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Board Report: April 29, 2010
Warren Bank was supervised by the Federal Reserve Bank of Chicago (FRB Chicago), under delegated authority from the Board, and by the Michigan Office of Financial and Insurance Regulation (State). The State closed Warren Bank on October 2, 2009, and the FDIC was named receiver. On October 29, 2009, the FDIC IG notified our office that Warren Bank’s failure would result in an estimated loss to the Deposit Insurance Fund (DIF) of $276.3 million, or 52 percent of the bank’s $530.9 million in total assets.
Warren Bank failed because its Board of Directors and management did not adequately manage loan portfolio risks as regional economic conditions began a protracted decline. Management placed a high reliance on (1) the bank’s familiarity with borrowers and (2) the collateral pledged to secure loans. Warren Bank’s Board of Directors and management were overly optimistic about the bank’s ability to withstand the economic downturn and did not adequately mitigate the risks associated with a loan portfolio that was highly concentrated in commercial real estate (CRE). In some instances, management renewed and extended loans and advanced additional funds to existing customers, apparently in the hope that market conditions would improve. However, management did not properly analyze the value of the underlying collateral and the borrowers’ creditworthiness. The bank’s asset quality deteriorated as underlying collateral values declined and loan defaults increased. The resulting losses eliminated earnings and depleted capital, which ultimately led to Warren Bank’s failure.
With respect to supervision, our analysis revealed that examiners repeatedly criticized the bank’s loan grading practices and allowance for loan and lease losses (ALLL) methodology. Despite recurring supervisory comments and findings, improvements made by bank management were insufficient to ensure that the bank’s credit risk management practices were commensurate with its risk profile. Examiners also cited recurring concerns regarding Warren Bank’s capital position. In 2003, examiners suggested that management maintain capital well above the PCA minimums due to the bank’s high risk profile. Management was encouraged to set capital levels above its industry peer group. Similar concerns were expressed in subsequent examination reports; however, Warren Bank’s yearend risk weighted capital levels never exceeded its peers.
Examiners did not issue an enforcement action compelling the bank to rectify recurring regulatory concerns regarding loan grading, the ALLL, and capital levels until September 2008. In our opinion, recurrent examination comments and findings warranted an enforcement action as early as 2006. In addition, we believe that an earlier supervisory action requiring the bank to maintain a higher capital threshold commensurate with its high risk profile could have reduced the cost of the failure to the DIF.
Warren Bank’s failure offered a lesson learned that can be applied when supervising banks with similar characteristics and circumstances. Specifically, Warren Bank’s failure illustrated the importance of an early and forceful response to recurring supervisory concerns, particularly when examiners determine that capital levels are not commensurate with an institution’s overall risk profile.
The Director of the Board’s Division of Banking Supervision and Regulation agreed with our conclusion and concurred with the lesson learned.