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Board Report:  December 8, 2010

Material Loss Review of Midwest Bank and Trust Company


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Midwest Bank and Trust Company (Midwest) was supervised by the Federal Reserve Bank of Chicago (FRB Chicago), under delegated authority from the Federal Reserve Board, and by the Illinois Department of Financial and Professional Regulation (State). The State closed Midwest in May 2010, and the FDIC was named receiver. On June 8, 2010, the FDIC IG notified us that Midwest's failure would result in an estimated loss to the DIF of $200.7 million, or 6.5 percent of the bank's $3.1 billion in total assets. 

Midwest failed because of the convergence of various factors. The Board of Directors and management pursued an aggressive growth strategy in 2002 and 2003, without establishing credit risk management controls commensurate with the bank's increasing size and risk profile. These weaknesses contributed to the bank developing commercial real estate (CRE) and construction, land, and land development (CLD) loan concentrations. During this time period, examiners also raised concerns about management's effectiveness and capabilities. These deficiencies resulted in a formal enforcement action in March 2004 that, among other things, required Midwest to enhance its credit risk management and hire a consultant to conduct an independent assessment of management's "functions and performance," including its expertise and qualifications. In response to the independent assessment, the bank overhauled its management team in 2004 and 2005. New management pursued "double-digit" loan growth while attempting to materially reduce loan concentrations, raise capital, and diversify the bank's funding sources. For the most part, management achieved only its growth objectives.

In 2007, Midwest developed an investment portfolio risk by increasing its preferred securities holdings in Fannie Mae and Freddie Mac, two government sponsored enterprises (GSEs). The value of these securities declined precipitously following the onset of the financial crisis in the fall of 2007, and in the first quarter of 2008, the bank took a $17.6 million write-down. The GSEs were placed into conservatorship in September 2008, and Midwest's management  subsequently wrote off the remaining $67 million value of these securities.

During this time frame, the bank also experienced significant asset quality deterioration in its CRE and CLD loan portfolios. In December 2008, the bank received $84.8 million from the Treasury's TARP, but management failed to raise  additional private capital. In 2008 and 2009, Midwest experienced significant losses, and Midwest's holding company injected $87 million in additional capital to preserve the bank's well capitalized status. These capital injections depleted the holding company's financial reserves and prevented it from further supplementing the bank's capital. By 2010, Midwest became fully exposed to the loan losses associated with its CRE and CLD asset quality deterioration, which rapidly depleted its capital. The State closed Midwest and appointed the FDIC as receiver on May 14, 2010.

With respect to supervision, FRB Chicago complied with examination frequency guidelines for the timeframe we reviewed and conducted regular off-site monitoring. Our analysis of FRB Chicago's supervision indicated that examiners identified key weaknesses--such as the bank's CRE and CLD concentrations, reliance on non-core funding, and reliance on the holding company's capital support--that contributed to the bank's failure. Yet, examiners did not act on multiple subsequent opportunities to take more forceful supervisory action that might have prompted management to resolve these weaknesses. For example, we believe the findings in a 2004 full scope examination did not warrant the upgrade that was made to Midwest's CAMELS composite rating because the bank had been placed under a formal enforcement action only two weeks prior to the start of the examination. In addition, between 2005 and 2007, FRB Chicago did not hold bank management accountable for failing to diversify the bank's loan portfolio and funding sources. We also noted that a 2008 full scope examination warranted additional CAMELS component rating downgrades and a CAMELS composite downgrade. However, it was not possible to determine whether alternative supervisory actions would have affected Midwest's subsequent decline.

We believe that Midwest's failure offered lessons learned that can be applied to supervising banks with similar characteristics and circumstances. This failure demonstrated (1) the importance of examiners holding management accountable for failing to address fundamental and persistent weaknesses, (2) the risks associated with an aggressive growth strategy that relies heavily on non-core funding and holding company capital support, and (3) the importance of examiners issuing CAMELS composite and component ratings consistent with the narrative comments included in examination reports.