Board Report: April 29, 2010
Irwin Union Bank and Trust (IUBT) was supervised by the Federal Reserve Bank of Chicago (FRB Chicago), under delegated authority from the Board, and by the Indiana Department of Financial Institutions (State). The State closed IUBT in September 2009, and the FDIC was named receiver. On October 29, 2009, the FDIC IG notified our office that IUBT’s failure would result in an estimated loss to the DIF of $552.4 million, or about 20.5 percent of the bank’s $2.7 billion in total assets.
IUBT failed because of the convergence of several factors. The Board of Directors and management pursued an aggressive growth strategy between 2000 and 2005 that relied upon high-risk business models. Management also depended on volatile non-core funding sources to support the bank’s growth strategy, which emphasized high-risk, high-yielding assets, such as 125 percent combined loan-to-value ratio loans. Meanwhile, management maintained few sources of liquidity support, which further increased IUBT’s risk profile. During the 2000 to 2005 growth period, the Board of Directors and management failed to ensure that the bank’s key corporate control functions and risk management practices kept pace with the bank’s expansion, increasingly complex operations, and escalating risk profile. The Board of Directors’ and management’s aggressive growth strategy resulted in IUBT’s total assets almost tripling between 2000 and 2005. However, for five consecutive years (2004 through 2008), the bank's net income decreased.
In 2007, reduced secondary market demand for mortgages hampered, and eventually eliminated, an IUBT subsidiary’s ability to sell its loans. As a result, the subsidiary was forced to hold the loans that it had originated to sell (including 125 percent combined loan-to-value ratio loans) in a declining real estate environment, which exposed IUBT to significant asset quality deterioration. In addition, IUBT’s exposure to real estate market declines was compounded by a significant concentration in commercial real estate (CRE) loans. As the value of IUBT’s assets continued to deteriorate, its Board of Directors and management adopted a strategy of selling more profitable business lines and branch offices to preserve the bank’s capital. However, IUBT’s remaining assets continued to deteriorate and deplete capital, which raised concerns about the bank’s viability and eventually resulted in IUBT losing access to key funding sources. On September 18, 2009, the State closed IUBT because of the imminent danger of a liquidity shortfall and appointed the FDIC as receiver.
Our analysis of FRB Chicago’s supervision of IUBT indicated that examiners identified key weaknesses in 2002 and 2003 regarding corporate governance, risk management systems, and internal controls, but missed multiple subsequent opportunities to take more forceful supervisory action. The fundamental risk management weaknesses, corporate governance issues, and key compliance deficiencies raised by FRB Chicago during examinations in 2002 and 2003 were early warning signs regarding IUBT’s Board of Directors’ and management’scapability to effectively manage a geographically dispersed, large, and complex banking organization. Based on the 2002 and 2003 examination findings, FRB Chicago issued two informal enforcement actions. In 2003 and 2004, IUBT was unable to fully resolve the issues noted in the informal enforcement actions, and unresolved issues noted during the continuous supervision process began to accumulate. We believe that FRB Chicago had multiple opportunities between 2002 and 2009 to take additional and stronger supervisory actions.
For example, we believe that the fundamental corporate governance issues and comprehensive liquidity risk management weaknesses noted during the January 2002 examination provided an early warning sign that management was not effectively managing the risks associated with adding a new bank subsidiary engaged in high loan-to-value lending. In our opinion, the examination findings warranted a stronger supervisory action, including an additional downgrade of the management CAMELS component rating to reflect that management was less than satisfactory. We also believe that FRB Chicago should have considered requesting that management refrain from additional growth or corporate restructurings affecting IUBT until the bank fully addressed the fundamental flaws noted during this examination. We believe that strong supervisory action would have alerted management to the urgent need to address these weaknesses before pursuing further changes or additional growth in the lines of business.
A 2005 full scope examination cited that management’s failure to enhance its market risk management capabilities contributed to a decrease in the bank’s annual earnings and, in our opinion, warranted a stronger supervisory response. During the 2005 examination, FRB Chicago also noted new and recurring violations of laws and regulations in the bank’s mortgage lending business lines, which we believe warranted a stronger enforcement action. In addition, a 2006 full scope examination once again revealed IUBT’s difficulties in resolving items contained in informal enforcement actions and raised by the continuous supervision process. We believe that IUBT’s inability to fully resolve, in a complete and timely manner, prior informal supervisory actions and issues noted during the continuous supervision process warranted an earlier formal enforcement action.
In late 2007, when economic conditions caused a liquidity disruption that reduced the bank’s access to the funding necessary to operate its home equity lending business, FRB Chicago reiterated the risk associated with IUBT’s dependence on uninterrupted liquidity in the secondary markets as a significant issue. Examiners raised the same concern almost five years earlier in a 2003 examination report, but did not hold the Board of Directors and management accountable for addressing that risk in the intervening years. We believe that an earlier and stronger supervisory action, such as a liquidity component ratings downgrade or a formal enforcement action related to liquidity risk management, might have addressed this fundamental liquidity planning weakness.
IUBT’s failure offered valuable lessons learned. Specifically, IUBT’s failure illustrated the importance of supervisors
The Director of the Board’s Division of Banking Supervision and Regulation concurred with our conclusions and lessons learned.
