If there’s one takeaway from the Federal Deposit Insurance Corp.’s latest annual report, it’s that there’s a new sheriff in town.
The sheriff, Jelena McWilliams, isn’t literally new, of course, given the FDIC’s new chairman was confirmed in May 2018. Yet, it wasn’t until last month that her imprint on the FDIC became clear, with the release of the agency’s annual report.
In last year’s report, former Chairman Martin Gruenberg spent the first half of his Message from the Chairman—the FDIC’s equivalent to an annual shareholder letter—reviewing the risks facing the banking industry and emphasizing the need for banks and regulatory agencies to stay vigilant despite the strength of the ongoing economic expansion.
“History shows that surprising and adverse developments in financial markets occur with some frequency,” wrote Gruenberg. “History also shows that the seeds of banking crises are sown by the decisions banks and bank policymakers make when they have maximum confidence that the horizon is clear.”
The net result, wrote Gruenberg, is that, “[w]hile the banking system is much stronger now than it was entering the crisis, continued vigilance is warranted.”
Gruenberg’s tone was that of a parent, not a partner.
This paternalistic tone is one reason that bankers have grown so frustrated with regulators. Sure, regulators have a job to do, but to imply that bankers are ignorant of the economic cycle belies the fact that most bankers have more experience in the industry than regulators.
This is why McWilliams’ message will come as a relief to the industry.
It’s not that she disagrees with Gruenberg on the need to maintain vigilance, because there’s no reason to think she does. But the tone of her message implies that she views the FDIC as more of a partner to the banking industry than a parent.
This is reflected in her list of priorities. These include encouraging more de novo formations, reducing the regulatory burden on community banks, increasing transparency of the agency’s performance and establishing an office of innovation to help banks understand how technology is changing the industry.
To be clear, it’s not that Gruenberg didn’t promote de novo formations, because he did. It was under his tenure that the FDIC conducted outreach meetings around the country aimed at educating prospective bank organizers about the application process.
But while Gruenberg’s conversation about de novo banks was buried deep in his message, it was front and center in McWilliams’ message, appearing in the fourth paragraph.
“One of my top priorities as FDIC Chairman is to encourage more de novo formation, and we are hard at work to make this a reality,” wrote McWilliams. “De novo banks are a key source of new capital, talent, ideas, and ways to serve customers, and the FDIC will do its part to support this segment of the industry.”
To this end, the FDIC has requested public comment on streamlining and identifying potential improvements in the deposit insurance application process. Coincidence or not, the number of approved de novo applications increased last year to 17—the most since the financial crisis.
The progress on McWilliams’ second priority, chipping away at the regulatory burden on community banks, is more quantifiably apparent.
The FDIC eliminated over 400 out of a total of 800 pieces of outstanding supervisory guidance and, in her first month as chairman, launched a pilot program that allows examiners to review digitally scanned loan files offsite, reducing the length of onsite exams.
Relatedly, the number of enforcement actions initiated by the FDIC continued to decline last year. In 2016, the FDIC initiated 259 risk and consumer enforcement actions. That fell to 231 the following year. And in 2018, it was down to 177.
“We will continue [in 2019] to focus on reducing unnecessary regulatory burdens for community banks without sacrificing consumer protections or prudential requirements,” McWilliams wrote. “When we make these adjustments, we allow banks to focus on the business of banking, not on the unraveling of red tape.”
Another of McWilliams’ priorities is promoting transparency at the agency. This was the theme of her first public initiative announced as chairman, titled “Trust through Transparency.”
The substance of the initiative is to publish a list of the FDIC’s performance metrics online, including call center response rates and turnaround times for examinations and applications. In the first two months the webpage was live, it received more than 34,000 page views.
Finally, reflecting a central challenge faced by banks today, the FDIC is in the process of establishing an Office of Innovation that, according to McWilliams, “will partner with banks and nonbanks to understand how technology is changing the business of banking.”
The office is tasked with addressing a number of specific questions, including how the FDIC can provide a safe regulatory environment that promotes continuous innovation. It’s ultimate objective, though, is in line with McWilliams’ other priorities.
“Through increased collaboration with FDIC-regulated institutions, consumers, and financial services innovators, we will help increase the velocity of innovation in our business,” wrote McWilliams.
In short, while the industry has known since the middle of last year that a new sheriff is in town at the FDIC, the agency’s 2018 annual report lays out more clearly how she intends to govern.
To understand the seismic shifts underway in the banking industry today, it’s helpful to look back at what a different industry went through in the 1980s—the industry for computer memory chips.
The story of Intel Corp. through that period is particularly insightful.
Intel was founded in 1968.
Within four years, it emerged as one of the leading manufacturers of semiconductor memory chips in the world.
Then something changed.
Heightened competition from Japanese chip manufacturers dramatically shrank the profits Intel earned from producing memory chips.
The competition was so intense that Intel effectively abandoned its bread-and-butter memory chip business in favor of the relatively new field of microprocessors.
It’s like McDonald’s switching from hamburgers to tacos.
In the words of Intel’s CEO at the time, Andy Grove, the industry had reached a strategic inflection point.
“[A] strategic inflection point is a time in the life of a business when its fundamentals are about to change,” Grove later wrote his book, “Only the Paranoid Survive.”
“That change can mean an opportunity to rise to new heights,” Grove continued. “But it may just as likely signal the beginning of the end.”
The parallels to the banking industry today are obvious.
Over the past decade, as attention has been focused on the recovery from the financial crisis, there’s been a fundamental shift in the way banks operate.
To make a deposit a decade ago, a customer had to visit an ATM or walk into a branch. Nowadays, three quarters of deposit transactions at Bank of America, one of the biggest retail banks in the country, are completed digitally.
The implications of this are huge.
Convenience and service quality are no longer defined by the number and location of branches. Now, they’re a function of the design and functionality of a bank’s website and mobile app.
This shift is reflected in J.D. Power’s 2019 Retail Banking Advice Study, a survey of customer satisfaction with advice and account-opening processes at regional and national banks.
Overall customer satisfaction with advice provided by banks increased in the survey compared to the prior year. Yet, advice delivered digitally (via website or mobile app) had the largest satisfaction point gain over the prior year, with the most profound improvement among consumers under 40 years old.
It’s this change in customers’ definition of convenience and service quality that has enabled the biggest banks over the past few years to begin growing deposits organically, as opposed to through acquisitions, for the first time since the consolidation cycle began in earnest nearly four decades ago.
And as we discussed in our latest issue of Bank Director magazine, the new definition of convenience has also altered the growth strategy of these same big banks.
If they want to expand into a new geographic market today, they don’t do so by buying a bunch of branches. They do so, instead, by opening up a few de novo locations and then supplementing those branches with aggressive marketing campaigns tied to their digital banking offerings.
It’s a massive shift. But is it a strategic inflection point along the same lines as that faced by Intel in the 1980s?
Put another way, has the debut and adoption of digital banking changed the fundamental competitive dynamics of banking? Or is digital banking just another distribution channel, along the lines of phone banking, drive-through windows or ATMs?
There’s no way to know for sure, says Don MacDonald, the former chief marketing officer of Intel, who currently holds the same position at MX, a fintech company helping banks, credit unions, and developers better leverage their customer data.
In MacDonald’s estimation, true strategic inflection points are caused by changes on multiple fronts.
In the banking industry, for instance, the fronts would include regulation, technology, customer expectations and competition.
Viewed through this lens, it seems reasonable to think that banking has indeed passed such a threshold.
On the regulatory front, for the first time ever, a handful of banks don’t have a choice but to focus on organic deposit growth—once the exclusive province of community and regional banks—as the three largest retail banks each hold more than 10 percent of domestic deposits and are thus prohibited from growing through acquisition.
Furthermore, regulators are making it easier for firms outside the industry—namely, fintechs—to compete directly against banks, with the Office of the Comptroller of the Currency’s fintech charter being the most obvious example.
Technology has changed, too, with customers now using their computers and smartphones to complete deposits and apply for mortgages, negating the need to walk into a branch.
And customer expectations have been radically transformed, as evidenced by the latest J.D. Power survey revealing a preference toward digital banking advice over personal advice.
To be clear, whether a true strategic inflection point is here or not doesn’t absolve banks of their traditional duty to make good loans and provide excellent customer service. But it does mean the rules of the game have changed.
Malcolm Holland, the CEO of Veritex Holdings in Dallas, Texas, wanted to expand in the Houston market in 2017 and was looking for a deal. He pursued three targets, but they were all snapped up by competing buyers.
Just as Holland was resigning himself to expand more slowly through de novo branch expansion, his phone rang. It was Geoffrey Greenwade, the president of Green Bancorp, a Houston-based bank with $4.4 billion in assets.
Would Holland be interested in meeting with Greenwade and Manuel Mehos, Green’s CEO and chairman? Greenwade asked.
Holland thought the executives were courting him. Instead, they asked if Veritex wanted to acquire Green.
It’s a unique story, as the now-$8 billion Veritex was smaller than Green when the deal was announced—Green’s balance sheet was 40 percent larger than Veritex’s.
The acquisition of Green—which closed on Jan. 1, 2019—has more than doubled the size of Veritex, and significantly increased its share in a second Texas market. It’s for these reasons that Bank Director identified this deal as the most transformative of 2018.
A deal as transformative as this—in which the seller is bigger than the buyer—is rare. With good reason: Most banks prefer bite-sized deals to minimize integration risk.
But this kind of deal can work well for the right buyer—expanding its capabilities and markets in one fell swoop.
To measure which of the deals announced in 2018 were the most transformative, Bank Director calculated seller assets as a percentage of buyer assets, using data from S&P Global Market Intelligence. The larger the seller compared to the buyer, the greater the opportunity and the more complicated the integration. We also examined seller size as an absolute value, to represent the deal’s transformative impact in its market.
You’ll find a list of the top ten deals at the end of this story.
Because the list does not award deal size alone, the two largest deals announced last year—Fifth Third Bancorp’s acquisition of $20 billion asset MB Financial and Synovus Financial Corp.’s acquisition of $12 billion asset FCB Financial Holdings—did not make the list. MB represented just 14 percent of Fifth Third’s assets and FCB 38 percent of Synovus.
Despite the difference in size, the deal between Veritex and Green made sense. “What we provided for them [was] a really clean credit history, and our stock had a higher value,” says Holland.
Just as importantly, says Holland, “I needed to mark their balance sheet. If they were going to be the accounting acquirer …. The deal would not have penciled out. So, I needed to acquire them, from an accounting standpoint, and mark their balance sheet down where it was appropriate.”
“Investors viewed the Veritex franchise maybe a little better than Green,” says Brett Rabatin, a senior research analyst at Piper Jaffray who covers Veritex. In 2015, a troubled energy sector resulted in a higher level of charge-offs in Green’s loan portfolio, raising concerns among investors that there could be further credit problems down the road.
Green addressed the energy exposure, and oil and gas represent a small portion of Veritex’s loan portfolio today, says Holland.
The combination roughly doubled Veritex’s branch footprint and has greatly expanded its presence in Houston—from one office to 11, giving Veritex the scale it needs to better compete in that market. The bank also gained expertise in commercial and middle market lending, as well as new treasury management products and services.
Green CFO Terry Earley has stayed on with Veritex in the same role, and Donald Perschbacher, Green’s chief credit officer, also joined the executive team. Greenwade is now president of the Houston market. Six directors from Veritex and three from Green, including Mehos, form the current board.
Holland isn’t afraid to adopt new practices from a seller that will improve his bank. It’s a lesson he’s learned over the years integrating the bank’s six previous acquisitions. “Individually, none of us could probably get where we can get together, and so let’s pick the best of each side, and together we will be better,” says Holland.
He’s also learned that integrating people—not technology and systems—ultimately determines the success of a transformative deal.
“The question is, how do you take that culture, your culture that’s been so successful, and institute it into their culture, yet picking up some of the things they do and putting into yours,” says Holland. The integration team spends time reviewing employee handbooks, for example, picking up new practices from the seller.
Culturally, Holland believes the Green acquisition is the best deal his bank has done. “Everybody pulling in the same direction, everybody working toward the same target. The openness and the collaboration have been unbelievable,” he says.
Veritex is now the 10th largest Texas-based banking franchise as a result of this transformative merger. “We think this bank has the ability to be a Texas powerhouse,” says Holland.
Ten Most Transformative Deals in 2018
|Rank||Buyer||Seller||Size of acquired bank (millions)||Impact on size of acquirer||Score*|
|1||Veritex Holdings (VBTX) Dallas, TX||Green Bancorp (GNBC) Houston, TX||$4,392||140%||3.33|
|2||WSFS Financial Corp. (WSFS) Wilmington, DE||Beneficial Bancorp (BNCL) Philadelphia, PA||$5,770||81%||8.33|
|3||Vantage Bancorp San Antonio, TX||Inter National Bank McAllen, TX||$1,379||250%||9.33|
|4||North Easton Savings Bank South Easton, MA||Mutual Bank Whitman, MA||$518||94%||24.7|
|5||CVB Financial Corp. (CVBF) Ontario, CA||Community Bank (CYHT) Pasadena, CA||$3,747||45%||27.0|
|6||Allegiance Bancshares (ABTX) Houston, TX||Post Oak Bancshares Houston, TX||$1,431||50%||27.7|
|7||Adam Bank Group College Station, TX||Andrews Holding Co. Andrews, TX||$639||60%||27.7|
|8||Ameris Bancorp (ABCB) Moultrie, GA||Fidelity Southern Corp. (LION) Atlanta, GA||$4,812||42%||28.3|
|9||Cadence Bancorp. (CADE) Houston, TX||State Bank Financial Corp. (STBZ) Atlanta, GA||$4,924||42%||28.7|
|10||Independent Bank Group (IBTX) McKinney, TX||Guaranty Bancorp (GBNK) Denver, CO||$3,722||42%||29.3|
Source: S&P Global Market Intelligence
*The score reflects how each deal ranked in terms of the impact of the seller’s size on that of the acquiring bank and the absolute size of the seller.
On July 31, 2018, the Office of the Comptroller of the Currency said it will begin accepting applications for a special purpose national bank charter designed specifically for fintech companies. The news came hours after the Treasury Department issued a parallel report preemptively supporting the move.
In connection with its announcement, the OCC issued a supplement to its Comptroller’s Licensing Manual as well as a Policy Statement addressing charter applications from fintech companies. Both are worth reviewing by anyone thinking about submitting an application.
The Application Process
To apply for a fintech charter, a company must engage in either or both of the core banking activities of paying checks or lending money. Generally, this would include businesses involved in payment processing or marketplace lending.
The fintech charter is not available for companies that want to take deposits, nor is it an option for companies seeking federal deposit insurance. Such companies would have to apply instead for a full-service national bank charter and federal deposit insurance.
The application process for a fintech charter is similar to that for a de novo bank charter, with each application reviewed on its own unique facts and circumstances.
The four stages of the application process are:
- The pre-filing phase, involving preliminary meetings with the OCC to discuss the business plan, proposed board and management, underlying marketing analysis to support the plan, capital and liquidity needs and the applicant’s commitment to providing fair access to its financial services
- The filing phase, involving the submission of a completed application
- The review phase, during which the OCC conducts a detailed review and analysis of the application
- The decision phase, during which the OCC determines whether to approve the application
The process from beginning to end can take up to a year or longer.
Living with a fintech charter
Fintech banks will be supervised in a similar manner to national banks. They will be subject to minimum capital and liquidity requirements that could vary depending on the applicant’s business model, financial inclusion commitments, and safety and soundness examinations, among other things.
Additionally, to receive final approval to open a fintech bank, an applicant must adopt and receive OCC approval of a contingency plan addressing steps the bank will take in the event of severe financial stress. Such options would include a sale, merger or liquidation. The applicant must also develop policies and procedures to implement its financial inclusion commitment to treat customers fairly and provide fair access to its financial services.
Similar to a traditional de novo bank, a fintech bank will be subject to enhanced supervision during at least its first three years of operation.
A company thinking about applying should consider:
- The advantages of operating under a single, national set of standards, particularly for companies operating in multiple states
- The ability to meet minimum capital and liquidity requirements
- The time and expense of obtaining a charter
- Whether a partnership with an existing bank is a superior alternative
- The potential for delays in the regulatory process for obtaining a charter, including delays resulting from the OCC application process or legal challenges to that process
There is one complicating factor in all of this. Following the OCC’s initial proposal to issue fintech charters in 2017, two lawsuits were filed challenging the OCC’s authority to do so—one by the Conference of State Bank Supervisors and one by the New York State Department of Financial Services. Both were dismissed, because the OCC had yet to reach a final decision. But now that the OCC has issued formal guidance and stated its intent to accept applications, one or both lawsuits may be refiled.
Whether this happens remains to be seen. But either way, the OCC’s decision to accept applications for fintech charters speaks to its commitment to clear the way for further innovation in the financial services industry.
Aaron Dorn spent two years putting together a checklist of things that needed to be in place and questions that needed to be answered before starting a new bank.
He considered buying an existing bank, but acquiring a company built on legacy core technology was a big inhibitor to building a digital-only bank, which was Dorn’s business plan. However, the idea of going de novo became too costly and intensive to justify the effort after the FDIC increased its capitalization requirements for startups following the financial crisis. Now, there are signs that the environment for de novos is improving. Economic conditions around the country are better and bank stock values are higher, but there are other factors that could also be significant drivers behind a recent uptick in de novo activity, all of which Dorn discovered in Nashville as he considered the de novo route.
Dorn, 37, formally began the process of raising capital in the fall of 2017 to form Studio Bank, which will officially open in a few weeks. He will serve as the CEO and also brought along a few former colleagues from Avenue Bank, where Dorn was the chief strategy and marketing officer. Avenue Bank was a 10-year-old “de facto de novo” (a recapitalized and rebranded Planters Bank of Tennessee) that sold in 2016 to Pinnacle Financial Partners, another Nashville-based bank. In fact, Studio’s music company-turned bank home sits in the shadow of Pinnacle’s headquarters building.
Just two banks have earned FDIC approval this year, but nearly more than a dozen de novo applications were awaiting approval in mid-June. That comes after just 13 banks opened in the seven preceding years, according to the agency. Capital raises for the new banks have been anywhere from a fairly standard $20 million to $100 million by Grasshopper Bank, based in New York.
This flurry of activity has naturally drawn attention and speculation about whether there will be a return to the level of new charter activity we saw previous to the financial crisis when in any given year there could be between 100 to 200 new bank formations. What exactly has inspired this growth in applications? Along with a stronger economy and higher valuations, the industry’s ongoing consolidation has created opportunities for former bankers like Dorn who are itching to get back into a business currently ripe with promise.
“These mergers are producing opportunities for groups to put together locally owned, more community focused financial institutions to service their market and also play an important role as community leaders,” said Phil Moore, managing partner at Porter Keadle Moore, an advisory and accounting firm.
But the question circulating among bankers and insiders is what has inspired the sharp increase in de novo activity. Or perhaps more importantly, what’s the recipe for starting a new bank today?
There’s a few things some agree need to be in place to get a new bank off the ground.
“The first is that these de novos are organizing in what could be considered underserved markets, secondly they are focusing on vibrant growth areas and third, they are generally organizing to serve an affinity group,” says Moore.
This is Dorn’s perspective also, who says he created Studio in part because the booming Nashville market has few local banks. Studio will focus on “creators,” as Dorn calls them, including musicians, nonprofits and startups, a very similar model to Avenue, except that Studio will operate from a digital platform.
The Nashville deposit market has doubled since the last de novo opened there in 2008, Dorn says. There is also a preference for local ownership. “Empirically, (Nashville is) a market that strongly prefers locally headquartered banks,” he says.
Studio is one of just two de novos that have been approved this year. The other, CommerceOne Bank, is in Birmingham, Alabama, another blossoming metro area that also has very few locally owned banks. Birmingham rates in the top 160 metro areas in the country, according to the Milken Institute’s 2017 Best-Performing Cities report.
Other pending applications that are also in high-performing areas like Oklahoma City, ranked 131, and Sarasota, Florida, ranked No. 6.
That’s still a far cry from the de novo activity seen in the decades prior to the financial crisis, but the interest in starting new companies can certainly be seen as encouraging.
There was a time, not long ago, when FDIC approved 237 applications in a single year. That was 2005. It’s unlikely there will be a return to similar activity levels, the de novo activity has grown from the post-recession single-digit levels to more than 20 open applications. That number that is anticipated to increase through 2018.
Among the de novos are geographically diverse groups involving non-traditional business models, online services, foreign nationals, ethnic/professional niches and minority ownership. Regulators have been open to applications that may have been deemed “non-starters” years ago.
Changes have been made to the FDIC application process that will benefit new community banks such as lessening the de novo period from seven to three years. The rescinding of the FDIC de novo period, the designation of de novo subject matter experts in the regional offices, and the issuance of supplemental guidance along with the FDIC’s “A Handbook for Organizer of De Novo Institutions” indicate a growing commitment by regulators to facilitate the process of establishing new community banks.
To ensure a smooth regulatory process and avoid significant cost outlays, groups should schedule and attend meetings with various regulatory agencies before pre-filing meetings to discuss the timeline and the likelihood of acceptance of an application. Federal and state regulators act in a timely manner, provide constructive feedback and can be easy to work with throughout the de novo process. Strong working relationship with the federal and state regulators, along with the collaboration between all parties highlight the importance of building the right team at the start.
The minimum opening capital requirement has been established at around $22 million. The caveat is that the capital must be in line with the risk profile of proposed bank, though more often than not $20 million or more of seed capital is almost always needed. Why is $22 million or more the magic number?
- Start-up costs and initial operating losses of $1.5 to $3 million;
- Profitability being achieved at between $175 to $225 million in assets;
- Required Tier One Leverage ratio above 8 percent or more throughout the de novo period;
- Creates an adequate loan-to-borrower limit.
Once the formation bank reaches the minimum capital requirement and gains approval it can open the doors. Once open, the bank can continue raising capital until a higher or maximum level is reached. Additionally, the ability to use 401k accounts for investors is a necessity.
De novo formations bring value to their communities, their markets, shareholders, and the banking industry by filling a void created by the consolidation. With the loss of many key banks, organizers and local businesses feel that larger banks are not providing the level of service and credit desired by small- to medium-sized business owners.
Since the Great Recession, select areas of the country have rebounded more strongly than others. Texas, the Dakotas, Florida, the Carolinas, Washington, D.C., Utah and Washington state are among leaders in job creation and population growth. Given the growth, along with the opportunities to serve growing ethnic and minority populations, many geographies across the country offer attractive opportunities for de novo banking.
Returns for de novo investors can be attractive. There is a risk associated with the initial start-up expenses and a resulting decline in tangible book value. A de novo raises initial capital at tangible book value. While building a franchise, reaching profitability and creating a successful bank allows for multiple expansions and strategic options which can provide attractive returns for initial investors.
Creating a well-connected and qualified board, management team and investor group is proven to be the best recipe for success. Having these individuals and businesses as deposit and lending customers increase, the community’s confidence in the bank facilitates the business generation, along with the marketing and word of mouth publicity.
The proper de novo team is comprised of the founder team, a strategic consultant with regulatory expertise and legal counsel. Business plans now routinely surpass 250 pages and legal requirements continue to expand. When choosing these partners, it is important they have experience in submitting de novo applications in recent years as nuances continue to evolve. Further, ensure all the fees paid are “success based,” so applicable expenses are aligned to the accomplishment of specific milestones.
Regulatory changes, market opportunities and industry consolidations have created an environment in which a de novo bank can form and flourish. With the right founding group and partners, now is the time to explore being part of the next wave of de novo banking.
This is the second in a five-part series that examines the bank M&A market from the perspective of five attendees at Bank Director’s Acquire or Be Acquired conference, which occurred in late January at the Arizona Biltmore resort in Phoenix.
Read the perspectives of other industry leaders:
John Asbury, president and CEO of Union Bankshares
Gary Bronstein, a partner at Kilpatrick Townsend & Stockton LLP
Eugene Ludwig, founder and CEO of Promontory Financial Group
It’s tempting to think that rising profits and higher stock valuations will spur merger and acquisition (M&A) activity in the bank industry. But that isn’t necessarily the case, says Kirk Wycoff, managing partner of Patriot Financial Partners L.P., a Philadelphia-based private equity fund that invests in banks with between $500 million and $5 billion in assets.
Wycoff characterizes the current M&A landscape as lukewarm. He gives it a grade of B. “About 4 percent of the industry consolidates every year,” he notes. “So 25 years ago, when there were 15,000 banks, there were 600 bank transactions a year. Now there are 6,000 banks, which translates into 240 transactions a year. The investment bankers always say, ‘Next year is going to be the best year ever,’ yet it’s always around 4 percent.”
There is no way to predict future transaction volumes with precision, of course, but Wycoff brings a lot of experience to bear on the issue. From 1991 to 2004, he was chairman and CEO of Progress Financial Corp., growing the Philadelphia-based bank from $280 million in assets to $1.2 billion before selling it to FleetBoston Financial Corp. After Bank of America Corp. bought FleetBoston in 2005, Wycoff founded Philadelphia-based Continental Bank. It became the fastest-growing de novo bank opened in the four years before the crisis and was sold in 2014 to Bryn Mawr Bank Corp., a $4.5 billion bank in neighboring Bryn Mawr, Pennsylvania. And since 2007, Wycoff has been a managing partner at Patriot Financial Partners.
Wycoff shared his perspective as a private equity investor on the M&A landscape with Bank Director at its latest Acquire or Be Acquired conference, held earlier this year at the Arizona Biltmore resort in Phoenix, Arizona. Wycoff’s perspective is one of five Bank Director has cultivated about the M&A landscape following the annual conference.
“I’ve been coming here for 24 years, both for the industry data that the presenters present and for the ideas on how to improve my companies,” says Wycoff. “I was a CEO the first 13 years I came here, so I used a lot of the ideas I picked up to improve the banks I was running. Since I’ve been an investor for the last 11 years we’ve been meeting our banks here, encouraging some of our banks and their boards to come here to learn about mergers and acquisitions, about concepts around accretion and dilution, about governance and the whole process of, if you need to do something strategically, how to do it right.”
Wycoff has a unique perspective on the relationship between profitability and M&A activity. The typical assumption is that higher profitability will spur transactions. It’s at the top of the cycle, after all, when buyers are flush with cash and sellers salivate at the prospect of high valuations. But Wycoff thinks there’s another way to look at this.
“People should think about the value of their bank as if M&A didn’t exist,” he says. “When banks return 15 percent on equity, which they’re on their way to doing, M&A becomes a much less necessary part of the plan because at that rate you’re going to double your capital every six years.”
Given the salutary impact of last year’s tax cuts, combined with the favorable operating environment, the industry could soon find itself in this situation. “As an investor, what struck me at this year’s conference is how good things are,” says Wycoff. “We’ve been in a very, very good credit environment, the industry has tremendous amount of capital, people are very optimistic and earnings are going up because of the tax bill.”
It’s in times like these that investors and board members need to avoid being lulled into a false sense of security, says Wycoff.
“CEOs will tell boards they deserve bonuses based on more earnings from tax reform when they maybe didn’t drive deposits or customer engagement or more margin.” Wycoff’s point is that now isn’t the time to become complacent. Instead, banks should be vigilant about operating expenses.
As an investor, Wycoff is also watching the evolution of bank stock ownership. The proliferation of exchange-traded funds and robo-advisors could detach bank valuations from fundamental performance, says Wycoff. This would create arbitrage opportunities for savvy investors, but it would break the feedback loop between the market and executives running banks. “That’s difficult because you like to think as a CEO or an investor that if a company does the right things, you get rewarded in your stock price.”
Fuller coffers also raise the importance of capital allocation. Should rising profits be used to increase dividends, accelerate stock buybacks, invest in the business or a combination of the three? That’s the question, notes Wycoff. “I hope that this additional profitability, which will inevitably drive stock prices higher for the banks that are doing well, isn’t frittered away on things that don’t create long-term value for shareholders.”
Evidence of how intertwined banking and technology have become could be seen at Bank Director’s 24th annual Acquire or Be Acquired Conference in Arizona, where nearly 20 percent of all sessions at the M&A event were devoted to technology. And while the results of audience response surveys showed that this shift is well-founded, they also uncovered lingering resistance to explore new capabilities and partnerships from the many bank C-Suite executives in attendance. Given the rapid decline in the number of U.S. banks and the fact that the build-to-sell model is still alive and well, perhaps a community bank’s time is better spent courting potential acquirers than potential fintech partners.
The audience at the Acquire or Be Acquired Conference is a powerful industry sampling, with over 650 bank CEOs, senior executives and directors from both private and publicly held financial institutions across the nation. Much can be gleaned from the inclinations of this crowd with regard to the broader banking industry in the U.S., so Bank Director takes several audience polls throughout the conference to harness that collective insight. Some interesting statistics emerged from this year’s conversations. The bankers polled indicated that:
- The primary driver of bank M&A activity in 2018 will be limited growth opportunities (45.9 percent). Only 7.2 percent of the audience cited the rise in technology-driven competition as the primary force behind M&A.
- Yet, when asked about what 2018 holds for online-only lenders, 29.9 percent said that banks will lose business to them and they may become even greater competitive threats.
- In addition, bankers at the conference believe their officers and directors will spend the most time talking about new technologies in 2018 (33.3 percent). Talent issues are potentially the second biggest topic for discussion (31.8 percent), which makes sense given that banks are working hard to compete against technology companies for talent. (See Bank Director’s 2017 Compensation Survey to learn more.)
- While fintech is acknowledged as a competitive threat, 57.6 percent of the audience disagreed with the premise that using fintechs to improve profits and attract customers is critical for their bank’s near-term success.
- What’s more, 65 percent of those polled rate their key vendors (payments, digital, core, lending, risk/fraud, etc.) as merely adequate—but still plan to re-sign with them when the time comes.
Is this the portrait of an industry that’s resistant to change, more risk averse than driven to grow, or does a closer look reveal pragmatic reasons for avoiding the headlong rush to adopt new technology solutions?
On day one of Acquire or Be Acquired, Curtis Carpenter, principal and head of investment banking at Sheshunoff & Co. Investment Banking, shared some stark statistics about the shrinking banking industry. We currently see both a lack of de novo bank openings (just eight new banks since 2010) and rapid consolidation, which Carpenter said is creating larger community banks and a focus on exit planning. Another audience poll confirmed that over half (52.8 percent) of the audience still believe the build-to-sell business model is viable. In addition, a majority of the crowd (42.4 percent) believes that the banks with the best chance to thrive operate an acquisition-driven growth model. If bankers think their best bet is to build their bank into an attractive acquisition target and wait to be bought, it’s no wonder they’re in no rush to bear the time and expense of adopting new technologies focused on organic growth.
From the stage, Carpenter posed a startling if central question: “Is this the end of community banking?” With consolidation on the rise and de novos all but extinct, the answer seems to trend to yes. If that’s true, are fintechs better served by targeting the banks with active acquisition programs as potential partners instead of potential sellers?
As consolidation continues, banks and fintechs need to keep a weather eye on one another. Each side of the equation has valuable information and strategies to offer the other, and the fates of these two industries are inextricably linked. Whatever course the banking industry takes, Bank Director and FinXTech will be there to help explore the strategies and relationships that unfold.