Standing up de novo institutions to replace community bank charters absorbed by mergers and acquisitions has been a well-documented pattern over several decades. But like many other industry traditions once thought unassailable, this one has drowned in the period following the financial crisis and it won't be coming back.
There have been nearly as many community bank charters lost to M&A in the past year as the annual average lost to failure during the financial crisis. With a stabilized economy, healthy housing market and ongoing distrust of the largest banks, why aren't the shrinking ranks of community banks being replenished by de novos? Contrary to popular — and perhaps political — belief, the answer is not the unwillingness of regulators to consider de novo applications.
Regulators have in fact sounded open to wanting more de novo bids. The Federal Deposit Insurance Corp. released guidance last year on the de novo application process that was seen as perhaps opening the door. At the time, a senior official at the FDIC said the agency was "looking forward to getting more … applications." Meanwhile, in an interview this past October with the ABA Banking Journal, Comptroller of the Currency Thomas Curry said "more de novo activity would be a signal of strength for the economy and for communities."
But new de novo activity has remained at a trickle. The reason why is simple economics, not regulators being stubborn. Many community banks continue to be strained by an evolving expense structure that is increasingly difficult to support with traditional products, services and delivery channels. Specific cost contributors and their respective degree of impact may still be open for intelligent debate, but the results are clearly visible in the stream of adequately capitalized community banks now being sold or merged. This cost structure is the primary reason for both so many community banks being sold and so few de novos following them.
As recently as 10 or 15 years ago, a group that raised $25 million from local citizens to obtain a charter and open a new bank could expect to be profitable in about two years despite having to build a loan portfolio, deposit book and infrastructure from scratch. A de novo today would begin at the same point, but the expense burden out of the starting gate is substantially heavier than their predecessors ever imagined.
The cost of technology — more accurately the cost of keeping up with changing technology — is many times the magnitude of what it was 10 to 15 years ago. Anti-money laundering, which today requires expensive monitoring, did not receive nearly the regulatory attention then that it does now. Outside audit costs, once a modest expense for most community banks, have increased substantially in recent years with changes in accounting rules, and audit costs will only get more demanding when additional decrees by the Financial Accounting Standards Board take effect. Meanwhile, painfully low net interest margins persist and community banks face incredibly strong competition from big banks for traditional fee income. The list goes on and on.
Instead of moving into the black on a sustainable basis in two or three years, most de novos today realistically wouldn't get there for four years or perhaps ever. With such projections, you might get entrepreneurial enthusiasm for starting a new community bank, but attracting capital and qualified management is still a tough sell.
Joseph C. Bonner is an independent banking consultant and former president at three community banks. He also founded Turnaround Banking LLC, which advises troubled financial institutions.