WASHINGTON - Federal regulators shut down and took control of $2.3 billion asset Superior Bank FSB in Hinsdale, Ill., on late Friday - the largest failure of an institution in two years and one that could end up costing hundreds of millions of dollars to resolve.

The Office of Thrift Supervision said the institution had become critically undercapitalized because of a host of problems.

"It had poor internal controls, poor risk management, and its lending and accounting practices were improper," said Scott Albinson, managing director of supervision with the OTS, in an interview. "Ultimately, the board and management did not properly oversee the activities of Superior Bank, which was engaging in a high risk business strategy."

Superior’s failure is a surprise to many because the prominent Pritzker family, who own the Hyatt Hotel chain as well as half of the thrift’s holding company, had agreed in May to recapitalize the institution with a $230 million cash investment. New York developer Alvin Dworman, who owned the other 50% of the holding company, had pledged to give another $95.5 million.

They had 60 days to put up the money, but it never materialized, Mr. Albinson said.

"I can’t speak for their rationale but they made a determination not to go forward," he said. "The two families failed to implement the capital plan and we did not receive another written capital plan."

The Pritzker family issued a statement that said they were "disappointed at the outcome and intend to cooperate with the regulators," said Harold S. Handelsman, an attorney for the Pritzker Interests. "The Pritzker Interests have been willing to make additional investments of more than $250 million into Superior Bank… that would give the bank a fighting chance to survive. However, as passive investors, we are not willing to put money down a black hole of uncertain numbers and unknown losses, which appear to be the case."

Although there was no official total for the cost of the resolution, analysts familiar with the bank estimated the cost would be at least $500 million. Superior is the only SAIF-insured institution to fail this year and the largest thrift failure in the past five years, the OTS said. Two small banks have closed already this year.

Regulators cited the bank’s overreliance on residual interests - the interest retained after the securitization and sale of loans. Residuals are a notoriously hard asset type to value and helped cause the 1999 failure of the First National Bank of Keystone in West Virginia, the last comparable failure.

A knowledgeable source said that the Pritzkers had been unwilling to put in the money because the reported value of the residuals had dropped steeply during the past two months.

"Since the Pritzkers submitted their proposal… along with the Dwormans in May, the valuation of the residuals, according to the bank’s own numbers in July, dropped by $232 million," said the source, who spoke on condition of anonymity. The source said that Greenwich Capital, the investment bank financing the deal, estimated the decline at over $500 million, and as a result, "the plan couldn’t possibly have worked because the bank would have been inadequately capitalized by at least several hundred million dollars."

The source added that regulators had turned down an offer Friday from the Pritzkers for an additional $210 million in cash.

Mr. Albinson said that Superior had been marked as a troubled institution one year ago, and that the OTS had worked "intensively" with the bank since then, whose primary focus had been the sale of subprime mortgage and automobile loans in the secondary market.

The Federal Deposit Insurance Corp. announced late Friday that they would take over Superior as a conservatorship, renaming the bank Superior Federal FSB, and reopen its 18 offices on Monday. The last time the FDIC resorted to such a measure was when Brooklyn-based Cross Land Federal Savings Bank failed in 1992. That institution took more than two years to sell its assets, but FDIC officials said they hoped that would not be the case with Superior.

"By transferring operations to New Superior, the FDIC will be better able to effect an orderly resolution with little to no disruption to insured depositors and other customers," said John Reich, acting FDIC Chairman. "Our goal is to have this institution back in private hands before year’s end."

As part of the transaction, the FDIC will provide a $1.5 billion line of credit to New Superior to support continued banking operations.

Some analysts who had been following Superior closely criticized the FDIC’s decision.

"Conservatorship is really stupid," said Bert Ely, an independent consultant. "(The FDIC) was never successful in doing a meaningful rehabilitation - they don’t have the expertise on hand to keep customers and employees."

Mr. Ely estimated that a $500 million loss to the Savings Association Insurance Fund could knock it down by six or more basis points, to less than $1.37 in reserves for every $100 in insured deposits.

But the FDIC said its board had decided the lowest-cost alternative "was to organize a new, strong institution that would operate under" its control.

At the time of closing, the FDIC said that Superior Bank had only $42.9 million of potentially uninsured deposits held by approximately 1,000 depositors - a steep decline from the approximately $250 million it held in those deposits at the end of 2000.

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