Bank Regulation: Analysis of the Failure of Superior Bank, FSB,  
Hinsdale, Illinois (07-FEB-02, GAO-02-419T).			 
								 
Shortly after Superior Bank's closure on July 27, 2001, the	 
Federal Deposit Insurance Corporation (FDIC) projected that the  
failure would result in a $426-$526 million loss to the deposit  
insurance fund. Superior Bank's business strategy of originating 
and securing subprime loans on a large scale was associated with 
the failure. In addition to the concentration in risky assets,	 
the bank failed to properly value and account for the interests  
that it had retained in pooled home mortgages. Superior's	 
external auditor, Ernst & Young, also failed to detect the	 
improper valuation of Superior's retained interest until the	 
Office of Thrift Supervision (OTS) and FDIC insisted that the	 
issue be reviewed by the auditor's national office. Federal	 
regulators did not identify and act on the bank's problems early 
enough to prevent a material loss to the deposit insurance fund. 
OTS, Superior's primary supervisor, was mainly responsible for	 
not acting earlier. FDIC was the first to recognize the problems 
in late 1998. Both agencies were aware of the substantial	 
concentration of retained interests that Superior held, but the  
apparently high level of earnings, the apparently adequate	 
capital, and the belief that the management was conservatively	 
managing the institution limited their actions. 		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-419T					        
    ACCNO:   A02745						        
  TITLE:     Bank Regulation: Analysis of the Failure of Superior     
Bank, FSB, Hinsdale, Illinois					 
     DATE:   02/07/2002 
  SUBJECT:   Bank failures					 
	     Banking regulation 				 
	     Bank management					 
	     Bank examination					 
	     Losses						 

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GAO-02-419T
     
United States General Accounting Office

GAO Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate

For Release on Delivery
Expected at 10:00 a.m., EDT, BANK REGULATION
Thursday, February 7, 2002

Analysis of the Failure of Superior Bank, FSB, Hinsdale, Illinois

Statement of Thomas J. McCool, Managing Director Financial Markets and
Community Investment

GAO-02-419T

Mr. Chairman and Members of the Committee:

We are pleased to be here to discuss our analysis of the failure of Superior
Bank, FSB, a federally chartered savings bank located outside Chicago, ILL.
Shortly after Superior Bank's closure on July 27, 2001, the Federal Deposit
Insurance Corporation (FDIC) projected that the failure of Superior Bank
would result in a $426 -$526 million loss to the deposit insurance fund.1
The magnitude of the projected loss to the deposit insurance fund resulted
in questions being raised by Congress and industry observers about what went
wrong at Superior, how it happened, and what steps can be taken to reduce
the likelihood of a similar failure.

Our testimony today (1) describes the causes of the failure of Superior
Bank, (2) discusses whether external audits identified problems with
Superior Bank, and (3) evaluates the effectiveness of federal supervision of
Superior, including the coordination between the primary regulator- the
Office of Thrift Supervision (OTS)-and the FDIC. Finally, we discuss the
extent that issues similar to those associated with Superior's failure were
noted in Material Loss Reviews conducted by inspectors general on previous
bank failures.

Our testimony is based on our review of OTS and FDIC files for Superior
Bank, including reports of on-site examinations of the bank and off-site
monitoring and analysis, and interviews with OTS and FDIC officials,
including officials in the Chicago offices who had primary responsibility
for Superior Bank. The scope of our work on the conduct of Superior's
external auditors was limited due to the ongoing investigation and potential
litigation by FDIC and OTS on issues surrounding the failure of Superior
Bank.

1The amount of the expected loss to the insurance fund is still in question.
To settle potential claims, former co-owners of Superior entered into a
settlement with FDIC and OTS in December 2001. The settlement calls for a
payment to FDIC of $460 million, of which $100 million already has been
paid. The remaining $360 million is to be paid over the next 15 years. The
ultimate cost to the insurance fund will be determined by the proceeds that
FDIC obtains from the sale of the failed institution's assets and other
factors.

Summary

The key events leading to the failure of Superior Bank were largely
associated with the business strategy adopted by Superior Bank's management
of originating and securitizing subprime loans on a large scale. This
strategy resulted in rapid growth and a high concentration of extremely
risky assets. Compounding this concentration in risky assets was the failure
of Superior Bank's management to properly value and account for the
interests that it had retained in pooled home mortgages.

Superior Bank generated high levels of "paper profits" that overstated its
capital levels. When federal regulators were finally able to get Superior
Bank to apply proper valuation and reporting practices, Superior Bank became
significantly undercapitalized. When the owners of Superior Bank failed to
contribute additional capital, the regulators were forced to place Superior
into receivership.

Superior's external auditor, Ernst & Young, also failed to detect the
improper valuation of Superior's retained interests until OTS and FDIC
insisted that the issue be reviewed by Ernst & Young's national office. As
noted earlier, FDIC and OTS are investigating the role of the external
auditor in Superior's failure, with an eye to potential litigation.

Federal regulators were clearly not effective in identifying and acting on
the problems at Superior Bank early enough to prevent a material loss to the
deposit insurance fund. OTS, Superior's primary supervisor, bears the main
responsibility for not acting earlier. Superior may not have been a problem
bank back in the mid-1990s, but the risks of its strategy and its exposure
to revaluation of the retained interests merited more careful and earlier
attention. FDIC was the first to recognize the problems in Superior's
financial situation, although the problems had grown by the time that FDIC
recognized them in late 1998.

Both agencies were aware of the substantial concentration of retained
interests that Superior held, but the apparently high level of earnings, the
apparently adequate capital, and the belief that the management was
conservatively managing the institution limited their actions. Earlier
response to the "concerns" expressed in examination reports dating to the
mid-1990s may not have been sufficient to avoid the failure of the bank, but
it likely would have prevented subsequent growth and thus limited the
potential loss to the insurance fund.

Problems in communication between OTS and FDIC appear to have hindered a
coordinated supervisory approach. FDIC has recently announced that it has
reached agreement with the other banking regulators to establish a better
process for determining when FDIC will use its authority to examine an
insured institution. While GAO welcomes improvements in this area, neither
OTS nor FDIC completely followed the policy in force during 1998 and 1999,
when OTS denied FDIC's request to participate in the 1999 examination. Thus,
following through on policy implementation will be as important as the
design of improved policies for involving FDIC in future bank examinations.

Background Superior Bank was formed in 1988 when the Coast-to-Coast
Financial Corporation, a holding company owned equally by the Pritzker and
Dworman families2, acquired Lyons Savings, a troubled federal savings and
loan association. From 1988 to 1992, Superior Bank struggled financially and
relied heavily on an assistance agreement from the Federal Savings and Loan
Insurance Corporation (FSLIC).3 Superior's activities were limited during
the first few years of its operation, but by 1992, most of the bank's
problems were resolved and the effects of the FSLIC agreement had
diminished. OTS, the primary regulator of federally chartered savings
institutions, had the lead responsibility for supervising Superior Bank
while FDIC, with responsibility to protect the deposit insurance fund, acted
as Superior's backup regulator. By 1993, both OTS and FDIC had given
Superior a composite CAMEL "2" rating4 and, at this time, FDIC began to rely
only on off-site monitoring of superior.

2The Pritzkers are the owners of the Hyatt Hotels, and the Dwormans are
prominent New York real estate developers.

3This assistance agreement included capital protection provisions and called
for reimbursement of expenses for collecting certain problem assets, payment
of 22.5 percent of pretax net income to FSLIC, and payment of a portion of
certain recoveries to the FSLIC. (In later years, there was a disagreement
over certain provisions to the assistance agreement and lawsuits were
filed.)

4OTS and the other regulators use the Uniform Financial Institution Rating
System to evaluate a bank's performance. CAMEL is an acronym for the
performance rating components: capital adequacy, asset quality, management
administration, earnings, and liquidity. An additional component,
sensitivity to market risk, was added effective January 1, 1997, resulting
in the acronym CAMELS. Ratings are on a 1 to 5 scale with 1 being the
highest, or best, score and 5 being the lowest, or worst, score.

In 1993, Superior's management began to focus on expanding the bank's
mortgage lending business by acquiring Alliance Funding Company. Superior
adopted Alliance's business strategy of targeting borrowers nationwide with
risky credit profiles, such as high debt ratios and credit histories that
included past delinquencies-a practice known as subprime lending. In a
process known as securitization, Superior then assembled the loans into
pools and sold interest in these pools-such as rights to principal and/or
interest payments-through a trust to investors, primarily in the form of
AAA-rated mortgage securities. To enhance the value of these offerings,
Superior retained the securities with the greatest amount of risk and
provided other significant credit enhancements for the less risky
securities. In 1995, Superior expanded its activities to include the
origination and securitization of subprime automobile loans.

In December 1998, FDIC first raised concerns about Superior's increasing
levels of high-risk, subprime assets and growth in retained or residual
interests. However, it was not until January 2000 that OTS and FDIC
conducted a joint exam and downgraded Superior's CAMELS rating to a "4,"
primarily attributed to the concentration of residual interest holdings. At
the end of 2000, FDIC and OTS noted that the reported values of Superior's
residual interest assets were overstated and that the bank's reporting of
its residual interest assets was not in compliance with the Statement of
Financial Accounting Standards (FAS) No. 125. Prompted by concerns from OTS
and FDIC, Superior eventually made a number of adjustments to its financial
statements. In mid-February 2001, OTS issued a Prompt Corrective Action
(PCA) notice to Superior because the bank was significantly
undercapitalized. On May 24, OTS approved Superior's PCA capital plan.
Ultimately, the plan was never implemented, and OTS closed the bank and
appointed FDIC as Superior's receiver on July 27, 2001. (A detailed
chronology of the events leading up to Superior's failure is provided in
App. I.)

Causes of Superior Primary responsibility for the failure of Superior Bank
resides with its owners and managers. Superior's business strategy of
originating and

Bank's Failure securitizing subprime loans appeared to have led to high
earnings, but more importantly its strategy resulted in a high concentration
of extremely risky assets. This high concentration of risky assets and the
improper valuation of these assets ultimately led to Superior's failure.

Concentration of Risky Assets

In 1993, Superior Bank began to originate and securitize subprime home
mortgages in large volumes. Later, Superior expanded its securitization
activities to include subprime automobile loans. Although the securitization
process moved the subprime loans off its balance sheet, Superior retained
the riskier interests in the proceeds from the pools of securities it
established. Superior's holdings of this retained interest exceeded its
capital levels going as far back as 1995.

Retained or residual interests5 are common in asset securitizations and
often represent steps that the loan originator takes to enhance the quality
of the interests in the pools that are offered for sale. Such enhancements
can be critical to obtaining high credit ratings for the pool's securities.
Often, the originator will retain the riskiest components of the pool, doing
so to make the other components easier to sell. The originator's residual
interests, in general, will represent the rights to cash flows or other
assets after the pool's obligations to other investors have been satisfied.

Overcollateralization assets are another type of residual interest that
Superior held. To decrease risk to investors, the originator may
overcollateralize the securitization trust that holds the assets and is
responsible for paying the investors. An originator can overcollateralize by
selling the rights to $100 in principal payments, for instance, while
putting assets worth $105 into the trust, essentially providing a cushion,
or credit enhancement, to help ensure that the $100 due investors is paid in
event of defaults in the underlying pool of loans (credit losses). The
originator would receive any payments in excess of the $100 interest that
was sold to investors after credit losses are paid from the
overcollateralized portion.

As shown in figure 1, Superior's residual interests represented
approximately 100 percent of tier 1 capital on June 30, 1995.6 By June 30,
2000, residual interest represented 348 percent of tier 1 capital. This
level of concentration was particularly risky given the complexities
associated with achieving a reasonable valuation of residual interests.

5These interests are known as residuals because they receive the last cash
flows from the loans.

6Tier 1 capital consists primarily of tangible equity capital-equity capital
plus cumulative preferred stock (including related surplus)-minus all
intangible assets, except for some amount of purchased mortgage servicing
rights.

Figure 1: Superior's Total Assets, Residuals, and Tier 1 Capital from 1993
to 2000

Note: Data are as of June 30 for each fiscal year shown.

Source: Superior Bank's financial statements and OTS.

Superior's practice of targeting subprime borrowers increased its risk. By
targeting borrowers with low credit quality, Superior was able to originate
loans with interest rates that were higher than market averages. The high
interest rates reflected, at least in part, the relatively high credit risk
associated with these loans. When these loans were then pooled and
securitized, their high interest rates relative to the interest rates paid
on the resulting securities, together with the high valuation of the
retained interest, enabled Superior to record gains on the securitization
transactions that drove its apparently high earnings and high capital. A
significant amount of Superior's revenue was from the sale of loans in

these transactions, yet more cash was going out rather than coming in from
these activities.

In addition to the higher risk of default related to subprime lending, there
was also prepayment risk. Generally, if interest rates decline, a loan
charging an interest rate that is higher than market averages becomes more
valuable to the lender. However, lower interest rates could also trigger
higher than predicted levels of loan prepayment-particularly if the new
lower interest rates enable subprime borrowers to qualify for refinancing at
lower rates. Higher-than-projected prepayments negatively impact the future
flows of interest payments from the underlying loans in a securitized
portfolio.

Additionally, Superior expanded its loan origination and securitization
activities to include automobile loans. The credit risk of automobile loans
is inherently higher than that associated with home mortgages, because these
loans are associated with even higher default and loss rates. Auto loan
underwriting is divided into classes of credit quality (most commonly A, B,
and C). Some 85 percent of Superior Bank's auto loans went to people with B
and C ratings. In Superior's classification system, these borrowers had
experienced credit problems in the past because of unusual circumstances
beyond their control (such as a major illness, job loss, or death in the
family) but had since resolved their credit problems and rebuilt their
credit ratings to a certain extent. As with its mortgage securitizations,
Superior Bank was able to maintain a high spread between the interest rate
of the auto loans and the yield that investors paid for the securities based
on the pooled loans. However, Superior's loss rates on its automobile loans
as of December 31, 1999 were twice as high as Superior's management had
anticipated.

Valuation of Residual Interests

Superior Bank's business strategy rested heavily on the value assigned to
the residual interests that resulted from its securitization activities.
However, the valuation of residual interests is extremely complex and highly
dependent on making accurate assumptions regarding a number of factors.
Superior overvalued its residual interests because it did not discount to
present value the future cash flows that were subject to credit losses. When
these valuations were ultimately adjusted, at the behest of the regulators,
the bank became significantly undercapitalized and eventually failed.

There are significant valuation issues and risks associated with residual
interests. Generally, the residual interest represents the cash flows from

the underlying mortgages that remain after all payments have been made to
the other classes of securities issued by the trust for the pool, and after
the fees and expenses have been paid. As the loan originator, Superior Bank
was considered to be in the "first-loss" position (i.e., Superior would
suffer any credit losses suffered by the pool, before any other investor.)
Credit losses are not the only risks held by the residual interest holder.
The valuation of the residual interest depends critically on how accurately
future interest rates and loan prepayments are forecasted. Market events can
affect the discount rate, prepayment speed, or performance of the underlying
assets in a securitization transaction and can swiftly and dramatically
alter their value.

The Financial Accounting Standards Board (FASB) recognized the need for a
new accounting approach to address innovations and complex developments in
the financial markets, such as the securitization of loans. Under FAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," 7 which became effective after December 31,
1996, when a transferor surrenders control over transferred assets, it
should be accounted for as a sale. The transferor should recognize that any
retained interest in the transferred assets should be reported in its
statement of financial position based on the fair value. The best evidence
of fair value is a quoted market price in an active market, but if there is
no market price, the value must be estimated. In estimating the fair value
of retained interests, valuation techniques include estimating the present
value of expected future cash flows using a discount rate commensurate with
the risks involved. The standard states that those techniques shall
incorporate assumptions that market participants would use in their
estimates of values, future revenues, and future expenses, including
assumptions about interest rates, default, prepayment, and volatility. In
1999, FASB explained that when estimating the fair value for

7FAS No. 140: Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, issued September 2000, replaced FAS No. 125.

Regulators' Concerns About the Quality of the External Audit

retained interests used as a credit enhancement, it should be discounted

8

from the date when it is estimated to become available to the transferor.

Superior Bank did not properly value the residual interest assets it
reported on its financial statements. Since those assets represented
payments that were to be received in the future only after credit losses
were reimbursed, they needed to be discounted at an appropriate
risk-adjusted rate, in order to recognize that a promise to pay in the
future is worth less than a current payment. Superior did not use
discounting when valuing its residual interest related to
overcollateralization. However, as a credit enhancement, the
overcollateralized asset is restricted in use under the trust and not
available to Superior until losses have been paid under the terms of the
credit enhancement. The result was that Superior Bank reported assets,
earnings, and capital that were far in excess of their true values. In
addition, there were other issues with respect to Superior's compliance with
FAS No. 125. When Superior finally applied the appropriate valuation
techniques and related accounting to the residual interests in early 2001,
at the urging of OTS, Superior was forced to take a write-off against its
capital and became "significantly undercapitalized."

Federal regulators now have serious concerns about the quality of Ernst &
Young's audit of Superior Bank's financial statements for the fiscal year
ending June 30, 2000. This audit could have highlighted the problems that
led to Superior Bank's failure but did not. Regulators' major concerns
related to the audit include (1) the inflated valuation of residual interest
in the financial statements and (2) the absence of discussion on Superior's
ability to continue in business in the auditor's report.

The accounting profession plays a vital role in the governance structure for
the banking industry. In addition to bank examinations, independent
certified public accountant audits are performed to express an opinion on
the fairness of bank's financial statements and to report any material

8This concept is reiterated in FASB's A Guide to Implemention of Statement
125 on Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities: Questions and Answers, Issued July 1999 and
revised September 1999. When estimating the fair value of credit
enhancements (retained interest), the transferor's assumptions should
include the period of time that its use of the asset is restricted,
reinvestment income, and potential losses due to uncertainties. One
acceptable valuation technique is the "cash out" method, in which cash flows
are discounted from the date that the credit enhancement becomes available.

weaknesses in internal controls. Auditing standards require public
accountants rendering an opinion on financial statements to consider the
need to disclose conditions that raise a question about an entity's ability
to continue in business. Audits should provide useful information to federal
regulators who oversee the banks, depositors, owners, and the public. When
financial audits are not of the quality that meets auditing standards, this
undermines the governance structure of the banking industry.

Federal regulators believed that Ernst & Young auditors' review of
Superior's valuation of residuals failed to identify the overvaluation of
Superior's residual interests in its fiscal year 2000 financial statements.
Recognizing a significant growth in residual assets, federal regulators
performed a review of Superior's valuation of its residuals for that same
year and found that it was not being properly reported in accordance with
Generally Accepted Accounting Principles (GAAP). The regulators believed the
incorrect valuation of the residuals had resulted in a significant
overstatement of Superior's assets and capital. Although Ernst & Young's
local office disagreed with the regulators findings, Ernst & Young's
national office concurred with the regulators. Subsequently, Superior
revalued these assets resulting in a $270 million write-down of the residual
interest value. As a result, Superior's capital was reduced and Superior
became significantly undercapitalized. OTS took a number of actions, but
ultimately had to close Superior and appoint FDIC as receiver.

An FDIC official stated that Superior had used this improper valuation
technique not only for its June 30, 2000, financial statements, but also for
the years 1995 through 1999. To the extent that was true, Superior's
earnings and capital were likely overstated during those years, as well.
However, in each of those fiscal years, from 1995 through 2000, Superior
received an unqualified, or "clean," opinion from the Ernst & Young
auditors.

In Ernst & Young's audit opinion, there was no disclosure of Superior's
questionable ability to continue as a going concern. Yet, 10 months after
the date of Ernst & Young's audit opinion on September 22, 2000, Superior
Bank was closed and placed into receivership. Auditing standards provide
that the auditor is responsible for evaluating "whether there is a
substantial doubt about the entity's ability to continue as a going concern
for a reasonable period of time." This evaluation should be based on the
auditor's "knowledge of relevant conditions and events that exist at or have
occurred prior to the completion of fieldwork." FDIC officials believe that
the auditors should have known about the potential valuation issues and
should have evaluated the "conditions and events" relating to

Superior's retained interests in securitizations and the subsequent impact
on capital requirements. FDIC officials also believe that the auditors
should have known about the issues at the date of the last audit report, and
there was a sufficient basis for the auditor to determine that there was
"substantial doubt" about Superior's "ability to continue as a going concern
for a reasonable period of time." Because Ernst & Young auditors did not
reach this conclusion in their opinion, FDIC has expressed concerns about
the quality of the audit of Superior's fiscal year 2000 financial
statements.

FDIC has retained legal and forensic accounting assistance to conduct an
investigation into the failure of Superior Bank. This investigation includes
not only an examination of Superior's lending and investment practices but
also a review of the bank's independent auditors, Ernst & Young. It involves
a thorough review of the accounting firm's audit of the bank's financial
statements and role as a consultant and advisor to Superior on valuation
issues. The major accounting and auditing issues in this review will include
(1) an evaluation of the over-collateralized assets valuation as well as
other residual assets, (2) whether "going concern" issues should have been
raised had Superior Bank's financials been correctly stated, and (3) an
evaluation of both the qualifications and independence of the accounting
firm. The target date for the final report from the forensic auditor is May
1, 2002. OTS officials told us that they have opened a formal investigation
regarding Superior's failure and have issued subpoenas to Ernst & Young,
among others.

Our review of OTS's supervision of Superior Bank found that the regulator
had information, going back to the mid-1990s, that indicated supervisory
concerns with Superior Bank's substantial retained interests in securitized,
subprime home mortgages and recognition that the bank's soundness depended
critically on the valuation of these interests. However, the high apparent
earnings of the bank, its apparently adequate capital levels, and
supervisory expectations that the ownership of the bank would provide
adequate support in the event of problems appear to have combined to delay
effective enforcement actions. Problems with communication and coordination
between OTS and FDIC also created a delay in supervisory response after FDIC
raised serious questions about the operations of Superior. By the time that
the PCA directive was issued in February 2001, Superior's failure was
probably inevitable.

Effectiveness of OTS and FDIC Supervision of Superior Bank

Weaknesses in OTS's
Oversight of Superior

As Superior's primary regulator, OTS had the lead responsibility for
monitoring the bank's safety and soundness. Although OTS identified many of
the risks associated with Superior's business strategy as early as 1993, it
did not exercise sufficient professional skepticism with respect to the "red
flags" it identified with regards to Superior's securitization activities.
Consequently, OTS did not fully recognize the risk profile of the bank and
thus did not address the magnitude of the bank's problems in a timely
manner. Specifically:

* OTS's assessment of Superior's risk profile was clouded by the bank's
apparent strong operating performance and higher-than-peer leverage capital;

* OTS relied heavily on management's expertise and assurances; and

* OTS relied on the external audit reports without evaluating the quality of
the external auditors' review of Superior's securitization activities.

OTS's Supervision of Superior was Influenced by its Apparent High Earnings
and Capital Levels

OTS's ratings of Superior from 1993 through 1999 appeared to have been
heavily influenced by Superior's apparent high earnings and capital levels.
Beginning in 1993, OTS had information showing that Superior was engaging in
activities that were riskier than those of most other thrifts and merited
close monitoring. Although neither subprime lending nor securitization is an
inherently unsafe or unsound activity, both entail risks that bank
management must manage and its regulator must consider in its examination
and supervisory activities. While OTS examiners viewed Superior Bank's high
earnings as a source of strength, a large portion of these earnings
represented estimated payments due sometime in the future and thus were not
realized. These high earnings were also indicators of the riskiness of the
underlying assets and business strategy. Moreover, Superior had a higher
concentration of residual interest assets than any other thrift under OTS's
supervision. However, OTS did not take supervisory action to limit
Superior's securitization activities until after the 2000 examination.

According to OTS's Regulatory Handbook, greater regulatory attention is
required when asset concentrations exceed 25 percent of a thrift's core
capital.9 As previously discussed, Superior's concentration in residual
interest securities equaled 100 percent of tier 1 capital in June 30, 1995
and grew to 348 percent of tier 1 capital in June 30, 2000. However, OTS's

9Section 211, Asset  Quality -Loan Portfolio Diversification, OTS Regulatory
Handbook, January 1994.

examination reports during this period reflected an optimistic understanding
of the implications for Superior Bank. The examination reports consistently
noted that the risks associated with such lending and related residual
interest securities were balanced by Superior's strong earnings,
higher-than-peer leverage capital, and substantial reserves for loan losses.
OTS examiners did not question whether the ongoing trend of high growth and
concentrations in subprime loans and residual interest securities was a
prudent strategy for the bank. Consequently, the CAMELS ratings did not
accurately reflect the conditions of those components.

Superior's business strategy as a lender to high-risk borrowers was clearly
visible in data that OTS prepared comparing it to other thrifts of
comparable size. Superior's ratio of nonperforming assets to total assets in
December 1998 was 233 percent higher than the peer group's median. Another
indicator of risk was the interest rate on the mortgages that Superior had
made with a higher rate indicating a riskier borrower. In 1999, over 39
percent of Superior's mortgages carried interest rates of 11 percent or
higher. Among Superior's peer group, less than 1 percent of all mortgages
had interest rates that high.

OTS's 1997 examination report for Superior Bank illustrated the influence of
Superior's high earnings on the regulator's assessment. The 1997 examination
report noted that Superior's earnings were very strong and exceeded industry
averages. The report stated that the earnings were largely the result of
large imputed gains from the sale of loans with high interest rates and had
not been realized on a cash flow basis. Furthermore, the report recognized
that changes in prepayment assumptions could negatively impact the
realization of the gains previously recognized. Despite the recognition of
the dependence of Superior's earnings on critical assumptions regarding
prepayment and actual loss rates, OTS gave Superior Bank the highest
composite CAMELS rating, as well as the highest rating for four of the six
CAMELS components-asset quality, management, earnings, and sensitivity to
market risk-at the conclusion of its 1997 examination.

OTS Relied on Superior's OTS consistently assumed that Superior's management
had the necessary

Management and Owners expertise to safely manage the complexities of
Superior's securitization activities. In addition, OTS relied on Superior's
management to take the necessary corrective actions to address the
deficiencies that had been identified by OTS examiners. Moreover, OTS
expected the owners of Superior' to come to the bank's financial rescue if
necessary. These critical assumptions by OTS ultimately proved erroneous.

From 1993 through 1999, OTS appeared to have had confidence in Superior's
management's ability to safely manage and control the risks associated with
its highly sophisticated securitization activities. As an illustration of
OTS reliance on Superior's management assurances, OTS examiners brought to
management's attention in the 1997 and 1999 examinations that underlying
mortgage pools had prepayment rates exceeding those used in the revaluation.
OTS examiners accepted management's response that the prepayment rates
observed on those subpools were abnormally high when compared with
historical experience, and that they believed sufficient valuation
allowances had been established on the residuals to prevent any significant
changes to capital. It was not until the 2000 examination, when OTS
examiners demanded supporting documentation concerning residual interests,
that they were surprised to learn that such documentation was not always
available. OTS's optimistic assessment of the capability of Superior's
management continued through 1999. For example, OTS noted in its 1999
examination report that the weaknesses it had detected during the
examination were well within the board of directors' and management's
capabilities to correct.

OTS relied on Superior Bank's management and board of directors to take the
necessary corrective action to address the numerous deficiencies OTS
examiners identified during the 1993 through 1999 examinations. However,
many of the deficiencies remained uncorrected even after repeated
examinations. For example, OTS expressed concerns in its 1994 and 1995
examinations about the improper inclusion of reserves for the residual
interest assets in the Allowance for Loan and Lease Losses. This practice
had the net effect of overstating the institution's total capital ratio. OTS
apparently relied on management's assurances that they would take the
appropriate corrective action, because this issue was not discussed in OTS's
1996, 1997, or 1999 examination reports. However, OTS discovered in its 2000
examination that Superior Bank had not taken the agreed-upon corrective
action, but in fact had continued the practice. Similarly, OTS found in both
its 1997 and 1999 examinations that Superior was underreporting classified
or troubled loans in its Thrift Financial Reports (TFR). In the 1997
examination, OTS found that not all classified assets were reported in the
TFR and obtained management's agreement to ensure the accuracy of subsequent
reports. In the 1999 examination, however, OTS found that $43.7 million in
troubled assets had been shown as repossessions on the most recent TFR,
although a significant portion of these assets were accorded a "loss"
classification in internal reports. As a result, actual repossessions were
only $8.4 million. OTS conducted a special field visit to examine the auto
loan operations in October 1999, but

OTS Placed Undue Reliance on the External Auditors

the review focused on the classification aspect rather than the fact that
management had not been very conservative in charging-off problem auto
credits, as FDIC had pointed out.

OTS also appeared to have assumed that the wealthy owners of Superior Bank
would come to the bank's financial rescue when needed. The 2000 examination
report demonstrated OTS's attitude towards its supervision of Superior by
stating that failure was not likely due to the institution's overall
strength and financial capacity and the support of the two ownership
interests comprised of the Alvin Dworman and Jay Pritzker families.

OTS's assumptions about the willingness of Superior's owners not to allow
the institution to fail were ultimately proven false during the 2001
negotiations to recapitalize the institution. As a result, the institution
was placed into receivership.

OTS also relied on the external auditors and others who were reporting
satisfaction with Superior's valuation method. In previous reports, GAO has
supported having examiners place greater reliance on the work of external
auditors in order to enhance supervisory monitoring of banks. Some
regulatory officials have said that examiners may be able to use external
auditors' work to eliminate certain examination procedures from their
examinations-for example, verification or confirmation of the existence and
valuation of institution assets such as loans, derivative transactions, and
accounts receivable. The officials further said that external auditors
perform these verifications or confirmations routinely as a part of their
financial statement audits. But examiners rarely perform such verifications
because they are costly and time consuming.

GAO continues to believe that examiners should use external auditors' work
to enhance the efficiency of examinations. However, this reliance should be
predicated on the examiners' obtaining reasonable assurance that the audits
have been performed in a quality manner and in accordance with professional
standards. OTS's Regulatory Handbook recognizes the limitations of
examiners' reliance on external auditors,10 noting that examiners "may" rely
on an external auditor's findings in low-risk areas. However, examiners are
expected to conduct more in-depth reviews of the external auditor's work in
high-risk areas. The handbook also suggests

10Section 350, Independent Audit, OTS Regulatory Handbook, January 1994.

that a review of the auditor's workpapers documenting the assumptions and
methodologies used by the institution to value key assets could assist
examiners in performing their examinations.

In the case of Superior Bank, the external auditor, Ernst & Young, one of
the "Big Five" accounting firms,11 provided unqualified opinions on the
bank's financial statements for years. In a January 2000 meeting with
Superior Bank's Audit Committee to report the audit results for the fiscal
year ending June 30, 1999, Ernst & Young noted that "after running their own
model to test the Bank's model, Ernst & Young believes that the overall book
values of financial receivables as recorded by the Bank are reasonable
considering the Bank's overall conservative assumptions and methods." Not
only did Ernst & Young not detect the overvaluation of Superior's residual
interests, the firm explicitly supported an incorrect valuation until, at
the insistence of the regulators, the Ernst &Young office that had conducted
the audit sought a review of its position on the valuation by its national
office. Ultimately, it was the incorrect valuation of these assets that led
to the failure of Superior Bank. Although the regulators recognized this
problem before Ernst & Young, they did not do so until the problem was so
severe that the bank's failure was inevitable.

Although FDIC Was First to Raise Concerns About Superior, Problems Could
Have Been Detected Sooner

FDIC raised serious concerns about Superior's operations at the end of 1998
based on its off-site monitoring and asked that an FDIC examiner participate
in the examination of the bank that was scheduled to start in January 1999.
At that time, OTS rated the institution a composite "1." Although FDIC's
1998 off-site analysis began the identification of the problems that led to
Superior's failure, FDIC had conducted similar off-site monitoring in
previous years that did not raise concerns.

During the late 1980s and early 1990s, FDIC examined Superior Bank several
times because it was operating under an assistance agreement with FSLIC.
However, once Superior's condition stabilized and its composite rating was
upgraded to a "2" in 1993, FDIC's review was limited to off-site monitoring.
In 1995, 1996, and 1997, FDIC reviewed the annual OTS examinations and other
material, including the bank's supervisory filings and audited financial
statements. Although FDIC's internal reports noted

11The "Big Five" accounting firms are Andersen LLP, Deloitte & Touche LLP,
Ernst & Young LLP, KPMG LLP, and PricewaterhouseCoopers LLP.

that Superior's holdings of residual assets exceeded its capital, they did
not identify these holdings as concerns.

FDIC's interest in Superior Bank was heightened in December 1998 when it
conducted an off-site review, based on September 30, 1998 financial
information. During this review, FDIC noted-with alarm-that Superior Bank
exhibited a high-risk asset structure. Specifically, the review noted that
Superior had significant investments in the residual values of securitized
loans. These investments, by then, were equal to roughly 150 percent of its
tier 1 capital. The review also noted that significant reporting differences
existed between the bank's audit report and its quarterly financial
statement to regulators, that the bank was a subprime lender, and had
substantial off-balance sheet recourse exposure.

As noted earlier, however, the bank's residual assets had been over 100
percent of capital since 1995. FDIC had been aware of this high
concentration and had noted it in the summary analyses of examination
reports that it completed during off-site monitoring, but FDIC did not
initiate any additional off-site activities or raise any concerns to OTS
until after a 1998 off-site review that it performed. Although current
guidance would have imposed limits at 25 percent, there was no explicit
direction to the bank's examiners or analysts on safe limits for residual
assets. However, Superior was clearly an outlier, with holdings
substantially greater than peer group banks.

In early 1999, FDIC's additional off-site monitoring and review of OTS's
January 1999 examination report-in which OTS rated Superior a "2"- generated
additional concerns. As a result, FDIC officially downgraded the bank to a
composite "3" in May 1999, triggering higher deposit insurance premiums
under the risk-related premium system. According to FDIC and OTS officials,
FDIC participated fully in the oversight of Superior after this point.

Poor OTS-FDIC Communication between OTS and FDIC related to Superior Bank
was a Communication Hindered problem. Although the agencies worked together
effectively on a Coordinated Supervisory enforcement actions (discussed
below), poor communication seems to Strategy have hindered coordination of
supervisory strategies for the bank.

The policy regarding FDIC's participation in examinations led by other
federal supervisory agencies was based on the "anticipated benefit to FDIC
in its deposit insurer role and risk of failure the involved institution
poses to the insurance fund."12 This policy stated that any back-up
examination activities must be "consistent with FDIC's prior commitments to
reduce costs to the industry, reduce burden, and eliminate duplication of
efforts."

In 1995, OTS delegated to its regional directors the authority to approve
requests by FDIC to participate in OTS examinations. 13 The memorandum from
OTS headquarters to the regional directors on the FDIC participation process
states that:

"The FDIC's written request should demonstrate that the institution
represents a potential or likely failure within a one year time frame, or
that there is a basis for believing that the institution represents a
greater than normal risk to the insurance fund and data available from other
sources is insufficient to assess that risk."

As testimony before this committee last fall documented, FDIC's off-site
review in 1998 was the first time that serious questions had been raised
about Superior Bank's strategy and finances. As FDIC Director John Reich
testified,

"The FDIC's off-site review noted significant reporting differences between
the bank's audit

report and its quarterly financial statement to regulators, increasing
levels of high-risk, subprime assets, and growth in retained interests and
mortgage servicing assets."14

Because of these concerns, FDIC regional staff called OTS regional staff and
discussed having an FDIC examiner participate in the January 1999

12Each federal banking agency is responsible for conducting examinations of
the depository institutions under its jurisdiction. FDIC is the federal
banking regulator responsible for examining federally insured
state-chartered banks that are not members of the Federal Reserve System. In
addition, FDIC may conduct a special examination of any insured depository
institution whenever the FDIC's Board of Directors decides that the
examination is necessary to determine the condition of the institution for
insurance purposes. 12 U.S.C. sect.1820(b) (2000).

13OTS Memorandum to Regional Directors from John F. Downey, Director of
Supervision, Regarding FDIC Participation on Examinations, April 5, 1995.

14Statement of John Reich, Acting Director, Federal Deposit Insurance
Corporation, on the Failure of Superior Bank, FSB, before the Committee on
Banking, Housing, and Urban Affairs, U.S. Senate, September 11, 2001.

examination of Superior Bank. OTS officials, according to internal e-mails,
were unsure it they should agree to FDIC's participation. Ongoing litigation
between FDIC and Superior and concern that Superior's "poor opinion" of FDIC
would "jeopardize [OTS's] working relationship" with Superior were among the
concerns expressed in the e-mails. OTS decided to wait for a formal, written
FDIC request to see if it "convey[ed] a good reason" for wanting to join in
the OTS examination.

OTS and FDIC disagree on what happened next. FDIC officials told us that
they sent a formal request to the OTS regional office asking that one
examiner participate in the next scheduled examination but did not receive
any response. OTS officials told us that they never received any formal
request. FDIC files do contain a letter, but there is no way to determine if
it was sent or lost in transit. This letter, dated December 28, 1998, noted
areas of concern as well as an acknowledgment that Superior's management was
well regarded, and that the bank was extremely profitable and considered to
be "well-capitalized."

OTS did not allow FDIC to join their exam, but did allow its examiners to
review work papers prepared by OTS examiners. Again, the two agencies
disagree on the effectiveness of this approach. FDIC's regional staff has
noted that in their view this arrangement was not satisfactory, since their
access to the workpapers was not sufficiently timely to enable them to
understand Superior's operations. OTS officials told us that FDIC did not
express any concerns with the arrangement and were surprised to receive a
draft memorandum from FDIC's regional office proposing that Superior's
composite rating be lowered to a "3," in contrast to the OTS region's
proposed rating of "2."

However, by September 1999, the two agencies had agreed that FDIC would
participate in the next examination, scheduled for January 2000.

In the aftermath of Superior's failure and the earlier failure of Keystone
National Bank, both OTS and FDIC have participated in an interagency process
to clarify FDIC's role, responsibility, and authority to participate in
examinations as the "backup" regulator. In both bank failures, FDIC had
asked to participate in examinations, but the lead regulatory agency (OTS in
the case of Superior and the Office of the Comptroller of the Currency in
the case of Keystone) denied the request. On January 29, 2002, FDIC
announced an interagency agreement that gives it more authority to enter
banks supervised by other regulators.

While this interagency effort should lead to a clearer understanding among
the federal bank supervisory agencies about FDIC's participation in the
examinations of and supervisory actions taken at open banks, it is important
to recognize that at the time that FDIC asked to join in the 1999
examination of Superior Bank, there were policies in place that should have
guided its request and OTS's decision on FDIC's participation. As such, how
the new procedures are implemented is a critical issue. Ultimately,
coordination and cooperation among federal bank supervisors depend on
communication among these agencies, and miscommunication plagued OTS and
FDIC at a time when the two agencies were just beginning to recognize the
problems that they confronted at Superior Bank.

The Effectiveness of Enforcement Actions Was Limited

As a consequence of the delayed recognition of problems at Superior Bank,
enforcement actions were not successful in containing the loss to the
deposit insurance fund. Once the problems at Superior Bank had been
identified, OTS took a number of formal enforcement actions against Superior
Bank starting on July 5, 2000. These actions included a PCA directive.

There is no way to know if earlier detection of the problems at Superior
Bank, particularly the incorrect valuation of the residual assets, would
have prevented the bank's ultimate failure. However, earlier detection would
likely have triggered enforcement actions that could have limited Superior's
growth and asset concentration and, as a result, the magnitude of the loss
to the insurance fund.

Table 2 describes the formal enforcement actions. (Informal enforcement
actions before July 2000 included identifying "actions requiring board
attention" in the examination reports, including the report dated Jan. 24,
2000.) The first action, the "Part 570 Safety and Soundness Action,"15
followed the completion of an on-site examination that began in January
2000, with FDIC participation. That formally notified Superior's Board of
Directors of deficiencies and required that the board take several actions,
including:

* developing procedures to analyze the valuation of the bank's residual
interests, including obtaining periodic independent valuations;

1512 C.F.R. Part 570.

* developing a plan to reduce the level of residual interests to 100 percent
of the bank's Tier 1 or core capital within 1 year;

* addressing issues regarding the bank's automobile loan program; and

* revising the bank's policy for allowances for loan losses and maintaining
adequate allowances.

On July 7, 2000, OTS also officially notified Superior that it had been
designated a "problem institution." This designation placed restrictions on
the institution, including on asset growth. Superior Bank submitted a
compliance plan, as required, on August 4, 2000.16 Due to the amount of time
that Superior and OTS took in negotiating the actions required, this plan
was never implemented, but it did serve to get Superior to cease its
securitization activities.

   Table 1: Enforcement Actions Taken by OTS Against Superior Bank or its
   Holding Companies Key provisions of the action Date Type of enforcement
                                   action

  July 5, 2000    Part 570 Safety and Soundness   Develop and implement a compliance
                                                  plan to limit
                                                         asset concentration in residual
                                                               interests to 100 percent
                                                             of core capital.
  February 12,   Prompt Corrective Action Notice     Develop a capital plan by March 14,
      2001                                                            2001, intended to
                                                  bring capital up to the adequately
                                                  capitalized level.
  February 14,       Prompt Corrective Action     Prohibit asset growth and require
      2001                  Directive             weekly sales of all
                                                   loans originated during the previous
                                                                  week.
  February 14,  Consent Orders to Cease and
      2001      Desist for Affirmative

  Relief Implement modifications to the loan purchases between the holding
                          companies and Superior.

February 14, 2001 Consent Orders to Cease and Desist for Affirmative Relief

Require holding companies to establish escrow accounts at Superior Bank and
deposit sums equal to two times the aggregate amount of any loss reasonably
projected on the sale of all loans originated.

May 24, 2001 Prompt Corrective Action Directive Requires Superior to
increase its capital-condition imposed in writing in connection with the
approval of its capital plan.

May 24, 2001 Stipulation and Consent to Individual Minimum Capital

                                Requirement

Modify capital requirements to allow Superior to hold less capital than
established under Prompt Corrective Action.

Source: OTS.

While Superior and OTS were negotiating over the Part 570 plan, Superior
adjusted the value of its residual interests with a $270 million write-down.
This, in turn, led to the bank's capital level falling to the "significantly

16In response to OTS requests on September 1 and October 27, 2000,
Superior's board provided additional information on September 29 and
November 13, 2000.

undercapitalized" category, triggering a PCA directive that OTS issued on
February 14, 2001.17

The PCA directive required the bank to submit a capital restoration plan by
March 14, 2001.18 Superior Bank, now with new management, submitted a plan
on that date, that, after several amendments (detailed in the chronology in
app. I), OTS accepted on May 24, 2001. That plan called for reducing the
bank's exposure to its residual interests and recapitalizing the bank with a
$270 million infusion from the owners. On July16, 2001, however, the
Pritzker interests, one of the two ultimate owners of Superior Bank, advised
OTS that they did not believe that the capital plan would work and therefore
withdrew their support. When efforts to change their position failed, OTS
appointed FDIC as conservator and receiver of Superior.

Although a PCA directive was issued when the bank became "significantly
undercapitalized," losses to the deposit insurance fund were still
substantial. The reasons for this are related to the design of PCA itself.
First, under PCA, capital is a key factor in determining an institution's
condition. Superior's capital did not fall to the "significantly
undercapitalized" level until it corrected its flawed valuation of its
residual interests. Incorrect financial reporting, such as was the case with
Superior Bank, will limit the effectiveness of PCA because such reporting
limits the regulators' ability to accurately measure capital.

Second, PCA's current test for "critically undercapitalized," is based on
the tangible equity capital ratio, which does not use a risk-based capital
measure. Thus it only includes on-balance sheet assets and does not fully
encompass off-balance sheet risks, such as those presented in an
institution's securitization activities. Therefore, an institution might
become undercapitalized using the risk-based capital ratio but would not
fall into the "critically undercapitalized" PCA category under the current
capital measure.

17Section 38 of the Federal Deposit Insurance Act authorizes PCA directives
when a bank's capital falls below defined levels. In an effort to resolve a
bank's problems at the least cost to the insurance fund, Section 38 provides
that supervisory actions be taken and certain mandatory restrictions be
imposed on the bank. (12 U.S.C. sect.1831o)

18On February 14, 2001, OTS also issued two consent orders against
Superior's holding companies.

Finally, as GAO has previously reported, capital is a lagging indicator,
since an institution's capital does not typically begin to decline until it
has experienced substantial deterioration in other components of its
operations and finances. As noted by OTS in its comments on our 1996 report:

"PCA is tied to capital levels and capital is a lagging indicator of
financial problems. It is

important that regulators continue to use other supervisory and enforcement
tools, to stop

unsafe and unsound practices before they result in losses, reduced capital
levels, or failure."19

Further, PCA implicitly contemplates that a bank's deteriorating condition
and capital would take place over time. In some cases, problems materialize
rapidly, or as in Superior's case, long-developing problems are identified
suddenly. In such cases, PCA's requirements for a bank plan to address the
problems can potentially delay other more effective actions.

It is worth noting that while Section 38 uses capital as a key factor in
determining an institution's condition, Section 39 gives federal regulators
the authority to establish safety and soundness related management and
operational standards that do not rely on capital, but could be used to
bring corrective actions before problems reach the capital account.

Similar Problems had The failure of Superior Bank illustrates the possible
consequences when Occurred in Some banking supervisors do not recognize that
a bank has a particularly Previous Bank Failures complex and risky
portfolio. Several other recent failures provide a

warning that the problems seen in the examination and supervision of
Superior Bank can exist elsewhere. Three other banks, BestBank, Keystone
Bank, and Pacific Thrift and Loan (PTL), failed and had characteristics that
were similar in important aspects to Superior. These failures involved FDIC
(PTL and BestBank) and the Office of the Comptroller of the Currency
(Keystone).

19Bank  and Thrift Regulation: Implementation  of FDICIA's Prompt Regulatory
Action Provisions, Nov. 1996, GAO/GGD-97-18, page 71.

BestBank was a Colorado bank that closed in 1998, costing the insurance fund
approximately $172 million. Like Superior, it had a business strategy to
target subprime borrowers, who had high delinquency rates. BestBank in turn
reported substantial gains from these transactions in the form of fee
income. The bank had to close because it falsified its accounting records
regarding delinquency rates and subsequently was unable to absorb the
estimated losses from these delinquencies.

Keystone, a West Virginia bank, failed in 1999, costing the insurance fund
approximately $800 million. While fraud committed by the bank management was
the most important cause of its failure, Keystone's business strategy was
similar to Superior's and led to some similar problems. In 1993, Keystone
began purchasing and securitizing Federal Housing Authority Title I Home
Improvement Loans that were originated throughout the country. These
subprime loans targeted highly leveraged borrowers with little or no
collateral. The securitization of subprime loans became Keystone's main line
of business and contributed greatly to its apparent profitability. The
examiners, however, found that Keystone did not record its residual
interests in these securitizations until September 1997, several months
after FAS No. 125 took effect. Furthermore, examiners found the residual
valuation model deficient, and Keystone had an unsafe concentration of
mortgage products.

PTL was a California bank that failed in 1999, costing the insurance fund
approximately $52 million. Like Superior Bank, PTL entered the
securitization market by originating loans for sale to third-party
securitizing entities. While PTL enjoyed high asset and capital growth
rates, valuation was an issue. Also, similar to Superior Bank, the examiners
over-relied on external auditors in the PTL case. According to the material
loss review, Ernst & Young, PTL's accountant, used assumptions that were
unsupported and optimistic.

Appendix I: Summary of Key Events Associated with the Failure of Superior
Bank

An abbreviated chronology of key events is described in table 1 below. Some
details have been left out to simplify what is a more complicated story.
Readers should also keep in mind that ongoing investigations are likely to
provide additional details at a later date.

 Table 1: Summary of Key Events Associated with the Failure of Superior Bank
                                 Date Event

December 1988 Superior Bank was formed through the acquisition of Lyons
Savings. The Pritzker and Dworman families purchase troubled Lyons Saving in
a Federal Savings and Loan Insurance Corporation (FSLIC) assisted
transaction.

1989 -1997 The Office of Thrift Supervision (OTS) rated Superior Bank a
composite "3" in 1989 and upgraded it to a "2" in 1991. OTS' rating stayed
at that level until it was upgraded to a "1" in 1997. The Federal Deposit
Insurance Corporation (FDIC) performed concurrent examinations of Superior
and gradually upgraded Superior's composite rating from a "4" in 1990 to a
"3" in 1991 and 1992 and to "2" in 1993. When Superior's condition
stabilized in 1993, FDIC began relying primarily on off-site monitoring.

June 1992 Superior payed its first dividend, $1.5 million in cash, to its
holding company, Coast-to-Coast Financial Holdings. The dividend represented
78 percent of net earnings for the fiscal year ending June 30, 1992. From
1992 through 2000, Superior paid out approximately $200.8 million in
dividends ($169.7 million in cash and $31.1 million in financial
receivables) to its holding companies.

December 1992 Superior Bank acquired Alliance Funding Company, a large-scale
mortgage banking company. Alliance Funding Company's focus was on low credit
quality home equity (subprime) lending, which became the core of Superior
Bank's operations.

March 1993 Superior Bank executed its first securitization of subprime
mortgage loans for the secondary market and began booking residual interests
on its balance sheet.

July 1993 OTS examination identified concerns with Superior's mortgage
banking operations, including increasing levels of excess mortgage servicing
rights which had a higher level of risk than traditional investments and
non-conforming loans involve a higher level of risk than traditional
lending.

June 1994 OTS examination reported that Superior's mortgage banking
operation, and the continued investment in the residual interests originated
by Superior, exposed the institution to a somewhat greater risk than normal.

1995 Superior created an auto lending division with plans to securitize and
sell the loans in a manner similar to the mortgage loans.

October 1995 OTS examination disclosed a potential concern with the level of
residual interests in Superior's inventory. As of June 30, 1995, residual
interests comprised 100 percent of core capital.

October 1995 OTS examination disclosed that a $2.6 million reserve
established to protect the residual interests from the changing business
cycle was improperly counted toward risk-based capital. OTS Regulatory Plan
noted that the removal of this reserve from the capital calculation could
result in Superior Bank's falling below the threshold for well-capitalized
institutions.

December 1995 OTS Regulatory Plan noted that residual interests totaled $108
million representing roughly 142 percent of core capital as of December 31,
1995. The regulatory plan stated that this concentration posed a risk to
capital since accelerated repayment of the underlying loans-due to a
downward movement of interest rates or other reasons-would cause a downward
valuation of the residual interests.

October 1996 OTS examination concluded that the residual interests were
adequately valued.

October 1997 OTS examination of Superior upgraded the composite rating to a
"1". The Report of Examination noted that this review disclosed no concerns
with management's calculations on the gains from the sale of loans and the
resulting imputed financial receivables.

September 1998 FDIC performs an off-site review of Superior Bank using the
Thrift Financial Reports and the audited financial statements as of June 30,
1998. FDIC concluded that (1) while Superior had not been identified as a
"subprime" lender in the past, interest rates exhibited by its current
held-for-sale loan portfolio were characteristic of such portfolios; (2)
Superior exhibited a high-risk asset structure due to its significant
investments in the residual values of the securitization of loans and held
for sale loans that exhibited interest rates that were substantially higher
than peer; and (3) Superior had substantial recourse exposure in loans
"sold" through its securitization program.

Date Event

December 1998 FDIC wrote a request to the OTS regional director requesting
FDIC participation in the upcoming January 1999 OTS examination. The letter
stated the key findings of the off-site review and requested FDIC's
participation in the upcoming exam "to better understand the potential risk
Superior's operations may represent to the FDIC insurance fund."

January 1999 OTS regional director and assistant regional director verbally
denied FDIC's request to participate in the exam. Their rationale was that
Superior was rated a composite "1" at its last examination and it was not
the regular practice of FDIC to participate in OTS exams of thrifts with
such ratings. In addition, they raised concerns over possible negative
perceptions an on-site FDIC presence might cause due to litigation between
Superior and FDIC.

March 1999 OTS completed safety and soundness examination and downgraded
Superior to a composite rating of "2." The Report of Examination identified
two items requiring action by Superior's Board of Directors. The first item
involved problems with the asset classification and the allowance for loans
and lease losses. The second item involved the need to establish adequate
procedures to analyze the ongoing value of the financial receivables and
servicing rights related to auto loans and that the book value of these
assets be adjusted in accordance with FAS 125. The exam also concluded that
the valuations of the residual interests, which represented 167 percent of
tangible capital as of December 31, 1998, were reasonable.

May 1999 FDIC lowered Superior's composite rating to a "3" on the basis of
off-site monitoring and the OTS 1999 examination. In June 1999, FDIC sent a
memorandum to the OTS regional director stating that a composite rating of
"3" was more appropriate and reflective of the overall risk inherent in
Superior. The memorandum stated that "off-site analysis of the following
conditions and ongoing trends lead us to believe that Superior's current
risk profile is unacceptably high relative to the protection offered by its
capital position. Some of these trends and conditions include:

(a) high growth/concentrations in residual value mortgage securities and
loan servicing assets;
(b) substantial growth/concentrations in high-coupon (about 250 basis points
higher than peer) mortgage loans
sold with recourse;
(c) substantial concentrations in "high-coupon" on-balance sheet mortgage
loans;

(d) explosive growth in high coupon (900 basis points more than peer) auto
loans that has resulted in a
concentration exceeding T1 capital;

(e) an increase in repossessed assets (mostly autos) to about 20% of T1
capital, with the majority classified
doubtful or loss by the OTS; and unusual regulatory reporting that reflects
residual securities reserves in the
general ALLL."

September 1999 FDIC sent a formal request to OTS requesting participation in
the 2000 examination. FDIC received written concurrence from OTS on
September 24, 1999.

October 1999 OTS conducted a field visit to review the 1999 examination
findings of deficiencies in management reporting of classified assets and
the apparent continued reporting deficiencies in two subsequent regulatory
reports.

May 2000 OTS and FDIC completed a joint exam of Superior (as of 1/24/00) and
assigned a composite rating of "4." The exam described the need for a number
of corrective actions including the need for Superior to obtain an
"independent valuation of the financial receivables related to the 1998-1
and 1999-1 securitizations from a third party source in order to validate
the results produced by the internal model."

July 2000 OTS issued a Notice of Deficiency and Requirements for Submission
of a Part 570 Safety and Soundness Compliance Plan letter to Superior Bank.
Superior was required to submit an acceptable Safety and Soundness
Compliance Plan (Corrective Plan) by August 4, 2000. Among other things, the
corrective plan was to provide for the development and implementation of
procedures for analyzing the fair market value of the residual interests and
auto financial receivables and adjusting the book value of these assets in
accordance with FAS No.115. Superior's corrective plan was also to address
credit underwriting, concentration of credit risk, and Allowance for Loan
and Lease Losses issues. As part of the 570 enforcement action, the bank was
required to reduce its level of financial receivables and related assets to
no greater than 100 percent of Tier 1 capital within a year.

October 2000 OTS and FDIC conducted a joint field visit to determine
management's compliance with promised corrective actions from the earlier
on-site examination. The field visit report concluded that Superior's
financial statements were not fairly stated at the most recent audit date of
June 30, 2000, due to incorrect accounting for the financial receivables and
overcollateralization assets, which resulted in inflated book entries on the
balance sheet for the respective assets, earnings and capital. The examiners
also concluded that the most recent audit report, prepared by Ernst & Young
as of June 30, 2000, should be rejected and that the audit report should be
restated

Date Event

to reflect the adjustments resulting from the field visit.

February 2001  Ernst & Young agrees with  the regulators that the accounting
for  the  financial  receivables   and   overcollateralization  assets  were
incorrect.

February 2001 OTS determined that Superior Bank was significantly
undercapitalized on or before December 31, 2000, as a result of adjustments
from the January 2000 exam and October 2000 field visit. OTS issued a PCA
Directive that required the bank to submit a capital restoration plan by
March 14, 2001. OTS terminated its review of the institution's Part 570
corrective plan as a result of the issuance of the PCA directive. OTS also
issued two Consent Orders to Cease and Desist for Affirmative Relief against
Superior's holding companies (Coast-to-Coast Financial Corporation and
Superior Holding, Inc.). One was issued to implement modifications to the
loan purchases between the holding companies and Superior "in order to
eliminate losses experienced by the Savings Bank within the lending
program." The other order required the holding companies to establish an
escrow account at Superior Bank and deposit sums "equal to two times the
aggregate amount of any loss the Savings Bank reasonably projects it will
incur on the sale of all loans originated by the Savings Bank during the
current calendar week, or $5 million, whichever is greater."

March 2001 Superior Bank and Ernst & Young completed a revaluation for all
the financial receivables and overcollateralization assets using the correct
accounting methodology and calculating from the inception date of each
securitization pool. The recalculation resulted in a required write-down of
the financial receivables and overcollateralization assets totaling $270
million. On March 2, 2001, Superior amended its December 31, 2000, TFR to
reflect the correct fair market value of the F/R and O/C assets. OTS
performed an off-site examination of Superior Bank and downgrades its
composite rating to a "5."

May 2001 OTS conditionally approved Superior Bank's amended capital
restoration plan (plan initiated submitted by Superior on March 14, 2001,
and amended on April 30, May 15, and May 18, including revisions received by
OTS on May 19 and May 21) and issued a Prompt Corrective Action Directive
requiring the bank to increase its capital levels by complying with the
terms of the capital restoration plan.

July 2001 A $150 million write-down of the residual interests was
necessitated by overly optimistic assumptions used in Superior's valuation
model.

July 2001 Pritzker interests sent a letter to OTS indicating that the plan
will not work and OTS closed Superior Bank, FSB, and placed the bank under
conservatorship of FDIC.

December 2001 FDIC and OTS reached a resolution with the holding companies
of Superior Bank on "all matters arising out of the operation and failure of
Superior Bank. Under the terms of the agreement, the Superior holding
companies and their owners (the Pritzker and Dworman interests) admit no
liability and agreed to pay the FDIC $460 million and other consideration."
*** End of document. ***