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Capitol Bancorp 10-Q 2011
form10q_a.htm


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

FORM 10-Q/A
AMENDMENT NO. 1

T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2010
 
OR
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from ________________ to ________________

Commission file number:  001-31708

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

Michigan
 
38-2761672
(State or other jurisdiction of
 
(IRS Employer Identification No.)
incorporation or organization)
   
Capitol Bancorp Center
   
Fourth Floor
   
200 N. Washington Square
   
Lansing, Michigan
 
48933
(Address of principal executive offices)
 
(Zip Code)

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

Not applicable
(Former name, former address and former fiscal year, if changed since last report)

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   T
No   £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes   £
No   £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer   £
   
Accelerated filer   £
Non-accelerated filer     £   (Do not check if a smaller reporting company)
 
Smaller reporting company   T

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at October 31, 2010
Common Stock, No par value
 
21,622,856 shares

 
Page 1 of 56

 
 
Explanatory Note

Capitol Bancorp Ltd. (Capitol) is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q to revise its unaudited condensed consolidated financial statements and other information as of and for the three months and nine months ended September 30, 2010 that were part of Form 10-Q that Capitol filed with the Securities and Exchange Commission (SEC) on November 15, 2010.

As discussed in Capitol's various SEC filings, regulatory agencies may require Capitol or its banks to increase their provision for loan losses or to recognize loan charge-offs based upon judgments different from those of management.  Any increase in the allowance for loan losses required by regulatory agencies could adversely impact Capitol's operating results and financial position.  The allowance for loan losses requires significant judgment, is an estimate and is one of Capitol's critical accounting policies.

Capitol's unaudited condensed consolidated financial statements for the three months and nine months ended September 30, 2010 have been revised to reflect an additional provision for loan losses of $11.7 million resulting from Michigan Commerce Bank's amended regulatory financial statements as of and for the period ended September 30, 2010 filed on February 22, 2011.  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.

Michigan Commerce Bank's amendment of its regulatory financial statements as of and for the period ended September 30, 2010 to increase its allowance for loan losses and related provision for loan losses in the amount of $11.7 million, resulted from a recently-completed joint examination of the bank by the Federal Deposit Insurance Corporation and the Office of Financial and Insurance Regulation of the State of Michigan.  Such examination commenced in September 2010.  The bank's decision to amend its interim financial statements was based on discussion with those regulatory agencies regarding expectations that certain examination findings, including a change in estimate regarding the bank's allowance for loan losses as of September 30, 2010, would require such amendment; however, the bank has not yet received the related examination report.

The information in this Amendment No. 1 to Form 10-Q not only revises the unaudited condensed consolidated financial statements that were contained in the originally-filed Form 10-Q for the three months and nine months ended September 30, 2010, but also amends other information in that Form 10-Q affected by the revision described above.  Therefore, this Amendment No. 1 should be read together with the originally-filed Form 10-Q.  Furthermore, this Amendment No. 1 does not reflect events occurring after the filing of the originally-filed Form 10-Q or update information or disclosures contained in the originally-filed Form 10-Q that were not affected by the revision described above.  Accordingly, this Amendment No. 1 also should be read in conjunction with subsequent filings of financial information by Capitol relating to its financial position and results of operations for the year ended December 31, 2010, as information in such subsequent filings may update or supersede certain information contained in this Amendment No. 1 to Form 10-Q.

The following items of the originally-filed Form 10-Q for the three months and nine months ended September 30, 2010 have been revised:

Part I – Financial Information:
Item 1 – Financial Statements (unaudited)
Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 4 – Controls and Procedures

In addition, as required by Rule 12b-15 under the Securities and Exchange Act of 1934, as amended, updated certifications by Capitol's principal executive officer and principal financial officer are filed herewith as Exhibit 31.1, Exhibit 31.2, Exhibit 32.1 and Exhibit 32.2 to this Amendment No. 1 on Form 10-Q which are currently dated March 2, 2011.



 
Page 2 of 56

 

INDEX

PART I.                      FINANCIAL INFORMATION

Forward-Looking Statements
Some statements contained in this document, including consolidated financial statements of Capitol Bancorp Limited (Capitol or the Corporation), 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 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 banks and Capitol's ability to respond to such actions, (ix) the cost of and access to capital, which may depend in part on Capitol's asset quality, prospects and outlook, (x) changes in governmental regulation, tax rates and similar matters, (xi) changes in management, (xii) consummation of pending sales of certain bank 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 (SEC), and (xv) the following, among others:

·  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;

·  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;

 
Page 3 of 56

 

INDEX – Continued

PART I.                      FINANCIAL INFORMATION – Continued

Forward-Looking Statements – Continued

·  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 each of Capitol's subsidiary banks' 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 the establishment of the allowance for loan losses and estimation of values of collateral or cash flow projections and various financial assets and liabilities;

·  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 subsidiary banks 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 and periodic payments on its trust-preferred securities without prior written regulatory authorization;

·  Administrative or enforcement actions of banking regulators in connection with any material failure of Capitol or its subsidiary banks 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;

·  Capitol's ability to continue as a going concern;

·  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 bank subsidiaries for any cross-guaranty liability;

 
Page 4 of 56

 

INDEX – Continued

PART I.                      FINANCIAL INFORMATION – Continued

Forward-Looking Statements – Continued

·  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 and regions 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 goodwill and other 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;

·  Changes in accounting standards or applications and determinations made thereunder;

·  The risk that the realization of deferred tax assets and recoverable income taxes may extend beyond 2010;

·  The risk that Capitol may not be able to complete its various proposed divestitures, mergers and consolidations of certain of its subsidiary banks or, if completed, realize the anticipated benefits of the proposed mergers and/or consolidations;

·  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 costs, effects and impact of litigation, investigations, inquiries or similar matters, or adverse facts and developments related thereto;

·  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;

·  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 of Capitol 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.

 
Page 5 of 56

 

INDEX – Continued

PART I.                      FINANCIAL INFORMATION – Continued

Forward-Looking Statements – Continued

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 Form 10-Q and Capitol's other periodic filings, including its 2009 Annual Report on Form 10-K, 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.

Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.  All subsequent written or oral forward-looking statements attributable to Capitol or persons acting on its behalf are expressly qualified in their entirety by the foregoing factors.  Investors and other interested parties are cautioned not to place undue reliance on such statements, which speak as of the date of such statements.  Capitol undertakes no obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events.

 
Item 1.
 
Financial Statements (unaudited):
Page
 
Condensed consolidated balance sheets – September 30, 2010 and December 31, 2009.
7
 
Condensed consolidated statements of operations – Three months and nine months ended
September 30, 2010 and 2009.
8
 
Condensed consolidated statements of changes in equity – Nine months ended
September 30, 2010 and 2009.
9
 
Condensed consolidated statements of cash flows – Nine months ended September 30,
2010 and 2009.
10
 
Notes to condensed consolidated financial statements.
11
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
26
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
51
Item 4.
Controls and Procedures.
51
 
PART II.
 
OTHER INFORMATION
 
 
Item 1.
 
Legal Proceedings.
 
52
Item 1A.
Risk Factors.
52
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
52
Item 3.
Defaults Upon Senior Securities.
52
Item 4.
[Removed and Reserved.]
52
Item 5.
Other Information.
52
Item 6.
Exhibits.
54
 
SIGNATURES
 
 
55
 
EXHIBIT INDEX
 
 
56




[The remainder of this page intentionally left blank]

 
Page 6 of 56

 

 
PART I, ITEM 1
 
               
CAPITOL BANCORP LIMITED
 
Condensed Consolidated Balance Sheets
 
As of September 30, 2010 and December 31, 2009
 
(in $1,000s, except share and per-share data)
 
               
     
(Unaudited)
       
     
September 30,
   
December 31,
 
     
2010
   
2009
 
      (As Revised--Note P)        
ASSETS
             
Cash and due from banks
    $ 86,917     $ 69,190  
Money market and interest-bearing deposits
      725,141       657,846  
Federal funds sold
      1,455       4,863  
 
Cash and cash equivalents
    813,513       731,899  
Loans held for sale
      7,736       11,119  
Investment securities -- Note C:
                 
   Available for sale, carried at fair value
      27,253       39,776  
   Held for long-term investment, carried at
                 
     amortized cost which approximates fair value
    3,422       5,791  
 
Total investment securities
    30,675       45,567  
Federal Home Loan Bank and Federal Reserve
               
  Bank stock (carried on the basis of cost) -- Note C
    22,020       21,646  
Portfolio loans:
                 
   Loans secured by real estate:
                 
    Commercial
      1,699,958       1,812,387  
    Residential (including multi-family)
      648,507       679,847  
    Construction, land development and other land
    357,587       444,420  
 
Total loans secured by real estate
    2,706,052       2,936,654  
   Commercial and other business-purpose loans
    488,300       580,524  
   Consumer
      32,308       37,336  
   Other
      25,282       24,486  
 
Total portfolio loans
    3,251,942       3,579,000  
   Less allowance for loan losses
      (160,502 )     (136,184 )
 
Net portfolio loans
    3,091,440       3,442,816  
Premises and equipment
      42,281       44,779  
Accrued interest income
      11,582       13,893  
Goodwill
      66,105       66,126  
Other real estate owned
      108,424       111,102  
Recoverable income taxes
      1,825       43,763  
Other assets
      30,262       39,099  
Assets of discontinued operations -- Note D
      --       560,131  
                   
            TOTAL ASSETS
    $ 4,225,863     $ 5,131,940  
                   
LIABILITIES AND EQUITY
                 
LIABILITIES:
                 
Deposits:
                 
   Noninterest-bearing
    $ 648,416     $ 577,858  
   Interest-bearing
      3,148,132       3,364,521  
 
Total deposits
    3,796,548       3,942,379  
Debt obligations:
                 
   Notes payable and other borrowings
      144,282       243,747  
   Subordinated debentures -- Note H
    167,550       167,441  
 
Total debt obligations
    311,832       411,188  
Accrued interest on deposits and other liabilities
    51,524       43,162  
Liabilities of discontinued operations -- Note D
    --       501,605  
 
Total liabilities
    4,159,904       4,898,334  
                   
EQUITY:
                 
Capitol Bancorp Limited stockholders' equity -- Notes F and N:
               
  Preferred stock (Series A), 700,000 shares authorized
               
      ($100 per-share liquidation preference); 50,980 shares
               
      issued and outstanding in 2010 (none in 2009) -- Note I
    5,098       --  
  Preferred stock (for potential future issuance),
               
    19,300,000 shares authorized (none issued and outstanding)
    --       --  
  Common stock, no par value, 50,000,000 shares authorized;
               
     issued and outstanding:    2010 - 21,623,056 shares                
                                                    2009 - 17,545,631 shares     288,031       277,707  
  Retained-earnings deficit
      (256,802 )     (115,751 )
  Undistributed common stock held by employee-benefit trust
    (558 )     (558 )
  Fair value adjustment (net of tax effect) for investment securities
               
     available for sale (accumulated other comprehensive income)
    198       (63 )
Total Capitol Bancorp Limited stockholders' equity
    35,967       161,335  
Noncontrolling interests in consolidated subsidiaries
    29,992       72,271  
 
Total equity
    65,959       233,606  
                   
            TOTAL LIABILITIES AND EQUITY
  $ 4,225,863     $ 5,131,940  
                   

 
Page 7 of 56

 

CAPITOL BANCORP LIMITED
 
Condensed Consolidated Statements of Operations (Unaudited)
 
For the Three and Nine Months Ended September 30, 2010 and 2009
 
(in $1,000s, except per share data)
 
   
 
   
 
 
    Three Month Period    
Nine Month Period
 
   
2010
   
2009
   
2010
   
2009
 
   
(As Revised--Note P)
         
(As Revised--Note P)
       
Interest income:
                       
  Portfolio loans (including fees)
  $ 47,527     $ 55,640     $ 144,781     $ 170,792  
  Loans held for sale
    72       136       194       515  
  Taxable investment securities
    126       89       437       262  
  Federal funds sold
    2       16       10       53  
  Other
    682       439       1,856       1,144  
Total interest income
    48,409       56,320       147,278       172,766  
Interest expense:
                               
  Deposits
    13,027       18,585       41,648       60,640  
  Debt obligations and other
    4,098       5,756       12,931       17,317  
Total interest expense
    17,125       24,341       54,579       77,957  
                                Net interest income
    31,284       31,979       92,699       94,809  
Provision for loan losses
    45,885       44,482       138,643       109,402  
Net interest income deficiency after
                         
                                  provision for loan losses
    (14,601 )     (12,503 )     (45,944 )     (14,593 )
Noninterest income:
                               
  Service charges on deposit accounts
    1,071       1,339       3,225       3,922  
  Trust and wealth-management revenue
    960       1,288       3,282       3,811  
  Fees from origination of non-portfolio residential
                               
     mortgage loans
    617       624       1,427       2,402  
  Gain on sale of government-guaranteed loans
    901       643       1,508       919  
  Realized gain (loss) on sale of investment securities
                               
     available for sale
    (4 )     41       10       42  
  Gain on debt extinguishment
                    1,255          
  Other
    3,353       939       7,951       3,959  
Total noninterest income
    6,898       4,874       18,658       15,055  
Noninterest expense:
                               
  Salaries and employee benefits
    18,989       20,705       57,871       68,343  
  Occupancy
    4,103       4,187       12,592       12,613  
  Equipment rent, depreciation and maintenance
    2,369       2,765       7,987       8,806  
  Costs associated with foreclosed properties and other
                               
     real estate owned
    14,645       9,577       35,386       17,916  
  FDIC insurance premiums and other regulatory fees
    3,733       3,455       12,136       9,964  
  Other
    7,918       8,068       23,177       19,570  
Total noninterest expense
    51,757       48,757       149,149       137,212  
Loss before income taxes
    (59,460 )     (56,386 )     (176,435 )     (136,750 )
Income taxes (benefit)
    56       66,436       (4,258 )     37,268  
Loss from continuing operations
    (59,516 )     (122,822 )     (172,177 )     (174,018 )
Discontinued operations -- Note D:
                               
  Income (loss) from operations of bank subsidiaries sold
    268       (206 )     854       467  
  Gain on sale of bank subsidiaries
    3,296       1,187       13,379       1,187  
  Less income tax expense
    1,292       6,274       5,159       6,618  
Income (loss) from discontinued operations
    2,272       (5,293 )     9,074       (4,964 )
NET LOSS
    (57,244 )     (128,115 )     (163,103 )     (178,982 )
Net losses attributable to noncontrolling interests in
                               
  consolidated subsidiaries
    5,078       45,426       22,052       59,315  
                                 
      NET LOSS ATTRIBUTABLE TO CAPITOL
                               
      BANCORP LIMITED
  $ (52,166 )   $ (82,689 )   $ (141,051 )   $ (119,667 )
                                 
      NET LOSS PER COMMON SHARE ATTRIBUTABLE
                               
      TO CAPITOL BANCORP LIMITED -- Note G
  $ (2.45 )   $ (4.75 )   $ (7.12 )   $ (6.93 )
                                 
See notes to condensed consolidated financial statements.
                               
                                 
 
 
 
 
Page 8 of 56

 
 

 
Page 9 of 56

 

CAPITOL BANCORP LTD.
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2010 and 2009
(in $1,000s)
             
   
2010
   
2009
 
   
(As Revised--Note P)
       
             
OPERATING ACTIVITIES
           
  Net loss
  $ (163,103 )   $ (178,982 )
  Adjustments to reconcile net loss to net cash provided
               
    by operating activities (including discontinued operations):
               
      Provision for loan losses
    140,984       114,909  
      Depreciation of premises and equipment
    6,305       7,841  
      Amortization of intangibles
    169       2,486  
      Net amortization (accretion) of investment security premiums (discounts)
    281       (38 )
      Loss on sale of premises and equipment
    258       107  
      Gain on sale of government-guaranteed loans
    (1,869 )     (1,887 )
      Gain on sale of bank subsidiaries
    (13,379 )     (1,187 )
      Gain on debt extinguishment
    (1,255 )     --  
      Realized gain on sale of investment securities available for sale
    (10 )     (42 )
      Loss on sale of other real estate owned
    1,744       1,007  
      Write-down of other real estate owned
    25,804       13,002  
      Amortization of issuance costs of subordinated debentures
    109       109  
      Share-based compensation expense
    435       719  
      Deferred income tax credit
    (47,933 )     (48,907 )
      Valuation allowance for deferred income tax assets
    49,393       55,992  
  Originations and purchases of loans held for sale
    (89,100 )     (261,950 )
  Proceeds from sales of loans held for sale
    91,994       257,552  
  Decrease in accrued interest income and other assets
    62,201       59,940  
  Increase in accrued interest expense on deposits and other liabilities
    9,086       2,751  
                 
                NET CASH PROVIDED BY OPERATING ACTIVITIES
    72,114       23,422  
                 
INVESTING ACTIVITIES
               
  Cash equivalents of acquired bank affiliate
    18,949       --  
  Proceeds from sales of investment securities available for sale
    22,075       916  
  Proceeds from calls, prepayments and maturities of investment
               
     securities
    14,935       14,529  
  Purchases of investment securities
    (22,298 )     (32,111 )
  Purchase of Federal Home Loan Bank stock
    (1,411 )     (1,672 )
  Redemption of Federal Home Loan Bank stock by issuer
    1,169       637  
  Net decrease in portfolio loans
    130,227       105,141  
  Proceeds from sales of government-guaranteed loans
    15,192       25,500  
  Proceeds from sales of premises and equipment
    3,742       1,974  
  Purchases of premises and equipment
    (7,420 )     (3,655 )
  Proceeds from sales of bank subsidiaries
    33,084       9,506  
  Proceeds from sales of other real estate owned
    35,590       11,182  
                 
                NET CASH PROVIDED BY INVESTING ACTIVITIES
    243,834       131,947  
                 
FINANCING ACTIVITIES
               
  Net increase in demand deposits, NOW accounts and savings accounts
    76,222       295,852  
  Net decrease in certificates of deposit
    (187,619 )     (27,992 )
  Net borrowings from (payments on) debt obligations
    (1,548 )     953  
  Proceeds from Federal Home Loan Bank borrowings
    541,480       2,768,830  
  Payments on Federal Home Loan Bank borrowings
    (649,067 )     (2,876,522 )
  Resources provided by noncontrolling interests
    --       134  
  Net proceeds from issuance of common stock
    6,870       --  
  Tax effect of share-based payments
    (293 )     (169 )
  Cash dividends paid
    --       (864 )
                 
                NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES
    (213,955 )     160,222  
                 
                INCREASE IN CASH AND CASH EQUIVALENTS
    101,993       315,591  
                 
Change in cash and cash equivalents of discontinued operations
    (20,379 )     (10,913 )
                 
Cash and cash equivalents at beginning of period
    731,899       519,436  
                 
                CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 813,513     $ 824,114  
                 
Supplemental disclosures:
               
  Cash paid during the period for interest on deposits and debt obligations
  $ 58,451     $ 88,356  
  Transfers of loans to other real estate owned
    60,239       80,991  
  Surrender of common stock to facilitate exercise of stock options
               
     and vesting of restricted stock
    13       23  
                 
See notes to condensed consolidated financial statements.
               

 
Page 10 of 56

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED

Note A – Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Capitol Bancorp Limited (Capitol or the Corporation) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q.  Accordingly, they do not include all information and footnotes necessary for a fair presentation of consolidated financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America.

The condensed consolidated financial statements do, however, include all adjustments of a normal recurring nature (in accordance with Rule 10-01(b)(8) of Regulation S-X) which Capitol considers necessary for a fair presentation of the interim periods.

The results of operations for the periods ended September 30, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010.

The consolidated balance sheet as of December 31, 2009 was derived from audited consolidated financial statements as of that date.  Certain 2009 amounts have been reclassified to conform to the 2010 presentation.

Note B – Accounting Standards Updates

In December 2007, a new accounting standard was issued to create accounting and reporting requirements for noncontrolling interests in a subsidiary (when it is not wholly-owned) and for the deconsolidation of a subsidiary and became effective January 1, 2009.  In January 2010, an accounting standards update was issued clarifying the types of transactions that should be accounted for as a decrease in ownership of a subsidiary, which became effective for the Corporation on January 1, 2010 (with retrospective application to January 1, 2009) and did not materially affect the Corporation's financial position or results of operations upon implementation.

A new standard became effective January 1, 2009 clarifying the accounting for transfers of financial assets and repurchase financing transactions.  Subsequently, further guidance revised requirements for the presentation and disclosure of transfers of financial assets and the effects of a transfer on an entity's financial position, financial performance and cash flows along with placing limitations on portions of financial assets that are eligible for accounting recognition as a sale.  The guidance applies to transfers of financial assets occurring on or after January 1, 2010 and did not materially affect the Corporation's financial position or results of operations upon implementation.

In December 2009, an accounting standards update was issued to improve financial reporting by entities involved with variable interest entities.  This update replaces the quantitative-based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which reporting entity has the power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity, and it requires additional disclosures about a reporting entity's involvement in variable interest entities.  The guidance became effective for the Corporation on January 1, 2010 and did not have a material effect on the Corporation's condensed consolidated financial statements upon implementation.

In January 2010, an accounting standards update regarding fair value measurements and disclosures was issued to require more robust disclosures about (1) different classes of assets and liabilities measured at fair value, (2) valuation techniques and inputs used, (3) the activity in Level 3 fair-value measurements, and (4) the transfers between Levels 1, 2, and 3 of fair-value estimates.  The new disclosures became effective for the Corporation beginning January 1, 2010, except for the disclosures about purchases, sales, issuances and settlements in the rollforward of activity in Level 3 fair-value measurements which become effective beginning January 1, 2011.  The required interim disclosures for 2010 are set forth in Note E.  Management does not expect this new guidance to have a material effect on the Corporation's condensed consolidated financial statements upon implementation in 2011 of the deferred disclosure requirements.


 
Page 11 of 56

 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note B – Accounting Standards Updates – Continued

In April 2010, an accounting standards update was issued clarifying that modifications of loans accounted for within a pool that have evidence of credit deterioration upon acquisition, do not result in the removal of those loans from the pool even if the modification would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. Loans not accounted for within pools continue to be subject to the troubled debt restructuring accounting provisions.  This new guidance is effective for modifications of loans accounted for within pools occurring after July 1, 2010 and did not have a material effect on the Corporation's condensed consolidated financial statements upon implementation.

In July 2010, an accounting standards update was issued which will require significant new disclosures on a disaggregated basis about the allowance for loan losses and the credit quality of loans.  Under this standards update, a rollforward of the allowance for loan losses with the ending balance further disaggregated on the basis of the impairment methods used to establish loss estimates, along with the related ending loan balances and significant purchases and sales of loans during the period are to be disclosed by portfolio segment or classification used for reporting purposes.  Additional disclosures will be required by type of loan, including credit quality, aging of past-due loans, nonaccrual status and impairment information.  Disclosure of the nature and extent of troubled debt restructurings that occur during the period and their effect on the allowance for loan losses, as well as the effect on the allowance regarding troubled debt restructurings that occur within the prior 12 months that defaulted during the current reporting period, will also be required.  The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the loan portfolio's risk and performance.  The majority of the disclosures, which are required as of the end of a reporting period, are effective for interim and annual periods ending after December 15, 2010 and will be first included in the Corporation's annual financial statements for the year ending December 31, 2010.  The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning after December 15, 2010 and will be first disclosed in the Corporation's financial statements for the interim period ending March 31, 2011.  Management does not expect this new guidance will have an effect on the Corporation's annual and interim consolidated financial statements upon implementation except for expanded disclosures therein.








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Page 12 of 56

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note C – Investment Securities

Investments in Federal Home Loan Bank and Federal Reserve Bank stock are combined and classified separately from investment securities in the condensed consolidated balance sheet, are restricted and may only be resold to, or redeemed by, the issuer.

Investment securities consisted of the following (in $1,000s):

   
September 30, 2010
   
December 31, 2009(1)
 
   
Amortized
Cost
   
Estimated
Fair
Value
   
Amortized
Cost
   
Estimated
Fair
Value
 
Available for sale:
                       
United States treasury
  $ 504     $ 508     $ 1,500     $ 1,500  
United States government agency
    21,381       21,448       12,956       12,939  
Mortgage-backed
    4,656       4,876       24,690       24,598  
Municipalities
    411       421       727       739  
      26,952       27,253       39,873       39,776  
Held for long-term investment:
                               
Capitol Development Bancorp
Limited III
     484        484        672        672  
Corporate
    2,789       2,789       5,119       5,119  
Other
    149       149                  
      3,422       3,422       5,791       5,791  
                                 
    $ 30,374     $ 30,675     $ 45,664     $ 45,567  

(1)  
Excludes investment securities related to discontinued operations with an amortized cost and estimated fair value of approximately $1 million.

Securities held for long-term investment are not subject to the classification and accounting rules relating to most typical investments.  In addition, Capitol's corporate investments consist mostly of equity-method investments in non-public enterprises which, accordingly, are outside of the scope of accounting rules for most typical investments which often require use of estimated fair value.  Those entities, which are primarily involved in making equity investments in or financing small businesses, use the fair value method of accounting in valuing their investment portfolios.  Notwithstanding that those investments are outside the scope of such accounting rules, they are included in Capitol's investment securities for financial reporting purposes to summarize all such investment securities together for reporting purposes.

Gross unrealized gains and losses on investment securities available for sale were as follows (in $1,000s):

   
September 30, 2010
   
December 31, 2009(1)
 
   
Gains
   
Losses
   
Gains
   
Losses
 
                         
United States treasury
  $ 4     $ --              
United States government agency
    67             $ 5     $ 22  
Mortgage-backed
    219               122       214  
Municipalities
    11               12       --  
                                 
    $ 301     $ --     $ 139     $ 236  

(1)  
Excludes gross unrealized gains of $2,000 related to operations discontinued in 2010.


 
Page 13 of 56

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note C – Investment Securities – Continued

Gross unrealized losses and carrying value (at estimated fair value) of securities available for sale at December 31, 2009 (none at September 30, 2010), all of which relate to securities with maturities of one year or less, are summarized below (in $1,000s):

   
Unrealized
Loss
   
Carrying
Value
 
             
United States government agency
  $ 22     $ 8,979  
Mortgage-backed
    214       19,879  
                 
    $ 236     $ 28,858  

Gross realized gains and losses from sales and maturities of investment securities were insignificant for the periods presented.

Scheduled maturities of investment securities held as of September 30, 2010 were as follows (in $1,000s):

   
Amortized
Cost
   
Estimated
Fair Value
 
             
Due in one year or less
  $ 5,136     $ 5,138  
After one year, through five years
    16,548       16,615  
After five years, through ten years
    784       819  
After ten years
    4,484       4,681  
Securities held for long-term
               
investment without stated
               
maturities
    3,422       3,422  
                 
    $ 30,374     $ 30,675  

Note D – Discontinued Operations

Through September 30, 2010, Capitol completed the following sales of bank subsidiaries (in $1,000s):

     
Sale
       
 
Date Sold
 
Proceeds
   
Gain (Loss)
 
Bank of Belleville(1)
April 27, 2010
  $ 4,990     $ 1,233  
Napa Community Bank(1)(3)
April 30, 2010
    21,574       7,372  
Ohio Commerce Bank(2)
June 30, 2010
    6,520       1,478  
Community Bank of Lincoln(2)
July 30, 2010
    3,750       1,268  
USNY Bank(2)
August 20, 2010
    2,700       (271 )
Adams Dairy Bank(2)
August 30, 2010
    4,335       559  
Bank of San Francisco(1)
September 27, 2010
    6,604       1,740  
                   
      $ 50,473     $ 13,379  

 
(1)
Previously a majority-owned subsidiary of Capitol.
 
(2)
Previously a majority-owned subsidiary of a bank-development subsidiary controlled by Capitol.
 
(3)
Under the terms of the sale transaction, Capitol could receive additional proceeds of up to $5.3 million in the future, subject to Napa Community Bank's future financial performance.

 
Page 14 of 56

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note D – Discontinued Operations – Continued

Capitol's consolidated results of operations would not have been materially different if the sales of these banks had occurred at the beginning of the periods presented; however, such sales are reflected on that basis in the pro forma condensed consolidated financial statements on page 49 of this document.

The results of operations of Adams Dairy Bank, Bank of Belleville, Bank of San Francisco, Community Bank of Lincoln, Napa Community Bank, Ohio Commerce Bank and USNY Bank, together with the results of operations of Bank of Santa Barbara and Yuma Community Bank which were sold in 2009, and Community Bank of Rowan and Summit Bank of Kansas City which were deconsolidated on September 30, 2009, are classified as discontinued operations for the periods presented and include the following components (in $1,000s):

   
Three Months Ended
September 30
   
Nine Months Ended
September 30
 
   
2010
   
2009
   
2010
   
2009
 
                         
Interest income
  $ 2,577     $ 11,025     $ 14,629     $ 32,767  
Interest expense
    479       2,952       3,119       9,485  
Net interest income
    2,098       8,073       11,510       23,282  
Provision for loan losses
    235       2,853       2,341       5,507  
Net interest income after provision
                               
for loan losses
    1,863       5,220       9,169       17,775  
Noninterest income
    148       1,101       1,319       2,871  
Gain on sale of bank subsidiaries
    3,296       1,187       13,379       1,187  
Noninterest expense
    1,743       6,527       9,634       20,179  
Income before income taxes
    3,564       981       14,233       1,654  
Less income tax expense
    1,292       6,274       5,159       6,618  
Net income (loss) from discontinued
                               
operations
    2,272       (5,293 )     9,074       (4,964 )
Net loss (income) attributable to
                               
noncontrolling interests in
                               
consolidated subsidiaries
    (53 )     5,304       (183 )     6,081  
Net income from discontinued
                               
operations attributable to Capitol
                               
Bancorp Limited
  $ 2,219     $ 11     $ 8,891     $ 1,117  
Net income from discontinued
                               
operations per common share
                               
attributable to Capitol Bancorp
                               
Limited
  $ 0.10     $ --     $ 0.45     $ 0.06  

Assets and liabilities of discontinued operations as of December 31, 2009 are summarized below (in $1,000s):

Assets:
     
Liabilities:
     
Cash and cash equivalents
  $ 77,023  
Noninterest-bearing
     
Loans held for sale
    5,014  
deposits
  $ 101,242  
Portfolio loans
    468,101  
Interest-bearing deposits
    367,012  
Less allowance for loan losses
    (8,480 )
Total deposits
    468,254  
Net portfolio loans
    459,621  
Debt obligations
    32,411  
Premises and equipment
    3,607  
Other liabilities
    940  
Other assets
    14,866            
              $ 501,605  
    $ 560,131            


 
Page 15 of 56

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note E – Fair Value

The following is a description of Capitol's valuation methodologies used to measure and disclose the fair values of its assets and liabilities on a recurring or nonrecurring basis:

 
Investment securities available for sale:  Securities available for sale are recorded at fair value on a recurring basis.  Fair value measurement is based on quoted prices, when available (Level 1).  If quoted prices are not available, fair values are measured using independent pricing models (Level 2).

 
Mortgage loans held for sale:  Mortgage loans held for sale are carried at the lower of cost or fair value and are measured on a nonrecurring basis.  There were no mortgage loans held for sale written down to fair value at September 30, 2010.  Fair value is based on independent quoted market prices, where applicable, or the prices for other whole mortgage loans with similar characteristics.

 
Loans:  The Corporation does not record loans at fair value on a recurring basis.  However, from time to time, nonrecurring fair value adjustments for collateral-dependent loans are recorded to reflect partial write-downs based on the observable market price, current appraised value of the collateral or other estimates of fair value.

 
Other real estate owned:  At the time of foreclosure, foreclosed properties are adjusted to estimated fair value less estimated costs to sell upon transfer from portfolio loans to other real estate owned, establishing a new accounting basis.  The Corporation subsequently adjusts estimated fair value of other real estate owned on a nonrecurring basis to reflect partial write-downs based on the observable market price or current appraisal data.

Long-lived and indefinite lived assets:  The Corporation does not record long-lived or indefinite-lived assets at fair value on a recurring basis.  However, from time to time, nonrecurring fair value adjustments to a long-lived or indefinite-lived asset are recorded to reflect partial write-downs based on the observable market price or other estimate of fair value.

Assets and liabilities measured at fair value on a recurring basis as of September 30, 2010 were as follows (in $1,000s):

   
 
Total
   
Significant Other
Observable Inputs
(Level 2)
 
             
Investment securities available for sale:
           
United States treasury
  $ 508     $ 508  
United States government agency
    21,448       21,448  
Mortgage-backed
    4,876       4,876  
Municipalities
     421        421  
                 
    $ 27,253     $ 27,253  




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Page 16 of 56

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note E – Fair Value – Continued

Assets and liabilities measured at fair value on a recurring basis as of December 31, 2009 were as follows (in $1,000s):

   
 
Total(1)
   
Significant Other
Observable Inputs
(Level 2)(1)
 
             
Investment securities available for sale:
           
United States treasury
  $ 1,500     $ 1,500  
United States government agency
    12,939       12,939  
Mortgage-backed
    24,598       24,598  
Municipalities
     739        739  
                 
    $ 39,776     $ 39,776  

 
(1)
Excludes investment securities related to discontinued operations approximating $1 million.

Assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2010 were as follows (in $1,000s):

   
 
 
Total
   
Significant
Unobservable
Inputs
(Level 3)
 
             
Impaired loans(1)
  $ 341,317     $ 341,317  
                 
Other real estate owned(1)
  $ 108,424     $ 108,424  

(1)  
Represents carrying value based on the appraised value of the applicable collateral or foreclosed property or
other estimates of fair value.  For other real estate owned, such fair value is reduced by estimated costs to sell
the properties.

Assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2009 were as follows (in $1,000s):

   
 
 
Total(2)
   
Significant
Unobservable
Inputs
(Level 3)(2)
 
             
Impaired loans(1)
  $ 136,506     $ 136,506  
                 
Other real estate owned(1)
  $ 111,102     $ 111,102  

(1)  
Represents carrying value based on the appraised value of the applicable collateral or foreclosed property or
other estimates of fair value.  For other real estate owned, such fair value is reduced by estimated costs to sell
the properties.
(2)  
Excludes impaired loans approximating $2,476,000 and other real estate owned approximating $718,000 related to
discontinued operations.



 
Page 17 of 56

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note E – Fair Value – Continued

Updated appraisals are generally obtained when it has been determined that a collateral-dependent loan has become impaired or when it is likely a real-estate loan will be foreclosed.  Adjustments to a loan's carrying value (or requirements for the allowance for loan losses) are made, when appropriate, after review of the appraisal data or subsequently if market conditions significantly decline further.  The timing of the recognition of a collateral-dependent loan as a nonperforming credit is dependent on several factors, including the performance of the loan, payment history and/or the receipt of updated borrower financial information.  Updated appraisals are also obtained from time to time for loans secured by real estate which are not deemed impaired or classified as nonperforming.

When borrower performance has deteriorated (for example, sales or leasing has not occurred as expected, the borrower has become delinquent on required payments or the borrower's updated financial information received indicates adverse financial trends), the loan will be downgraded and, if appropriate, an updated appraisal will be ordered.  In the period between a loan being recognized as impaired and receipt of an updated appraisal, the loan will be included within loss contingency pools.  Upon receipt and review of updated appraisal data and after any further fair value analysis is completed, the loan will be further evaluated for appropriate charge-down.  Generally, negative differences between appraised value, less the estimated cost to sell, and the related carrying value of the loan are charged to the allowance for loan losses when the appraisal has been received and reviewed.  Occasionally, additional amounts may be included in the estimate of requirements for the allowance for loan losses if there are pending circumstances which may adversely impact the fair value estimates.  Internally-developed evaluations may be used when the amount of the loan is less than $250,000.  Internal evaluations may also be used when the most recent appraisal date is within a year and economic conditions have had corrections or deterioration.  Updated fair value information is generally obtained at least annually for collateral-dependent loans and other real estate owned.





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Page 18 of 56

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note E – Fair Value – Continued

Comparative carrying values and estimated fair values of financial instruments based upon the accounting guidance set forth in ASC 825-10 (formerly FAS 107) were as follows (in $1,000s):

    September 30, 2010 (As Revised)      December 31, 2009   
   
Carrying
Value
   
Estimated
Fair Value
   
Carrying
Value
   
Estimated
Fair Value
 
Financial assets:
                       
Cash and cash equivalents
  $ 813,513     $ 813,513     $ 731,899     $ 731,899  
Loans held for sale
    7,736       7,736       11,119       11,119  
Investment securities:
                               
Available for sale
    27,253       27,253       39,776       39,776  
Held for long-term investment
    3,422       3,422       5,791       5,791  
      30,675       30,675       45,567       45,567  
Federal Home Loan Bank and Federal Reserve
Bank stock
    22,020       22,020       21,646       21,646  
Portfolio loans:
                               
Loans secured by real estate:
                               
Commercial
    1,699,958       1,630,108       1,812,387       1,732,535  
Residential (including multi-family)
    648,507       618,514       679,847       644,894  
Construction, land development and other
land
     357,587        320,827        444,420        371,339  
Total loans secured by real estate
    2,706,052       2,569,449       2,936,654       2,748,768  
Commercial and other business-purpose loans
    488,300       475,090       580,524       564,028  
Consumer
    32,308       32,399       37,336       37,692  
Other
    25,282       23,821       24,486       22,770  
Total portfolio loans
    3,251,942       3,100,759       3,579,000       3,373,258  
Less allowance for loan losses
    (160,502 )     (160,502 )     (136,184 )     (136,184 )
Net portfolio loans
    3,091,440       2,940,257       3,442,816       3,237,074  
                                 
Financial liabilities: