A couple of years back in this blog, we noted with more than a dash of skepticism that the FDIC was trying to make it easier for new banks to test the financial waters. After all, the actions by then – FDIC Chairman Martin Gruenberg to jump start the creation of new institutions – slashing the period of microscopic regulatory scrutiny for new bank ventures from eight months to three – came at a time when some on Capitol Hill wanted to expand the reach of Dodd-Frank.
As a bit of a refresher on why we were more than a little concerned about the FDIC boss’s move, here’s the heart of our 2016 post:
“Don’t misunderstand, the idea of more community banks is a good one, especially for growing bedroom communities of larger cities that are at present, banking deserts. Consider the town of Odenville, Ala.
In growing St. Clair County on the outskirts of Birmingham, Ala., Odenville once had a community bank in the heart of town. No more. Developers, as well as new and lifelong residents, say a new bank is needed.
So, Gruenberg’s move is a good one, right? In the words of the ESPN college football analyst Lee Corso: “Not so fast, my friend.”
Some have even gone so far as to cook up recipes for a successful de novo, including ingredients like hiring a successful CEO from an active or closed community bank, and trying to lure quality officers with strong salaries and stock options, as well as a quality board of respected community leaders.
When Gruenberg claimed the demise of the de novos is because of economic factors I totally agreed.
But the real economic factors differ drastically from Gruenberg’s take.
Sure, you can find a seasoned bank CEO and his team of officers that are interested in joining a de novo. With a guaranteed salary and lavish stock options, who wouldn’t be interested?
The problem is finding a qualified board of directors. Most smart business people have heard the horror stories of successful business people being sued after serving on a bank’s board of directors. Many officers and directors were sued only months after receiving CAMELS ratings of one or two. The FDIC wanted to show the public how they were protecting everyone’s hard- earned money.
No business leader who has poured his or her life into making their business a success, wants to see a nice nest egg shattered when the bank’s officers and board are sued. Even an out-of-court settlement can be devastating, not only for the bank and its reputation, but for the bottom line of its individual board members. FDIC litigation is a nightmare in a gray flannel suit.
Trying to raise capital is another factor. How many smart businessmen want to invest $20 to $30 million in a de novo, knowing it could take years before turning a profit. And you can’t get director’s fees until the bank turns a profit. With Dodd-Frank and other governmental regulations, it will be hard for community banks to show a profit in the future. Now comes FASB’s CECL (Current Expected Credit Loss) where you have to write down loans before the ink even dries on the loan documents.
And with all the lawsuits filed by the FDIC, the Directors and Officers Liability Insurance (D&O insurance) has spiked 30 to 40 percent, also eating into the profits.
Add in the costs of cutting edge technology, and it’s a tough pill for smart business folks to swallow. Gruenberg is right when he says economics have hampered de novo creation, but that’s a small part of the story.
I hate to say it, but the FDIC started dimming that Welcome Sign several years ago, and I’m not sure if or when it will ever come back.
A recent article in the ABA Banking Journal posed the pivotal question: “The Welcome Sign Is Up for De Novos –But Is It Enough?
Our thought is, not only is it insufficient, but the FDIC and other banking regulators need to examine a variety of ways to give board members a bit more comfort. For now, Gruenberg’s latest move is like putting a tuxedo on a pig – you can call it a Welcome, but it’s still a pig.”
This 2016 piece is important to consider in a modern context. New bank applications seem to slowly be picking up steam. In the first half of 2018, according to an article by Paul Joegriner, the FDIC has received 11 applications for new banks, almost twice as many as regulators received in 2017. And from 2011-2017 Joegriner writes, the FDIC received only 30 applications for de novos, with only 10 of those approved.
As our 2016 post noted, there are a variety of other factors besides the economy that factor into a reluctance to jump into the banking waters, or the slow pace of approval.
Joegriner noted three factors:
First, raising capital for a de novo is sometimes-treacherous sledding. It takes raising $30-35 million in the current new bank environment. And, it takes a good period of time to sell stock in the bank, because, Joegriner notes “most bank capital raises are private offerings, exempt from federal regulation, but only available to accredited investors, institutional investors, or high-net worth individuals.”
You can spend a lot of time and money raising capital while hiring bank consultants and legal experts. And keep in mind, you have to raise the money and hire the management team, before the regulators even take a look.
Joegriner offered a somewhat startling example from an American Banker article concerning a planned de novo in one of America’s wealthiest cities, Newport Beach, California. There, Core Commercial couldn’t raise the needed capital.
Joegriner makes a key point when it comes to raising capital. Unlike real estate, where location is key, the city is only part of the equation. “It’s identifying and engaging with potential investors and doing roadshows,” he wrote.
Second, the soundness of management and the business model comes into play. A good many FinTech firms have failed in banking ventures because their executives have no knowledge of the banking industry and regulations. In addition, regulators are insistent upon the de novo bank’s board of directors having a significant level of banking experience as well. From 2008 to 2015 over 500 banks failed, taking out at least 5,000 experienced board members. Would the regulators allow any of those “experienced” board members back on a new bank board? Keep in mind, those bank directors had to be successful business people and accredited investors before they ever got on their first bank board.
Bitcoin exchanges flounder in navigating regulatory waters because of vulnerability to money laundering, Ponzi schemes and malware, not to mention the well-founded concerns over the absence of a central issuing authority or oversight.
And bank founders need to have an understanding of FDIC positions on emerging industries like Bitcoin or cannabis or payday lending, especially if the founders have ties to these industries, Joegriner rightly contends. For the FDIC and other banking regulators, that rightfully raises red flags.
And briefly, a final factor for de novo applications is the quality of those applications. Joegriner notes that the current FDIC Chair, Jelena McWilliams, said the agency wants to move more quickly on applications.
Joegriner cited two banks as examples. Charles Schwab Trust Bank and Bird-In-Hand Bank. Schwab Trust took three months from application to approval, while Bird took a year. Schwab brought an experienced banking team and significant capital to the table, that no doubt helped put the pedal to the metal for its approval.
Joegriner offered a powerful analogy: “Think of the application as a ‘window’ into the startup bank’s organization. A transparent, sound and well-articulated application will speed the FDIC’s processing time.”
There is a huge need for innovation among community banks and de novo will have an advantage of starting with new platforms and technology rather than the clunky systems that remain at older banks.
The bottom line? De novo bank applications seem to slowly be picking up steam. But the success of those applications and the brightness of Washington’s “Welcome” sign depends as much on the applicants themselves and not solely on the shoulders of the FDIC.
Read Paul Joegriner’s complete article here: https://www.linkedin.com/pulse/new-banks-trending-up-paul-joegriner
Read our 2016 article on de novo banks here: http://longlastingideas.com/fdics-welcome-sign-for-de-novos-might-as-well-be-unplugged/
I look forward to your thoughts.