De Novo Class of ’07-08 Now Takeover Candidates

Wanted: a Hollywood ending.

More than 200 banks opened their doors in 2007 and 2008, expecting they would have, per usual, a few years to turn a profit. The de novos had some reason to be optimistic. The pre-financial-crisis cohort missed the boom in commercial real estate lending, and in so doing, preserved credit quality and saved capital.

The de novos also missed much of the mid-decade's CRE profits, however, and now many are treading water, at best, waiting for the elusive rebound while coping with higher regulatory compliance costs.

"The economy has just not played out for them," said Mark Tipton, chairman and chief executive of the acquisitive Georgia Commerce Bank. "A lot of these banks started with a business plan of being a real estate bank. … Today, that would be like saying you're going to be a buffalo hunter."

Tipton is among those who, tempted by untapped capital and relatively clean balance sheets, are interested in providing an exit strategy to such banks, now bait for acquirers like him interested in low-risk deals.

About 45% of the 214 banks that were formed in 2007-08 posted losses last year, according to data from SNL Financial and compiled by FBR Capital Markets. The group did average a narrow gain last year — but only on the back of three highly profitable banks. Absent those, the class lost an average of $127,000, and banks in ailing states such as Georgia and Florida are considered cheap.

Perhaps, if financial reform hadn't come along with the specter of a never-ending hike in regulatory costs, de novos would be more likely to stick it out in hopes of eventually turning a profit.

"There was even more scrutiny on de novos and their growth than any other community bank segment" before financial reform, said Tom Lykos, a managing director at Commerce Street Capital. Now, "they have to ask themselves how they fit in the new world of Dodd-Frank."

Only three banks from the 2007-08 class have been sold this year. A number of industry observers said selling will become a more viable option for younger, unprofitable banks.

Undone by higher operating expenses, Founders Bank in Sugar Land, Texas, for example, decided to sell itself to Vista Bank Texas in Houston.

"With the environment we had in both a slow-growth market and the CRE limitations … we just did not think a de novo could meet its shareholders' expectations," said Jim Sturgeon, the $140 million-asset bank's president and CEO.

The single-branch Founders, which formed in late 2007, posted a loss of $2.2 million last year and was never profitable.

Sturgeon originally expected the bank to start making money every month in its second year and have assets of at least $350 million by now. By merging into the $455 million-asset Vista, "we're really just taking a big jump into that plan," he said.

Founders raised an additional $7.6 million in capital last year and spent the past two years looking to buy another young bank before agreeing to sell. Sturgeon said the three biggest obstacles that had blocked it from buying were culture clash, disagreements on bank valuations and, most of all, egos.

"It is hard for [these bankers] to turn around and let go of what they just created," Sturgeon said. "It hurts me" to sell, but most of the capital raised last year "came from shareholders who sat across from me and said, 'I'm doing the deal based on you,' so it doesn't take a lot for me to submerge my ego."

Tipton and Lykos agreed that not all de novos are going extinct, and that their ability to survive will greatly depend on the strength or weakness of core markets. In fact, some young banks have been able to raise additional capital to make acquisitions that will help them grow in spite of a slow organic growth market and tighter regulatory restrictions.

FirstAtlantic Bank in Jacksonville, Fla., said Monday that it had filed an application with its regulator to buy a branch in Orange Park, Fla., from Synovus Financial Corp. The $210 million-asset FirstAtlantic, which opened in 2007 using an older charter, raised about $12.4 million in November to make branch and bank acquisitions. Though the bank is profitable, Mitch Hunt, FirstAtlantic's president and CEO, said growing through acquisitions is appealing as a way of deploying capital.

"I believe it is very difficult for a $200 million bank to provide meaningful long-term returns," Hunt said. "As other community banks realize that and are open to that, a lot of them will look to combine in adjacent markets."

To be sure, some industry observers are not yet sold on the theory that acquirers will line up to buy young banks.

David Rainbolt, the president and chief executive at BancFirst Corp. in Oklahoma City, said he might consider buying a de novo but he questioned how long it would take such a purchase to become profitable.

"It is cheaper upfront but in the long run, it takes a greater amount of time to produce earnings," Rainbolt said. "Hamburgers are always cheaper than steak but not always a better value."

There is also the belief that many young banks remain in denial, hopeful that profitability remains just a quarter or two away.

Sturgeon, who still talks with the de novo bankers whose institutions he tried to acquire, said many of them still say they will start making money next year. A number of bankers also believe that bank values will grow significantly in 2015.

"My response is, 'I don't know what you're smoking, but please send me some,' " Sturgeon said.