New Law Offers Banks a Way to Accelerate Deposit Growth

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deposit-8-31-18.pngFor a long time, it seemed as if the deck was stacked against community banks. Since the financial crisis, the nation’s largest banks have gobbled up some $2.4 trillion in new deposits. Big banks have deep pockets to spend on technology—money that smaller banks don’t have. And because of their concerns about safety, customers with more than $250,000 to deposit often shy away from community banks, thinking they are risky places to park deposits given the potential for a bank failure.

But now, some of that imbalance has shifted in favor of community banks. In May, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act. One of many bank-friendly aspects of the new law is a change in treatment of most reciprocal deposits. (Reciprocal deposits are deposits that banks place through a deposit placement network in exchange for matching deposits. Exchanging deposits on a dollar-for-dollar basis via a deposit placement network enables participating banks to provide their customers with access to FDIC insurance beyond $250,000.) Subject to certain restrictions, most reciprocal deposits are now considered nonbrokered. In enacting this change, Congress and the president have essentially acknowledged that most reciprocal deposits tend to behave like other deposits that come from locally based customers, and therefore, are a more stable source of funds than traditional brokered deposits.

Thanks to the new law, a well-capitalized bank with a CAMELS rating of 1 or 2 can hold reciprocal deposits up to the lesser of 20 percent of its total liabilities, or $5 billion, without those deposits being treated as brokered. (Reciprocal deposits over these amounts are treated as brokered.) Further, a bank that drops below well-capitalized status no longer requires a waiver from the Federal Deposit Insurance Corp. to continue accepting reciprocal deposits so long as it does not receive an amount of reciprocal deposits that causes its reciprocal deposits to exceed a previous four-quarter average.

The change in classification is pivotal for many banks. Here’s why:

  • Banks can seek out more large-dollar, safety-conscious customers—business they may not have attracted before, particularly if they’re a smaller community bank competing with a bank that is perceived as “too-big-to-fail.” Many business and nonprofit customers fall into this bucket.
  • Additionally, community banks can pursue more government and financial institution deposits as the nation’s largest banks—which are subject to liquidity coverage ratio calculations—look to shed these deposits. This will provide an opening for community banks to win these large-dollar deposits and to go after the whole banking relationship.
  • But that’s not all. Banks can also do more to replace or reduce their reliance on:
    • Collateralized deposits, which can be associated with significant opportunity costs, since they require banks to invest funds in U.S. Treasuries or other securities that might otherwise be used to fund loans that generate higher returns, and require additional cash outlays for such things as tracking securities.
    • Deposits that come through internet listing services. Such deposits don’t build franchise value the way reciprocal deposits do, and they tend to come from more rate-sensitive customers, not to mention out-of-state or out-of-market customers—who tend to be less loyal.
    • Higher-priced wholesale funding.
  • Finally, community banks can use reciprocal deposits to lock in more low-cost funding as a hedge against higher rates in the future—to take advantage of low deposit betas for services like Insured Cash Sweep® and CDARS®, and to secure customers for longer terms through, for example, a CD offering like CDARS.

Each of these can have a significant, positive impact on the bottom line and on return-on-assets and return-on-equity ratios. And each of these is something that banks can do more of now. Bottom line: With the new law, reciprocal deposits have become even more attractive for well-capitalized banks to use so that they can have more funds on hand and can make more loans.

Funding may still be a challenge for community banks in an environment of increased deposit competition. But thanks to the new law, community banks will at least have greater access to a tool to that can make their jobs easier.

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.