Post-crisis organizers find a whole new de novo ballgame
For Shaza Andersen, starting a new bank is as much a personal decision as a financial one.
The day after the $2.1 billion-asset WashingtonFirst, the bank she founded 15 years ago, announced it would be sold, Andersen remembers how quiet the office was, the typical chatter among employees muted as they processed the news.
The decision made sense financially for shareholders — Sandy Spring Bancorp in Olney, Md., agreed to pay 256% of tangible book value in the May 2017 deal — but Andersen struggled with the idea of letting go of the company and the team she built.
She recalls sitting in the car with her husband, reading aloud some of the letters and emails she received from employees, and crying. Stories of having a child while working for the Reston, Va., bank. Of the support they felt from the team. Of how she had helped advance their careers.
Now, a year after the deal with Sandy Spring closed, Andersen is starting over again.
She is leading efforts to form a new bank in the Washington area, and in that idea she has a lot more company lately than there has been in years.
Regulators are encouraging new bank formations, after a decade of sparse activity in the wake of the financial crisis. The pace is starting to pick up in response, with 15 getting approval last year and dozens more in the pipeline.
Though the fundamentals of organizing a bank are largely the same as in decades past, none of the details seem to be.
What organizers like Andersen will find has changed this time around — besides regulators who are eager to be helpful — is the need to raise more initial capital, to have a broader management team signed on while still in the planning stage, to set realistic growth expectations, to have a more diverse business plan that does not rely too heavily on commercial real estate, and to push any plans for an exit strategy further out than in the past.
Consultants working with organizing banks say the capital needed today is double or triple what might have been considered adequate before the crisis, in part because of the need to scale up to reach profitability more quickly.
Andersen, though, says she believes all the effort will be worth it. "I love my job," she said. "We are helping people realize their dreams."
Buying is an option
Historically, consolidation gave rise to new banks, as entrepreneurial management teams would spin off from the acquired bank and start anew. But after the financial crisis, almost nobody chartered a new bank. Instead, they often chose to buy a small bank, add capital and relocate it to a metro area — a workaround that regulators encouraged.
One recent example of these so-called de facto de novos is the $72 million-asset Bank of Houston, a unit of BOH Holdings.
James Stein, chairman, president and chief executive of Bank of Houston, is a second-time bank builder. He concluded this time around that it would be better to buy a bank than charter one.
Stein's group raised $17.5 million to purchase and recapitalize the $28 million-asset Dublin National Bank in Texas in April 2018. The bank's headquarters moved to Houston in May 2018 and its name changed to Bank of Houston. But it still serves the Dublin market.
The group is currently conducting a secondary offering to raise another $15 million to $20 million.
"It's more difficult to go down the de novo path. So few of them have been chartered," Stein said. "But there are lots of smaller community banks out there that don't have a succession plan and have reached the end of their natural growth progression."
The benefits of buying included existing core deposits, a bank that is operating day one and an experienced back office, Stein said.
Still, buying a small, rural, 126-year-old bank presented its own challenges — it wasn't a turnkey solution to the model Stein needed to serve his Houston market this time around.
"We are going through the process and bringing in all new IT vendors," he said. "We are upgrading technology across the board, making ourselves easier to do business with."
Data provided by the Federal Deposit Insurance Corp. shows many groups still prefer to buy versus charter. That suggests overall de novo activity is even stronger than the startup numbers alone imply. From July through December last year, 14 organizing groups went through the change-in-control process — meaning they acquired a bank — while deposit insurance was issued to 13 new charters in that same period.
Regulators prefer organizers to buy a small bank and relocate it, said Dan Bass, managing director in the Houston office of Performance Trust Capital Partners.
"A lot of small charters don't have long-term plans, and this kills two birds with one stone," he said. "It brings new capital into the banking industry and solves the problem with little banks that don't have succession plans."
Bass said regulators expect the acquiring group to continue to serve rural communities after the headquarters are moved.
Besides Bank of Houston, Bass said five other groups acquired small banks in Texas and moved their headquarters to a metro area in 2018. By comparison, there were no newly chartered banks in the state last year.
But the purchase model isn't right for everyone. Texas did have one fresh charter in 2017, when Bank of Austin opened.
Kurt Purdom, deputy banking commissioner for the Texas Department of Banking, said he sees many reasons that organizers might not be quick to open despite consolidation in the state — including the daunting regulatory process and thin margins caused by low rates. As rates start to rise again, he expects to see more interest.
Purdom said a few groups have come in to inquire about chartering a new bank recently, though he hasn't officially received their applications yet.
But, he stressed, "We are open for business."
Then and now
Industry experts don't expect the volume of de novo banks to rise to levels seen before the financial crisis — when an average of more than 100 were approved annually.
Any fears of a cycle repeating are tempered by the tamer numbers and heightened supervision.
Today's de novos are subject to more scrutiny and guidance from regulators than their counterparts before the crisis, industry experts said. They must communicate with regulators often to ensure they don't stray from expectations.
As with the regulators, bankers and de novo organizers also learned lessons from the financial crisis, said Lee Bradley, senior managing director at Community Capital Advisors in Duluth, Ga.
"I think for bankers that went through the financial crisis, those wounds are still fresh," Bradley said. "We're never going to go back to those days of purely living off of commercial real estate, and the regulators are keenly aware of that past, too."
Young banks represented an outsize number of bank failures during the crisis. Among banks chartered between Jan. 1, 2000, and Dec. 31, 2006, 15% ended up failing, according to FDIC data. In comparison, 5% of banks chartered before 2000 ultimately failed.
The more recently chartered banks also tended to fail more often than established banks during the 1980s banking crisis, a pattern the FDIC noted in its analysis after the 2008 meltdown.
This insight prompted the FDIC to make a change in 2009, lengthening the time that new banks were subject to greater regulatory scrutiny. The agency raised the so-called official de novo period to seven years, from three years.
That was scaled back to three years in 2016 in a tangible sign that regulators were looking to encourage new charter applications.
Though industry observers agree that the bar to entrance for a new bank has been significantly raised, they also say regulators are interested in streamlining and making the process as transparent and efficient as they can.
"There is a true interest from Washington to increase the number of de novos out there," said Randy Dennis, president of DD&F Consulting Group in Little Rock, Ark.
Most of the de novo bank failures during the crisis were tied to unfeasible growth expectations and decisions to stray from approved business plans. Often the failed de novos also had high concentrations of commercial real estate in their portfolios and relied heavily on brokered deposits to fuel growth. So regulators are even more skeptical of alternative forms of funding for de novos these days and emphasize core deposits more heavily.
The plan at Bank of Houston — and several other de novos — is to rely on a commercial-and-industrial line of business, along with investors who will both have deposit accounts and help drive business to the bank.
Find a leader
Of all the steps in winning approval for a de novo, finding the right leadership is paramount, said Byron Richardson, a senior consultant at Bank Resources who works with de novo groups.
Regulators look for savvy directors and management teams who have run or started banks before.
Bankers who are qualified to run de novos — and are interested in it — are harder to find after the long interlude from new bank activity, Richardson said. Just two new banks opened between 2011 and 2016.
"All these folks who started banks in 2006 or 2007, they are 10 years older and some of them have aged and are not willing to commit the time or effort for a startup venture," Richardson said.
Still, activity has picked up considerably, by all accounts. Since 2017, at least 36 groups either have opened banks or have started planning to do so, according to data compiled by American Banker. Of these ventures, women are leading five.
Most of the half-dozen de novo banks that opened in 2018 identified CEOs early in the organization process. Investors are more likely to put their money in when they know who will be running the bank, consultants said.
Investor-led groups that wait too long to hire bank management teams may face a longer approval process.
Organizers of Scottsdale Community Bank in Arizona have taken a lot of time getting ready to apply to the FDIC — 10 years. But the group hired a CEO in late 2018 and is now in the midst of raising its initial capital.
The next step will be filing an FDIC application. Mainly the group wanted to wait for better economic conditions before diving into the organization process, said George Weisz, who is expected to become the proposed bank's chairman.
A change in tone
Regulators and bankers were rusty on the de novo application process after a nearly 10-year hiatus from new bank formation.
Besides, for many years, low interest rates and increased regulations made it hard to justify new banks, said Thomas Curry, a partner at the Boston law firm Nutter and former comptroller of the currency.
The FDIC approved 15 de novo applications in 2018, more than in the prior four years combined. By comparison, about 200 applications got approved in 2008, in the months leading up to the financial crisis.
"There was not a lot of interest on the part of organizing groups after such a scary moment," said David Baris, a partner with the law firm Kennedy Sutherland in Washington.
The lack of activity is likely not all attributable to the economy and regulatory attitudes, in his view. "Perhaps it's a perception that the future of community banks isn't quite as rosy as it was before," Baris said. "I can't explain it all as to why there is a drop-off like this."
Pennsylvania's Bank of Bird-in-Hand became the first de novo to get approved after the financial crisis. The bank was organized in 2013 by a group of mostly Amish businessmen who raised $20 million in initial capital with the intention of serving the Amish community east of Lancaster.
"We started with 10 people and we did everything from changing toilet paper to forecasting — we did it all," said Lori Maley, Bank of Bird-in-Hand's president and CEO. "Now we're up to 50 employees in just over five years."
Early on, the group sometimes felt like the regulators' guinea pig, Maley said. "We plowed the way" for other de novos, she said.
One key to getting approval was convincing regulators that the Amish and Mennonite farmers and small-business owners in the Lancaster area were underserved. Despite facing intense regulatory scrutiny and skepticism, the group succeeded — though it would be two more years before another organizing group would manage to get a charter.
Organizers and industry observers say that attitudes toward de novo banks have improved dramatically since Jelena McWilliams took over as FDIC chair last year. The agency has held roundtable discussions around the country about the de novo application process, recently updated its de novo guidebook and is seeking input about ways the application process could be streamlined or otherwise improved.
"I do truly believe there has been a change from the top down," Maley said.
Andersen, the proposed CEO of Trustar Bank in Virginia, was pleasantly surprised when FDIC officials offered to travel to meet with her team in person after she expressed interest in starting another bank.
"In all my years of working with the FDIC, our case managers and regional directors have never come to visit us," Andersen said, adding that her group typically would have to fly to meet with the regional office in Atlanta. "This was the first time we felt a change in the way they have done business."
Andersen said she is impressed that the FDIC has adhered to its internally set timetables for the review and comment periods during the application process.
"Every time we have called them, they have called right back," Andersen said. "The responsiveness I feel has been tremendous."
De novos today must have substantially more capital than the ones that opened before the financial crisis. Organizing groups can expect to raise at least $20 million to $25 million initially. Most startup banks before 2009 raised less than $10 million.
That higher barrier to entry has caused most new bank activity to occur near major metro areas, Baris said.
Last year, new banks opened in Birmingham, Ala., Nashville, Tenn., and Sarasota, Fla. And the first de novo to open this year was Watermark Bank in Oklahoma City.
There are four banks being proposed in the Washington area: Trustar Bank, VisionBank, Moxy Bank and Marathon International Bank.
Several of the newly organizing groups cite Washington's diverse economy and recent bank merger activity as a driving force behind the efforts.
VisionBank keeps its temporary offices in a WeWork in Tysons, Va. Millennial entrepreneurs and startup founders mingle in the WeWork lobby, where members help themselves to fruit-infused water and kombucha bottles line a glass refrigerator.
The hip working environment contrasts with the suits worn by VisionBank co-founders Mindi McClure and Richard Horn. Still, the duo said they enjoy being in an innovative atmosphere surrounded by younger entrepreneurs.
The WeWork office "fits into one of our themes," which is to recruit young employees and clients, said McClure, VisionBank's proposed chairman and CEO.
"We want to create a great bank for today, for 2019," McClure said, adding that she expects an emphasis on youthfulness to infuse a lot of fresh perspective.
"A whole generation has come up in those 15 years," where startup banks were nearly nonexistent, she said. "People that age are becoming an important part of the economy and they've never worked with a startup bank."
McClure, an investment banker, was the founding CEO of MHM Capital in 2009. Before that, she spent 15 years at the investment bank FBR, where she helped small banks raise capital, develop strategic plans and pursue M&A.
She also served on the board of Bank of Georgetown until its sale to United Bankshares in 2016, and has personally invested in de novo banks.
The board service "let me see behind the curtain and see what really made community banking work," she said.
McClure said she is proud that five of VisionBank's 12 directors are women. She also aims to recruit investors and future customers who vary in age and backgrounds.
VisionBank submitted its application to the FDIC in October and is raising $25 million to $30 million in startup capital.
The bank plans to serve small and midsize businesses in the Washington market; that's where McClure and Horn, who is the proposed bank's chief operating officer and general counsel, have spent the majority of their careers. Horn had been general counsel at WashingtonFirst.
The co-founders said their WeWork office neighbors could make great customers. They hope to open the bank by late May.
The number of banks in Washington has fallen by 25% since June 2008, from 102 to 77, according to the FDIC.
Lately there has been a wave of consolidation in the market among community banks. WashingtonFirst, Access National, Middleburg Financial, Cardinal Financial and Bank of Georgetown are among the banks with assets below $5 billion that were sold to larger competitors in the last three years.
"What that means is there are a lot of customer relationships sitting in a bank where they never intended to be," McClure said.
A familiar model
Increased regulatory and technology costs have caused hundreds of community banks to sell themselves or merge in the last decade. The total number of banks with assets of less than $1 billion has fallen by 45% since the end of 2004, to 4,632 institutions, according to the FDIC.
Most bank organizers cite the declining number of community banks as the primary reason for opening new ones. The de novo banks that opened in 2018 all aim to fill a void left in their communities after consolidation.
Organizers seem undaunted by the tough operating environment that caused such consolidation.
McClure and Horn said they believe they have a technological advantage over established banks because they can start with new technology platforms rather than trying to improve clunky legacy systems.
Frank Teas, the proposed CEO of The Millyard Bank in Nashua, N.H., contends there is a lack of local banks serving small and midsize businesses in his area. Of 21 financial institutions with deposits in that market, just seven of those are based in New Hampshire.
Teas started Nashua Bank in 2007 and sold it in 2012 to New Hampshire Thrift Bancshares, the parent of Lake Sunapee Bank, for $19.4 million.
Millyard Bank submitted its application to the FDIC in December.
"I wanted to do it again," said Teas, who grew up two miles down the road from the community bank his grandfather ran. "I am in love with community banking and I have a huge passion for being an integral part in a business owner's success."
Regulators are more comfortable approving business plans that aim to offer traditional banking services — to replace the financial institutions lost to consolidation. Organizing groups with a fintech slant or de novos hoping to hone in on one particular niche should expect to face more regulatory hurdles, greater costs and longer timetables, Baris said.
The fintech Varo Money, for example, which plans to offer consumer banking services with no fees, has faced several setbacks in its quest to gain a national bank charter, including having to pull its FDIC application last year to address regulators' concerns.
The new banks that opened in 2018 embody the traditional community banking model. They are focused on their local communities offering services like commercial lending, private banking and consumer lending.
Even so, some in the industry would like to see new ventures tackling particular niches or putting an innovative spin on traditional banking services.
Ray Grace, North Carolina's commissioner of banks, said he would like to see more de novos proposing innovative approaches to banking. He points to two examples of niche models that worked in his state — Live Oak Bank in Wilmington, which uses technology to focus on a few types of small businesses nationwide, and Square 1 Financial in Durham, which targeted entrepreneurs before it sold to PacWest Bancorp in 2015.
"These are very interesting models. They kind of intrigue me," Grace said. "I like to poke and prod and figure out where the risk points are. I would like to see more of those, because it brings an innovative spirit into a business that badly needs it."
Community banks need to change the way they approach banking to stay relevant, Grace said, adding that he'd like federal regulators to allow more experimenting.
"I want to see the FDIC take a more flexible position with respect to that," Grace said.
The Trustar team started working together on Jan. 2, and Andersen said her bank could open as early as June. It's an aggressive timetable — it took over a year of work to get WashingtonFirst open in 2004.
But Andersen feels confident, given the team's previous experience with the de novo process.
Andersen said she had 75% of her investor subscriptions two weeks after her offering circular was distributed. Trustar plans to raise $35 million to $50 million in initial capital. WashingtonFirst raised just $10 million before it opened.
Many WashingtonFirst investors — who made a lot of money from its sale to Sandy Spring for $489 million — have been eager to invest in Trustar, Andersen said. The new bank aims to win back WashingtonFirst customers, too.
"Things seem to be moving at a quicker pace than last time and that part has been exciting to me," Andersen said.
Marissa Fajt contributed to this story.