“Build it or buy it?” The question is not just for home buyers — it also applies to those seeking to start a bank.
There are two well-established ways to start a bank and, at any given time over the past 40 years, it has usually been clear which approach made more sense.
In the 1990s, high regulatory hurdles translated into few de novos. And again, from 2008 until 2016, the Federal Deposit Insurance Corp. placed a virtual moratorium on de novos, channeling organizers toward buying an existing small bank to make it their own — a “de facto” de novo. During this period, most “new” banks were recapitalizations of troubled banks forced to sell.
Those periods are in contrast to times like the late 1990s until the beginning of the Great Recession in 2007, when new banks were relatively easy and inexpensive to form. The result was a wave of de novo charters that averaged more than 100 per year.
In the last few years, a notable shift in regulatory attitudes has once again made it possible for organizers to obtain a de novo charter. But some markets also feature small, healthy banks for sale — especially rural markets with little growth potential or those with aging management teams. At current bank stock values, these banks could be cost-efficiently purchased and rebuilt to form a de facto de novo. So which approach makes more sense for bank organizers today? The answer depends on a few key factors.
There are several benefits to a de novo charter approach, specifically:
- A clean slate, including the latest technology without potentially cumbersome or outdated legacy systems.
- An improved regulatory willingness to facilitate the formation of new banks, with a more definite timeframe for approval.
- A shortened de novo restriction period of three years.
- No time spent looking for an existing bank that passes due diligence scrutiny and can be bought on terms acceptable to the new management team, organizers and investors.
However, headwinds to the de novo charter approach include:
- Regulators requiring de novo groups to raise significantly more capital than previously required.
- Comparable returns available from more-established publicly-traded bank stocks.
- Regulators’ reluctance to approve innovative or high-growth business plans.
The benefits from buying an existing charter and operating it as a de facto de novo include:
- Existing systems, which allow the bank to avoid start-up costs.
- Potential existing profitability of the established bank that can be further leveraged.
- Substantially more flexibility in developing the bank’s business plan, including a niche or specialty-focused plan; as well as raising capital, including multiple rounds, different valuations, and on an as-needed basis, leading to greater interest from investors.
- Additional flexibility to structure compensation for organizers who undertake the effort to rebuild the bank or contribute at-risk capital to the venture.
But there are also unique headwinds for organizers who choose to buy or invest in a smaller charter approach face, including:
- The ability to find a bank that can be acquired or that will accept growth capital and a change in officers and directors on terms acceptable to the new management team, organizers and investors.
- Challenges in continuing to serve the bank’s existing market area, which in many cases will be rural with little or no growth, while expanding into a new market.
- A less-clear regulatory pathway and timeframe for regulatory approval.
- The potentially high costs of replacing legacy infrastructure and IT systems.
If the economy continues its modest growth and existing banks continue to consolidate, we expect to see additional efforts to form new banks. Whether the better path for potential bank organizers is a traditional or a de facto de novo bank will depend on a number of factors. Based on our experience in the current cycle, we would caution that the importance of and challenges in raising sufficient capital for either approach cannot be over-emphasized. A de novo bank effort that runs out of capital is no prettier than an unfinished home construction project.