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Capitol Bancorp 10-Q 2011
form10q.htm


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

FORM 10-Q

T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
 
SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2011
 
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   T
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, 2011
Common Stock, No par value
 
41,045,267 shares
 
 
Page 1 of 61

 
 
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:

·  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;

·  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 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;

 
 
Page 2 of 61

 
 
INDEX – Continued

PART I.                      FINANCIAL INFORMATION – Continued

Forward-Looking Statements – Continued

·  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 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 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 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;

·  The continued availability of credit facilities provided by Federal Home Loan Banks to Capitol's banking subsidiaries;
 
 
Page 3 of 61

 
 
INDEX – Continued

PART I.                      FINANCIAL INFORMATION – Continued

Forward-Looking Statements – Continued

·  The uncertainties of future depositor activity regarding potentially uninsured deposits;

·  The possibility of the Federal Deposit Insurance Corporation (FDIC) assessing Capitol's banking subsidiaries for any cross-guaranty liability;

·  Governmental monetary and fiscal policies, as well as legislative and regulatory changes or mandates, 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, increases in allowance for loan loss reserves and operational limitations;

·  Changes in general economic or industry conditions, nationally or in the communities in which Capitol conducts business, including without limitation, concerns regarding the recent downgrade of the United States' credit rating and the sovereign debt crisis in Europe which could have a material adverse effect on Capitol's business, financial condition and liquidity;

·  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 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 costs, effects and impacts of litigation, investigations, inquiries or similar matters, or adverse facts and developments related thereto, including without limitation, the current investigation by the SEC and the results of regulatory examinations and reviews;

·  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.
 
 
Page 4 of 61

 
 
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 2010 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, 2011 and December 31, 2010.
6
 
Condensed consolidated statements of operations – Three months and nine months
ended September 30, 2011 and 2010.
 
7
 
Condensed consolidated statements of changes in equity – Nine months ended
September 30, 2011 and 2010.
 
8
 
Condensed consolidated statements of cash flows – Nine months ended September 30,
2011 and 2010.
 
9
 
Notes to condensed consolidated financial statements.
10
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
35
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
55
Item 4.
Controls and Procedures.
55
 
PART II.
 
OTHER INFORMATION
 
 
Item 1.
 
Legal Proceedings.
 
56
Item 1A.
Risk Factors.
57
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
58
Item 3.
Defaults Upon Senior Securities.
58
Item 4.
[Removed and Reserved.]
58
Item 5.
Other Information.
59
Item 6.
Exhibits.
59
 
SIGNATURES
 
 
60
 
EXHIBIT INDEX
 
 
61




[The remainder of this page intentionally left blank]
 
 
 

 
Page 5 of 61

 

PART I, ITEM 1
 
                 
CAPITOL BANCORP LIMITED
 
Condensed Consolidated Balance Sheets
 
As of September 30, 2011 and December 31, 2010
 
(in $1,000s, except share and per-share data)
 
                 
   
(Unaudited)
         
   
September 30,
     
December 31,
 
   
2011
     
2010
 
ASSETS
               
Cash and due from banks
    $ 52,222       $ 44,135  
Money market and interest-bearing deposits
      371,647         395,655  
Federal funds sold
      --         50  
Cash and cash equivalents     423,869         439,840  
Loans held for sale
      1,745         5,587  
Investment securities -- Note C:
                   
   Available for sale, carried at fair value
      24,690         15,489  
   Held for long-term investment, carried at
                   
     amortized cost which approximates fair value
    2,012         2,893  
Total investment securities     26,702         18,382  
Federal Home Loan Bank and Federal Reserve
                 
  Bank stock (carried on the basis of cost) -- Note C
    14,266         15,494  
Portfolio loans -- Note D:
                   
   Loans secured by real estate:
                   
    Commercial
      1,046,009         1,189,110  
    Residential (including multi-family)
      380,893         441,629  
    Construction, land development and other land
    142,256         184,823  
Total loans secured by real estate     1,569,158         1,815,562  
   Commercial and other business-purpose loans
    211,191         285,916  
   Consumer
      14,796         18,559  
   Other
      2,855         5,226  
Total portfolio loans     1,798,000         2,125,263  
   Less allowance for loan losses
      (102,917 )       (130,851 )
Net portfolio loans     1,695,083         1,994,412  
Premises and equipment
      28,856         32,158  
Accrued interest income
      5,638         6,880  
Other real estate owned
      104,169         101,497  
Other assets
      16,442         13,853  
Assets of discontinued operations -- Note E
      152,187         912,111  
                     
            TOTAL ASSETS
    $ 2,468,957       $ 3,540,214  
                     
LIABILITIES AND EQUITY
                   
LIABILITIES:
                   
Deposits:
                   
   Noninterest-bearing
    $ 370,715       $ 375,076  
   Interest-bearing
      1,782,876         2,042,956  
Total deposits     2,153,591         2,418,032  
Debt obligations:
                   
   Notes payable and other borrowings
      71,909         111,699  
   Subordinated debentures -- Note I
      149,131         167,586  
Total debt obligations     221,040         279,285  
Accrued interest on deposits and other liabilities
    52,497         49,737  
Liabilities of discontinued operations -- Note E
    135,338         831,841  
Total liabilities     2,562,466         3,578,895  
                     
EQUITY:
                   
Capitol Bancorp Limited stockholders' equity -- Notes G and L:
                 
  Preferred stock (Series A), 700,000 shares authorized
                 
      ($100 per-share liquidation preference); 50,980 shares
                 
      issued and outstanding
      5,098         5,098  
  Preferred stock (for potential future issuance),
                 
    19,300,000 shares authorized (none issued and outstanding)
    --         --  
  Common stock, no par value, 1,500,000,000 shares authorized;
                 
     issued and outstanding:  2011 - 41,045,267 shares                  
                                                  2010 - 21,614,856 shares     292,175         287,190  
  Retained-earnings deficit
      (392,644 )       (353,757 )
  Undistributed common stock held by employee-benefit trust
    (541 )       (541 )
  Fair value adjustment (net of tax effect) for investment securities
                 
     available for sale (accumulated other comprehensive income)
    81         156  
Total Capitol Bancorp Limited stockholders' equity deficit
    (95,831 )       (61,854 )
Noncontrolling interests in consolidated subsidiaries
    2,322         23,173  
Total equity deficit     (93,509 )       (38,681 )
                     
            TOTAL LIABILITIES AND EQUITY
  $ 2,468,957       $ 3,540,214  
                     
See notes to condensed consolidated financial statements.
                 

 
Page 6 of 61

 

CAPITOL BANCORP LIMITED
Condensed Consolidated Statements of Operations (Unaudited)
For the Three and Nine Months Ended September 30, 2011 and 2010
(in $1,000s, except per share data)
                         
 
Three Month Period
   
Nine Month Period
 
 
2011
   
2010
   
2011
   
2010
 
Interest income:
                       
  Portfolio loans (including fees)
  $ 25,551     $ 31,770     $ 80,878     $ 99,613  
  Loans held for sale
    16       56       51       153  
  Taxable investment securities
    80       53       172       302  
  Federal funds sold
    2       1       6       8  
  Other
    354       502       1,072       1,380  
Total interest income
    26,003       32,382       82,179       101,456  
Interest expense:
                               
  Deposits
    5,886       10,092       19,568       33,224  
  Debt obligations and other
    3,084       3,919       9,265       12,310  
Total interest expense
    8,970       14,011       28,833       45,534  
Net interest income
    17,033       18,371       53,346       55,922  
Provision for loan losses -- Note D
    17,482       42,297       37,188       129,237  
Net interest income (deficiency) after
                 
provision for loan losses
    (449 )     (23,926 )     16,158       (73,315 )
Noninterest income:
                               
  Service charges on deposit accounts
    845       839       2,448       2,571  
  Trust and wealth-management revenue
    784       960       2,545       3,282  
  Fees from origination of non-portfolio residential
                               
     mortgage loans
    285       480       703       1,151  
  Gain on sale of government-guaranteed loans
    381       409       1,424       616  
  Gain on debt extinguishment -- Note I
    --       --       16,861       1,255  
  Realized gain (loss) on sale of investment securities
                               
     available for sale
    --       (4 )     --       10  
  Other
    2,646       3,088       7,434       7,015  
Total noninterest income
    4,941       5,772       31,415       15,900  
Noninterest expense:
                               
  Salaries and employee benefits
    12,433       14,799       38,791       45,704  
  Occupancy
    1,738       2,981       7,583       9,262  
  Equipment rent, depreciation and maintenance
    1,886       1,941       5,890       6,703  
  Costs associated with foreclosed properties and other
                               
     real estate owned
    6,986       14,177       23,774       34,266  
  FDIC insurance premiums and other regulatory fees
    2,124       3,073       7,569       10,316  
  Other
    5,357       6,558       16,829       20,388  
Total noninterest expense
    30,524       43,529       100,436       126,639  
Loss before income tax benefit
    (26,032 )     (61,683 )     (52,863 )     (184,054 )
Income tax benefit
    (691 )     (316 )     (3,197 )     (6,232 )
Loss from continuing operations
    (25,341 )     (61,367 )     (49,666 )     (177,822 )
Discontinued operations -- Note E:
                               
  Income from operations of bank subsidiaries sold
    635       2,491       1,786       8,473  
  Gain (loss) on sale of bank subsidiaries
    (56 )     3,296       4,496       13,379  
  Less income tax expense
    6       1,664       1,664       7,133  
Income from discontinued operations
    573       4,123       4,618       14,719  
NET LOSS
    (24,768 )     (57,244 )     (45,048 )     (163,103 )
Net losses attributable to noncontrolling interests in
                               
  consolidated subsidiaries
    2,006       5,078       6,137       22,052  
                                 
      NET LOSS ATTRIBUTABLE TO CAPITOL
                               
      BANCORP LIMITED
  $ (22,762 )   $ (52,166 )   $ (38,911 )   $ (141,051 )
                                 
      NET LOSS PER COMMON SHARE ATTRIBUTABLE
                               
      TO CAPITOL BANCORP LIMITED -- Note H
  $ (0.55 )   $ (2.45 )   $ (1.02 )   $ (7.12 )
                                 
See notes to condensed consolidated financial statements.
                               

 
Page 7 of 61

 

 

 
Page 8 of 61

 

CAPITOL BANCORP LTD.
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2011 and 2010
(in $1,000s)
             
   
2011
   
2010
 
             
OPERATING ACTIVITIES
           
  Net loss
  $ (45,048 )   $ (163,103 )
  Adjustments to reconcile net loss to net cash provided
               
    by operating activities (including discontinued operations):
               
      Provision for loan losses
    39,616       140,984  
      Depreciation of premises and equipment
    4,347       6,305  
      Amortization of intangibles
    --       169  
      Net amortization of investment security premiums
    14       281  
      Loss on sale of premises and equipment
    25       258  
      Gain on sale of government-guaranteed loans
    (2,264 )     (1,869 )
      Gain on sale of bank subsidiaries
    (4,496 )     (13,379 )
      Gain on extinguishment of debt
    (16,861 )     (1,255 )
      Realized gain on sale of investment securities available for sale
    --       (10 )
      Loss (gain) on sale of other real estate owned
    (76 )     1,744  
      Write-down of other real estate owned
    15,694       25,804  
      Amortization of issuance costs of subordinated debentures
    76       109  
      Share-based compensation expense
    171       435  
      Deferred income tax credit
    (816 )     (5,808 )
      Valuation allowance for deferred income tax assets
    --       4,515  
  Originations and purchases of loans held for sale
    (28,035 )     (89,100 )
  Proceeds from sales of loans held for sale
    33,331       91,994  
  Decrease in accrued interest income and other assets
    15,018       64,954  
  Increase in accrued interest expense on deposits and
               
     other liabilities
    6,432       9,086  
                 
                NET CASH PROVIDED BY OPERATING ACTIVITIES
    17,128       72,114  
                 
INVESTING ACTIVITIES
               
  Cash equivalents of acquired bank affiliate
    --       18,949  
  Proceeds from sales of investment securities available for sale
    488       22,075  
  Proceeds from calls, prepayments and maturities of investment
               
     securities
    10,104       14,935  
  Purchases of investment securities
    (19,386 )     (22,298 )
  Redemption of Federal Home Loan Bank stock by issuer
    2,167       1,169  
  Purchase of Federal Home Loan Bank stock
    (861 )     (1,411 )
  Net decrease in portfolio loans
    209,625       130,227  
  Proceeds from sales of government-guaranteed loans
    26,959       15,192  
  Proceeds from sales of premises and equipment
    405       3,742  
  Purchases of premises and equipment
    (941 )     (7,420 )
  Proceeds from sale of bank subsidiaries
    37,818       33,084  
  Payments received on other real estate owned
    238       --  
  Proceeds from sales of other real estate owned
    22,737       35,590  
                 
                NET CASH PROVIDED BY INVESTING ACTIVITIES
    289,353       243,834  
                 
FINANCING ACTIVITIES
               
  Net increase in demand deposits, NOW accounts and savings accounts
    156,492       76,222  
  Net decrease in certificates of deposit
    (404,212 )     (187,619 )
  Net payments on debt obligations
    (134 )     (1,548 )
  Proceeds from Federal Home Loan Bank borrowings
    174,850       541,480  
  Payments on Federal Home Loan Bank borrowings
    (217,206 )     (649,067 )
  Resources provided by noncontrolling interests
    9,000       --  
  Net proceeds from issuance of common stock
    --       6,870  
  Tax effect of share-based payments
    (256 )     (293 )
                 
                NET CASH USED IN FINANCING ACTIVITIES
    (281,466 )     (213,955 )
                 
                INCREASE IN CASH AND CASH EQUIVALENTS
    25,015       101,993  
                 
Change in cash and cash equivalents of discontinued operations
    (40,986 )     (80,861 )
                 
Cash and cash equivalents at beginning of period
    439,840       532,674  
                 
                CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 423,869     $ 553,806  
                 
Supplemental disclosures:
               
  Cash paid during the period for interest on deposits and debt obligations
  $ 32,362     $ 58,451  
  Transfers of loans to other real estate owned
    39,067       60,239  
  Surrender of common stock to facilitate vesting of restricted stock
    12       13  
  Exchange of common stock for redemption of debt
    5,082       3,325  
                 
See notes to condensed consolidated financial statements.
               

 
Page 9 of 61

 

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, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011.

The consolidated balance sheet as of December 31, 2010 was derived from audited consolidated financial statements as of that date.  Certain 2010 amounts have been reclassified to conform to the 2011 presentation.

Capitol's ability to continue to operate as a going concern is contingent upon a number of factors which are discussed on page 47 of this document, as well as a variety of risk factors discussed elsewhere in this document and in Capitol's other filings with the SEC.  Capitol's auditors included a going concern qualification in the most recent report on the Corporation's audited consolidated financial statements as of December 31, 2010.

Note B – Accounting Standards Updates

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 became effective beginning January 1, 2011.  These new disclosures did not have a material effect on the Corporation's consolidated financial statements upon implementation.

In July 2010, an accounting standards update was issued which requires 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 are required by class 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, are also 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 under this new guidance, which are required as of the end of a reporting period, were first implemented in 2010 and are set forth in Note D.  The disclosure about activities that occur during a reporting period became effective January 1, 2011 and the disclosures about troubled debt restructurings became effective this quarter which did not have an effect on the Corporation's consolidated financial statements upon implementation except for expanded disclosures therein as set forth in Note D.


 
Page 10 of 61

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note B – Accounting Standards Updates – Continued

In April 2011, an accounting standards update was issued clarifying what constitutes a troubled debt restructuring.  When performing the evaluation of whether a loan modification or restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (1) the debtor is experiencing financial difficulties as defined by the guidance, and (2) the modification constitutes a concession.  This guidance also clarifies that a creditor is precluded from using the borrower's effective interest rate test when performing this evaluation.  For identification and disclosure purposes, this new guidance became effective beginning in the third quarter of 2011 and was applied retrospectively to modifications occurring on or after January 1, 2011 that remain outstanding at September 30, 2011.  As a result of implementing this new guidance in the third quarter of 2011, the Corporation reassessed all loan modifications or restructurings that occurred on or after January 1, 2011 to determine whether those loans are now considered troubled debt restructurings.  As a result, the Corporation determined the recorded investment in such newly-identified troubled debt restructurings for which the allowance was previously measured under a general allowance methodology, and is now measured under a specific-reserve methodology, was $63.1 million and the allowance for loan losses associated with those loans, on the basis of a current evaluation of loss, was $9.5 million.   The implementation of this new guidance did not have a material effect on the Corporation's consolidated financial statements upon implementation except for expanded disclosures therein as set forth in Note D.

In April 2011, an accounting standards update was issued to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets on substantially the agreed upon terms.  This standard eliminates consideration of the transferor's ability to fulfill its contractual rights and obligations from the criteria, as well as related implementation guidance (i.e., that it possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets), in determining effective control, even in the event of default by the transferee.  Other criteria applicable to the assessment of effective control are not changed by this new guidance.  This new guidance will become effective January 1, 2012 and management does not expect it to have a material effect on the Corporation's consolidated financial statements upon implementation.

In May 2011, an accounting standards update was issued to amend the fair value measurement and disclosure requirements to explain how to measure fair value in certain instances, but it does not require additional fair value measurements.  Some of the amendments include clarification regarding the application of the highest and best use and valuation premise concepts, measuring the fair value of an instrument classified in a reporting entity's stockholders' equity, measuring the fair value of financial instruments that are managed within a portfolio, application of premiums and discounts in a fair value measurement and expanded disclosure requirements to include quantitative information about the unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy.  This new guidance is effective prospectively beginning January 1, 2012 and management does not expect it will have a material effect on the Corporation's consolidated financial statements upon implementation.

In June 2011, an accounting standards update was issued to amend the options available for the presentation of other comprehensive income.  An entity will have the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  An entity will no longer be able to present the components of comprehensive income as part of the statement of stockholders' equity.  Regardless of which presentation method an entity chooses, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.  This new guidance is effective retrospectively for all annual and interim periods presented beginning January 1, 2012 and management does not expect it will have a material effect on the Corporation's consolidated financial statements upon implementation.  In October 2011, the FASB decided to defer the presentation of reclassification adjustments until further consideration.



 
Page 11 of 61

 

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, 2011
   
December 31, 2010(1)
 
   
Amortized
Cost
   
Estimated
Fair
Value
   
Amortized
Cost
   
Estimated
Fair
Value
 
Available for sale:
                       
United States treasury
  $ 4,016     $ 4,029     $ 503     $ 506  
United States government agency
    12,489       12,505       12,664       12,681  
Mortgage-backed
    7,733       7,821       1,808       1,924  
Municipalities
    330       335       371       378  
      24,568       24,690       15,346       15,489  
Held for long-term investment:
                               
Capitol Development Bancorp
Limited III
     224        224        463        463  
Other equity investments
    1,788       1,788       2,430       2,430  
      2,012       2,012       2,893       2,893  
                                 
    $ 26,580     $ 26,702     $ 18,239     $ 18,382  

 
(1)
For comparative purposes, original balances as previously reported have been adjusted to exclude amounts related to discontinued operations.

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, 2011
   
December 31, 2010
 
   
Gains
   
Losses
   
Gains
   
Losses
 
                         
United States treasury
  $ 13           $ 3        
United States government agency
    22     $ 6       18     $ 1  
Mortgage-backed
    118       30       116          
Municipalities
    5               7          
                                 
    $ 158     $ 36     $ 144     $ 1  


 
Page 12 of 61

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note C – Investment Securities – Continued

The age of gross unrealized losses and carrying value (at estimated fair value) of securities available for sale are summarized below (in $1,000s):

   
September 30, 2011
   
December 31, 2010
 
   
Unrealized
Loss
   
Carrying
Value
   
Unrealized
Loss
   
Carrying
Value
 
One year or less:
                       
United States government agency
  $ 6     $ 5,399              
Mortgage-backed
    30       3,150              
    $ 36     $ 8,549     $ --     $ --  
In excess of one year:
                               
United States government agency
  $ --     $ --     $ 1     $ 4,797  

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

Scheduled maturities of investment securities held as of September 30, 2011 were as follows (in $1,000s):

   
Amortized
Cost
   
Estimated
Fair Value
   
               
Due in one year or less
  $ 8,828     $ 8,850    
After one year, through five years
    3,622       3,638    
After five years, through ten years
    887       911    
After ten years
    11,231       11,291    
Securities held for long-term investment
                 
without stated maturities
    2,012       2,012    
                   
    $ 26,580     $ 26,702    







[The remainder of this page intentionally left blank]


 
Page 13 of 61

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note D – Loans

The following tables present the allowance for loan losses and the carrying amount of loans based on management's overall assessment of probable incurred losses (in $1,000s), and should not be interpreted as an indication of future charge-offs:

   
September 30, 2011
 
   
Secured by Real Estate
                         
   
 
 
 
Commercial
   
Residential
(including
multi-
family)
   
Construction,
Land
Development
and Other
Land
   
Commercial
and Other
Business-
Purpose
Loans
   
 
 
 
Consumer
   
 
 
 
Other
   
 
 
 
Total
 
                                           
Allowance for loan losses:
                                         
Individually evaluated
                                         
for impairment
  $ 10,039     $ 3,218     $ 3,893     $ 2,308     $ 244     $ 7     $ 19,709  
Collectively evaluated
                                                       
for probable incurred
                                                       
losses
    38,052       18,970       10,189       14,713       1,239       45       83,208  
                                                         
Total allowance
                                                       
for loan losses
  $ 48,091     $ 22,188     $ 14,082     $ 17,021     $ 1,483     $ 52     $ 102,917  
                                                         
Portfolio loans:
                                                       
Individually evaluated
                                                       
for impairment
  $ 173,568     $ 52,127     $ 45,298     $ 19,241     $ 260     $ 7     $ 290,501  
Collectively evaluated
                                                       
for probable incurred
                                                       
losses
    872,441       328,766       96,958       191,950       14,536       2,848       1,507,499  
                                                         
Total portfolio loans
  $ 1,046,009     $ 380,893     $ 142,256     $ 211,191     $ 14,796     $ 2,855     $ 1,798,000  


   
December 31, 2010(1)
 
   
Secured by Real Estate
                         
   
 
 
 
Commercial
   
Residential
(including
multi-
family)
   
Construction,
Land
Development
and Other
Land
   
Commercial
and Other
Business-
Purpose
Loans
   
 
 
 
Consumer
   
 
 
 
Other
   
 
 
 
Total
 
                                           
Allowance for loan losses:
                                         
Individually evaluated
                                         
for impairment
  $ 9,800     $ 5,568     $ 6,415     $ 6,077                 $ 27,860  
Collectively evaluated
                                                   
for probable incurred
                                                   
losses
    40,625       30,230       12,595       18,735     $ 719     $ 87       102,991  
                                                         
Total allowance for
                                                       
loan losses
  $ 50,425     $ 35,798     $ 19,010     $ 24,812     $ 719     $ 87     $ 130,851  
                                                         
Portfolio loans:
                                                       
Individually evaluated
                                                       
for impairment
  $ 171,881     $ 54,442     $ 52,734     $ 25,892     $ 22             $ 304,971  
Collectively evaluated
                                                       
for probable incurred
                                                       
losses
    1,017,229       387,187       132,089       260,024       18,537     $ 5,226       1,820,292  
                                                         
Total portfolio loans
  $ 1,189,110     $ 441,629     $ 184,823     $ 285,916     $ 18,559     $ 5,226     $ 2,125,263  

(1)
For comparative purposes, original balances as previously reported have been adjusted to exclude amounts related to discontinued operations.



 
Page 14 of 61

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LIMITED – Continued

Note D – Loans – Continued

The allowance for loan losses is maintained at a level believed adequate by management to absorb potential losses inherent in the loan portfolio at the balance-sheet date.  Management's determination of the adequacy of the allowance is an estimate based on evaluation of the portfolio (including potential impairment of individual loans and concentrations of credit), past loss experience, current economic conditions, volume, amount and composition of the loan portfolio and other factors.  The allowance is increased by provisions for loan losses charged to operations and reduced by net charge-offs.

The tables below summarize activity in the allowance for loan losses for the three months and nine months ended September 30, 2011 (in $1,000s) by loan type:

   
Three Months Ended September 30, 2011
 
   
Secured by Real Estate
                         
   
 
 
 
Commercial
   
Residential
(including
multi-
family)
   
Construction,
Land
Development
and Other
Land
   
Commercial
and Other
Business-
Purpose
Loans
   
 
 
 
Consumer
   
 
 
 
Other
   
 
 
 
Total
 
                                           
Beginning balance
  $ 51,075     $ 23,680     $ 15,731     $ 20,104     $ 977     $ 69     $ 111,636  
                                                         
Charge-offs
    (11,297 )     (6,376 )     (5,790 )     (5,556 )     (137 )             (29,156 )
Recoveries
    989       537       361       1,003       63       2       2,955  
Net charge-offs
    (10,308 )     (5,839 )     (5,429 )     (4,553 )     (74 )     2       (26,201 )
                                                         
Provision for loan
                                                       
losses
    7,324       4,347       3,780       1,470       580