De Novo Banks Need a Niche

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Horse-drawn buggies may not be the only throwbacks welcoming visitors to Pennsylvania Dutch country this summer.

Eighteen investors—many of them Amish—are planting the seeds for a new community bank outside Lancaster, Pa.

If the investors can convince regulators that the new institution will thrive, Bank of Bird-in-Hand would become the first de novo in the United States in more than two years. Organizers filed applications in early January with the Federal Deposit Insurance Corp. and the state Department of Banking and Securities.

Though many are watching its progress with regulators closely, the hopeful startup is unlikely to see much company, at least over the next year, according to lawyers, consultants and investment bankers. The regulatory and economic factors that froze de novo activity for the last few years remain in force. In addition, changes in technology and customer behavior could conspire to make the traditional startup a thing of the past—or at least a lot more difficult.

"It is harder on all fronts," says Nicholas Bybel Jr., an attorney in Harrisburg, Pa., who is advising the group in Bird-in-Hand, a small farming community east of Lancaster. Most of the organizers were involved in another local startup, HomeTowne Heritage Bank, which was sold in 2003 to National Penn Bancshares Inc., in Boyertown, Pa.

The new effort is being looked at as a bellwether by industry observers. It is helpful for gauging just how much harder the de novo process has become.

Many attorneys and consultants feel the FDIC has been discouraging the formation of new banks since late 2008, preferring that investors plow money into existing institutions that need capital to survive. In 2009, the agency tightened oversight of startups, which have been rare in the years since. The country's last new bank, the $39 million-asset Start Community Bank in New Haven, Conn., opened in the fourth quarter of 2010.

"I've had groups communicate with me about the possibility of forming a de novo bank in the traditional model, and I have at this point been discouraging them from pursuing it, just because the time frame and the regulatory hurdles are so severe," says James Rockett, a lawyer with Bingham McCutchen in San Francisco.

Even if regulators become more open to de novos, the application process is unquestionably longer and more difficult than it was before the financial crisis, according to attorneys and consultants who advise bank organizers.

"It's a literal minefield right now trying to figure out what they want," says Charles Ingram, a managing director at Dallas-based investment bank Commerce Street Capital LLC.

But some requirements are clear. Having a niche—one that is demonstrably underserved-is a prerequisite for any new community bank aiming for regulatory approval, experts say.

"I would not bet very heavily on that generic business bank," says Jim Deitch, who has founded two banks and is now CEO of TeraVerde Management Advisers, a consulting firm in Lancaster, Pa.

Bank of Bird-in-Hand proposes to cater to Amish and Mennonite farmers and small-business owners in eastern Lancaster, a target market that the organizers say is underserved.

About 30,000 Amish people live in Lancaster County, along with 29,000 Mennonites and other Anabaptists, according to the Pennsylvania Dutch Convention and Visitors Bureau. The demographic is reflected in plans for the bank's headquarters, formerly the home of a prominent local doctor: Adequate off-street parking will be available for vehicles and horse-drawn carriages and wagons, the FDIC application notes.

Roughly half the bank's loans are expected to go to farms with annual sales of less than $500,000. The bank also intends to offer online banking for both retail and business customers.

In addition to detailed questions about their customers, new banks face higher capital requirements. In the 2000s, some banks started with as little as $6 million dollars in capital. But no more, according to Jeff Marsico, executive vice president of The Kafafian Group, a community bank consulting firm based in Parsippany, N.J. He says the new minimum is probably about $20 million, which is the target amount that Bank of Bird-in-Hand set in its application.

Another constraint relates to funding. The use of brokered deposits and other tools that fueled de novos in the mid-2000s are viewed less favorably, with regulators likely to cap the amount of alternative funding sources a bank can tap, says Byron Richardson, president of Bank Resources, a consulting firm in Atlanta.

"That will act as a natural governor to slow the growth," he says.

Regulators are only the first hurdle, though. The new economics of the industry make the path more difficult for startups, which will face a world of lower interest rates and higher compliance costs.

Taking over an existing bank may offer a better return—and continue to be more palatable to regulators, says Wes Brown, a managing director for St. Charles Capital, an investment banking firm in Denver.

"Maybe in an agricultural setting in Pennsylvania there's a unique market to address that nobody else is addressing," Brown says. "But, in general, you can buy existing banks that already have $100 million worth of loans."

The move toward mobile banking also complicates the landscape, says Robert Grasing, president of Robert Nolan Company, a consulting firm in Simsbury, Conn. A de novo might not be able to count on branches to bring in customers the way they might have in the past. "I think that's the real issue-the customer behaviors. They're not going to want to go to branches anymore."

The approach laid out by the Bank of Bird-in-Hand sounds workable for the community it will serve, Grasing says. But, he adds, "I think that's unusual for the climate that we're in."

Still, the pace of de novos is expected to eventually rebound at least a little from the recent dearth.

Walt Moeling, a partner in the Atlanta office of law firm Bryan Cave, says the economy will improve, and the banking climate will too—and more community banks will sprout. "I say that because it always has," he says, "even though everybody said it never would."

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