any increase in the allowance required by regulatory agencies could have a negative impact on Capitol's operating results, capital adequacy and financial position.
Capitol and/or its affiliates are or may become involved from time to time in information-gathering requests, investigations and proceedings by government agencies which may lead to adverse consequences.
Capitol and/or its affiliates are or may become involved from time to time in information-gathering requests, reviews, investigations and proceedings (both formal and informal) by government agencies, including the SEC, regarding their respective businesses. Such matters may result in material adverse consequences, including without limitation, adverse judgments, settlements, fines, penalties, injunctions or other actions, amendments and/or restatements of Capitol's SEC filings and/or financial statements, as applicable, and/or determinations of material weaknesses in its disclosure controls and procedures. The SEC is investigating and has made several requests for information, including by subpoena, concerning issues which Capitol understands relate to accounting and reporting matters involving certain of its loans and the related allowance for loan losses. This could lead to an enforcement proceeding by the SEC which, in turn, may result in one or more such material adverse consequences.
Capitol and its banking subsidiaries operate in an environment highly regulated by state and federal government agencies; changes in federal and state banking laws and regulations could have a negative impact on its business.
As a bank holding company, Capitol is regulated primarily by the Federal Reserve Board. Many of Capitol's current bank affiliates are regulated primarily by state banking agencies, the FDIC, the OCC (in the case of one national bank) and the OTS (in the case of Capitol's federal savings bank subsidiaries).
Various federal and state laws and regulations govern numerous aspects of the banks' operations, including:
Federal and state regulatory agencies have broad discretion and power to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies. Capitol and its banking subsidiaries undergo periodic examinations by one or more regulatory agencies. Following such examinations, Capitol may be required,
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Item 1A. Risk Factors – continued.
among other things, to change its asset valuations or the amounts of required loan loss allowances or to restrict bank operations. Those actions would result from the regulators' judgments based on information available to them at the time of their examination, and their estimate of future economic conditions. Judgments of various regulatory agencies vary, and regulatory agencies may change their position and require application of their judgment retroactively, causing institutions to change methodologies for the allowance for loan losses, resulting in restatement of their regulatory financial statements, including their capital position.
Capitol's banking subsidiaries are required to follow a wide variety of state and federal consumer protection and similar statutes and regulations. Federal and state regulatory restrictions limit the manner in which Capitol and its banking subsidiaries may conduct business and obtain financing. Those laws and regulations can and do change significantly from time to time and any such change could adversely affect Capitol and its banking subsidiaries.
Several of Capitol's banking subsidiaries have entered into formal agreements with their respective regulatory agencies which impose various additional requirements on those institutions which may further restrict their operations.
There is a risk of potential cross-guaranty liability relating to Capitol's banking subsidiaries.
In accordance with Federal Reserve Board policy, Capitol is expected to act as a source of financial strength to its banking subsidiaries and to commit resources to support its banking subsidiaries in circumstances in which Capitol might not otherwise do so. Under the Bank Holding Company Act of 1956, as amended, the Federal Reserve Board may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve Board's determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the agency determines that divestiture may aid the depository institution's financial condition.
As FDIC-insured depository institutions, Capitol's banking subsidiaries may be held liable for any loss incurred or expected to be incurred by the FDIC in connection with another FDIC-insured institution under common control with the institution in "default" or "in danger of default." This liability is commonly referred to as "cross-guaranty" liability. A "default" is generally defined as the appointment of a conservator or receiver and "in danger of default" is defined as certain conditions indicating that a default is likely to occur absent regulatory assistance. An FDIC cross-guaranty claim against a depository institution is generally senior in right of payment to claims of the holding company and its affiliates against the depository institution.
If the FDIC is appointed the conservator or receiver of an insured depository institution, upon its insolvency or in certain other events, the FDIC has the power: (1) to transfer any of the depository institution's assets and liabilities to a new obligor without the approval of the depository institution's creditors; (2) to enforce the terms of the depository institution's contracts pursuant to their terms; or (3) to repudiate or disaffirm any contract or lease to which the depository institution is a party, the performance of which is determined by the FDIC to be burdensome and the disaffirmance or repudiation of which is determined by the FDIC to promote the orderly administration of the depository institution.
To date, none of Capitol's banking subsidiaries have received any notice of assessment of cross-guaranty liability. Capitol's banking subsidiaries have, however, received notice from the FDIC that the FDIC may assess a cross-guaranty liability relating to a failed community bank in Florida which ceased operations in November 2009. The FDIC alleges that the Florida bank was an affiliated institution of Capitol, although Capitol owned no securities of that bank or otherwise controlled the failed institution. The aggregate loss to the FDIC of that failed bank approximated $23.6 million. The FDIC has until November 2011, two years from the date of such notice, to determine whether to assess that potential cross-guaranty liability, if any.
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Item 1A. Risk Factors – continued.
Capitol is subject to a written agreement with the Federal Reserve Bank of Chicago which restricts Capitol's ability to take certain actions. Noncompliance with the written agreement could have a material impact on Capitol.
In September 2009, Capitol and its second-tier bank holding companies entered into a written agreement with the Federal Reserve Bank of Chicago (the Reserve Bank) under which Capitol agreed to refrain from the following actions without the prior written consent of the Reserve Bank (i) declare or pay dividends; (ii) receive dividends or any other form of payment representing a reduction in capital from Michigan Commerce Bank or from any of Capitol's subsidiary institutions that is subject to any restriction by the institution's federal or state regulator that limits the payment of dividends or other intercorporate payments; (iii) make any distributions of interest, principal, or other sums of subordinated debentures or trust-preferred securities; (iv) incur, increase or guarantee any debt; or (v) purchase or redeem any shares of its own stock, the second-tier bank holding companies, nonbank subsidiaries or any of the banking subsidiaries that are held by shareholders other than Capitol.
Capitol has also agreed to (i) submit to the Reserve Bank, a written plan to maintain sufficient capital at Capitol on a consolidated basis and at Michigan Commerce Bank (as a separate legal entity on a stand-alone basis); (ii) notify the Reserve Bank no more than 30 days after the end of any quarter in which Capitol's consolidated or Michigan Commerce Bank's capital ratios fall below the approved capital plan's minimum ratios as well as if any subsidiary institution's ratios fall below the minimum ratios required by the institution's federal or state regulator; (iii) review and revise its allowance for loan losses (ALLL) methodology for loans held by Capitol and submit to the Reserve Bank a written program for maintenance of an adequate ALLL for loans held by Capitol; (iv) take all necessary actions to ensure each of its subsidiary institutions comply with Federal Reserve regulations; (v) refrain from increasing any fees or charging new fees to any subsidiary institution without the prior written consent of the Reserve Bank; (vi) submit to the Reserve Bank a written plan to enhance the consolidated organization's risk management practices, a strategic plan to improve the consolidated organization's operating results and a cash flow projection; (vii) comply with laws and regulations regarding senior executive officer positions and severance payments; and (viii) provide quarterly reports to the Reserve Bank regarding these undertakings. While Capitol is working to achieve compliance with that regulatory agreement, there is no assurance that it will achieve such compliance.
Certain of Capitol's banking subsidiaries have entered into formal agreements with their primary regulatory agencies. Noncompliance with the agreements could have a material impact on Capitol.
Certain of Capitol's banking subsidiaries have entered into formal agreements with their applicable federal and state bank regulatory agencies in response to elevated levels of nonperforming assets, loan losses and adverse operating results. Those agreements provide for certain restrictions and other guidelines and/or limitations to be followed by those banking subsidiaries. Generally, those agreements require the banks to maintain an adequate ALLL, reduce levels of nonperforming and other classified assets and implement revised budgets and liquidity and capital adequacy projections to improve financial performance. When a bank enters into a formal regulatory agreement, it is generally precluded from meeting the criteria as a "well-capitalized" institution although it may meet or exceed such threshold on a computational basis. In addition, the banks' capital classification places limitations on some of their activities, such as the permissibility of accepting or renewing brokered deposits, among other things. Additionally, such banks are subject to higher levels of FDIC insurance assessments.
In addition to the above, the FDIC gave notice to many of Capitol's banking subsidiaries in December 2009 that, to mitigate the effects of any possible assessment arising from potential cross-guaranty liability, they should be encouraged to arrange a sale, merger or recapitalization such that Capitol no longer controls the banking subsidiary. The FDIC's encouragement is consistent with Capitol's previously-announced plans to selectively divest of some of its banking subsidiaries in conjunction with reallocating capital resources to the remaining banking subsidiaries.
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Item 1A. Risk Factors – continued.
Capitol may not be able to raise additional capital without its existing shareholders suffering substantial dilution.
Capitol believes that it will likely need to raise additional capital in order to achieve sufficient regulatory capital levels. Capitol's ability to raise additional capital will depend on conditions in its private and public capital markets, as well as economic conditions and a number of other factors, most of which are outside Capitol's control and on Capitol's financial performance. Accordingly, there can be no assurance that Capitol or its banking subsidiaries can raise additional capital or do so on acceptable terms. If Capitol cannot raise additional capital when and/or as needed, it may have a material adverse effect on its financial condition, results of operations and prospects.
The recent dramatic decline in the market price of Capitol's common stock means that any future issuance of previously-unissued common stock could significantly dilute the ownership of existing holders of Capitol's common stock, because Capitol would have to issue many more shares than if it had raised the same amount of capital when its share price was higher. Absent a substantial improvement in Capitol's financial performance and stock price, it is unlikely that Capitol would be able to raise additional capital without further diluting the ownership of existing holders of its common outstanding stock.
Capitol's common stock is subordinate to Capitol's existing and future indebtedness and Capitol's outstanding Series A preferred stock, and effectively subordinated to all the indebtedness and other claims against Capitol's banking subsidiaries.
Shares of Capitol's common stock will rank junior to all of Capitol's existing and future indebtedness and to other non-equity claims with respect to assets available to satisfy its claims. Further, holders of Capitol's common stock are subject to prior dividend and liquidation rights of the holders of its outstanding shares of Series A preferred stock. The Series A preferred stock of Capitol has an aggregate liquidation preference of $9.5 million. The terms of Capitol's Series A preferred stock prohibit Capitol from paying dividends with respect to its common stock unless all accrued and unpaid dividends for any completed dividend periods with respect to the Series A Preferred Stock have been paid, subject to declaration of such dividends by Capitol's board of directors, if any.
In addition, Capitol's right to participate in any distribution of assets of any of Capitol's banking subsidiaries upon any such bank's liquidation or otherwise, and the ability of holders of Capitol's common stock to benefit indirectly from such distribution, will be subject to the prior claims of creditors of such bank, as well as any prior claims of holders of Capitol's preferred securities. As a result, holders of Capitol's common stock are structurally subordinated to all existing and future liabilities and obligations of each of Capitol's banking subsidiaries, as well as any prior claims of holders of Capitol's preferred securities.
Capitol may not successfully accomplish its efforts to return to profitability.
Capitol is executing a plan to return to profitability by restructuring its operations and balance sheet. In addition, Capitol has sold several banking subsidiaries and related bank locations and has definitive agreements for additional sales of such banking subsidiaries and/or locations to help Capitol achieve its priorities. However, it is unlikely that these transactions may result in a return to profitability or permit Capitol to reach its regulatory capital targets.
Capitol is deferring payments on all of its outstanding trust-preferred securities and the accrued but unpaid amounts are being accumulated as a liability on Capitol's consolidated balance sheet. That liability is expected to increase as Capitol has no current plans to resume any such interest payments at any time in the near future and is currently prohibited from doing so without prior regulatory approval.
Capitol has exercised its right to defer interest payments on the subordinated debentures relating to Capitol's trust-preferred securities. As a result, periodic interest payments (generally on a quarterly basis) on the related trust-preferred securities are being deferred. Capitol may defer such interest payments for a total of 20 consecutive calendar quarters without causing an event of default under the documents governing these securities. After such period, Capitol
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Item 1A. Risk Factors – continued.
must pay any previously deferred interest payments and resume periodic interest payments thereon or Capitol will be deemed to be in default under the related trust-preferred indentures and the pertinent documents. Such payments have been deferred for seven quarterly periods, as of December 31, 2010.
Capitol does not have current plans to resume interest payments on the subordinated debentures in the near future and is currently prohibited from any such payments without prior regulatory approval. Before resuming these payments, however, Capitol would have to pay the accrued amounts in full, if approved, prior to commencing any future payments of interest on those securities. As of December 31, 2010, those accrued but unpaid amounts approximated $20.8 million.
Compliance with the recently enacted Dodd-Frank Act may adversely impact Capitol's operating results.
In July 2010, Congress enacted regulatory reform legislation known as the Dodd-Frank Act (DFA). Many aspects of the DFA are subject to further rulemaking and will take effect over several future years, making it difficult to anticipate the overall financial impact to Capitol, its banking subsidiaries or the banking industry. This new law broadly affects the financial services industry by implementing changes to the financial regulatory landscape aimed at strengthening the sound operation of the financial services sector, including provisions that, among other things, will:
Capitol's management is reviewing the provisions of the DFA and assessing its probable impact on the business, financial condition and results of operations of Capitol and its banking subsidiaries. Provisions in the legislation that affect deposit insurance assessments and payment of interest on demand deposits could increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. Provisions in the legislation that revoke the Tier 1 capital treatment of newly issued trust preferred securities could require Capitol to seek other sources of capital in the future.
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Item 1A. Risk Factors – continued.
An investment in Capitol's common stock is not an insured deposit and is subordinate to any outstanding preferred securities of Capitol.
An investment in Capitol's common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, its deposit insurance fund or by any other public or private entity. Investment in Capitol's common stock is inherently risky for the reasons previously described in this "Risk Factors" section, or elsewhere in this Form 10-K or the documents incorporated by reference herein, and is subject to the same market forces that affect the price of common stock in any company. As a result, stockholders holding Capitol's common stock could lose some or all of their investment.
In addition, Capitol's common stock is subordinate to the claims of Capitol's creditors, trust-preferred securities and its preferred stock currently outstanding as well as any of which may be issued by Capitol in the future.
All of Capitol's debt obligations, and its obligations under its debentures and preferred securities of certain related subsidiaries that Capitol has guaranteed, will likely have priority over Capitol's common stock with respect to payment in the event of liquidation, dissolution or winding-up and with respect to the payment of dividends, subject to regulatory requirements for any such distributions.
Capitol has issued debentures to certain of its subsidiaries which are Delaware business trusts which, in turn, issued publicly-placed preferred securities to purchase those debentures in conjunction with offerings of trust-preferred securities. Capitol also has additional trust-preferred securities which were privately placed. Capitol has guaranteed the preferred securities. The documents governing these securities, including the indenture under which the debentures were issued, restrict Capitol's ability and/or right to pay a dividend on its common stock under certain circumstances and give the holders of the preferred securities preference on liquidation over the holders of Capitol's common stock. In April 2009, Capitol announced that it had elected to defer interest payments on its subordinated debentures. Pursuant to the terms of a written agreement with the Federal Reserve Bank of Chicago, Capitol is currently prohibited from making any cash payments, including interest, on the debentures and preferred securities without prior regulatory approval. The total estimated annual interest that would be payable on the debentures and the underlying debt securities, if not deferred, is approximately $13.6 million. While Capitol defers the payment of interest, it will continue to accrue the future interest obligation at the applicable interest rate. Capitol is prohibited from declaring or paying cash dividends on its common stock during such deferral and is restricted from redeeming or purchasing any shares of its common stock except under very limited circumstances. Capitol's obligation under the debentures, the preferred securities and the guarantee approximates $170.8 million at an average interest rate currently approximating 6.17% per annum, generally payable quarterly.
In any liquidation, dissolution or winding-up of Capitol, its common stock would rank after all debt and creditor claims against Capitol, the claims with respect to the debentures and the guarantee of the preferred securities of certain related subsidiaries, and other senior equity securities, if any. As a result, holders of Capitol's common stock will not be entitled to receive any payment or other distribution of assets upon the liquidation, dissolution or winding-up of Capitol until all of its obligations to its debt holders have been satisfied and holders of senior equity securities have received any payment or distribution due to them.
Offerings of debt, which could be senior to Capitol's common stock upon liquidation, and/or preferred equity securities which may be senior to Capitol's common stock for purposes of dividend distributions or upon liquidation, may adversely affect the market price of Capitol's common stock.
In the future, Capitol may attempt to increase Capitol's capital resources by entering into debt or debt-like obligations that may be unsecured or secured by all or up to all of Capitol's assets, or by issuing debt or equity securities, which could include issuances of secured or unsecured commercial paper, medium-term notes, senior notes, subordinated notes, common stock or securities convertible into common stock. Upon an occurrence of Capitol's liquidation, which is not currently expected, Capitol's lenders and holders of Capitol's debt obligations would receive a distribution of Capitol's available assets ahead of any distributions to the holders of Capitol's common stock. Because Capitol's decision to incur
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Item 1A. Risk Factors – continued.
debt and issue securities in any future offerings will depend on market conditions and other factors beyond Capitol's control, Capitol cannot predict or estimate the amount, timing or nature of any of its future offerings and/or debt transactions which may be senior to its common stock. Further, market conditions could require Capitol to accept less favorable terms for the issuance of its securities in the future.
Capitol's board of directors is authorized to issue one or more classes or series of preferred stock from time to time without any action on the part of the shareholders. Capitol's board of directors also has the power, without shareholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights and preferences over Capitol's common stock with respect to dividends or upon Capitol's dissolution, winding up and liquidation and other terms. If Capitol issues preferred shares in the future that have a preference over its common stock with respect to the payment of dividends or upon liquidation, or if Capitol issues preferred shares with voting rights that dilute the voting power of its common stock, the rights of holders of its common stock or the market price of Capitol's common stock could be adversely affected.
Issuance or sales of common stock or other equity securities could result in an "ownership change" as defined for U.S. federal income tax purposes. In the event an "ownership change" would occur, Capitol's ability to fully utilize a significant portion of its U.S. federal and state tax net operating losses could be impaired and Capitol could lose certain built-in losses that have not been recognized for tax purposes as a result of the operation of Section 382 of the Internal Revenue Code of 1986, as amended.
Capitol's ability to use certain realized net operating losses and unrealized built-in losses to offset future taxable income may be significantly limited if it experiences an "ownership change" as defined by Section 382 of the Internal Revenue Code of 1986, as amended (the Code). An ownership change under Section 382 generally occurs when a change in the aggregate percentage ownership of the stock of the corporation held by "five percent shareholders" increases by more than fifty percentage points over a rolling three-year period ending on the transaction date. A corporation experiencing an ownership change generally is subject to an annual limitation on its utilization of pre-change losses and certain recognized built-in losses equal to the value of the stock of the corporation immediately before the "ownership change," multiplied by the long-term tax-exempt rate (subject to certain adjustments). The annual limitation is increased each year to the extent that there is an unused limitation in a prior year. Since U.S. federal net operating losses generally may be carried forward for up to 20 years, the annual limitation also effectively provides a cap on the cumulative amount of pre-ownership-change losses and certain post-change recognized built-in losses that may be utilized. Pre-ownership-change losses and certain recognized built in losses in excess of the cap are effectively unable to be used to reduce future taxable income. In certain circumstances, issuances or sales of common stock (including any common stock issuances or debt-for-equity exchanges and certain transactions involving common stock that are outside of Capitol's control) could result in an "ownership change" under Section 382.
While Capitol may, under certain circumstances, be able to utilize certain tax strategies (including a "tax preservation" rights plan) to protect against an "ownership change", if an "ownership change" under Section 382 were to occur, the value of Capitol's net operating losses and a portion of the net unrealized built-in losses will be impaired. Because a valuation allowance currently exists for substantially the full amount of Capitol's deferred tax assets, no additional charge to earnings would result. However, an "ownership change", as defined above, could adversely impact Capitol's ability to recognize Tier 1 capital from the potential future release of Capitol's valuation allowance. Currently, there are no material amounts of deferred tax assets includable in Capitol's regulatory capital measurements.
Problems encountered by financial institutions larger than or similar to Capitol could adversely affect financial markets generally and have indirect adverse effects on Capitol.
The commercial soundness of many financial institutions may be closely interrelated as a result of credit, trading, clearing or other relationships between the institutions. As a result, concerns about, or a default or threatened default by, one institution could lead to significant market-wide liquidity and credit problems, losses or defaults by other institutions. This is sometimes referred to as "systemic risk" and may adversely affect financial intermediaries, such as clearing
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Item 1A. Risk Factors – continued.
agencies, clearing houses, banks, securities firms and exchanges, with which Capitol interacts on a daily basis, and therefore could adversely affect Capitol.
Capitol's banking subsidiaries' small size may make it difficult to compete with larger institutions because Capitol is not able to compete with large banks in the offering of significantly larger loans.
Legal lending limits of banks constrain the size of loans that those banks can make. Many of Capitol's banks' competitors have significantly larger capitalization and, hence, an ability to make significantly larger loans. The inability to offer larger loans limits the revenues that can be earned from interest amounts charged on larger loan balances.
Capitol's commercial loan concentration in small businesses and loans collateralized by commercial real estate increases the risk of defaults by borrowers and substantial credit losses could result, causing shareholders to lose their investment.
Capitol's banking subsidiaries make various types of loans, including commercial, consumer, residential mortgage and construction loans. Capitol's strategy emphasizes lending to small businesses and other commercial enterprises. Capitol typically relies upon commercial real estate as a source of collateral for many of its banking subsidiaries' loans. Recently, regulatory agencies have expressed concern with banks with large concentrations in commercial real estate due to the recent downturn in the real estate markets in certain areas of the country, leading to increased risk of credit loss, incurred losses and extended sale periods. Loans to small and medium-sized businesses are generally riskier than single-family mortgage loans. Typically, the success of a small or medium-sized business depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business. In addition, small and medium-sized businesses frequently have smaller market-share than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial variations in operating results, any of which may impair a borrower's ability to repay a loan. Recently, due to borrower performance difficulties and adverse real estate market conditions, levels of nonperforming loans, foreclosures and loan losses increased significantly at Capitol, resulting from the current severe recessionary environment. Substantial further credit losses could result, causing shareholders to lose their investment in Capitol's securities.
Actions by the Open Market Committee of the Federal Reserve Board (FRBOMC) may adversely affect Capitol's net interest income.
Changes in Market Interest Rates. Capitol's results of operations are significantly dependent on net interest income. Net interest income is the difference between interest income on interest-earning assets, such as loans, and interest expense on interest-bearing liabilities, such as deposits. Therefore, any change in general market interest rates, whether as a result of changes in monetary policies of the Federal Reserve Board or otherwise, can have a significant effect on net interest income. Capitol's assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristic of assets and liabilities. As a result, changes in interest rates can affect net interest income in either a positive or negative way.
In 2008, the FRBOMC decreased interest rates to near zero and such interest rates have continued throughout 2009 and 2010. Future stability of interest rates and FRBOMC policy, which impact such rates, are uncertain.
Changes in the Yield Curve. Changes in the difference between short and long-term interest rates, commonly known as the yield curve, may also harm Capitol's business. For example, short-term deposits may be used to fund longer-term loans. When differences between short-term and long-term interest rates shrink or disappear, the spread between rates paid on deposits and received on loans could narrow significantly, decreasing net interest income.
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Item 1A. Risk Factors – continued.
Loan origination activities, for both commercial and residential mortgages, involve collateral valuation risks and the risk of subsequent identification of origination fraud or other losses which could exceed Capitol's allowance for loan losses.
Capitol's banking subsidiaries use an enterprise-wide loan policy which provides for conservative loan-to-value guidelines when loans are originated. In today's difficult real estate economy in many parts of the country, falling property values and significant foreclosure activity of both residential and commercial real estate property are resulting in significant loan losses at many financial institutions. Further, although most residential mortgage loans have been originated and sold to third parties, if it is subsequently determined that such loans were originated with any element of alleged fraud, such as exaggerated borrower income or assets, for example, the originating institution may be liable for any losses relating to such loans and may have to repurchase those loans. The potential for additional loan losses from valuation issues or fraud is unknown. Fraud risks are particularly difficult to identify and quantify, especially when the duration of the risk is the same as the term of the loan, often as long as 30 years or more. Occurrences of fraud are often more prevalent during an economic downturn or recession. Potential losses from valuation issues or occurrences of fraud could significantly exceed allowances for loan losses, adversely affecting Capitol's results of operations.
If Capitol cannot recruit and retain highly qualified personnel, its banking subsidiaries' customer service could suffer, causing its customer base to decline.
Capitol's strategy is also dependent upon its continuing ability to attract and retain highly qualified personnel. Availability of personnel with appropriate community banking experience varies. If Capitol does not succeed in attracting new employees or retaining and motivating current and future employees, its business could suffer significantly, increasing the possibility of a loss of value in its common stock.
Capitol's banking subsidiaries have decentralized management which could have a negative impact on the rate of growth and profitability of Capitol and its banking subsidiaries.
Capitol's banking subsidiaries have independent boards of directors and management teams. This decentralized structure gives the banks control over the day-to-day management of their institution, including credit decisions, the selection of personnel, the pricing of loans and deposits, marketing decisions and the strategy in handling problem loans. This decentralized structure may impact Capitol's ability to uniformly implement corporate or enterprise-wide strategy at the bank level. It may slow Capitol's ability to react to changes in strategic direction due to outside factors such as rate changes and changing economic conditions. This decentralized structure may cause additional management time to be spent on internal issues and could negatively impact the growth and profitability of the banks individually as well as the holding company.
New accounting or tax pronouncements may be issued by the accounting standard-setters, regulatory agencies or other government bodies which could change existing accounting methods. Changes in accounting methods could negatively impact Capitol's results of operations and financial condition.
Current accounting and tax rules, standards and policies influence the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards and policies are constantly evolving and may change significantly over time. Events that may not have a direct impact on Capitol, such as the bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board (FASB), the SEC, the Public Company Accounting Oversight Board, and various taxing authorities responding by adopting and/or proposing substantive revisions to laws, regulations, rules, standards and policies. New accounting pronouncements under the FASB Accounting Standards Codification have occurred and may occur in the future. A change in accounting standards may adversely affect Capitol's reported financial condition and results of operations.
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Item 1A. Risk Factors – continued.
Capitol's business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, Capitol's business and a negative impact on its results of operations.
Capitol relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems, whether due to severe weather, natural disasters, acts of war or terrorism, criminal activity or other factors, could result in failures or disruptions in general ledger, deposit, loan, customer relationship management and other systems. While Capitol has disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of Capitol's information systems could damage the reputation of Capitol and its banking subsidiaries, result in a loss of customer business, subject Capitol and its banking subsidiaries to additional regulatory scrutiny, or expose Capitol to civil litigation and possible financial liability, any of which could have a material adverse effect on its results of operations.
Capitol could face unanticipated environmental liabilities or costs related to real property owned or acquired through foreclosure. Compliance with federal, state and local environmental laws and regulations, including those related to investigation and clean-up of contaminated sites, could have a negative effect on expenses and results of operations.
A significant portion of Capitol's banking subsidiaries' loan portfolios are secured by real property. During the ordinary course of business, Capitol's banking subsidiaries may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, Capitol's banking subsidiaries may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require Capitol's banking subsidiaries to incur substantial expenses and may materially reduce the affected property's value or limit its banking subsidiaries' ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase Capitol's banking subsidiaries' exposure to environmental liability. Although Capitol's banking subsidiaries have policies and procedures to require an environmental review before initiating any foreclosure action on real property, those reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on results of operations.
Capitol's controls and procedures may fail or be circumvented, which could have a material adverse effect on Capitol's business, results of operations and financial condition.
Capitol periodically reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurance that the objectives of the system are met. Any failure or circumvention of controls and procedures, or failure to comply with regulations related to controls and procedures could have a material adverse effect on Capitol's business, results of operations and financial condition.
Capitol's banking subsidiaries have restricted investments in Federal Home Loan Banks which may be subject to future impairment.
As of December 31, 2010, Capitol's banking subsidiaries had investments in several Federal Home Loan Banks approximating $18 million. Such investments are restricted securities which may be redeemed only by the issuer. Future redemption of the securities is subject to the issuers' liquidity and capital adequacy which are, in part, dependent upon valuation of the issuers' significant mortgage-backed securities portfolios.
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Item 1A. Risk Factors – continued.
Capitol's bylaws and its rights plan, as well as certain banking laws, may have an antitakeover effect.
Provisions of Capitol's bylaws, rights plan and certain federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire Capitol, even if doing so might be perceived to be beneficial to shareholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination which, in turn, could adversely affect the market price of the common stock.
Capitol has currently entered into agreements to sell several banking subsidiaries, and is pursuing additional divestiture opportunities in an effort to improve the capital position of its remaining banks.
During 2009, Capitol announced plans to pursue divestiture of some of its banking subsidiaries (or those which are banking subsidiaries of Capitol's bank-development subsidiaries) on a selective basis for the purpose of reallocating capital to enhance the capital position of its retained banking subsidiaries. Capitol and/or its bank-development subsidiaries have entered into definitive agreements to sell its interests (or controlling interests held by bank-development subsidiaries) in the following banking subsidiaries in 2011: 1st Commerce Bank, Bank of Feather River, Bank of Fort Bend, Bank of Las Colinas, Bank of Tucson – main office, Community Bank of Rowan, Evansville Commerce Bank and High Desert Bank.
In 2010, Capitol sold its ownership in Adams Dairy Bank, Bank of Belleville, Bank of San Francisco, Community Bank of Lincoln, Fort Collins Commerce Bank, Larimer Bank of Commerce, Loveland Bank of Commerce, Napa Community Bank, Ohio Commerce Bank, Southern Arizona Community Bank and USNY Bank. The remaining pending bank sales are subject to regulatory approval and other contingencies and the risk that the timing of such sales are extended beyond what is currently anticipated or that some could fail to obtain regulatory approval. In addition, some of the pending sales are subject to capital-raising activities to facilitate the sale and, accordingly, are subject to the risk that the requisite funds may not be successfully raised.
Item 1B. Unresolved Staff Comments.
Item 2. Properties.
The names and locations of Capitol's banking subsidiaries are listed on Pages F-59 – F-60, Financial Information Section of Annual Report, under the caption "Note A—Nature of Operations, Basis of Presentation and Principles of Consolidation," which is incorporated herein by reference.
Most of the banking subsidiaries' locations are leased and many operate from a single location. Most of Capitol's banking subsidiaries' facilities are generally small (i.e., less than 10,000 square feet), first floor offices with convenient access to parking. The Ann Arbor location of Michigan Commerce Bank, Capitol's largest banking subsidiary, occupies the largest leased facility, approximately 18,000 square feet.
Community Bank of Rowan, First Carolina State Bank, Indiana Community Bank, Sunrise Bank (Jeffersonville, Georgia location) and the Grand Haven, Holland, Muskegon and Portage office locations of Michigan Commerce Bank own their office facilities.
Some of Capitol's banking subsidiaries have drive-up customer service capability. Capitol's banking subsidiaries are typically located in or near high traffic centers of commerce in their respective communities. Customer service is enhanced through Internet banking, remote deposit capture and utilization of ATMs to process some customer-initiated transactions and some of the banks also make available a courier service to pick up transactions at customers' locations.
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Item 2. Properties. – continued.
Capitol's Lansing, Michigan executive offices are located within the same building as Capitol National Bank. Those offices include administrative, operations, legal, accounting, human resources, credit administration, risk management and executive staff.
Data processing centers are located in both Lansing, Michigan and Phoenix, Arizona.
Capitol's Phoenix, Arizona executive offices are located within the same building as Sunrise Bank of Arizona's Camelback office. Those offices include administrative, operations, credit administration, risk management and executive staff.
Certain office locations are leased from related parties. Rent expense, including rent expense under leases with related parties, is incorporated by reference from Pages F-78, Financial Information Section of Annual Report, under the caption "Note F—Premises and Equipment" and under the caption "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" of Item 13 of this Form 10-K.
Management believes Capitol's and its banking subsidiaries' offices to be in good and adequate condition and adequately covered by insurance.
Item 3. Legal Proceedings.
As of December 31, 2010, there were no material pending legal proceedings to which Capitol or its subsidiaries was a party or to which any of its property was subject, except for proceedings which arise in the ordinary course of business. In the opinion of management, pending legal proceedings will not have a material effect on the consolidated financial position or results of operations of Capitol.
In November 2010, Capitol received a subpoena from the Chicago office of the SEC. The subpoena requests information regarding Capitol's allowance for loan losses and related allowance estimation process and computational methodology, Capitol's methodology for grading loans and the process for making provisions for loan losses and Capitol's provision for loan losses prior to March 31, 2009. In addition, on March 30, 2011, Capitol was informed that it would be receiving an additional subpoena from the Chicago office of the SEC concerning Capitol's recently amended and restated Form 10-Q for the period ended September 30, 2010. The subpoena and the SEC's corresponding investigation are nonpublic, which means that the information Capitol provides to the SEC will not be made available publicly, however, could result in Capitol amending its prior SEC filings in the future, depending on the outcome of such investigation.
Capitol understands that the issuance of subpoenas by the Commission, in itself, does not mean that the SEC has concluded that Capitol has broken the law or that the SEC has a negative opinion of Capitol. Capitol is fully complying with the SEC's requests, and looks forward to a timely resolution.
Item 4. (Removed and Reserved).
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Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
A. Market Information:
Incorporated by reference from Pages F-3 – F-4, Financial Information Section of Annual Report, under the caption "Information Regarding Capitol's Common Stock," Page F-6 under the caption "Shareholder Information" and Pages F-82 – F-84 under the caption "Note K—Stockholders' Equity and Stock-Based Compensation."
Incorporated by reference from the second paragraph on Page F-4 Financial Information Section of Annual Report, under the caption "Information Regarding Capitol's Common Stock."
Incorporated by reference from Page F-2, Financial Information Section of Annual Report, under the caption "Quarterly Results of Operations (unaudited)" and subcaption "Cash dividends paid per share," the first paragraph on Page F-4, Financial Information Section of Annual Report under the caption "Information Regarding Capitol's Common Stock" and Pages F-97 – F-100, Financial Information Section of Annual Report, under the caption "Note R—Capital Requirements and Related Regulatory Matters."
D. Securities Authorized for Issuance Under Equity Compensation Plan:
Summary of Equity Compensation Plans as of December 31, 2010
Incorporated by reference from Page F-3, Financial Information Section of Annual Report, under the caption "Information Regarding Capitol's Common Stock."
F. There were no purchases of equity securities by the issuer or affiliated purchasers in the fourth quarter of 2010.
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Item 6. Selected Financial Data.
Incorporated by reference from Page F-2, Financial Information Section of Annual Report, under the caption "Selected Consolidated Financial Data" under the column heading "As of and for the Year Ended December 31, 2010, 2009, 2008, 2007 and 2006."
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Incorporated by reference from Pages F-11 – F-49, Financial Information Section of Annual Report, under the caption "Management's Discussion and Analysis of Capitol's Business, Financial Condition and Results of Operations"
and Pages F-6 – F-10, Financial Information Section of Annual Report, under the caption "Cautions Regarding Forward-Looking Statements."
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Incorporated by reference from Pages F-41 – F-44, Financial Information Section of Annual Report, under the caption "Trends Affecting Operations" and Pages F-6 – F-10, Financial Information Section of Annual Report, under the caption "Cautions Regarding Forward-Looking Statements."
Item 8. Financial Statements and Supplementary Data.
See Item 15 (under subcaption "(a) 1 and 2. Financial Statements/Schedules") of this Form 10-K for specific description of financial statements incorporated by reference from Financial Information Section of Annual Report.
Incorporated by reference from Page F-2, Financial Information Section of Annual Report, under the caption "Quarterly Results of Operations (unaudited)."
Capitol revised its previously-reported unaudited condensed consolidated financial statements as of and for the three months and nine months ended September 30, 2010 to reflect an additional provision for loan losses of $11.7 million, resulting from Michigan Commerce Bank's amended regulatory financial statements filed on February 22, 2011 as of and for the period ended September 30, 2010. Michigan Commerce Bank is a significant subsidiary of Capitol. Prior to Michigan Commerce Bank's filing of such amended regulatory financial statements, its allowance for loan losses was believed by management to be appropriate based on information known at the time of the bank's original filing of its regulatory financial statements as of September 30, 2010. On March 3, 2011, Capitol filed Amendment No. 1 to Form 10-Q for the periods ended September 30, 2010 to reflect this adjustment.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
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Item 9A. Controls and Procedures.
Disclosure Controls and Procedures:
Capitol maintains disclosure controls and procedures designed to ensure that the information Capitol must disclose in its filings with the Securities and Exchange Commission is recorded, processed, summarized and reported on a timely basis. Capitol's Chief Executive Officer and Chief Financial Officer have reviewed and evaluated Capitol's disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act) as of the end of the period covered by this report (Evaluation Date). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, Capitol's disclosure controls and procedures are effective.
Management's Annual Report on Internal Control Over Financial Reporting:
Incorporated by reference from Pages F-50 – F-51, Financial Information Section of Annual Report.
Changes in Internal Control Over Financial Reporting:
No change in Capitol's internal control over financial reporting occurred during Capitol's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Capitol's internal control over financial reporting.
Item 9B. Other Information.
See information disclosed in response to Item 8 of this Annual Report on Form 10-K.
Effective January 1, 2011, Capitol merged the Employee Stock Ownership Plan with its 401(k) plan into an amended and restated plan that was renamed the Capitol Bancorp Limited Retirement Plan. A copy of the plan is attached as Exhibit 10.15 to this Annual Report on Form 10-K.
Effective March 31, 2011, Joseph D. Reid elected to reduce his compensation by an additional 25%, to $487,500.
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Item 10. Directors, Executive Officers and Corporate Governance.
Pursuant to Michigan law and Capitol's bylaws, Capitol's business, property and affairs are managed under the direction of its board of directors. Capitol's board of directors has responsibility for establishing broad corporate policies and for Capitol's overall performance and direction, but is not involved in Capitol's day-to-day operations. Members of the board of directors are kept informed of the issues facing Capitol by participating in board and committee meetings and by reviewing information provided to them on a periodic basis. Board members also have ongoing discussions with Capitol's executive officers to update them on matters relating to Capitol.
Capitol's amended and restated bylaws establish that the number of directors shall not be less than five nor more than twenty-five. Currently, Capitol's board of directors has set the number of directors at nineteen. The bylaws provide that its board of directors be split into three classes, Class I, Class II and Class III. Class I currently has six directors, Class II has seven directors and Class III has six directors.
The following table sets forth the members of each class of the board of directors of Capitol and information furnished by them regarding their age and principal occupation for at least the past five years, as of March 1, 2011. Except as otherwise disclosed in the biographical information, no director or executive officer is related to any other director or executive officer by blood, marriage or adoption.
Class I Directors with Terms Expiring in 2011*
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* Richard Henderson previously served as a director until his resignation in May 2010. Lawrence Connell was subsequently nominated to
serve the remainder of Mr. Henderson's term.
Class II Directors with Terms Expiring in 2012
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Class III Directors with Terms Expiring in 2013
There are no arrangements or understandings between any of Capitol's directors or executive officers and any other person pursuant to which that director or executive officer was nominated or elected as a director or an executive officer of Capitol or any of its subsidiaries.
No director or executive officer of Capitol is a party to any material legal proceedings or has a material interest in any such legal proceedings that is or may be adverse to Capitol or any of its subsidiaries.
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Capitol's bylaws, as amended and restated, provide that its board of directors may delegate responsibility to committees. During 2010, Capitol's board of directors had a separately designated standing Audit Committee. Following is a list of the membership of the Audit Committee, as well as its primary functions:
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Nominations for Directors
Capitol's Nominating and Governance Committee will consider nominees for director that are recommended by shareholders. A shareholder wishing to recommend a director candidate for consideration by the Nominating and Governance Committee should send such recommendation to the Secretary of Capitol at Capitol Bancorp Limited, Capitol Bancorp Center, 200 N. Washington Square, Lansing, MI 48933, who will then forward it to the Nominating and Governance Committee. Any such recommendation should include a description of the candidate's qualifications for board service, the candidate's written consent to be considered for nomination and to serve if nominated and elected, addresses and telephone numbers for contacting the shareholder and the candidate for more information and any other information concerning such candidate that must be disclosed as to nominees in proxy solicitations pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. A shareholder who wishes to nominate an individual as a director candidate at the annual meeting of shareholders rather than recommend the individual to the Nominating and Governance Committee as a nominee must comply with the advance notice requirements set forth in Capitol's bylaws, as amended. The Nominating and Governance Committee will evaluate shareholder-recommended director candidates in the same manner it evaluates director candidates identified by other means.
The board of directors and the Nominating and Governance Committee periodically review the size of the board of directors. In considering candidates for the board of directors, the Nominating and Governance Committee first considers the evolving needs of the board and searches for candidates that fill any current or anticipated future need. The Nominating and Governance Committee then considers the entirety of each candidate's credentials and does not have any specific minimum qualifications that must be met by a nominee recommended by the Nominating and Governance Committee. Each individual is evaluated in the context of the board as a whole, with the objective of recommending a group that can best serve Capitol's business and represent shareholder interests through the exercise of sound judgment using its diversity of experience.
The Nominating and Governance Committee considers the specific qualities and skills of each candidate and is guided by the following basic selection criteria for all nominees: independence; highest character and integrity; experience and understanding of strategy and policy-setting; financial acumen or other professional, educational or business experience relevant to an understanding of Capitol's business; technical expertise, experience or specialized skills relevant to Capitol's business that will add specific value as a board member; reputation for working constructively with others; ability to represent the interests of Capitol's shareholders, the communities it serves and its employees; and sufficient time to devote to board matters. The Nominating and Governance Committee also gives consideration to diversity, experience and specialized expertise in the context of the needs of the board of directors as a whole, including leadership positions in public companies, nonpublic business enterprises, or not-for-profit, professional or educational organizations. The Nominating and Governance Committee does not have a formal policy with respect to diversity; however, the board and the Nominating and Governance Committee believe that it is essential that the board members represent diverse viewpoints. The Nominating and Governance Committee's nomination process is designed to ensure that the Committee fulfills its responsibility to recommend candidates that are properly qualified to serve Capitol for the benefit of all of its shareholders.
In addition to independence, leadership and a high standard of integrity, the board believes that its members should encompass the right diversity, mix of characteristics and skills for the optimal functioning of the board in its oversight of Capitol. The board believes it should be comprised of individuals with skills in areas such as organizational leadership and strategic planning, finance and insurance, banking, entrepreneurship, compliance and audit, legal, real estate, accounting, government and governmental relationships and information technology.
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When considering whether directors and nominees have the experience, qualifications and skills to enable the board to satisfy its oversight responsibilities effectively and provide the board with experience in a wide variety of areas, the Nominating and Governance Committee focused primarily on the information discussed in each director's individual biographies set forth on pages 45 through 47 of this Form 10-K. Set forth below are the conclusions reached by the board with regard to its directors.
All of the members of the board possess management expertise through their leadership positions. With regard to Mr. Reid, the board considered the many years of leadership experience that he has with Capitol, which the board believes provides him with unique insights into Capitol's challenges, as well as intimate knowledge of its operations, and best positions him to lead Capitol in its day-to-day operations as well as in its strategic planning. As corporate president of Capitol, Ms. Reid is best positioned to provide knowledge of the day-to-day administration of Capitol.
Experience in the financial industry is exhibited by Messrs. Ballard, Becker, Epolito, Ferguson, Kasten, Miller and Reid, and Ms. Reid. Mr. Ballard served as president, chief executive officer and as a member of the board of directors of Portage Commerce Bank from its inception in 1988 until 2009 when it merged with and into Michigan Commerce Bank and this experience provides him with insight into Capitol's affiliate bank operations. With regard to Mr. Becker, the board considered Mr. Becker's experience as founder of Becker Insurance Agency and 24 years of experience managing that insurance agency. Mr. Devine has over 20 years of service on the boards of directors of various affiliates of Capitol, several from the formation stages and in the capacity of chairman. Mr. Epolito has significant business experience in the insurance industry, and Mr. Ferguson formerly served on the board of directors of Freddie Mac. Mr. Kasten has over 20 years experience on the boards of directors of various affiliate banks of Capitol, several of which he served as chairman. Mr. Miller has experience in the financial services industry, with 10 years experience in various areas of banking. Mr. Reid served as a member of the board of directors of Fincor Holdings, Inc. and Access BIDCO, L.L.C., and Ms. Reid previously served as an officer and director of Access BIDCO, L.L.C., in which some of Capitol's banking subsidiaries have an ownership interest.
Mr. Connell has significant regulatory experience which is instrumental in providing guidance to Capitol's board of directors. Additionally, he has extensive experience in financial and asset management matters.
Capitol's board of directors also considered the service on various bank affiliates' boards and committees with regard to Messrs. Ballard, Becker, Devine, Ferguson, Genova, Johns, Kasten, Maas, Meeusen, Nofziger, O'Leary, Reid and Sable and Ms. Reid, many of whom served as founding members and chairmen. Their extensive knowledge of banking matters is integral to an understanding of the role of community banks.
The board of directors considered the strong entrepreneurial background brought by Messrs. Becker, Epolito, Genova, Kasten, Maas, Meeusen, Miller, Nofziger and O'Leary from the operation of their respective business enterprises as such expertise is valuable to Capitol's structure and operations. Mr. Epolito has experience in the areas of employee compensation and management processes and evaluation. The board considered Mr. Genova's operation of a news company as chairman and chief executive officer, as well as the management experience that Mr. Maas has through the operation of his asset management firm and several other enterprises. The board considered the business leadership experience of Mr. O'Leary, who has spent over 47 years as a corporate officer of a successful paint company, in addition to his years of service as corporate secretary and a director of Capitol.
With regard to Dr. Falkenberg, the board considered his experience in the establishment and operation of a medical professional corporation for 37 years, the founding and operation of a medical imaging company and establishment of a medical residency teaching program, in addition to extensive compliance and audit responsibilities in those roles.
The board considered the extensive legal background of Messrs. Devine and Maas and Ms. Reid. Additionally, Mr. Reid has significant legal expertise, with over 20 years served as a trial attorney prior to forming Capitol.
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Messrs. Ferguson and Johns both have substantial experience in the field of real estate development, and Mr. Ferguson also has significant community involvement and leadership, especially due to his past appointment with the Lansing City Council and current role as chair of the board of trustees of Michigan State University. Ms. Gaskin brings her expertise of the real estate industry and extensive community involvement, including prior service as president of the Rotary Club of Lansing.
With regard to Mr. Meeusen, the board considered his significant experience, expertise and background with regard to accounting matters as a certified public accountant, which includes his status as Capitol's audit committee financial expert under SEC guidelines.
The board considered the strategic planning experience, as well as the expertise of government and government relationships of Mr. Sable through his service with the U.S. government and extensive financial and business education. Mr. Ferguson also provides experience on government relationships.
Both Mr. Epolito and Mr. Sable have experience in the area of information technology.
Section 16(a) Beneficial Ownership Reporting Compliance
Rules and regulations promulgated by the SEC require periodic reporting of the beneficial ownership of and transactions involving Capitol's securities relating to directors, officers and beneficial owners of 10% or more of Capitol's securities. Under those rules and regulations, it is required that certain acquisitions and divestitures of Capitol's securities be disclosed via reports filed within prescribed time limits. Based on Capitol's review of filings made during the year ended December 31, 2010, there were no transactions completed which were not reported timely pursuant to the filing requirements.
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The following table sets forth compensation paid to Capitol's nonemployee directors in 2010. Directors who are employees receive no additional compensation for serving on the board or its committees and are omitted from this table.
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Capitol provides nonemployee directors the following cash compensation:
Corporate Governance Guidelines and Code of Ethics
Capitol's board of directors is committed to good corporate governance and believes that an attentive, performing board is most appropriate for Capitol. With that commitment, during the past year the board has reviewed Capitol's corporate governance policies and practices and has assured itself Capitol is adhering to the rules of the SEC. In addition, the board has implemented other corporate governance practices and procedures on a best-practices basis.
Capitol has adopted a Code of Ethics that applies to its senior financial officers, including its principal executive officer and its principal financial officer. Capitol's other corporate governance documents, including its Code of Ethics, corporate governance guidelines, charters of committees of the board and other important policies, are available on its website at www.capitolbancorp.com. Each of these is also available in print to any shareholder, without charge, upon request to the Secretary of Capitol at Capitol Bancorp Center, 200 N. Washington Square, Lansing, MI 48933. As permitted by SEC rules, Capitol intends to post on its website any amendment to, or waiver from, any provision in the Code of Ethics that applies to its chief executive officer, chief financial officer, controller or persons performing similar functions, and that relates to any element of the standards enumerated in the rules of the SEC.
Capitol's current executive officers are as follows:
For more information with respect to Mr. Connell, Ms. Reid and Mr. Reid, see Class I Directors with Terms Expiring in 2011 and Class III Directors with Terms Expiring in 2013.
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Gregory R. Bixby – Mr. Bixby became Capitol's Chief Information Officer in January 2007. Prior to that time, he was Chief Information Officer for Republic Bancorp, Inc.
Brian K. English – Mr. English has served in his current capacity as General Counsel since 2001.
David D. Fortune – Mr. Fortune has served as Chief Credit Officer for Capitol since 2004. Prior to that time, he was a Senior Vice President/Credit Administration for Capitol.
Lee W. Hendrickson – Mr. Hendrickson has served as the Chief Financial Officer for Capitol since 1991.
Michael M. Moran – Mr. Moran joined Capitol in 2000 as the Executive Vice President of Corporate Development and currently serves as Chief of Capital Markets.
Todd C. Surline – Mr. Surline joined Capitol in 2007 as Chief of Human Capital Management. He previously served as Vice President of Human Resources of Michigan State University Federal Credit Union. He currently serves as Chief Administrative Officer.
Bruce A. Thomas – Mr. Thomas joined Capitol in 1998 as Senior Vice President of Risk Management. He has also served as Chief Operating Officer and President of the Eastern Regions, and currently serves as President of Bank Operations. Effective December 2010, Mr. Thomas also began serving as acting interim president of Capitol's largest banking subsidiary, Michigan Commerce Bank.
Stephen D. Todd – Mr. Todd joined Capitol in 2000 as Director of Bank Performance, and has also served as President of the Southwest Region and Chief of Bank Financial Analysis of Capitol. He currently serves as Chief of Bank Performance.
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Item 11. Executive Compensation.
Compensation Discussion and Analysis
In the paragraphs that follow, Capitol provides an overview and analysis of its compensation programs and policies, material compensation decisions Capitol has made under those programs and policies with respect to Capitol's named executive officers (the "Named Executive Officers"), and the material factors that Capitol considered in making those decisions will be provided. Under the heading, "Executive Compensation," is a series of tables containing specific information about the compensation earned by or paid in 2010 to the following individuals:
· Joseph D. Reid, Chairman and CEO;
· Lee W. Hendrickson, Chief Financial Officer;
· Lawrence Connell, Vice Chairman, Vice Chairman and a Principal Officer of Michigan Commerce Bank;
· Cristin K. Reid, Corporate President; and
· Bruce A. Thomas, President of Bank Operations.
Like many companies, especially in the financial services sector, the adverse economic conditions over the last few years resulted in significant losses from operations for Capitol and a significant decline in Capitol's financial position and value of its publicly-traded securities. These factors are reflected in the decreased compensation of Capitol's Named Executive Officers because Capitol's compensation program is designed to align a significant portion of compensation with the performance of Capitol and the interests of Capitol's shareholders. Changes that have resulted include:
Objectives of the Compensation Program
Capitol's compensation program is administered by Capitol's Compensation Committee (the "Compensation Committee"). The objectives of the program are to:
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Elements of the Compensation Program
To ensure achievement of the program objectives, compensation is provided to the Named Executive Officers in the following elements:
· Base Pay;
· Annual Incentive Pay;
· Long-Term Incentive Pay; and
· Perquisites and Other Personal Benefits.
The purpose, design and determination of amounts and 2010 pay decisions are described below.
Design of the Total Compensation Program
Prior to changes made to the design of the program in late 2009, Capitol did not attempt to set each compensation element for each executive within a particular range related to levels provided by industry peers. Instead, the Compensation Committee used market comparisons as one factor in making compensation decisions. The principal factors considered when making individual executive compensation decisions included:
· Individual contribution and performance;
· Reporting structure;
· Internal pay relationship;
· Complexity and importance of role and responsibilities;
· Leadership and growth potential;
· Strategic importance; and
· Technical implications such as tax, accounting and shareholder dilution.
The Compensation Committee does not assign a specific weighting to these factors and may exercise its discretion when making compensation decisions for the Named Executive Officers.
When reviewing the components of the compensation program, the Compensation Committee, together with Capitol's internal director of its human resources department, works to ensure the total compensation package is competitive with the external marketplace and remains balanced from an internal equity standpoint. However, it is the total compensation package that should be competitive, and not necessarily on the basis of individual elements.
The Compensation Committee does not maintain a stated policy with regard to cash versus noncash compensation. However, the allocation of cash and noncash compensation for each of the Named Executive Officers is reviewed annually.
In general, the Compensation Committee does not take into account amounts realizable from prior compensation when making future pay decisions. However, grant date amounts and values are considered, particularly when establishing long-term incentive award grants. The Compensation Committee reviews a total compensation tally sheet for Mr. Reid annually. The tally sheet is used to inform the Compensation Committee of Mr. Reid's total compensation and accumulated value from Capitol's equity plan.
In light of the extreme volatility in the U.S. financial markets in 2010 and general public concern over executive compensation among financial institutions, Capitol took the additional measure of meeting with certain senior officers of Capitol to discuss the risk profile of its total executive compensation program for the Named Executive Officers. The Compensation Committee concluded that the total compensation program, which balances fixed compensation (base pay and retirement benefits) and various forms of shorter and longer term incentive pay (annual cash bonus and equity compensation) is appropriate and does not encourage the Named Executive Officers to take excessive or unnecessary risks.
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Benchmarking and Peer Companies
Under the direction of the Compensation Committee, beginning in late 2009, Capitol began benchmarking base pay, annual incentive pay and long-term incentive pay for the purposes of compensation to be paid to Capitol's executive officers in future periods as an additional factor to be considered in the determination of compensation. Prior to 2009, the Compensation Committee did not attempt to set each compensation element for each executive within a particular range related to levels provided by industry peers.
The Compensation Committee believes that the external market should be defined as peer companies in the banking industry of a similar asset size, geographic diversity and complexity similar to Capitol. Notwithstanding the external market factors, the Compensation Committee recognizes that because of Capitol's unique structure (numerous individual financial institutions within Capitol's organization), operating philosophy and national geographic footprint, finding a comparable peer group is difficult, as the Compensation Committee has not been able to identify any financial institution or group of financial institutions whose structure is as complex as Capitol's. For example, institutions of a similar asset size to Capitol's may have an executive handle certain duties that would be impossible for one officer to handle within Capitol's more complex structure.
For 2011, the Compensation Committee identified two reference groups of peer financial companies that it will use for purposes of benchmarking its compensation practices. These include a group of 15 similarly-sized regional banks and a group of 15 institutions that have operations in more than five states or institutions with multiple banking affiliates. The reference group of similarly-sized banks included banks with total assets between $1 billion and $12.5 billion at December 31, 2010, compared to $3.5 billion of assets for Capitol as of such date.
Additionally, market data was collected from multiple published survey sources representing national financial institutions of an asset size, geographic diversity and complexity similar to Capitol. The Compensation Committee believes that the combination of peer company data and survey data reflects Capitol's external market for business and executive talent. Accordingly, in 2009, the Compensation Committee began to use both of these sources when comparing Capitol's executive compensation to the external market. The Compensation Committee does not utilize any stated weighting of external market data with which to benchmark compensation levels of the Named Executive Officers. Instead, the Compensation Committee evaluates the market data along with the other factors listed previously to determine the appropriate compensation levels of the Named Executive Officers on an individual basis. The Compensation Committee uses these sources of market data to ensure that the compensation being paid by Capitol is competitive with those of its peer companies.
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The Compensation Committee maintains flexibility to deviate from market-median practices for individual circumstances, including qualifications, experience and responsibilities. The Compensation Committee also considers an internal review of the executive's compensation relative to other executive officers and the individual performance of the executive in establishing the base salary as well as the increased duties taken on by Capitol's executive officers during these difficult economic times.
Base pay is an important element of executive compensation because it provides executives with a stable level of monthly income. Internal and external equity, performance, experience and other factors are considered when establishing base salaries. Base pay is not directly related to Capitol's operating performance.
Capitol pays its executive officers a base salary as fixed compensation for their time, efforts and commitments throughout the year. To aid in attracting and retaining qualified executive officers, the Compensation Committee seeks to keep base salaries competitive. In determining the appropriate base pay, the Compensation Committee also considers, among other factors, the nature and responsibility of the position. Additionally, executives are evaluated on certain core competencies that are used to evaluate all of Capitol's staff members, such as championing change and improvement, delivering high quality client service, listening and communication abilities and participating as a team player.
The Compensation Committee does not utilize a mathematical formula in which these factors or their interrelationships are quantified and weighted (either in general, or with respect to any individual executive). During a particular year, one factor or group of factors may play (but does not necessarily play) a more significant role in the determination of an executive's base salary than in other years, based on the Compensation Committee's judgment and discretion. An executive's individual performance may be assessed based upon any of his or her demonstrated leadership skills, accomplishment of objectives, business unit or functional accountabilities and personal contributions. A broad range of factors relevant to each of these areas, generally qualitative in nature, may be considered in this assessment. The Compensation Committee's judgments regarding base salaries are also strongly influenced by the judgments and recommendations of the chief executive officer with respect to the Named Executive Officers other than himself and Cristin K. Reid for which base salary is determined by the Compensation Committee.
The Compensation Committee does not assign a specific weighting to these factors when making compensation decisions. Base salary changes are generally approved in November of each year and are effective January 1st of the following year. No specific weighting is targeted for base salaries as a percentage of total compensation. The Compensation Committee reviews base salaries annually and, beginning in 2010, targets salary compensation at or near the 50th – 75th percentile of the peer group, but maintains flexibility to deviate from market-median practices for individual circumstances, including qualifications, experience and responsibilities. The Compensation Committee also considers an internal review of the executive's compensation relative to other executive officers and the individual performance of the executive in establishing the base salary.
Effective March 31, 2011, Joseph D. Reid elected to reduce his base salary compensation by 25%, which followed reductions of 20% on October 1, 2009 and 10% effective January 1, 2009. During their Fall 2010 meeting, the Compensation Committee approved base pay for Mr. Reid and the other Named Executive Officers. No increases were made to any of the Named Executive Officers' base pay in 2010. The Compensation Committee observed that the base pay levels for all of the Named Executive Officers approximated the 50th percentile of external market data.
Due to the continuing adverse economic conditions and the challenges facing the financial services industry, no base pay increases were approved for 2009, 2010 or 2011, and most of Capitol's senior management group agreed to a voluntary 10% salary reduction effective January 2009, including the Named Executive Officers. The 2008, 2009 and 2010 years were extremely challenging for Capitol and the financial services industry, as reflected in the adverse operating performance of Capitol and many other banks across the country, and the extraordinary measures being taken by the federal government to aid companies in the banking industry.
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Base pay levels as approved by the Compensation Committee remained effective January 1, 2011. Base pay levels are set forth in the Summary Compensation Table. Mr. Reid makes recommendations on the pay levels of his direct reports for the Compensation Committee's review and approval (with the exception of Brian K. English and Cristin K. Reid, which are set by the Compensation Committee in its sole discretion). Mr. Reid does not make recommendations to the Compensation Committee on his own compensation level (other than the previously-discussed voluntary base pay reductions requested by Mr. Reid). The Compensation Committee, in executive session and without members of Capitol's management present, determines the pay levels for Mr. Reid, to be subsequently ratified by its board of directors.
Annual Incentive Pay
Annual incentive pay is provided to the Named Executive Officers to recognize achievement of financial targets, both on the overall corporate level and the individual level, and is paid in accordance with the quantitative and qualitative terms of the Capitol Bancorp Ltd. Management Incentive Plan (the "MIP") which was approved by Capitol's shareholders at the 2003 Annual Meeting of Shareholders. In establishing the performance goals under the MIP, the Compensation Committee may utilize the following quantitative and qualitative factors:
The MIP provides the Compensation Committee the latitude to establish primarily cash-based incentive compensation programs to promote high performance and achievement of corporate goals by officers, encourage shareholder value and allow officers to participate in the long-term prospects of Capitol. Under the MIP, the Compensation Committee may elect to approve awards in the form of shares of Capitol's common stock. In issuing such shares as payment of awards under the MIP, the Compensation Committee may establish any conditions or restrictions it deems appropriate. No awards were granted or approved under the MIP in 2010.
Annual Bonus of Mr. Reid
Pursuant to the terms and conditions of Mr. Reid's employment agreement, Mr. Reid is eligible to receive an annual cash bonus in an amount equal to 2% of Capitol's net income for the immediately preceding fiscal year upon Capitol's achievement of (i) growth of Capitol's earnings per share equal to or greater than 10% for the immediately preceding fiscal year and (ii) growth of Capitol's total assets, as reflected on Capitol's year-end audited financial statements, equal to or greater than 10% for the immediately preceding fiscal year.
Due to the adverse financial performance and the weakened capital position of Capitol during 2010, the Compensation Committee determined not to pay any Named Executive Officer, including Mr. Reid, any annual bonus.
These decisions were made due to the continuing adverse economic conditions, the challenges facing the financial services industry and Capitol's adverse financial results and are consistent with Capitol's compensation philosophy. The 2008, 2009 and 2010 years were extremely challenging for Capitol and the financial services industry, as reflected in the adverse operating performance and financial condition of Capitol and many other banks across the country and the extraordinary measures being taken by the federal government to aid companies in the banking industry.
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The Compensation Committee approved a target of 2% of 2011 net income (if any) as Mr. Reid's bonus. To determine the bonus payment amount, if any, the Compensation Committee will base it upon the following qualitative measures approved by the Compensation Committee:
Bonus Plan for the Other Named Executive Officers
The remaining Named Executive Officers are eligible to participate in the MIP and the Capitol Bancorp Limited 2007 Equity Incentive Plan (the "Stock Incentive Plan"). No bonuses under the MIP were paid to any Named Executive Officers due to the performance and capital position of Capitol in 2010.
For 2011, Capitol established the following individual targets as a percentage of 2010 base salary earnings for the Named Executive Officers in the MIP:
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The individual targets are not formula driven. For all of the Named Executive Officers in the MIP, the targets are set at the discretion of the chief executive officer and must be approved by the Compensation Committee. The bonus targets are based on external market data, internal equity considerations and strategic objectives for corporate performance such as Capitol's operational performance, asset growth, asset quality, operating results, return on assets, return on equity, total shareholder return and the effective execution of Capitol's strategic plan. The targets for a calendar year are reviewed annually at the preceding Fall meeting of the Compensation Committee and altered as deemed appropriate. Payment amounts for the Named Executive Officers, with the exception of the chief executive officer and Ms. Reid, are made based on recommendations of the chief executive officer and approval of the Compensation Committee. Bonus amounts in excess of or below target may be paid at the discretion of the chief executive officer with the approval of the Compensation Committee. Before the chief executive officer makes recommendations to the Compensation Committee regarding annual bonus payments for the other Named Executive Officers, the chief executive officer discusses these issues with the Compensation Committee. The Compensation Committee has the discretion to approve, disapprove or alter the recommendations.
Long-Term Incentive Pay
Long-term incentives are awarded to the Named Executive Officers in an effort to align management and shareholder interests, ensure future performance of Capitol, enhance ownership opportunities and to increase shareholder value. Capitol maintains the MIP and the Stock Incentive Plan which was approved by shareholders and authorizes the granting of the following types of awards for executives:
· Stock Options;
· Stock Appreciation Rights;
· Restricted Stock and Restricted Stock Units;
· Performance Unit and Performance Share Awards;
· Cash-Based Awards; and
· Other Stock-Based Awards.
As set forth in the Summary Compensation Table, long-term incentives have been awarded to the Named Executive Officers in the form of stock options and restricted stock. The provisions of such grants are determined by the Compensation Committee taking into account a variety of factors, including grants from prior years, external market data, internal equity considerations, performance, overall share usage, shareholder dilution and cost.
The Company periodically grants stock options to executives. No stock option grants were made to Named Executive Officers in 2010. Stock option grants are designed to assist Capitol to:
Such grants are discretionary by the Compensation Committee, reflecting the position of each executive officer within Capitol and that person's proportionate responsibility for overall corporate performance. The allocation of stock options among executive officers is not based on any measure of Capitol's performance, but is based on a subjective evaluation of individual performance and the scope of the individual's responsibilities.
Option exercise prices are set at the closing price of Capitol's common stock on the date of grant. The Compensation Committee has never granted options with an exercise price that is less than the closing price of Capitol's common stock on the grant date, nor has it granted options that are priced on a date other than the grant date.
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Shares of restricted stock are granted to the Named Executive Officers to create an immediate link to shareholder interests and enhance ownership opportunities. A restricted stock award of 224,720 shares was granted to Mr. Connell in July 2010.
No other restricted stock awards were granted to Named Executive Officers in 2010.
Stock Ownership Guidelines
Capitol does not currently maintain a formal policy for executive stock ownership requirements. The Compensation Committee believes that the use of restricted stock for the Named Executive Officers serves to reinforce stock ownership and aligns executive and shareholder interests.
While the Compensation Committee believes a significant portion of the Named Executive Officers' total compensation should be linked to Capitol's stock price, no specific weighting is targeted for long-term incentive pay as a percentage of total compensation.
In its review in late 2010, the Compensation Committee observed that long-term incentive awards to Mr. Reid were at approximately the 50th and the 75th percentile of external market data. Long-term incentive awards to the remaining Named Executive Officers were also between the 50th and the 75th percentile of external market data. The Compensation Committee determined that it was critical to continue to place a strong emphasis on future financial performance and increasing shareholder value, while offering a competitive total rewards package. No long-term awards were granted in 2010 to the Named Executive Officers.
Historically, the Compensation Committee has generally approved and granted long-term incentive awards to the Named Executive Officers and any other designated employees at the Fall meeting or at the hire date of newly designated employees, as applicable. Capitol maintains no policy, whether official or unofficial, for timing the granting of stock options or other equity-based awards in advance of the release of material nonpublic information. In 2010, Capitol followed its historical equity grant practice by reviewing whether any grants should be made at its Fall 2010 Compensation Committee meeting. No long-term incentive awards were made to Named Executive Officers following the review.
Perquisites and Other Personal Benefits
Capitol does not provide significant perquisites or personal benefits to its executive officers. The Named Executive Officers are provided with an automobile allowance and, in the case of Mr. Reid, the use of an automobile leased by the Corporation. Additionally, Capitol provided living expenses of $5,000 per month for one year to Mr. Connell, expiring in May 2011.
Long-term incentives to align the interests of Capitol's employees with the shareholders have been implemented through the development of an Employee Stock Ownership Plan (the "ESOP"). The ESOP typically provides annual awards of Capitol's common stock subject to vesting requirements. All of Capitol's employees, with the exception of the chief executive officer, are eligible to participate in the program after meeting certain length of service and age qualifications. In response to the financial performance of Capitol, employer contributions to the ESOP were suspended for the third consecutive year in 2010.
Capitol has a 401(k) plan which includes an employer match as a percentage of employees' contributions to the plan. In response to the financial performance of Capitol, employer matching contributions were suspended for the second consecutive year in 2010. In January 2011, the ESOP and 401(k) plan were merged to create the Capitol Bancorp Limited Retirement Plan.
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In an effort to retain the long-term services of certain of its executives, Capitol has an executive supplemental income program for some of its executives. Individual agreements call for the payment to the subject employee or designated beneficiary of an annual benefit, or lump sum payment at the employee's or beneficiary's election, which is approximately equal to a percentage of the annual base salary of each employee, when entered into, for a period up to fifteen years in the event of either the employee's retirement or the death of the employee before attaining retirement age. In the event of a change of control of Capitol (as defined in the agreements), which is not approved by Capitol's board of directors, each employee can retire with full benefits at any time after attaining the age of 55 without approval of the board of directors. The benefit liabilities under the agreements are covered by insurance contracts funded by Capitol and/or its subsidiaries. Capitol has entered into executive supplemental income agreements with two individuals listed in the Summary Compensation table, Messrs. Hendrickson and Thomas.
Additionally, Capitol has health insurance and other programs that are usual and customary to encourage retention of Capitol's employees. Capitol does not maintain a defined-benefit pension plan and does not have any active nonqualified deferred compensation plans.
Role of the Compensation Committee
Consistent with public-company corporate governance standards and as defined by the NYSE, which Capitol uses to determine "independence" among members of its board, its Compensation Committee is composed entirely of independent directors. No Compensation Committee member participates in any of Capitol's employee compensation programs. Each year, the Nominating and Governance Committee reviews all direct and indirect relationships that each director has with Capitol and its board of directors subsequently reviews its findings. The board of directors has determined that none of the Compensation Committee members have any material business relationships with Capitol.
The Compensation Committee has responsibility for establishing, implementing and continually monitoring adherence with Capitol's compensation philosophy. The Compensation Committee ensures that the total compensation paid to senior management is fair, reasonable and competitive. Generally, the types of compensation and benefits provided to the Named Executive Officers are similar to other executive officers of Capitol. The Compensation Committee believes that the most effective executive compensation program is one that is designed to reward the achievement of annual, long-term and strategic goals by Capitol, and which aligns executives' interests with those of the shareholders by rewarding performance above established goals, with the ultimate goal of improving shareholder value. Specifically, the Compensation Committee seeks to reward performance as measured by financial metrics and successful execution of Capitol's strategic plan.
The Compensation Committee periodically reviews the compensation levels of the board of directors. In its review, the Compensation Committee looks to ensure that the compensation is fair and reasonably commensurate to the amount of work required both from the individual directors as well as from the board in the aggregate.
The Compensation Committee is responsible for the review and approval of corporate goals and objectives, relevant to the compensation of Capitol's chief executive officer, to evaluate the performance of the chief executive officer in light of the goals and objectives, and determine and approve the chief executive officer's compensation levels based on this evaluation. Additionally, the Compensation Committee reviews compensation levels for members of Capitol's executive management group. To achieve these goals and objectives, the Compensation Committee expects to maintain compensation plans that create an executive compensation program that is set at competitive levels of comparable public financial services institutions (to the extent comparable entities may be identified) with comparable performance. The Compensation Committee makes recommendations to the board of directors with respect to compensation plans and equity-based plans and oversees the administration of the compensation, incentive and equity-based benefit plans of Capitol. The Compensation Committee periodically reviews director and board committee compensation levels and practices and recommends to the board changes in such compensation levels and practices.
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Policy on Internal Revenue Code Section 162(m) Compliance
Section 162(m) of the Internal Revenue Code generally limits the corporate tax deduction to $1,000,000 in a taxable year for compensation paid to each "covered employee" of Capitol, which under Section 162(m) and guidance issued under the section, includes all of the Named Executive Officers unless the compensation is "performance based."
In order to preserve Capitol's tax deduction, the Compensation Committee approved the MIP for "covered employees." In the event that a "covered employee's" total compensation would exceed the amount deductible under Section 162(m), the MIP allows the Compensation Committee, in its sole discretion, to defer cash components of the "covered employee's" compensation until the plan year after he or she ceases to be a "covered employee" or upon his or her death or disability.
For 2010, no payments were made to the Named Executive Officers under the MIP and no amounts paid to Named Executive Officers were subject to the tax-deduction limitation described above.
Policy on Recovery of Awards
On November 15, 2010, following prior approval by the Compensation Committee of Capitol's board of directors, Capitol's employment agreements with Lee W. Hendrickson, Cristin K. Reid and Bruce A. Thomas were amended and restated in their entirety (the "Amended and Restated Employment Agreements"). The Amended and Restated Employment Agreements, among other things, contain a provision providing for the recoupment of unearned incentive compensation if Capitol's board of directors, or an appropriate committee thereof, determines that any fraud, negligence or intentional misconduct by the Named Executive Officer is a significant contributing factor to Capitol having to restate all or a portion of its consolidated financial statements. Capitol's board of directors or Compensation Committee may require reimbursement of any bonus or incentive compensation previously paid to the Named Executive Officer. Except as set forth in the Amended and Restated Employment Agreements, Capitol currently has no written policy with respect to recovery of awards when financial statements are restated. However, in the event of a restatement, Capitol would recover any awards as required by applicable law.
The recent economic downturn and its effects on Capitol and the financial system make it difficult for the Compensation Committee to set appropriate enterprise-wide and individual performance criteria for compensation purposes. Additionally, continued economic volatility, and its effects on Capitol's common stock price, may cause the value of stock options and restricted stock shares or units that Capitol has awarded to its Named Executive Officers to fall below levels that the Compensation Committee deems necessary to provide appropriate performance and retention incentives for such officers. Accordingly, the Compensation Committee will continue to exercise discretion in determining compensation for Capitol's Named Executive Officers to ensure that Capitol continues to meet its compensation philosophies and objectives.
2010 Compensation Decisions
As described above, due to the continuing adverse economic conditions and the challenges facing the financial services industry, no base pay increases were approved for 2010 or 2011, and most of Capitol's senior management group agreed to a voluntary 10% salary reduction effective January 2009. The Compensation Committee reviewed and approved the 2009 salary reduction request. The 2008, 2009 and 2010 calendar years were extremely challenging for Capitol and the financial services industry, as reflected in the adverse operating performance of Capitol and many other banks across the country, and the extraordinary measures being taken by the federal government to aid companies in the banking industry. The base pay as approved by the Compensation Committee remained effective as of January 1, 2011.
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Compensation Committee Report
The Compensation Committee of Capitol has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the board that it be included in Capitol's Annual Report on Form 10-K for the year ended December 31, 2010.
Equity Compensation Plan Information
The following table summarizes information regarding Capitol's equity compensation plans in effect as of December 31, 2010:
* Does not include shares that may be issued if Capitol elects to pay awards made under the Capitol Bancorp Ltd. Management
Incentive Plan in the form of shares of Capitol's common stock. Also does not include shares that were approved to be issued
under the 2007 Incentive Plan, which includes a provision increasing the shares available for the plan in an amount equal to
2% of the outstanding shares of common stock as of December 31 of each year.
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The following table sets forth all compensation paid to the Named Executive Officers:
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Joseph D. Reid
In March 2003, Capitol entered into an employment agreement with Mr. Reid. The agreement had an initial term of three years, which was set to expire in March 2006. Pursuant to the terms of the agreement, its employment period is automatically extended for a three-year term on each annual anniversary of the agreement, unless Capitol provides Mr. Reid with notice sixty days prior to such anniversary. The agreement permits Capitol to give Mr. Reid notice of its intention to stop the automatic renewal, in which case the agreement will expire two years and sixty days from the date of Capitol's notice to him. Capitol has not provided notice of its intention to stop the automatic renewal in 2010. Accordingly, the agreement will not expire until at least March 13, 2014.
Capitol is not permitted to reduce Mr. Reid's annual salary at any time during the term of the agreement. However, Mr. Reid asked for a voluntary reduction in his 2009 compensation totaling 30%, 10% in January 2009 and an additional 20% in October 2009. Additionally, effective March 31, 2011, Joseph D. Reid asked for a voluntary reduction of his base salary of 25%.
During the term of his employment, Mr. Reid will be entitled to an annual cash bonus based on achieving targets for both growth rates for earnings per share and consolidated assets. Mr. Reid is also entitled to certain long-term incentive compensation consisting of common stock and cash. Capitol will grant Mr. Reid options to purchase shares of Capitol's common stock at an exercise price equal to the fair market value of Capitol's common stock on the date of such grant based on specific corporate development objectives during the term of the agreement.
In 2006, both Mr. Reid and the Compensation Committee began a review of Mr. Reid's current compensation under the terms of his employment agreement. At the time the agreement was entered into in 2003, neither Mr. Reid nor the Compensation Committee anticipated the rate of growth of affiliate banks that Capitol had been able to achieve. Under the terms of the agreement, Mr. Reid was, in part, incentivized to develop new banks, being awarded stock options based on the number of banks developed.
In August 2007, Mr. Reid and Capitol entered into an amendment to his employment agreement which reduced his total cash compensation and limited the equity incentives paid to him based on the future development of Capitol. The amendment amended the original agreement as follows:
Lee W. Hendrickson, Lawrence Connell, Cristin K. Reid and Bruce A. Thomas
Capitol has employment agreements with each of the Named Executive Officers, with the exception of Lawrence Connell. On November 15, 2010, following prior approval by the Compensation Committee of Capitol's board of directors, employment agreements with the following Named Executive Officers were amended and restated in their entirety: Cristin K. Reid, Lee W. Hendrickson and Bruce A. Thomas.
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The Named Executive Officers entered into the Amended and Restated Employment Agreements at the request of Capitol to provide for greater uniformity concerning the employment agreements for Capitol's executive officers and to update the prior employment agreements to reflect changes in the law. The Amended and Restated Employment Agreements incorporate the current salary level of each Named Executive Officer, acknowledge the 10% voluntary salary reductions discussed previously herein and include several additional provisions considered beneficial to Capitol when compared to the earlier employment agreements including:
Pursuant to the Amended and Restated Employment Agreements, Capitol agreed to employ the Named Executive Officers for a term of 36 months beginning on November 15, 2010, each in their current respective positions with Capitol. Under the Amended and Restated Employment Agreements for each of the Named Executive Officers, on each anniversary date of the agreement, the employment period will be automatically extended for an additional year, unless Capitol has provided prior notice to the Named Executive Officer that the term will not be extended further.
Ms. Reid and Messrs. Hendrickson and Thomas asked for a voluntary salary reduction of 10% effective January 1, 2009.
Grants of Plan-Based Awards
The following table shows all plan-based awards granted to the Named Executive Officers during 2010: