Review of Crofton Bank Failure Cites Risk

Suburban Federal Savings, the only local bank to fail during this recession, collapsed because its managers took too many risks in the pursuit of rapid growth and its regulators did not prevent them, according to a review published Friday by the Treasury Department's inspector general.

The report said that the grandson of Suburban Federal's founder took over in 2003 and rapidly increased the bank's lending to real estate developers. The bank also slashed its mortgage lending standards, accepting lower credit scores and smaller down payments, and making most loans without verifying incomes or assets.

By 2007, the Crofton bank's portfolio was packed with loans for undeveloped subdivisions and mortgages on overpriced homes.

The goal, according to the report, was to make the family-owned company sufficiently profitable for a lucrative public stock offering.

The result was different: "When the real estate market it served took a downturn in 2008, Suburban was particularly vulnerable and the losses ultimately led to its demise," the report said.

Suburban Federal was seized by regulators in January and sold to Virginia-based Bank of Essex.

The company was regulated by the Office of Thrift Supervision, the federal agency that oversees banks that specialize in mortgage lending. It is the job of regulators to keep banks from hurting themselves because bank failures have a disproportionate impact on the broader economy, reducing the availability of loans in the surrounding community. The failure of Suburban Federal also cost the Federal Deposit Insurance Corp. an estimated $126 million to repay the bank's depositors.

The inspector general found that OTS examiners identified many of Suburban Federal's problems and ordered changes, but they failed to follow through.

The report notes that the OTS identified accounting problems in 2003 that it ordered the bank to correct. Regulators found the same problems in 2005 and ordered the same corrections. When regulators returned in 2007, they found some of the same problems again. The report says that a senior OTS official opposed penalizing the bank for its repeated failure to make corrections because she viewed such penalties as "more of a punitive measure used to correct attitude problems."

The failure to force changes has emerged as a common theme in the growing number of postmortems about bank failures during the financial crisis. This is the ninth such report by Treasury's inspector general, and many more are in progress. Ninety-two banks have failed this year.

The report also says that the OTS should have required the bank to diversify its lending, limiting the consequences of a downturn in real estate development.

The report noted that an internal review by the OTS had reached similar conclusions, a point echoed by OTS spokesman William Ruberry.

"The inspector general affirmed the findings that the OTS had already made and as the report pointed out, the OTS is acting on those findings," Ruberry said.