How One Bank Chairman Created a Diverse Board

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When Charles Crawford Jr. took over as chairman and CEO of Philadelphia-based Hyperion Bank in August 2017, the 11-year-old de novo’s board had shrunk from 15 directors at its inception to the statutory minimum of just five, and its future was anything but certain.

Hyperion had been formed in 2006, but never seemed to find its stride. “When you start a new bank you typically lose money for the first two years, and by year three you should have enough critical mass to be achieving profitability for your shareholders,” says Crawford. “Unfortunately for Hyperion, they lost money for seven straight years. A lot of those 15 board members said ‘You know what? This isn’t so fun.’” One by one, most of them left the board.

Crawford had also formed a new bank in 2006, but this venture turned out to be much more successful than Hyperion. Crawford’s bank — known as Private Bank of Buckhead and situated in an upscale community north of Atlanta – was sold in 2017. After the sale, an investor in both Private Bank and Hyperion asked him to take a close look at its operation and perhaps join the board. Crawford says he saw “a great entrepreneurial opportunity” and signed on.

Since then, Crawford has raised $18 million in capital, which has enabled the $250 million asset bank to finally begin to grow, and opened a branch in the Atlanta market. He has also rebuilt the Hyperion board almost from scratch. Today’s board has eight members, including an African American male, who joined the board in 2018, and three females who signed on in the fourth quarter of 2019. Crawford values the different experiences and points of view – often referred to as diversity of thought – that the group brings to the governance process.

“To me, it’s not just gender and ethnic diversity,” Crawford says. “It’s backgrounds and skillsets and knowledge, and that people think differently and ask different questions.” Hyperion’s board diversity didn’t occur by accident. “You do have to be very intentional to be able to build a diverse board or a diverse workforce,” he says.

One of Crawford’s challenges in rebuilding the board was his unfamiliarity with the Philadelphia business community. He graduated from the University of Pennsylvania but hadn’t lived in Philadelphia for over 30 years, so he didn’t know a lot of people there. One of his first recruits was Robert N.C. “Bobby” Nix III, an African American attorney with extensive experience serving on bank boards, including one occasion when he had to step in and take over as the interim CEO. Crawford was introduced to Nix by another Hyperion director who has since left the board.

Nix says he quickly developed a rapport with Crawford. “He is a very accomplished banker and a really bright and nice guy,” Nix says. “I got along with Charlie really well and had a great comfort level with him. And we talked about a lot of stuff about how I would like to see the bank go, and he actually listened.”

One of Nix’s suggestions was to recruit an economist because Hyperion is an active construction lender and that tends to be a cyclical business. Crawford later brought to the board Lara Rhame, the chief U.S. economist at FS Investments, an alternative asset manager in Philadelphia. Crawford started playing tennis after he moved to Philadelphia as a way of meeting people, and a fellow tennis player connected him to Rhame. Crawford said he was looking to add more talent to the Hyperion board.

“Lara and I had coffee and I explained what the bank was up to and [what] the mission [was] and got to know her background,” Crawford says. “I’ve never had an economist on my bank board, but it is very valuable. She helps not just me but the other directors and bank management see the big picture of what’s going on.”

Crawford first met another female director – Gretchen Santamour, a partner at the Philadelphia law firm Stradley Ronon, where she specializes in business restructurings and loan workouts – through a public relations consultant that did some work for the bank. Santamour invested in Hyperion when Crawford did a capital raise and later sent him a note. “She said, ‘I’m glad to see that you have a female on your bank board. Most community banks I’m aware of don’t. If you ever want to add to that let me know. I’d be glad to help you.’ I took that very literally and followed up with Gretchen later and said, ‘I got your note and frankly with your experience as an attorney and [with] workouts, and being so engrained in the Philadelphia business community, how about you? Would you be willing to serve? And she said she would.’ So she, too, has been a great addition.”

A third female director at Hyperion is Jill Jinks, CEO at Insurance House Holdings, an agency located in Marietta, Georgia. Jinks had been an investor in the Private Bank of Buckhead and had served on the board. Jinks also invested in Hyperion when Crawford did his capital raise, and when Hyperion expanded into the Atlanta market, he asked Jinks to become a director. “I had the experience of having her as a director for a decade on my previous bank [board] and I knew her,” Crawford says. “She chaired my audit committee – she’s chairing [Hyperion’s audit committee] now – and I knew she would be of great value to us, both in the Atlanta market and in general with governance.”

In addition to himself, other Hyperion directors include Louis DeCesare, Jr., the bank’s president and chief operating officer who joined the company in 2013; James McAlpin, Jr., a partner at the Atlanta-based law firm Bryan Cave Leighton Paisner and leader of the firm’s financial services client services group; and Michael Purcell, an investment adviser and former Deloitte & Touche audit partner with deep ties in the Philadelphia business community.

The story of how Crawford rebuilt the bank’s board reveals several important truths about board diversity. When bank boards need to recruit a new director they tend to rely on personal networks, and some of Hyperion’s directors were individuals that Crawford already knew. But the Hyperion board’s diversity is also intentional. Board diversity won’t happen unless the people driving the refreshment process make it happen through a deliberate process.

“As you can tell from my story, and I think this would be true with most community banks, we didn’t hire a big recruiting firm to help us ‘ID’ directors,” Crawford says. “My advice is, reach out to community organizations … by being involved. I remember back at my Atlanta bank, I served on the City of Atlanta Board of Ethics and it exposed me to a whole different group of people. And the chair of that board … was [an] African-American [who] had served on the Delta Credit Union board and he ended up joining my board. It’s just another example of, if you get out in the community, you’re going to get exposed to and meet people you otherwise wouldn’t if you’re sitting in your boardroom, or office, hoping they’ll come to you.” Nix, Rhame and Santamour are a case in point; all were unknown to Crawford before he recruited them to the board.

Crawford has another piece of advice for bank boards looking to be more inclusive. “Building a diverse board … is an ongoing, moving target,” he says. “I don’t think you’re ever done, as your community ebbs and flows, to make sure that either your board or our workforce looks like your community.”

Capital, Digital Initiatives Set De Novos Up for Success

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In 2018, Matt Pollock and a group of business leaders and experienced bankers organized a new bank to fill a gap they saw in the Oklahoma City market. And he believes their tech-forward approach sets them apart from competing financial institutions.

“A lot of [banks] fall into the same traps in how they approach client services and products and relationships, and they just don’t do a very good job,” says Pollock, the CEO of $110 million Watermark Bank, which opened its doors in January 2019. “So, we really focused on [building] the right team, with the right model that really drives the business community.”

Few de novo banks have formed since the 2008-09 financial crisis. Of the 1,042 community banks chartered in the eight years preceding that crisis, 13% failed and another 20% were acquired or liquidated, according to a 2016 Federal Deposit Insurance Corp. study. Overall, de novo banks accounted for 27% of all failures from 2008 to 2015, and exited at double the rate of small, established banks.

De novo institutions are particularly fragile: They don’t tend to be profitable in their early years as they invest in building their business and reputation in their markets. In today’s environment, low rates pressure net interest margins, exacerbating these challenges.

With that in mind, Bank Director used FDIC data to analyze the 24 de novo banks formed from January 2017 through December 2019 to understand how they’re performing today and how they might weather the current economic downturn. We examined efficiency, through the overhead and efficiency ratios, and profitability, through return on assets and return on equity, as of Dec. 31, 2019. We also included equity capital to assets and net interest margin in the analysis. Watermark came in fifth in our ranking.  

Today’s batch of de novo banks features higher capital levels, a requirement that has dampened new bank formation. (The FDIC doesn’t set a minimum capital threshold for de novo banks; expectations vary based on the bank’s market, size, complexity, activities and business model.)

If the recession deepens, those high capital levels could come in handy as banks find it trickier to raise more capital, says Nicholas Graham, senior managing director at FinPro. “Many of the de novos that formed over the past several years, in a very general statement, have not fully leveraged their capital to date,” he says. “Therefore, they have more capital right now, all else being equal, to potentially weather this storm.”

Stringent capital requirements led some bank organizers to acquire rather than start a bank from scratch. Not so for Watermark Bank. Acquiring a charter was too expensive due to high bank valuations toward the end of the cycle, says Pollock, and an acquisition would have bogged the founders down with legacy cultural and technological issues.

So, they decided to start fresh. “Let’s build our systems and our workflows exactly how we want to do it; we’ll have to roll up our sleeves, it will take a little bit longer, probably a little bit more work but in the end, it would be a benefit,” says Pollock. “We ran a very lean operation, opened with 12 people, got up and running, and we quickly got to a break-even faster than many others.”

Prioritizing technology sets Watermark and many of its de novo peers apart from those chartered before the 2008-09 crisis. And it allowed Watermark to rise to the occasion in issuing Paycheck Protection Program loans, despite high demand and a spare staff.

“We did as many PPP loans in 10 days as we did loan transactions in our first year of operation,” says Pollock. “There was some stress, but at the end of the day we walked away and said, ‘We have good processes and procedures, we have extremely talented people, and we’re capable of leveraging our platform and our operational capabilities that we have today to a much higher level,’” he says.

Flexibility and nimbleness give de novo banks an advantage. “They’re more quickly able to adapt and add new products and services that may be more beneficial in this time of uncertainty,” says Graham.

Savvy de novos are investing in the digital infrastructure needed for modern banking, says Rick Childs, a partner at Crowe LLP. But there’s one more attribute he believes strengthens a de novo: extensive banking experience on the board and management team.

“You can skin the cat a lot of different ways in banking, but if you don’t have a lot of capital to help you weather the lean years, and if you don’t have strong management and [directors] to make sure you’re not taking unnecessary risk,” it will be hard to survive, he says. “[If] you know how to react when a difficult time comes around, then the rest will follow.”

Top Performing De Novo Banks

Rank Bank Name Asset Size (000s) NIM (3/31/2020) Overall Score
#1 The Bank of Austin $202,738 3.36% 5.8
#2 CommerceOneBank $258,590 3.34% 6.2
#3 Winter Park National Bank $418,816 2.89% 7.0
#4 Tennessee Bank & Trust $272,173 3.25% 7.7
#5 Watermark Bank $110,423 3.40% 8.0
#6 Infinity Bank $110,145 4.41% 8.6
#7 Ohio State Bank $130,519 2.22% 9.5
#8 Gulfside Bank $97,154 3.14% 10.6
#9 The Millyard Bank $23,524 1.41% 11.2
#10 Beacon Community Bank $161,029 3.05% 12.1

Source: Federal Deposit Insurance Corp.
Each bank was ranked based on profitability, efficiency, NIM and capital as of Dec. 31, 2019. The overall score reflects the average of these ranks.

What’s Trending at Acquire or Be Acquired 2019

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Smart Leadership – Today’s challenges and opportunities point to one important solution: strong boards and executive teams.
Predicting The Future – Interest is growing around mergers of equals, commercial deposits and shifting team dynamics.
Board-Level Concerns – Three characteristics define the issues facing bank directors.
Spotlight on Diversity – Diverse backgrounds fuel stronger performance.
Digging into Strategic Issues – The end of the government shutdown could yield more IPOs.

Three New Ways the FDIC Is Helping Community Banks

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regulation-3-8-19.pngIf 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.” Twitter_Logo_Blue.png

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.

The Most Important Question in Banking Right Now

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banking-2-15-19.pngTo 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.

The Story Behind 2018’s Most Transformative Deal

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acquisition-2-8-19.pngMalcolm 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.

What You Need to Know About the OCC’s Fintech Charter

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OCC-10-17-18.pngOn 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:

  1. 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
  2. The filing phase, involving the submission of a completed application
  3. The review phase, during which the OCC conducts a detailed review and analysis of the application
  4. 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.

Pre-application considerations
A company thinking about applying should consider:

  1. The advantages of operating under a single, national set of standards, particularly for companies operating in multiple states
  2. The ability to meet minimum capital and liquidity requirements
  3. The time and expense of obtaining a charter
  4. Whether a partnership with an existing bank is a superior alternative
  5. 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.

What It Takes to Go De Novo Today

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de-novo-7-27-18.pngAaron 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.

Are De Novos Making A Comeback?

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de-novo-7-3-18.pngThere 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.