Nonbank commercial lenders are facing intense scrutiny as they try to start or buy a bank these days, so much so that more are starting to abandon their plans.
Some lenders and observers contend the long and painful approval process amounts to a roadblock that unnecessarily shuts off a potential source of capital for the banking industry. But others say the hurdles are justified, especially since commercial loans are becoming more stressed as the economy continues to flounder.
"We have learned some lessons from the crisis that we have just gone through, and it has colored our views of new entrants into the banking system," said William Haraf, commissioner of the California Department of Financial Institutions. "So for a company that has been operating as a nonbank financial institution to gain access to deposits, we would want to look at them very carefully."
Though the lenders are eager for cheap deposit funding, a few have called off plans to enter the retail banking business, after encountering extensive regulatory delays. Among them are CapitalSource Inc. of Chevy Chase, Md., and Mercantile Capital Corp. of Altamonte Springs, Fla.
Others have scrapped initial plans, but not given up entirely. Last week NewStar Financial Inc. of Boston terminated its deal to buy a Florida bank and withdrew its application to become a bank holding company, because the Federal Reserve was resistant to its plan to transfer some assets to the bank. But NewStar said it still considers buying a bank an attractive option.
Christopher Hurn, the chief executive at Mercantile, said he is "bitter" about his experience with regulators. Mercantile had applied for a national bank charter in March 2008. The seven-year-old lender, which focuses on making Small Business Administration 504 loans, wanted to use deposits to help fund its growth. It intended to retain its name and operate as a division of the proposed Emergent National Bank.
Though the Office of the Comptroller of the Currency cleared Mercantile to receive a charter in September, the company ultimately withdrew its application in February, Hurn said. It concluded that the Federal Deposit Insurance Corp. seemed unlikely to grant deposit insurance.
Hurn said Mercantile had the banking experience and capital it needed to satisfy the OCC, so he can only guess at why the FDIC might have balked. "We had a conference call with an FDIC official out of Atlanta who basically said to us that we had been successful already with our current nonbank business model," he said. "He made the comment, 'Why should we help you become a bank so you can take advantage of FDIC insurance on deposits? You're doing just fine now.' "
Hurn said he is frustrated because Mercantile had spent $1.8 million to organize Emergent. He is among those who believe the FDIC has an unofficial moratorium on approving new banks — which, he argued, deprives the banking industry of fresh capital that it needs.
An FDIC spokeswoman flatly denied any moratorium exists. "It is just not the case," she said.
She also said the approval process remains the same as in years past. "We are processing applications and there have been no changes in the requirements for deposit insurance."
The Fed declined to comment, and the OCC did not return a call.
Several observers defended the regulatory wariness. They said the FDIC and other regulators are taking their time — and rightly so.
Rick Childs, a director at the accounting and consulting firm Crowe Horwath LLP, said some monoline lenders have struggled after getting into banking in the past, so such plans have been drawing more scrutiny in recent years.
He said the concern is that these companies might not weather crises well, because their lending is not diversified and the management tends to lack depth in banking experience.
"I'm not surprised that the FDIC is very cautious," he said. "There's no upside to the FDIC taking a risk. There is only downside."
Childs said the economy is likely making regulators even more cautious about commercial lenders in particular. "Last year, if a mortgage broker approached the FDIC, it would've been nearly impossible, and I think this year, there is a similar effect for commercial lenders," he said.
Terry Keating, a managing partner at Amherst Partners LLC in Chicago, said some commercial lenders operate in a risky niche that banks avoid, such as subprime auto loans. Their capital would need to be higher than regulators require for a typical bank.
"There is absolutely nothing wrong with having a higher-risk business," Keating said. "But banks are not set up to absorb that kind of a structure."
NewStar's deal to buy the $225 million-asset Southern Commerce Bank in Tampa had been expected to close by May 1 initially. Before walking away, the companies extended the deadline twice, as NewStar negotiated with regulators for an exemption that would have allowed it to transfer assets to the bank.
Without that, NewStar would not have been able to improve the bank's profitability, so the deal would not make economic sense, said David Long, an analyst with William Blair & Co.
Like many Florida banks, Southern Commerce has asset-quality problems. Though it was well capitalized, 13.19% of its loans were not current at March 31, according to FDIC data.
Long said he could see NewStar striking a deal with another bank where the ability to transfer assets would be less important. "There will be other banks with better balance sheets," he said.
Calls to NewStar and Dickinson Financial Corp., the parent company of Southern Commerce, were not returned. But Timothy J. Conway, NewStar's CEO, said in a press release last week that the company would consider "alternative approaches to acquiring a commercial bank" that would satisfy federal bank regulators.
Rod Jones, a partner at Shutts & Bowen LLP in Orlando, said he would expect regulators to look askance at companies that lend nationally but want to buy a community bank for deposit funding.
"That conceptually, it seems to me, is just atypical of what regulators are used to seeing in a community bank," Jones said. "I can't say for sure that the regulators couldn't be persuaded that it makes sense, given the right mix of variables. But I think it would be a tough presumption to overcome that 'this isn't the kind of bank we're in the business of insuring, by and large.' "
As with NewStar, several other deals where commercial lenders planned to buy banks have fallen through. But specific reasons were not immediately clear.
In early March, Orchard First Source Asset Management LLC of Rolling Meadows, Ill., announced it would take an 80% ownership stake in the teetering Beverly Hills Bancorp Inc. of Calabasas, Calif.
The deal price was not disclosed, but Orchard said the seller's $1.5 billion-asset bank unit would become well capitalized again. Six weeks later Beverly Hills announced that the deal had been called off because it did not receive regulatory approval. The bank failed April 24.
Orchard declined to comment.
Marlin Business Services Corp. of Mount Laurel, N.J., is one commercial lender that succeeded in becoming a bank. However, regulators imposed growth restrictions for the first three years.
"If you are a finance company looking to start a bank right now, it is going to be problematic for the same reason they are holding us to the growth limit. Start-ups are more risky, and we are in a risk-averse environment," said Daniel Dyer, Marlin's CEO, who called the regulatory approval process "very thorough, but not onerous."
His company, which specializes in equipment financing, opened an industrial loan company in March 2008. It received Fed approval to become a bank holding company in late December and converted its ILC to a commercial bank the following month.
Robert Napoli, an analyst at Piper Jaffray & Co., said that Marlin, which has assets of $690 million, may have benefited from its small size and good timing.
The $15.1 billion-asset CapitalSource hit enough snags to call off a similar plan.
Last summer it began operating an industrial loan company, after acquiring the deposits and most of the assets of Fremont General Corp. from the FDIC.
Late last year Haraf's office approved the conversion of the ILC into a commercial bank. But CapitalSource never received approval from federal regulators to become a bank holding company and finally gave up. In filing its first-quarter results with the Securities and Exchange Commission in May, it mentioned that it had withdrawn its application with the Fed.
CapitalSource declined to give specifics about what had caused the holdup. But Donald F. Cole, CapitalSource's chief financial officer, said in an e-mail that a primary reason it sought the bank holding company designation was to gain access to the Treasury Department's Troubled Asset Relief Program. It continued to pursue the designation, even after missing the deadline for seeking Tarp, because of the time and money it had invested.
However, the company realized by May that the approval would just take too long.
"We view BHC status as a 'nice to have' rather than a 'must have' benefit," Cole said.
Haraf would not discuss any particular institution, but said sometimes different agencies have opposing views on applications. "There might be something we are willing to approve, but the federal regulators might not be willing," Haraf said. "However, more often than not, we see things pretty much the same way."