The Missing Piece in Community Bank M&A

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The community bank space is consolidating at a blistering pace, but buyers may be overlooking a key consideration when thinking about mergers and acquisitions. Prospective buyers should consider how other footprints complement growth opportunities against their own, lest they make critical and expensive mistakes. In this video, Kamal Mustafa, chairman of the Invictus Group, explains why bank buyers should assess a target’s footprint, and how to value the industries and lending opportunities within a new market.

  • Market Considerations and Assessments
  • Focusing on Industries, Not Loans
  • Target Valuations

Will We Ever See Three Times Book Again?

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Mergers and acquisitions are examined as part of Bank Director’s Inspired By Acquire or Be Acquired. Click here to access the content on BankDirector.com.

In the late 1990s, the economy was doing well.

Bank stocks traded at such rich multiples that no one batted an eye when a management team sold their bank for two times book. That valuation meant you were a mediocre bank.

Take Fifth Third Bancorp in Cincinnati. In the ‘90s, its stock traded at more than five times book value. A well run and efficient bank, it had the currency to gobble up competitors and it did.

It announced a deal in 1999 to buy Evansville, Indiana-based CNB Bancshares for 3.6 times tangible book value and 32 times earnings. “That was not completely unheard of,” says Jeff Davis, managing director at consultancy Mercer Capital. Fifth Third announced a deal in 2000 to buy Old Kent Financial Corp for a 42% premium.

In fact, Fifth Third was a little late to the M&A premium game. The average bank M&A deal price reached a peak of 2.6 times tangible book value in 1998. The median price was 24 times earnings that year.

M&A Pricing Peaked in 1998

Source: Mercer Capital, S&P Global Market Intelligence and FDIC.

It was such a hot market for bank acquisitions, investors rushed into bank stocks in order to speculate on who would get purchased next. I remember sitting down with then-president of the Tennessee Bankers Association, Bradley Barrett, in the mid-2000s. He predicted the market would fall and many banks would suffer.

Boy, was he right. He was probably the first to school me in banking cycles.

Fast forward two decades. The industry is in a relatively depressed trough for bank valuations. Selling a bank for three times book value in the 2020s seems a remote fantasy. And it is. The pandemic and the economic uncertainty that kicked off this decade took a huge chunk out of banks’ earning potential and dragged down shares. As of Feb. 2, the KBW Nasdaq Bank Index was down 4% compared to a year ago. The S&P 500 was up 18% in the same time frame.

Granted, bank stock valuations have improved during the last six months. Investors tie bank stocks to the health of the economy: When the economy is improving, so will bank stocks, the thinking goes. As pricing improves, bankers should be more interested in doing deals in 2021, Davis says. Much of bank M&A pricing is dependent on the value of the acquirer’s stock, since most deals have a stock component.

But rising stock prices haven’t translated into higher prices for deals — at least not yet. The average price to tangible book value for a bank deal at the end of 2020 was 116%, according to Davis, presenting slides during a session of Inspired by Acquire or Be Acquired.

Improved stock valuations alone can’t alleviate the pressure holding down M&A premiums. Newer loans are pricing lower as companies and individuals refinance or take on new loans at lower rates, slimming net interest margins.

Plus, investors have also been less receptive recently to banks paying big premiums for sellers, says William Burgess, co-head of investment banking for financial institutions at Piper Sandler, during an Inspired By presentation.

There’s usually a rise of mergers of equals in times after an economic crisis, and that’s exactly what the industry is experiencing. The rollout of the vaccine and improving economic conditions could lead to more confidence on the part of buyers, higher stock prices and more bank M&A. Sellers, meanwhile, are under pressure with low interest rates, slim margins and the costs of rapidly changing technology.

“We think there’s going to be a real resurgence in M&A in late spring, early summer,” Burgess says.

To see M&A pricing rise to three times book, though, interest rates would have to rise substantially, Davis says. But higher interest rates could pose broader problems for the economy, given the heavy debt loads at so many corporations and governments. Corporations, homeowners and individuals could struggle to make debt payments if interest rates rose. So would the United States government. By the end of 2020, America’s debt reached 14.9% of gross domestic product, the highest it has been since World War II. In an environment like this, it might be hard for the Federal Reserve to raise rates substantially.

“The Fed seems to be locked into a low-rate regime for some time,” Davis says. “I don’t know how we get out of this. The system is really stuck.”

Why Record Deposit Growth Should Spur Funding Rebalancing

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Is there such thing as a gold lining?

In a year with seemingly constant crises, finding silver linings has been crucial in maintaining optimism and planning for a post-pandemic future. Banks have faced myriad challenges, but core deposit growth may represent a fundamental strategic advantage for profitability enhancement.

Total FDIC-insured domestic bank deposit balances increased by nearly 18%, or just under $2.6 trillion, over the first nine months of 2020. While government stimulus efforts and the Federal Reserve’s return to a zero interest rate policy are driving factors, higher levels of deposits should remain on bank balance sheets into the foreseeable future. Forward-thinking banks should be proactive in repositioning this funding to aid profitability improvement for years to come. Core deposit growth gives banks a chance to reduce exposure to higher cost non-transaction deposits, brokered deposits, repurchase agreements and borrowings. But despite this year’s massive deposit inflows, the Federal Deposit Insurance Corp. reports that other borrowed funds have only declined by 12%, or $167 billion, over the first nine months of 2020.

Higher loan-loss provisioning in 2020 has strained net income across the banking sector, reducing net operating income to levels not seen since the Great Recession. This may make the costs of funding restructuring — such as prepayment fees or relationship discounts on loan pricing — seem like exorbitant earnings constraints, representing an impediment to action. We believe this is short-sighted.

Economic weakness and macro uncertainty has tempered loan growth, and forced banks to maintain larger balances of lower-yielding liquid assets on the asset side of the balance sheet. Most community banks remain heavily reliant on net interest income to drive higher operating revenues. But net interest margin pressure has accelerated in 2020; combined with negligible core loan growth (excluding participation in the Small Business Administration’s Paycheck Protection Program), operating revenues have been stuck in neutral. As a result, return on equity and return on assets metrics have suffered.

There are three reasons why banks should judiciously adjust their funding profiles while the yield curve maintains a positive slope and before competitive factors limit alternatives.

Driving higher core deposit balances in challenging economic times through above-peer rates not only promotes growth, but engenders customer goodwill and loyalty. Banks have the luxury of growing customer deposit balances by increasing their offered interest rates, which  can be offset by reducing the reliance on higher-cost borrowings. Furthermore, assuming the Federal Reserve’s interest rate policy stays in place for several years, future opportunities will emerge to gradually adjust core deposit products’ rates. 

Funding adjustments provide the chance to rethink deposit products, loans or investments that may no longer be core to the business strategy. Liability restructuring can be the impetus for corresponding changes to the asset side of the balance sheet. Perhaps certain loan categories are no longer strategic, or investment securities have moved beyond risk parameters. Asset and liability rebalancing can refresh and refocus these efforts. 

Banks with higher core deposits as a percentage of total deposits higher tangible book value (TBV) multiples than peers. Our research at Janney shows that for all publicly traded banks, price-to-TBV multiples are 15% higher for banks with core deposit ratios above 80% compared to banks with less than 80% core deposit ratios. Better funding should also result in a higher core deposit premium, when a more-normalized M&A environment returns.

Nobody expects banks to perfectly forecast the future, but it would be a low-probability wager to assume that Fed intervention and the current interest rate policy will remain in place indefinitely. Banks that allow market forces to dictate deposit pricing and borrowings exposure without taking action are missing a huge opportunity. Making mindful funding decisions today to reduce reliance on non-core liabilities lays the groundwork for changes in future profitability and shareholder value.

Why Two Community Banks Raised Debt to Repurchase Shares

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The coronavirus pandemic has motivated some banks to raise capital and others to repurchase shares.

Two banks opted to do both.

These institutions recently paired subordinated debt raises to buy back discounted shares in immediately accretive transactions. Leadership of both banks attribute the pair of opportunities — and the pricing they were able to obtain — to the pandemic, and other community banks could make a similar trade.

“What had happened was a perfect storm of an opportunity to buy back at a pretty good discount because of the Covid-19 impact on financial stocks, and the popularity or the market that had developed for subordinated debt,” says Paul Brunkhorst, CEO of Crazy Woman Creek Bancorp in Buffalo, Wyoming.

The bank constructed a twofer trade that would leverage investors’ demand for yield while capitalizing on the persistent discount in its shares. Brunkhorst reached out to a larger in-state financial institution about a $2 million private placement of its subordinated debt at a 5% rate; he says the direct placement kept pricing low for the $138 million bank. Crazy Woman Creek then repurchased 15% of its outstanding common stock. The transactions were included in the same Aug. 18 release.

“It wasn’t taken lightly. We are affecting shareholder value in a positive manner. We’re also incurring this debt, so we better be darn sure of the capital position, the asset quality and the regional economy,” he says. “We were comfortable going after the subordinated debt with the primary reason of repurchasing those shares.”

Executives at Easton, Maryland-based Shore Bancshares decided to pad robust capital levels with an additional $25 million in subordinated debt as “safety capital” at the end of August.

So far, the safety capital hasn’t been needed. Second loan modification requests declined to about 10%, and the $1.7 billion bank has yet to experience defaults. Management decided to deploy $5.5 million of those newly raised funds toward restarting its halted share repurchase program at the beginning of September.

The repurchase, which required sign off from the Federal Reserve, was immediately accretive to tangible book value. If fully exercised, the buyback would reduce share count by 4.5%.

“When you can buy stock back at 60% or 70% of tangible book, that’s probably the best thing you could ever do for your shareholders,” says CEO Lloyd “Scott” Beatty Jr. “In terms of rewarding them, I can’t think of a better way to do it.”

Both executives say shareholders have been pleased with the buyback announcements. They also found the capital raise to be straightforward and relatively quick, with healthy demand and pricing. Brunkhorst says he’s surprised more banks haven’t cut out the middleman to solicit demand and conduct their own private placements. It was Shore’s first time raising sub debt; its offering carried a rating from Kroll Bond Rating Agency and a price of 5.38%.

“I would say probably if you’re thinking about [raising capital], I’d get out there as soon as possible. There’s a lot of activity in this,” Beatty says. “I’d be inclined to pick your investment banker and get out and enter the market as quickly as you can.”

The Measure of a “Good” Deal

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What makes a good bank deal? Depends on who you ask.

Mergers and acquisitions are a vital strategic undertaking for banks, and consolidation trends continue to shape the industry. To that end, I asked four presenters speaking at Bank Director’s 2020 Acquire or Be Acquired Conference the same question: “What is the most important metric of a bank deal? And what is the most important thing that can’t be measured?”

The response of the interviewees — a community bank CEO, two attorneys and an investment banker — were kept secret from each other. Their unique and varied responses belie their perspectives and experiences when it comes to bank M&A, and hopefully can shed some light on how others in the industry think about, and measure, a “good” deal.

Before Announcement
For Curtis Carpenter, principal and head of investment banking at Sheshunoff & Co. Investment Banking, the most important criteria to getting a good deal done comes down to location. “Geography is the most reliable characteristic to getting the deal done in today’s market. Where a bank is located is driving deals more than ever,” he says.

He points out that institutions in high-growth areas have a “high probability” of commanding a strong price, whereas a robust, profitable bank in a rural area with declining demographics may be challenged to get a deal done at a reasonable valuation.

For buyers, coming up with a reasonable purchase price and accurately assessing a seller’s asset quality are the most important elements in a good deal, says Bob Monroe, a partner at Stinson LLP.

“If you buy a bunch of junk, you’re going to get a bunch of junk, and you generally won’t have a successful deal,” he quips.

To account for the uncertain performance of acquired loans, Monroe says buyers will either not acquire certain assets or set up an escrow account that is equal to the present value of the assets in question so they can get worked out.

Frank Sorrentino III, chairman and CEO of ConnectOne Bancorp in Englewood Cliffs, New Jersey, says it was difficult to try to nail down an answer, even though “I knew what the question was going to be.”

Sorrentino has guided the $6.2 billion bank through three deals since 2014, and initially felt that a good deal can be measured by the market’s response. But he says the market might pan some deals that it doesn’t “fully digest or understand” because the deal may not generate immediate value at announcement.

For Sorrentino, good deals are ones that provide better internal opportunities for the pro forma bank and create additional value.

“I don’t care which metric you use, I don’t care what spreadsheet you use for your modeling — at the end of the day, are you creating more value? There are various components to values: some are financial, some are nonfinancial, but I think it really comes down to value,” he says. “Are you adding 1 and 1 and getting something north of 2?”

At, and After, Announcement
During Day 1 of the conference, Keefe, Bruyette & Woods President and CEO Tom Michaud highlighted that the premium that acquirers have offered sellers has declined since 2010. Part of that decline has come from a decline in potential buyers, but he added that investor concern around the pro forma company’s earnings per share and tangible book value growth has imposed discipline on deals.

One metric that Carpenter says can indicate a good deal is the performance of the buyer’s stock after the merger is announced, relative to the valuation the seller received.

“The most measurable tangible metric for grading the success of a bank sale would be price to tangible book value, and then how that stock performs in the 12 months after announcement,” he says. This is especially important for prospective sellers that would consider a merger that includes stock.

Peter Weinstock, a partner at Hunton Andrews Kurth, extends this to the second full year after a merger is consummated. Weinstock wrote in an email that the most important metric is the pro forma bank’s earnings per share accretion in that second year.

“While tangible book value earn-back is much ballyhooed — and has lately been a metric that has led to some good deals not being done — the true success of the deal is measured in what it does for the acquirer’s profitability once the majority of cost savings and synergies are achieved,” he wrote.

Sorrentino cautions that value creation doesn’t always carry a time stamp, and that bankers should resist short-term thinking or relying solely on metrics when assessing the value of a company or a deal.

“Sometimes the value is not necessarily created on financial terms. There could be value created [in a deal] because of talent, or because of the business lines you’re taking on,” Sorrentino says, adding that technological capabilities, efficiencies and cultural elements can also be acquired in a deal. “Everyone wants to look at the EPS accretion at announcement or tangible book value dilution. It may not be that simple.”

After Close
There is some agreement as to the most important unmeasurable aspect of a good deal. The consensus coalesces around integration and the cultural fit of the two banks. Buyers must manage the deal integration in a way that incentivizes and excites the seller’s employees, lest they look for other opportunities.

“Being able to fit your culture in with the seller’s culture is extremely important, because otherwise you’ll have a flat tire running down the road,” Monroe says. “It won’t be smooth.”

Adding to that, Weinstock wrote that the buyer’s “willing[ness] to spend the leadership time, devote the financial resources and risk overcommunicating” in order to integrate the banks’ operations, vision and culture is the most important immeasurable metric of a good deal.

For sellers, the hardest thing for banks to measure in a deal is how it will affect their employees, Carpenter says. Executives at selling banks often hope that a deal only furthers the opportunities and careers of its employees, as well as benefits the selling bank’s community. One way prospective buyers can help sellers with this concern is by putting the prospective seller in touch with former CEOs of previously acquired banks.

“More often than not in this environment, [deals] really come down to one buyer courting a seller, or you’ve reduced the number of bidders down. The seller is wondering ‘Is this a good deal? Can we trust this guy?’” Carpenter says. “The buyer can offer up, ‘Here’s two people that ran banks we bought, call them and asked them how it went.’”

Michaud says banks considering engaging in M&A should “start at the end,” identifying what they want a deal to achieve.

“It needs to be all of these things to work: well-priced, strategic merit and be logical, earn-back that fits within the barrier. It can’t be complex and have a lot of noise, it must be accretive or investors will want to know why you did it, and it needs to be well-structured too so everyone stays in their seat and is there to execute,” he says. “If you do all of these things, you can create a lot of shareholder value.”

A Better Way to Value Deposit-Driven Deals

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deposits-4-1-19.pngThere’s no doubt that the focus these days on acquisitions centers around deposits. When surveyed at the 2019 Acquire or Be Acquired conference, 71 percent of attendees said that a target’s deposit base was the most important factor in making the decision to acquire. This suggests that targets with excess liquidity (low loan-to-deposit ratios) will be highly valued in the market going forward.

This strategic objective is out of whack with traditional deal valuation metrics.

The two primary traditional deal metrics are tangible book value (TBV) payback period and earnings per share (EPS) accretion. Investors expect every deal to meet the benchmarks of a low TBV payback period (ideally less than three years) and be accretive to EPS, according to a presentation from Keefe Bruyette & Woods President and CEO Tom Michaud.

These are earnings-based metrics, and targets with low loan-to-deposit ratios have lower earnings because they have larger securities portfolios relative to loans. Therefore, traditional consolidation modeling will undervalue those targets with longer payback periods and lower accretion. Potential acquirers will struggle to justify competitive prices for these highly valued targets.

Why are deals that clearly create shareholder value by strengthening the buyer’s deposit base not reflected by the deal metrics du jour? Because those metrics are flawed. How can you justify a deposit-driven deal to an investor base that is focused on TBV payback and EPS accretion? By abandoning traditional valuation methods and using forward-looking, common sense analytics that capture the true value of an acquisition.

Traditional consolidation methodology projects the buyer and seller independently, then combines them with some purchase accounting and cost savings adjustments. Maybe the analyst will increase consolidated loan growth generated from the excess deposits acquired. This methodology does not capture the true value of the acquired deposits.

The intelligent acquirer should first project its own financials under realistic scenarios, given current market trends. Industry deposit growth has already begun to slow, and the big banks are taking more and more market share. If the bank were to grow loans organically, it must be determined:

  • How much of the funding would come from core deposits and how much would require brokered deposits or other borrowings like Federal Home Loan Bank advances and repurchase agreements? This change in funding mix will drive up incremental interest expense.
  • How many of the bank’s existing depositors will shift their funds from low cost checking and savings accounts to higher cost CDs to capture higher market rates? This process will increase the bank’s existing cost of funds.
  • What will happen to my deposit rates when my competitors start advertising higher rates in a desperate play to attract deposits? This will put more pressure on the bank’s existing cost of funds.
  • How many of my existing loans will reprice at higher rates and help overcome increasing funding costs? Invictus’ BankGenome™ intelligence system suggests that, while the average fixed/floating mix for all banks in the US is 60/40, the percentage of floating rate loans actually repricing at higher rates in the next 12 months is much lower because the weighted average time between loan reset dates is more than six quarters.

Standalone projections for the buyer must adequately reflect the risks inherent in the current operating environment. These risks will affect a bank’s bottom line and, therefore, shareholder value. This process will create a true baseline against which to measure the impact of the acquisition. Management must educate its investors on the flaws in legacy analytics, so they can understand a deal’s true value.

In the acquisition scenario, the bank is acquiring loan growth with existing core deposit funding attached. And if the target has excess deposits, the acquirer can deploy those funds into additional loans grown organically without the funding risks due to current market trends. The cost differential between the organic growth and acquisition scenarios creates real, tangible savings. These savings translate to higher incremental earnings from the acquisition, which alleviate TBV payback periods and EPS accretion issues. Traditional deal metrics may be used as guideposts in evaluating an acquisition, but a misguided reliance on them can obscure the true strategic and financial shareholder value created in a transaction.

Every target should be analyzed in depth, with prices customized to the acquirer’s unique balance sheet and footprint. Don’t pass on a great deal because of flawed traditional methodologies.

Why Purchase Accounting Matters So Much During a Bank Deal

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accounting-12-24-18.pngBank management must understand how purchase accounting works, how it can impact a transaction, and being involved can ensure all assumptions are complete and accurate. Here’s a specific look at interest rate mark and Core Deposit Intangible (“CDI”) purchase accounting analyses.

These analyses establish fair value of balance sheet assets and liabilities through a series of mark-to-market valuations. In addition to cost savings and transaction expenses, purchase accounting is one of the transaction adjustments that can have the largest impact on the metrics of a deal. Purchase accounting, however, is often seen as less straight-forward than other transaction adjustment components.

Overview of Mark-to-Market Impact of Assets and Liabilities
To evaluate and engage in discussions with a financial advisor, management must first understand the mechanics of interest rate mark adjustments. A premium on an asset marked-to-market will increase the value of the asset and in capital on day 1, which is then amortized through interest income over the remaining life of the asset. Conversely, a discount on an asset marked-to market will decrease the value of the asset and in capital on day 1, which is then accreted into interest income over the life of the asset. 

As an offsetting entry in purchase price allocation, the higher fair value of an asset the lower the amount of goodwill created. A premium on an asset will increase tangible book value per share (TBVS) but decrease forward earnings as the mark is amortized, while a discount on an asset will decrease TBVS on day 1 but increase forward earnings as the mark is accreted. Liabilities are intuitively the opposite of assets, with a premium resulting in a negative hit to capital on day 1, but lower forward interest expense over the life of the products. A discount will bolster capital on day 1 but will increase forward interest expense over time.

One item of note in the mark-to-market of loans is exit pricing. To represent additional risk assumed with a loan acquisition, an exit premium should be applied to each loan type and should capture a liquidity discount as well as an underwriting discount. Exit prices should vary by loan type. The liquidity and underwriting risk on a 1-4 family residential loan is very different than a speculative construction loan, and the different characteristics should be captured in market values and exit prices.

Publicly reporting institutions now have to to begin reporting the fair value of its loan portfolio under the “exit” price application, which illustrates the importance and proliferation of exit price methodology across the industry, not just in M&A transactions.

Land and buildings are assessed by comparing the net book value (with accumulated depreciation) against a third-party valuation. The mark on buildings will be accreted/amortized over the remaining life of the property.

The CDI takes into account the qualitative value of deposit relationships. There are multiple variables that can impact a CDI but the following provides an overview of major components: weighted average life of a product, cost of core deposit related activities, fee income on core deposits and alternative cost of funding and discount rates. The higher the values for any of these components, the higher the CDI. These variables may be offset by noninterest expense associated with core deposit related activities and the discount rate, for which higher values will reduce the CDI.

Management Involvement
Given the intricacies with mark-to-market purchase accounting, it is clear management should engage a financial advisor to explain the assumptions driving each adjustment and the impact. 

Mark-to-market purchase accounting is not something that should be approached only as a requirement of closing. The financial advisor in a transaction should also be conducting purchase accounting as part of due diligence.

If detailed purchase accounting is not occurring, there could be material marks not accounted for that can drastically affect the metrics of a transaction. Your financial advisors should on a regular basis explain the fair value assessment process and the methodologies.

Key Takeaways
Transaction adjustments are rarely detailed in pro forma analytics, which limits management’s ability to engage in meaningful conversation with its financial advisor. The best financial advisors provide a detailed breakout of all transaction adjustments to provide management with as much knowledge as possible. Without that, it is impossible for management to have the understanding required to ask important questions and actively participate in review of assumptions.

Always request full detail on all adjustments and to have management walked through each adjustment, along with the assumptions and methodologies used. Have calls throughout the process, and remember that fair value analyses are not reserved for closing. This should start early in due diligence. Interest rate marks and CDI can have a meaningful effect on the metrics of a transaction and, if not modeled properly, can create a misleading picture. It is crucial to first verify that the firm has the capacity to model with management and have a meaningful dialogue on critical assumptions.

These assumptions will make or break a deal and will continue drive the resultant entity’s accounting long after the transaction closes.

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.

Three Themes Are at the Top of Bankers’ Minds Right Now

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risk-6-14-18.pngIf one looks at the bank industry as a whole, it’s easy to agree with Jamie Dimon, the chairman and CEO of JPMorgan Chase & Co., the nation’s biggest bank by assets, that we are in the midst of a “golden age of banking.”

This is true on multiple fronts. Dimon’s comments were directed specifically at the easing of the regulatory burden on banks, an evolution that has been going on since the change in administration at the beginning of last year. The lighter touch is most evident at the Consumer Financial Protection Bureau, which has taken a more passive approach to enforcement actions under its current acting director, Mick Mulvaney. The broadest base of regulatory relief culminated last month, when federal legislation was signed into law that eased the compliance burden on smaller banks in particular.

Banks are also reaping benefits from the cut last year in the corporate income tax rate from 35 percent down to 21 percent. The change led to a surge in profits and profitability.

These events highlight a trio of themes that emerged from this year’s Bank Audit & Risk Committees Conference hosted by Bank Director in Chicago. Each theme is unique, but the common denominator is that bank boards face an evolving landscape when it comes to the macroeconomic environment, cyber security threats and the means through which a bank can navigate this landscape.

Profitability is a point that Steve Hovde, chairman and CEO of Hovde Group, stressed in a presentation on the current and future state of banking. Banks earned a record $56 billion in the first quarter of the year, which amounted to 28 percent growth over the same quarter of 2017. And while the industry has yet to report a return on assets above 1 percent on an annual basis since the financial crisis a decade ago, the average bank eclipsed that figure in the first three months of the year.

And banks aren’t just more profitable, they’re also arguably safer, former Comptroller of the Currency Thomas Curry noted in a conversation with Bank Director magazine Editor in Chief Jack Milligan. Curry pointed to the fact that banks have more capital than they’ve had in decades.

Yet, as Hovde noted, many of these positive performance trends are not being experienced equally across the industry, with the lion’s share going to the biggest banks. The return on average assets of banks with between $10 billion and $50 billion in assets is 1.27 percent compared to 0.72 percent for banks with less than $1 billion in assets. This is also reflected in bank valuations, with big banks trading on average for more than two times tangible book value compared to 1.4 percent for smaller banks.

This gap is projected to grow with time, in part because of a second theme that coursed through conversations at this year’s Bank Audit & Risk Committees Conference: trends in technology and cyber threats, which large banks have deeper pockets to address. Of all the things that concern bank officers and directors right now, especially those tasked with audit- and risk-related duties, the need to defend against cyber threats is at the top of the list.

There are approximately 20 million hostile cyber events every day, with an estimated 200,000 of these targeted at financial institutions, noted Alex Hernandez, vice president of DefenseStorm, a cybersecurity defense firm. Seventy-three percent are perpetrated by people outside the organization compared to 28 percent by insiders. It isn’t just criminals who pose a threat, as nation-state actors are behind 12 percent of hostile cyber events, with their timing tending to coincide with elections.

The solution, Hernandez notes, is to double down on the fundamentals of cyber defense. “The most effective way to address cyber threats isn’t to focus on the latest shiny object like artificial intelligence, it’s about educating your staff and securing your network.” To this point, most threats come through unsophisticated channels, be it an email phishing scheme or malware delivered by way of a thumb drive.

One challenge in addressing these threats is simply recruiting the right expertise—not only on the bank level, but also on the board. Finding and retaining the right talent in not only information security but elsewhere was also a recurring theme. Most board members in attendance acknowledge they don’t know enough about technology to ask the right questions. But recruiting people who do is easier said than done, especially for banks in rural communities, who often try to tap into nearby metro areas for talent, or offer creative compensation plans to mitigate risk and retain younger officers.

There are certainly reasons to suggest big banks are experiencing a golden age, but smaller and mid-size banks shouldn’t use this recent change in fortune as an excuse to rest on their laurels. It remains incumbent on bank officers and directors to stay vigilant against ever-evolving cybersecurity risks and focused on recruiting the talent and designing effective governance structures to address them.