When MagnetBank opened two years ago, its founders chartered it as an industrial loan company, because that charter seemed to suit its unconventional business model of funding commercial loans entirely with wholesale deposits.
But this month the Salt Lake City lender ditched its ILC charter and converted to a state-chartered commercial bank. The reason: Controversy surrounding the charter — brought on by Wal-Mart Stores Inc.'s 2005 application to start an ILC — had hog-tied the lender's efforts to raise capital, and its management feared the problems could threaten its expansion plans.
"The regulatory environment surrounding industrial banks has changed dramatically since the bank commenced operations in 2005," MagnetBank said in a
The climate changed, of course, after Wal-Mart filed its application and then Home Depot Inc. made a bid to acquire an ILC in Minnesota.
The applications brought unprecedented scrutiny to the charter, as consumer advocates, community bankers, and lawmakers worried that the retail giants would use their ILCs to expand into retail banking.
The controversy precipitated bills in the House of Representatives and the Senate that would bar commercial firms from acquiring ILCs (though no legislation has been enacted), as well as a slew of state legislation designed to prohibit commercially owned ILCs from branching into their states.
In July 2006 the Federal Deposit Insurance Corp. imposed a six-month moratorium on all new ILC applications. That moratorium was extended by a year in January for applications filed by commercial firms.
MagnetBank's October 2006 application to raise $50 million through a private placement to fund its rapid growth got caught up in the controversy. Utah regulators approved that application in December, but the FDIC did not make a final decision — even after the first moratorium ended in January.
Frustrated by the federal agency's inaction, MagnetBank changed its tack. In June it filed an application to convert to a commercial bank charter. Regulators approved the switch last month, and it became official Aug. 16, after shareholders unanimously approved it.
Along with the charter change, the FDIC approved MagnetBank's plan for raising capital.
Darrell Pittard, the company's founder, chairman, and chief executive officer, said in an interview this week that the ILC charter was becoming more trouble that it was worth.
"We really don't need … [the charter] anymore," he said. "It was causing us delays."
ILCs are typically owned by corporations — such as BMW Group or Target Corp. — and used as deposit-gathering tools to fund the activities of their parent companies.
The uncertainty surrounding the charter has prompted some companies to rethink their plans.
Several commercial firms, such as Blue Cross Blue Shield Association, that had planned to charter ILCs have opted for thrift charters instead, and even Wal-Mart, which said it wanted an ILC to cut the cost of processing credit card transactions, has withdrawn its application.
MagnetBank, however, is a business lender that became an ILC because the charter allows banks to fund themselves entirely with wholesale deposits.
ILCs are not permitted to accept retail deposits, and though wholesale deposits are generally more expensive, MagnetBank executives said they preferred this approach, because the deposits can be gathered without a costly infrastructure.
ILCs typically do not operate branches. Since opening in September 2005 with $48 million of assets, MagnetBank has established loan production offices in Atlanta, Houston, Raleigh, Salt Lake City, and Boise, Idaho, and by June 30 of this year its assets had swelled to $504 million.
It is also making money. Though it often takes a start-up two or three years to turn a profit, MagnetBank earned $1.1 million last year, its first full year of operations, and it made nearly $2.5 million in the first half of this year, according to FDIC data.
The conversion to a state commercial charter should eliminate future regulatory delays and preserve MagnetBank's ability to open loan production offices in other states, Mr. Pittard said.
More than a dozen states have passed or considered laws in the last two years that would prohibit commercially owned ILCs from opening branches there. Though MagnetBank is not commercially owned and has loan offices, not branches, Mr. Pittard said its management did not want to take any chances with the charter.
"I didn't want to get into a fight with a state regulator as to whether my office was a loan production office or a branch," he said.
Though the new charter gives MagnetBank the authority to accept demand deposits and open full-service branches, Mr. Pittard said it has no plans to do so.
"It's the same business plan with a different charter," he said.
Tom Bay, the supervisor of banks at the Utah Department of Financial Institutions, said that even though his agency remains wary of wholesale deposit funding, it approved MagnetBank's application to convert and continue to fund itself with wholesale deposits, because it has been doing so in a safe and sound manner for roughly two years.
"They had already been up and running with their business plan and showed that they were able" to manage wholesale funding appropriately, Mr. Bay said. "So there is no reason to prevent them" from converting.
Wholesale funding can be risky if not managed properly, he said, because it can move quickly from one bank to another as interest rates change, creating potential liquidity problems.
