Centennial Bancorp in Portland, Ore., has waded into the merchant banking waters, and many small banks are expected to follow.
The $849 million-asset company has formed a group to introduce its small and midsize business customers to third parties that can provide equity, asset-based, equipment, and real estate financing.
We are generating a fee for ourselves without having to take the underwriting risk, said executive vice president Mike Paul. As the customers grow with the help of our partners, we end up with clients that are able to take commercial-type credit.
Behind an expected wave of small banks entering merchant banking are new federal rules that will take effect this year. Centennials move did not require the change, but Fed Governor Laurence H. Meyer said Thursday that many community banks have created financial holding companies specifically to take advantage of merchant powers authorized under Gramm-Leach-Bliley.
Three-quarters of the domestic [financial holding companies] have assets of less than $500 million, and half of these have assets of less than $150 million, Mr. Meyer said in a speech to the American Law Institute and the American Bar Association. These smaller entities appear to be most interested in using the insurance agency and merchant banking powers and far less interested in securities and insurance underwriting.
For years banks have been able to invest in small-business investment corporations federally regulated venture capital organizations that are funded in part by government grants but now they can engage directly in merchant banking as a result of Gramm-Leach-Bliley.
However, Ken Clayton, chief legislative counsel at the American Bankers Association, said that most banking companies are holding their breath until regulators rule on the requirements for entering the business.
In March the Federal Reserve proposed a $6 billion cap on equity investments for any financial holding company, as well as a requirement that holding companies reserve 50 cents for every $1 of equity investments. Last month the Fed eliminated the $6 billion cap idea and proposed a sliding scale for capital requirements based on the aggregate amount of equity invested.
Bankers are relieved that regulators have at least scaled back their original proposals, Mr. Clayton said. If the final version isnt too restrictive, many community banks will jump at the chance to enter the new field, he said.
A lot of members on our Community Bankers Council see a lot of significant opportunities in merchant banking, he said.
Richard Ayotte, chief executive of American Brokerage Consultants, a St. Petersburg, Fla., company that matches banks with third-party brokerage firms, said many of the smaller banks that will enter merchant banking will most likely take Centennials route and form alliances with third parties.
Merchant bankers, like securities brokers, are so specialized in their processes and have a lot of expertise, Mr. Ayotte said. It would be tough for many smaller banks to compete on their own with seasoned firms, he said.
Mike Niehuser, an equity analyst for Redchip.com in Portland, added that it will not matter to customers if the services are in-house or outsourced. All customers care about is whether the banker can deliver on his promises of quality and price, he said.
Mr. Paul said many of Centennials smaller customers had been asking for alternative financing help them grow. The company has not ruled out making direct equity investments or providing asset-based lending, but he said that at this point the business lines were too expensive to establish internally.
It would take a lot of capital to build up an infrastructure, and it would take quite a while to generate revenues, he said. Also, wed be competing against folks who had been in the business for a while, so it made more sense to partner with companies which already have systems in place.
In six years Centennial has nearly tripled its assets by acquiring smaller banks and developing de novos. Mr. Niehuser said its new merchant banking group is a sign that the company has grown to a level where it can compete with the larger banking companies in the Northwest.
This newest service marks a transition from a community bank to a midsize commercial bank.