Report: Examiners failed to curb risky lending at Irwin Union

The Federal Reserve’s inspector general said examiners at the Chicago Fed failed to curb risky real estate lending that led to losses at banks in Indiana and Michigan that were later closed.

Columbus, Ind.-based Irwin Union Bank and Trust almost tripled in size from 2000 to 2005 as it extended credit to subprime mortgage borrowers with insufficient collateral, Fed Inspector General Elizabeth Coleman said in a report. Chicago Fed supervisors missed “multiple opportunities between 2002 and 2009 to take additional and stronger supervisory actions,” the report said.

Irwin Union was nearly 140 years old when it filed for bankruptcy liquidation in September 2009 after failing to land a bailout from the federal government.

At Warren, Mich.-based Warren Bank, early supervisory action by the Chicago Fed could have reduced the cost of the ultimate failure, blamed on excessive concentration in commercial real estate, Coleman said in a separate report. Both banks were closed last year.

The findings, dated April 29 and posted on the Fed’s Web site, follow similar criticism last year of supervisory flaws at the Atlanta Fed. Senate Banking Committee Chairman Christopher Dodd is leading an effort to scale back the Fed’s supervision, saying the central bank failed to curtail risky lending practices that contributed to the collapse of the housing market. The measure is part of a proposed overhaul of financial regulation now under debate in the Senate.

Dodd wants to narrow the Fed’s supervisory authority to bank holding companies with more than $50 billion in assets, while the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency would regulate other banks. A bill passed by the House of Representatives in December left the Fed’s current supervisory authority intact.

“There is justification for stripping them of some regulatory responsibilities based on their performance,” said James Barth, a former chief economist at the Office of Thrift Supervision who is now a professor of finance at Auburn University in Auburn, Alabama.

The Inspector General’s reports “reflect on the Fed to the extent they weren’t doing their job,” he said. “The Fed was also overseeing a lot of mortgage products that caused problems. The Fed in a number of instances hasn’t distinguished itself.”

Reports by the inspector general last year criticized the Atlanta Fed’s supervision of Riverside Bank of the Gulf Coast in Cape Coral, Fla., and First Georgia Community Bank.

“The Fed got it wrong but who got it right?” said Brian Olasov, a managing director at the McKenna Long & Aldridge law firm in Atlanta. “These loan products were in demand and performing well right up until the music stopped. In retrospect, bank lenders, capital market investors and regulators all got it wrong.”

Fed Governor Daniel Tarullo is leading an overhaul of examinations by the central bank, aiming to identify potential threats across the banking industry. While supervising commercial banks, Fed district banks process checks and report on regional business conditions.

Irwin Union Bank’s failure resulted in an estimated loss to the FDIC’s deposit insurance fund of $552.4 million, or 20.5 percent of the bank’s $2.7 billion in total assets.

“A borrower could receive as much as 125 percent of his/her home’s value” at the bank, the report said. “This product creates high credit risk because of the lack of collateral support.”

While most of Irwin’s borrowers didn’t pose a significant credit risk, home equity loans with low collateral were offered to “subprime customers who presented a heightened risk of default, which further increased the credit risk associated with these loans.” The company also “developed a risky loan program that did not require borrower income verification.”

Patrick Parkinson, the Fed’s bank supervision director in Washington, wrote in a letter attached to the report that “We concur with the conclusions,” and “additional and stronger supervisory actions may have been warranted.”

Chicago Fed spokesman Douglas Tillett declined to comment beyond the Fed’s response in the report.

Warren Bank’s failure resulted in an estimated loss to the FDIC of $276.3 million, or 52 percent of the bank’s total assets of $530.9 million.

Warren’s board and management “were overly optimistic about the bank’s ability to withstand the economic downturn and did not adequately manage the risks associated with its loan portfolio, which was highly concentrated in commercial real estate,” the report said. In 2004, commercial real estate loans equaled about 790 percent of total capital and 70 percent of total assets.

Examiners didn’t issue an enforcement action to force the bank to improve its loan grading and capital until September 2008, Coleman wrote. “Recurrent examination comments and findings warranted an enforcement action as early as 2006,” she said. Earlier action “could have reduced the cost of the failure.”

Parkinson said in his letter, “the report notes the importance of an early and forceful response to recurring supervisory concerns and we concur with this conclusion.”

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