Puerto Rico-based Doral Financial (NYSE:DRL), the holding company for Doral Bank, is facing a liquidity crisis, on the back of both the island's spiking municipal bond rates and the recent refusal of the commonwealth to return almost $230 million in tax overpayments, plus interest.
Doral and Puerto Rico came to an agreement on March 26, 2012, where the government agreed to return the overpaid taxes. On May 14 of this year, Doral received a letter wherein Hacienda, the Puerto Rico Department of Treasury, unilaterally decided that the 2012 Closing Agreement is null and that Doral has no right to a refund of its overpaid taxes. It is unlikely that this matter is even close to finished, with Doral and Puerto Rico now needing to either renegotiate terms or allow a court to determine the matter.
The disputed tax payments, or overpayments, were apparently made between 2000 and now. Apparently, Puerto Rico does not have records of what payments it had received, because on April 15, Doral received a letter from Hacienda requesting that Doral provide proof it made actual tax payments to Hacienda that are subject to the 2012 Closing Agreement. On April 23, Doral responded with copies of tax payments it made.
This is a problematic time for both Puerto Rico and Doral, both of which are in dire need of capital. Puerto Rico's municipal bonds now trade at significantly higher yields than the average muni due to default concerns or possible bankruptcy reorganization like Detroit recently chose. Doral's concerns are more immediate, having received a letter from the Federal Deposit Insurance Corporation on May 1, warning that the bank may no longer count these tax repayments as Tier 1 Capital. Without those payments, Doral may fail to comply with the FDIC's regulatory capital requirements.
Doral is developing a revised capital plan to regain compliance with regulatory requirements, and it must submit a contingency plan for the sale, merger, or liquidation of Doral Bank in case it can't raise enough capital this summer. This FDIC issue means that until it regains compliance, Doral cannot accept any new brokered deposits.
Additionally, Standard & Poor's Ratings division of McGraw Hill Financial (MHFI) now believes that a Doral default is a virtual certainty, because it expects the company's weakened stock price and overall financial condition to make it difficult to raise the needed capital. Moreover, regulatory issues could slow down or wholly prevent and that its regulatory troubles may stand in the way of potential asset sales.
Doral did already sell one asset, pending regulatory approval. On May 15, Doral reported the pending sale of its healthcare asset-based lending business, Doral Healthcare Finance, to a subsidiary of privately held Triumph Bancorp. The price of the sale was not disclosed, and it is unclear how long regulatory approval may take.
If Doral is able to survive its near term need to sell assets at a time when would-be buyers are aware that it is a fire-sale, Doral shares should rebound quite resiliently from their present levels. Moreover, if Doral is capable of either promptly achieving a positive declaratory judgment on its dispute with Puerto Rico or negotiating a reduced payment and modified terms for the 2012 Closing Agreement, shares are likely to appreciate.
Asset sales are far more probable than Puerto Rico paying off the debt that it cannot presently afford to pay anyway. Therefore, it appears this is a hole from which Doral must try to dig itself out by lightening its load of assets. Doral last indicated holding $8.5 billion in assets, though this precise valuation may be in question due to the uncertain future of its commercial and Puerto Rican mortgage holdings, and also the discount that those assets must suffer in the short-term fire-sale that must now occur.
In the meanwhile, buying a share of Doral is much like playing the lottery, because the share is likely to either be worthless or worth multiples of the present investment if the bank can shrink itself to grow. Given the prompt sale of its healthcare financial asset, it appears as though Doral understands the situation and is willing to take the necessary pain in order to maintain itself. If it can, investors will reap a significant windfall, but they must also understand that it is just as likely, if not more-so, that they will be tearing up those shares like a losing lottery ticket.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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