The Feds May Have Bolted The Door Too Quickly

When Philip Gottlieb bought 7,500 shares of preferred stock in First City Bank Corporation of Texas Inc. at about $2.50 each last October, he thought he was buying into a fairly typical turnaround situation. After all, the Houston bank's bondholders had just agreed to a recapitalization plan that looked promising. But Gottlieb, who heads up a small limited partnership called the Lawrence Fund, was in for a pleasant surprise: Even though the bank was closed by regulators and the preferred shares fell to 1 a share in late December, the stock has since rocketed to $38.50. Gottlieb realized a profit of nearly $88,000 when he sold a third of his shares two weeks ago, and he's sitting on unrealized gains of about $177,000--all for an investment of just $19,243.

What's more, several traders and analysts believe even higher prices for the shares are possible before the year is out. The reason: First City is suing the Federal Deposit Insurance Corp. and its other regulators. Among other things, the bank is charging that regulators closed First City's bank units while the franchise still had real value--and shortly before First City was to present a recapitalization plan to its shareholders. First City President and Chief Operating Officer Robert W. Brown says his company would have been worth $1 billion if it had been allowed to remain in business, and First City is suing to recover that amount in damages, as well as punitive damages of $2 billion.

It's highly unlikely that First City will get everything it's demanding in its suit. But on Oct. 8, just two weeks after First City filed suit, the bank and the government announced they would hold talks over the next 60 days. Some investors believe the mere fact that the FDIC and First City went into settlement talks so quickly means the agency will likely agree to a hefty settlement rather than go through a jury trial in First City's home state, and they think that a deal is possible by early December. The FDIC's director of resolutions, Harrison Young, says he can't comment on the agency's discussions with First City.

A big settlement could mean the bank's bondholders, preferred stock owners, and even common shareholders are in for still more gains. In the wake of its earlier recapitalization, First City found itself with much less debt than most banks, so any settlement would cover its bond obligations relatively easily. That's good news for equity investors: The preferred stock Gottlieb owns, for example, has a par value of $50 and accrued dividends of $15 per share. The senior preferred stock, which is trading near its par value of $100, has accrued dividends of nearly $40 per share.

First City has had difficulties for years, having been recapitalized in 1988 with $970 million in Federal assistance and a smaller amount of private investment. By 1992, though, First City was in trouble again. State and federal bank regulators moved in and closed First City's bank units on the last Friday in October, arguing that an early move would stop losses from growing and the government's resolution costs from ballooning. At the time, the FDIC board estimated that the closing would cost the government $500 million.

TRIGGER-HAPPY? Less than six months later, however, the government revised its estimate. After it received bids for First City assets from Chemical Bank and others, the FDIC announced the government would net a surplus of $60 million. "I was astonished by how good a deal we'd gotten," says the FDIC's Young. "By offering the [First City] banks separately, we got better premiums." First City alleges that the surplus is a lot higher than $60 million--more like $400 million to $500 million, according to First City's Brown. "It looks like there was a major error of judgment on the part of the FDIC and the other regulators," says William L. Eddleman Jr., an analyst at Harris Securities Inc. He thinks the FDIC could settle for nearly $400 million, which would be more than enough to cover the full value of First City's preferred stock.

A payment anywhere near that amount could be deeply embarrassing to the FDIC. It could suggest that the bank regulators were trigger-happy.

Plenty of things could still go wrong for investors. The FDIC could refuse to make a large settlement payment, for one thing. First City's estimates of value could also be too high. But optimists among the crowd that is following the First City saga predict that instead of red ink, the FDIC will wind up with a very red face.