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Board Report:  December 15, 2011

Review of the Failure of Legacy Bank


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Legacy Bank (Legacy) began operations in July 1999 as a de novo state member bank headquartered in Milwaukee, Wisconsin. Legacy was supervised by the Federal Reserve Bank of Chicago (FRB Chicago) under delegated authority from the Board, and by the State of Wisconsin Department of Financial Institutions (State). The State closed Legacy on March 11, 2011, and named the FDIC as receiver. According to the FDIC, the bank's total assets at closing were $225.1 million, and its failure resulted in an estimated $43.5 million loss to the Deposit Insurance Fund. While the loss is beneath the materiality threshold, we conducted an in-depth review after determining that Legacy's failure presented unusual circumstances: Examiners concluded that bank officers engaged in unsafe and unsound banking practices, and the bank received $5.5 million in funds from the Treasury's Capital Purchase Program under the Troubled Asset Relief Program (TARP).

Legacy failed because its board of directors and management did not adequately control the risks associated with the bank's aggressive growth strategy, which focused on lending in low- to moderate-income neighborhoods within the city of Milwaukee. The bank was a community development financial institution that provided financial services to customers in an underserved community. Management depended on noncore funding sources to support the bank's growth strategy, which included providing loans to revitalize residential housing and commercial properties in distressed neighborhoods in Milwaukee. As a result, the bank developed a concentration in commercial real estate (CRE) loans and became vulnerable to a downturn in the local economy. The failure of Legacy's board of directors and management to implement risk management practices commensurate with the bank's increased risk profile, coupled with a weakening real estate market, led to rapid asset quality deterioration. Mounting losses eliminated the bank's earnings and depleted capital, which prompted the State to close Legacy and appoint the FDIC as receiver.

With respect to supervision, FRB Chicago complied with the examination frequency guidelines for the 2006-2011 time frame we reviewed, conducted regular off-site monitoring, and implemented the applicable PCA provisions. Our analysis of FRB Chicago's supervision of Legacy revealed that FRB Chicago identified the bank's fundamental weaknesses, including ineffective board of directors oversight, poor internal controls, and a high concentration in CRE loans, but did not take early, forceful supervisory action to address those weaknesses. Specifically, we believe that the findings noted during a March 2008 full-scope examination warranted stronger criticism, including CAMELS composite and component rating downgrades. We also noted that FRB Chicago complied with the process outlined in Treasury's evaluation guidance when Legacy's holding company applied for TARP funds in October 2008.  

We believe that Legacy's failure offers lessons learned that can be applied when supervising banks with similar characteristics. In our opinion, Legacy's failure demonstrated the importance of (1) examiners assuring that management implements credit risk management practices commensurate with the bank's strategy and risk profile, including CRE concentration levels, and (2) supervisors assigning CAMELS composite and component ratings consistent with the examination's findings and narrative examination comments.

The Director of BS&R concurred with our conclusions and lessons learned.