It’s a tough operating environment for banks these days. Net income has improved for commercial banks in the United States since its precipitous drop during the financial crisis, but the industry still isn’t back to the same levels of profitability it enjoyed in the preceding years. Net interest margins (NIM) remain compressed. Competitive pressures have grown, as banks aren’t just fighting with each other for loans but also credit unions and, increasingly, tech-savvy marketplace lenders. At the same time, the cost of doing business while meeting regulatory requirements means the industry is working harder than ever to be efficient.
“It is perhaps the most challenging time to work in the industry that I’ve ever experienced in my career,” says Kent Ellert, chief executive officer at FCB Financial Holdings, a bank holding company based in Weston, Florida, with $8.2 billion in assets. He’s worked in banking for more than three decades. “The rate environment is very competitive-it’s almost irrationally competitive-and there seems to be more than a sufficient amount of competitors on every transaction.”
But while it’s a tough environment, it’s not impossible to grow.
Since 2010, the eight largest U.S. institutions have been gradually reducing their systemic footprint, which leaves banks between $5 billion and $50 billion in assets poised to take on market share. Last year, the investment banking firm Keefe, Bruyette & Woods identified 25 banks that its analysts say are primed to steal market share from the big banks, and subdivided these so-called Challenger Banks into two categories.
The first group (which KBW dubbed “Growing the Old Fashioned Way”) relies on a community bank model that promotes a strong corporate culture and market knowledge. These banks include Eagle Bancorp, based in Bethesda, Maryland, with $6.4 billion in assets. “[We] truly believe that the old-fashioned way of community banking, getting to know your customers, getting to know your community and most importantly, getting to know the needs of the community, [are] integral in becoming a successful bank,” says Eagle CEO Ron Paul.
Eagle has created “a culture that attracts great talent,” says Catherine Mealor, managing director at KBW. Also, “they have a reputation in their markets for having a quick turnaround [and] being very good at relationship banking.”
Other traditional community bank models identified for their strong growth potential include Bank of the Ozarks, based in Little Rock, Arkansas, with $12 billion in assets, BankUnited of Miami Lakes, Florida, with $26 billion in assets, and South State Corp., based in Columbia, South Carolina, with $8.7 billion in assets.
Of these traditional players, Mealor says “they’re still just your typical community bank, but they do it really better than [any other bank].”
The second group of banks-which KBW categorized as “Changing the Conversation”-emphasizes technology, a smaller branch footprint and expertise in niche areas. These banks approach banking with the mindset that “you can’t just be a community bank. You’ve got to be something totally different,” says Mealor. As a result, these banks aren’t necessarily constrained by geography, such as San Diego-based BofI Holding, with $7.7 billion in assets, which uses an Internet-only operating model for its consumer banking business. But not all of these banks rely so predominately on technology to generate growth and improved efficiency. New York-based Signature Bank, with $36.5 billion in assets, focuses on hiring high-producing lending teams in the metropolitan New York real estate market. Signature doesn’t have traditional, ground-floor branches, which would be expensive to operate. Instead, lenders work out of second-floor offices.
Both types of banks prove that smaller-but not too small-can be better.
“A lot of these smaller banks are able to move the needle a lot more effectively than the large cap banks. They’re able to be more nimble,” says Mealor, which enables quick decision making. These banks also know their customers. “They’re able to be more effective in their community, more so than the larger cap banks.”
The banks identified by KBW aren’t just great at growth. Two in particular rated highly in Bank Director’s 2016 Bank Performance Scorecard, published in the third quarter of this year. FCB ranked fifth among banks with $5 billion to $50 billion in assets, and Western Alliance Corp., headquartered in Phoenix, Arizona, ranked sixth in the same asset class. A high level of profitability, measured through return on average assets (ROAA) and return on average equity (ROAE) in Bank Director’s ranking, contributes to the strong performance of both institutions, but the business models fueling them couldn’t be more different.
These banks are proving that growth can happen in today’s market. But expecting to operate in a highly profitable manner with a status quo strategy or subpar execution just won’t cut it.
The private equity group behind FCB-then known as Bond Street Holdings-purchased 93-year-old Florida Community Bank from the Federal Deposit Insurance Corp. in 2009, when the bank had just $836 million in assets. It achieved much of its initial growth through a string of eight additional FDIC-assisted deals through 2010 and 2011. In 2014, it purchased Great Florida Bank. (While not an FDIC-assisted deal, the bank was under a consent order to raise more capital.) “There was a lot of money raised back in the crisis to roll up failed and troubled banks. FCB has done one of the better jobs at doing that,” says Brady Gailey, managing director at KBW. The management team at FCB, including Ellert, kept the acquired deposits, cleaned up the problem loans and replaced lending staff. “They acquired these failed banks, took them down to almost nothing and then rebuilt them back with quality professionals that they knew from having been in banking for decades in Florida,” says Gailey.
FCB’s story is similar to another strong performing bank-BankUnited, also an FDIC-assisted deal that was turned around and rehabbed, in a favorable transaction where the FDIC agreed to reimburse CEO John Kanas and his private equity investors for up to 95 percent of the bank’s losses. “That was a phenomenal deal, probably the best FDIC deal of the cycle. Once that happened, money poured into Florida, and everybody wanted to start a bank and try to replicate that deal that John Kanas did. Nobody has been able to get anywhere close to that, except for Kent Ellert at FCB,” says Gailey. The Florida market contributes greatly to the growth of these two banks: The financial crisis damaged the state’s economy, taking down a lot of banks along with it, but FCB and BankUnited were able to turn around failed institutions and grow along with Florida’s again-booming economy. But Kanas and his management team at BankUnited have New York roots, and in 2013 started to expand into the New York metropolitan area. FCB remains a Florida-focused operation.
FCB CEO Ellert built his career in the Florida banking market, logging 18 years at Wachovia Corp. (and its predecessor First Union Corp.) until 2007, before troubled Wachovia’s purchase by Wells Fargo & Co. in 2008. His own team reflects that background: Producers with local expertise coupled with experience at national banks. This expertise fuels FCB’s growth engine, says Ellert. “Banking is a local business. The delivery of products and services of a commercial bank are very much rooted in the knowledge that the bank possesses about the individual clients and the market,” he says. “The first and most important thing we did was build a team around very experienced, very seasoned banking professionals from our market.”
Florida is prone to boom and bust cycles, so this market knowledge is valuable. “It’s rare to have a management team that has been local in Florida, in the banking business, their whole lives,” says Gailey. Local Florida connections have also helped Ellert and his team attract lenders to drive loan growth.
With the exception of the 2014 Great Florida acquisition, FCB has largely focused on organic growth, rather than M&A, during the past five years. “Your best asset is one that you’ve originated. You’ll earn more revenue per client [and] you have a better sense of what the true credit quality is,” says Ellert. “You are what you eat, so you’re better off with your own cooking.” His approach to lending is balanced, aiming for an equal proportion of residential mortgages, commercial & industrial loans and commercial real estate loans. In Florida, “that’s about the safest distribution of assets that you can build,” he says. “That gives you more flexibility if a particular asset class weakens.”
Of course, FCB’s size, growth and market presence also make it a good acquisition target for a larger bank wanting to get in on the action in a now-booming Florida. Ellert doesn’t reject the idea of a future merger, but right now, FCB has no near-term plans to sell. There’s still room for FCB to grow.
Western Alliance operated much like your traditional community bank until 2010. But like Florida, the impact of the financial crisis was deeply felt in the bank’s former hometown of Las Vegas, Nevada. Suddenly, the fastest growing state in the nation “turned into ground zero for the financial crisis,” says Western Alliance Chief Financial Officer Dale Gibbons. It was clear to bank management that the bank’s model would have to change.
Western Alliance shifted gears from its traditional retail model, found its strong suit in commercial lending and emerged with a focus on several niche business lines, in areas including technology, renewable energy, life sciences, the hospitality industry and homeowners associations. “We try to provide the businesses that we target [with] the best of what a large bank has to offer and what a community bank has to offer, which would include the product array, sophistication and capacity of a large bank, but a service level that’s more attuned to that of a community bank,” says Robert Sarver, the company’s CEO and chairman.
This focus on lending to niche industries means Western Alliance is no longer tied to the ups and downs of one geographic market, and diversifies the bank’s loan portfolio. “Ten years ago, we were heavily concentrated in Nevada,” says Sarver. “Part of our business strategy has been to manage our risk better by getting more diversification on our loan book, by product type and geography.”
Sarver has a long track record in the industry, with a reputation for thinking differently than his peers. He founded National Bank of Tucson in 1984, when he was just 23 years old. Later renamed National Bank of Arizona, he lead the bank until it was acquired in 1994 by Zions Bancorp. Sarver is also the executive director of a real estate company, Southwest Value Partners, and managing partner of the Phoenix Suns basketball team.
“He really doesn’t like how the banking industry thinks. He definitely likes to zig when everyone is zagging,” says Brad Milsaps, managing director at Sandler O’Neill + Partners.
“If you follow the industry, you’re going to be one step and one economic cycle behind,” says Sarver.
For example, you won’t find residential mortgages in Western Alliance’s loan portfolio, a business line the bank jettisoned upon transitioning to a commercial focus. Margins are narrower on residential mortgages. The compliance risk is higher. “You’ve got to be very cognizant of your overhead and the cost of delivering your product,” says Sarver. “We got out of the residential mortgage space, which takes tremendous scale in order to compete profitably in today’s environment.” Western Alliance reported a NIM of 4.65 percent in the second quarter of 2016.
Western Alliance takes an opportunistic approach to growth via acquisition, seeking new product lines or desired geographic areas. “They’ve been a strong acquirer of banks, and very thoughtful about what lines of business they want to be in, and what geographies they want to be in,” says Brett Rabatin, a senior research analyst at Piper Jaffray.
The 2015 acquisition of San Jose, California-based Bridge Bank provided Western Alliance with a niche line serving the technology sector, a stronger footprint in northern California and an attractive deposit franchise. Few banks offer credit tailored for the technology industry. “Consequently, we think the risk-adjusted returns have been a little bit better there than areas that are more saturated, like commercial real estate lending,” says Gibbons.
The bank also purchased a $1.4 billion hotel finance loan portfolio from General Electric Co. subsidiary GE Capital in April, and gained 35 GE Capital employees, along with their requisite expertise. (Considered a Systemically Important Financial Institution until June of this year, GE Capital had been shedding assets in order to shrink itself down to escape this designation.)
In Bank Director magazine’s August 2015 digital edition, Western Alliance was ranked as the top acquirer over the past five years by S&P Global Market Intelligence, based on a total shareholder return for the period of 907 percent.
Both Western Alliance and FCB emerged stronger following the financial crisis. Despite their dissimilar business models, both share common traits that contribute to their growth.
First, both promote a culture highly focused on the customer. FCB’s Ellert is known to personally meet with bank customers on a regular basis. Given the bank’s close geographic base-each client is at maximum a few hours away by car-members of the bank’s executive team are available to lenders who request support with a prospective or current client, though Ellert is careful to add that executive involvement isn’t intended to undermine the expertise of the lender. “When you grow to the point where you need a plane to get to your customer, everything gets more complicated, and it gets hard to be agile and flexible,” says Ellert.
While Western Alliance has a much broader footprint than FCB, executives are involved in relationship management, says Sarver. He thinks that adds value: Customers are willing to pay more for exceptional service.
Second, these banks are very good at attracting lenders, in contrast to much of the industry. Bank Director’s 2016 Compensation Survey found that recruiting commercial lenders is a top challenge. There aren’t enough talented commercial lenders to go around.
Western Alliance and FCB buck this trend. Both institutions pay their lenders well. Cultures that support the lender certainly help. The ability to work at a bank that’s firing on all cylinders when it comes to growth and performance-and that has the platform to support that growth-is also a strong incentive.
“If you can provide bankers with a platform [so] that they can make their customers happy and are able to be successful in attracting new customers, and servicing their existing book of business, and make good money doing it, we found that we’ve been able to attract bankers,” says Sarver.
Western Alliance also has a knack for acquiring talented lenders along with the niche business lines it acquires. The Bridge Bank acquisition is an example of acquiring new skills. “We didn’t have anyone at Western Alliance before that deal that really understood or had depth in that sector. We needed to acquire that. We’re not going to start lending in some space that we don’t understand,” says Gibbons.
Both banks are highly efficient, with each reporting an efficiency ratio of 45 percent in the second quarter. FCB manages this magic trick through simple operating leverage, keeping their expenses down while growing interest income.
Western Alliance focuses on more efficient business lines-remember, the bank exited residential mortgages. “We selected businesses where we have a competitive advantage,” says Gibbons. “What we haven’t selected are [business lines] that generally have high efficiency ratios.” The organization also has a relatively light branch footprint, with 41 offices that average $400 million in deposits. These locations serve more as meeting places between lender and client, rather than a traditional retail branch. Western Alliance doesn’t need to be on every corner.
“We’ve been able to manage our overhead well,” says Sarver.
Western Alliance and FCB are both asset sensitive, meaning that a rise in short term interest rates-as Federal Reserve Chair Janet Yellen indicated will gradually happen-is likely to make these banks more profitable as the interest generated on loans increases.
“It’s an overcrowded system right now,” says Mealor. “You’ve got to find a way to differentiate yourself, both to get investor attention and to get customer attention.”
The challenger banks have set themselves apart from other institutions by focusing on what they do best. By doing so, they’ve found a way to grow. FCB’s Ellert, as well as Sarver and Gibbons at Western Alliance, all recognize the industry’s challenges, particularly continued low interest rates and the regulatory burden. And maintaining the same level of growth and profitability is, in and of itself, a challenge-but one that more banks wish they had to face.