With the Bank of Lincolnwood's demise last month, Illinois briefly tied Georgia for the dubious distinction of having the most bank failures this year.

Though Georgia has since regained the lead, Illinois banks are getting shut fast enough for the state to keep pace with others that had massive real estate meltdowns, such as California and Florida.

"It is a surprise in that Illinois isn't thought to have been a major part of the boom-bust cycle that has been the main driver so far behind most of the bank failures," said Matthew Anderson, a partner with the market research firm Foresight Analytics LLC. "The reason we've seen a lot of failures in Georgia and Florida is because they were the main areas for that boom and subsequent bust. You just don't think of Illinois in that same group."

As with the other states, Illinois can attribute some blame to the real estate downturn. But at least three banks there succumbed partly because of their investments.

With fewer lending opportunities in the slow-growing Midwest, some there bought heavily into mortgage-backed securities, which have had a slew of ratings downgrades lately, and the preferred shares of Fannie Mae and Freddie Mac, which became worthless after the government takeover of those entities in the fall.

Observers say more trouble lies ahead, as a growing number of banks in the state are getting caught in a vise, having to contend with deteriorating credit quality while also taking writedowns on the securities they own.

"From what we've seen it looks like some of the people in Illinois are making some big bets on their investment portfolios," said Chip MacDonald, a partner at Jones Day in Atlanta who puts out an analysis of each failure. "I've been startled by the whole thing. I thought people were much more conservative in the Midwest."

This year six banks in Illinois have failed, as have six in California and three in Florida. Georgia has the most failures, tallying nine.

Still, Illinois had as many banks under extreme stress at the end of the first quarter as Georgia, according to a Foresight analysis of data from the Federal Deposit Insurance Corp. The two states led the country in the number of undercapitalized banks, with 17 each.

A handful more have entered into regulatory agreements since the quarter ended.

To be sure, one reason Illinois has so many distressed banks is just the law of numbers. As one of the last states to allow branch banking in the early 1980s, it has more banks than any other state, with 652 institutions headquartered there. Georgia has only half as many.

Another is the typical trouble with construction and development loans.

While Chicago real estate is less battered than Atlanta or Southern California, experts said its far-flung suburbs are struggling with slow home sales.

"A lot of these Chicago area banks got themselves in a lot of trouble by lending in what I call the Inland Empire of Chicago — areas like Joliet, Naperville and Oswego," said Gus Dourdourekas, an independent bank investor. "They lent money to build hundreds of subdivisions out there and I am not sure who is going to buy into them."

That's the case for the $311 million-asset First DuPage Bank in Westmont, which lost $1.3 million in the first quarter and sank to adequately capitalized.

Roughly 38% of its loans were in construction and development, and it classified 16.6% of its loans as noncurrent at March 31.

"At this point, we are a few steps behind the Bank of Lincolnwood," conceded Jeffrey Voss, the president and chief executive officer at First DuPage.

Foresight, of Oakland, Calif., compiles its own list of banks that it sees as either undercapitalized or in danger of becoming so. Of the 371 banks on its list, 42 are in Illinois compared with 55 each in Georgia and Florida and 20 in California.

In analyzing the balance sheets of the problem banks in Illinois, Foresight found that construction loans made up the largest share of nonperformers, 36%.

But Anderson said one difference between Illinois banks and the strugglers in other states is that securities are more of an issue.

At least 17 took hits on their investments during the fourth quarter and 11 did so in the first quarter.

No other state even came close. Florida had the next-highest number of problem banks reporting securities hits, with seven in the fourth quarter and three in the first quarter.

While it is unclear what types of securities are weighing down all the banks, the $431 million-asset National Bank of Commerce in Berkeley failed after writedowns on its Fannie Mae and Freddie Mac shares left it in a negative capital position.

The same investments also hurt the $17 billion-asset FBOP Corp. in Oak Park, which has nine banks in four states.

FBOP took a $936 million loss on its securities portfolio in the fall.

Now at least three of its banks are undercapitalized, including one in Illinois, Community Bank of Lemont. It had a total risk-based capital ratio of 2.83% at the end of the first quarter.

Beyond the securities hit, the Lemont bank is also dealing with staggering credit issues, led primarily by construction loans. More than a third of its assets were nonperforming at March 31.

Calls to FBOP and the Lemont Bank were not returned.

For others, trust-preferred securities are proving problematic.

The $1.4 billion-asset Peotone Bancorp Inc. swung to a $43.3 million loss in the first quarter, from a $3.73 million profit the year earlier, primarily because of losses in its securities portfolio, according to FDIC data.

All four of its bank units — Rock River Bank in Oregon, Peotone Bank and Trust Co. in Peotone, First National Bank of Danville, and Founders Bank in Worth — were undercapitalized at the end of the first quarter.

While some of the banks are having more loan trouble than others, sources familiar with Peotone say that trust-preferreds are a primary stress. The company did not return a call.

The sources say Peotone is affiliated through common ownership with four other banks that also became undercapitalized because of major securities hits in the first quarter, including First State Bank of Winchester.

Chuck Frost, the president and CEO of the $33 million-asset First State, would not comment on Peotone, but said his bank's issues stem primarily from trust-preferreds.

"At the time, they seemed like a good investment, they paid back a good coupon, and now we are looking at possible closure because of them," Frost said. "It is just a sad thing. You buy these assets and they seem fine, but they turned so bad so quickly."

First State lost $2.5 million in the first quarter, compared with earnings of $55,000 the year earlier, after a $1.5 million loss on its securities.

The writedown left the bank with a capital deficit at March 31; its total risk-based capital ratio was negative 4.15%.

Frost said he is negotiating with state regulators and the FDIC on a cease-and-desist order. He is also searching for capital, but so far those efforts have been fruitless.

In addition, the failure of Strategic Capital Bank in Champaign and Citizens National Bank in Macomb was at least partially a result of downgraded collateralized mortgage obligations.

Those two banks shared similar ownership, according to the FDIC, and sources familiar with the banks said two Chicago bankers bought controlling stakes in them in 2006 and then loaded up on brokered deposits, out-of-area loan participations and CMOs.

"Your safety is supposed to be in your securities portfolio. That was those banks' problems," said Benjamin Shapiro, a partner with Belongia Shapiro & Hynes LLP in Chicago. "Your securities portfolio is your source of liquidity, it is not a place to try and turn them into high-earning assets. That's a big risk."

Beneath the leverage, the problem participations and the CMOs was still a good community bank, said Leon Holschbach, the president and CEO of Midland States Bancorp Inc., which acquired Strategic Capital through the FDIC.

"Did something go wrong in Champaign? No," Holschbach said. "The story was not about what is wrong in central Illinois. The story is that big-city investors got their hands on a community bank, and with a highly leveraged portfolio, management ran into a perfect storm."

Some experts contend that while securities have played a role in the problems, they aren't a systemic threat to most Illinois banks. The reason, they say, that half the failures in the state have been at least partially securities related is that regulators might be able to dispose of those banks easier than one with severe loan trouble. So they go for those first.

"I think the FDIC probably finds it easier to locate a buyer for a bank with investment problems," said Rebel Cole, a finance professor at DePaul University in Chicago. "And that is because it is probably easier to put a value on a security than it is find the value in a bunch of construction loans."

Cole pointed to the prompt failure of National Bank of Commerce, while the $7.7 billion-asset Corus Bankshares Inc. in Chicago has been lingering for months as bad condo loans in areas like Florida, Georgia and California pile up. A third of its assets were nonperforming at the end of the first quarter.

"It is interesting to watch who gets closed and who is allowed to continue," Cole said.

Shapiro said it takes less work to clean up an investment portfolio than it does to fix a loan book, so buyers might be more interested in those cases. "Workouts are much, much more resource intensive," Shapiro said.

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