Welcome to de novo
country, where capital is king
In terms of the
actual number of startups through the first half of the year, 2005 would appear
to be a strong but by no means banner year for de novo banks, proof positive
that looks can be deceiving.
from de novo
In terms of the actual number of startups through
the first half of the year, 2005 would appear to be a strong but by no means
banner year for de novo banks, proof positive that looks can be deceiving.
That's because, based on growing initial capital positions, aided in
large part by a renaissance in investor interest, the startup bank phenomenon
clearly continues to build momentum. Through the first two quarters, 2005 is on
pace to see roughly 118 new banks formed, putting this year ahead of the past
four years in terms of the number of banks formed annually, though that tally
falls far short of the heady period of 1997 to 2000, which peaked in 1999 with
the formation of 200 banks, according to the SNL DataSource.
In one very
important way though, today's startups are well ahead of their peers from that
recent record-setting period. The capital raised to finance these banks has
grown tremendously, from $1.30 billion of total equity raised in 1999, or an
average of $6.5 million per bank, to $1.15 billion, or $10.8 million per bank,
in 2004, and an estimated $1.71 billion, or $14.5 million per bank, in
Capital is the true measuring stick for the de novo bank
phenomenon, according to Dan Hudson, CEO of San Luis Obispo, Calif.-based
BankMark, a consulting company that focuses specifically on starting new banks.
"It is the most primary driving force of the four forces that drive the
chartering process in the eyes of the regulators, a diverse group of competent
businesspeople from the market, a sound and proven management team, a viable
market, and capital, and capital is king," Hudson told SNL Financial. "It is the
one thing that you can never have enough of or have more of and get compensating
balances in other places, where there may be a deficiency. Capital is forgiving,
it is always forgiving."
And even if the absolute number of startups is
off the high-water mark of 1999, "business is booming" by Hudson's account. He
said his firm has 20 bank startup clients signed and going, with 40 more in the
queue, and these days he is turning down a third of the prospective clients that
approach BankMark, which he sees as a sign that 2005 and the coming years could
well prove even stronger than available data would indicate.
Part of the
difficulty in getting a true gauge of the de novo movement is the lag in time,
Hudson said. Because "the de novo process is 18 months at minimum from start to
finish, a lot of the numbers don't fall in an annual category, so that the next
year you see the previous year's hard work." Plus, it's difficult to truly
assess the real number of banks in the various stages of the formation process
at any one point time. But based on anecdotal evidence and his own firm's
success, Hudson sees the phenomenon, at least in the near term, as continuing to
pick up steam.
Russ Hunt, President of Tampa, Fla.-based independent
investment bank Kendrick Pierce & Co., agrees. "From a highlights
standpoint, I think the last couple of years have been highlights in new banks."
Hunt's firm specializes in capital raising, M&A and financial advisory
services and is no stranger to de novo banking. Kendrick Pierce most recently
served as sole manager and adviser in the formation of Bradenton, Fla.-based
Freedom Bank in April 2005, raising $15.5 million to start the
Hunt's home state is known for producing a bumper annual crop of
startup banks, and he said that even though absolute levels of de novo banks may
rise and fall from year to year, the clear trend is toward banks starting out
with more of everything. "I've never seen anything like it, in terms of the
amount of capital, who is willing to invest in a de novo bank, and what
management teams are willing to start a new bank," he said.
A number of
factors are driving the latest de novo boom, according to the industry observers
with whom SNL spoke.
Continued consolidation within the fractured
banking industry has created conditions that are conducive to de novo
formations, namely executives looking for a new gig and consumers and businesses
in the local market looking for a new community bank. Hudson sees the incidence
of de novo banks sprouting up in the wake of a merger as a natural, market-based
"The [local] bank goes away, there is a market that is
underserved, and the market comes together and decides, 'We can do this
ourselves,'" Hudson said. "And this is an important point, the market is not
always driven by a group that just made a lot of money on a merger and
acquisition or a group of unemployed bankers. It is just the natural dynamics of
For example, Hudson said that key to the success of de novo
banks is the fact that they almost always serve the 'under-the-radar businesses'
of a community, those that a larger bank moving into the area via acquisition is
not as interested in serving given the lesser borrowing needs. "The large banks
can't really dip down and be responsive to the market, so the market is driving
need," he said.
Anthony Costa, a veteran banker who helped start Empire
State Bank NA and who serves as chairman and CEO of the Newburgh, N.Y.-based
company, which IPO'd in April 2004, said that for local consumers and small
businesses alike, the need for a community bank is clear.
"A lot of
people miss being able to walk into a bank branch, and while they may know the
teller or the manager, they're not people who can make any decisions. They have
to go to Buffalo or Albany (N.Y.) or Charlotte (N.C.) to get a decision. You
don't have to do that in a local bank. You can walk in and talk to the president
or CEO or chief lending officer, and people like that, they like talking to
somebody who can make a decision."
The career of Costa, a colorful
character with banking in his blood, is not all that atypical of many of the
executives forming banks today. He is the former CEO of Fishkill, N.Y.-based
Mid-Hudson Savings Bank, which sold to First Fidelity Bancorp of Lawrence, N.J.,
in August 1994, only to have the acquirer become the acquired when First
Fidelity agreed to sell to Charlotte-based First Union (now Wachovia Corp.) a
year later. Though he no doubt made out financially on a "double dip" from the
two deals, Costa did not find being part of such a large banking organization as
enjoyable as his days with a smaller bank and departed when he was
In fact, according to Jeff Hunt, a principal with Kendrick Pierce
and brother of Russ, his firm has observed that new banks often start up once
the noncompete agreements of executives working for a larger bank to which they
sold their former institution have expired. "You have the management team of the
target company wanting to get out and start a new company but not wanting to
forfeit any compensation, so they wait that year or two and then come out and
This process is a real draw for investors. "Both myself
and (COO) Phil Guarnieri came out of merger deals where we made a lot of money
for our shareholders, so people related the fact that they invested before with
me and they made a lot of money. And there is a certain amount of coattail
investing there," Costa said. "I was quick to point out that past performance is
no guarantee of future results, as they are fond of saying on Wall Street, but I
do think there is a certain effect there."
"You are going to pick up
bankers who are unemployed and looking for new opportunity and investors that
scored well and are going to be pushing for new opportunities," Hudson
Michael Weinstock, founder of Portfolio Placements &
Resumes LLC, an executive placement firm focusing on the portfolio and money
management industry, and a private investor with a significant number of
investments in de novo banks, said finding executives with experience building
and selling a bank goes a long way. "If someone has had experience doing it
once, that's a great incentive to invest even more money," he said.
chart below, which tracks the annual number of whole-bank and -thrift deals
against the annual number of de novo formations, helps illustrate the
correlation between deal and de novo activity. "I think there is a correlation.
My correlation internally is that for every one I start and that ultimately
sells, I get two more. So if I plant one today and in seven years it sells, it
will split off into two different groups. That is our formula, and we've found
over the years that that seems to be true," Hudson said.
And here is
where the "planarian principal" or domino effect of de novo banks can perhaps be
seen most clearly. Bank executives who start a bank, sell it and then build
again, serial startup artists in other words, draw interest from investors.
Costa may explain it best when he describes the way in which he took his startup
bank proposal to investors in the community.
"One thing I told them all,
I said, 'Look, let's not get confused here. At the end of the day, we're here to
make money, to build value. We're not here to be your local community bank. That
works fine, and it's great, but if we make it valuable enough that somebody
offers us a lot of money, we're going to go to the stockholders and ask what
they want to do. Don't get confused,'" Costa said.
"If that happens, and
we would prefer that it doesn't, but if it did and it was the best bang for our
buck, then I'm going to take it to the shareholders, and if they say 'Let's
sell,' then we're going to sell. And I said, 'We can do this again. We did it
once. Next time, we won't make all the mistakes we made this
Savvy investors in turn consistently put money into these
executive's projects, as well as the splinter projects of other related
executives, so that those like Weinstock and his wife, a retail executive, can
over time flip their investment in one bank into several. It goes without saying
that as a result, investment bankers like the Hunts and consultants like Hudson
have more and more projects to work on as well.
"What I always tell
people and what my wife and I subscribe to is that we mentally look to stick it
in a drawer for 10 years," said Weinstock. "The reality has been that we see our
investment, no pun intended, pay huge dividends, usually by years four or five.
So what we've been seeing with many of the investments is that right around the
five-year mark there seems to be a great deal of activity with regard to mergers
or acquisitions, where the small bank is absorbed into a much larger entity
because they are making huge inroads into the larger entity's domain, or mergers
of equals, which recently happened with one of our investments, and right around
that time we decide whether to stick with it."
That investment was
Westfield, N.J.-based Town Bank, which in August agreed to merge with Two River
Community Bank. Weinstock estimates that in the five years he has held the
investment in Town Bank, its value has appreciated 135%. "So now, because we are
looking to invest in other banks, what we will probably do is take our initial
investment off the table and leave the house money to play with, maybe even take
half the profits and invest in two other banks," he said.
"So as the
years go on, we'll continue to have this domino effect where one turns into
three and three turns into seven, seven turns into 15, and by the time I'm 60, I
hope to have investments probably in anywhere between 100 and 200 small
Investing in banks in a general sense has a number of
other things going for it. Costa points to a nostalgia factor, because banks are
a traditional, conservative, safe investment. "People like the idea of investing
in a bank, because when was the last time that you really heard of a bank going
down?" he asked.
Weinstock also sees the safety as a draw, such that the
"downside risk [is] a lot more minimized than investing in the stock market with
any company that goes public, whatever they may do, whatever service they
provide. You're not going to get a big bang for your buck initially, but if you
amortize it out over five, six, seven years and are willing to stick it in a
drawer, most of our investments have been running clearly on an annualized basis
at over 20%. You just have to be a little patient with it."
believe that investors see banks as an attractive investment, in that they offer
lower volatility and typically pay long-term rewards. But both are cautious
about the realities of investing in de novo banks. "Let's not forget though that
banking is cyclical, and you go through good and bad times. Some of these de
novos unfortunately will have some stumbles, and when that starts happening I
think you might see a pull-back in individual investor enthusiasm," said Russ
Hunt. "But for the foreseeable future, hopefully that's on a one-off basis and
Adds Jeff Hunt, "I think the one thing we cringe about
is the investor who thinks that if he invests in a bank, it's going to sell for
4x book value. There are a lot of people that think that way, especially down
here in Florida. That doesn't always happen, and percentage-wise it doesn't
happen to a lot more banks than it does happen to."
But investing in
startup banks, particularly those that intend to trade publicly, can also be
ideal in that individual investors can take self-directed retirement funds like
IRAs and put money from them toward an ownership stake in a de novo bank. Costa
said he was surprised at the number of community investors Empire State garnered
through IRA contributions. "We had quite a few," he said, adding that he even
consolidated some of his own IRAs and put the funds toward an investment in the
Weinstock said he and his wife plan on using IRA funds for future
de novo investments. "More and more I've heard, I've seen and now my wife and I
are in the process of doing that ourselves, because [otherwise] you can take a
hit on your ready cash or in the need to be liquid."
investors have also proved a fertile base for investing in startup banks, and
Jeff Hunt said that the level of institutional participation has increased in
recent years from a period when "we hardly saw any institutional
"I think for the institutional guys, it's not that there is a
de novo that is going to start and be a sleepy bank but that there are really
good management teams they want to back, and I think that's been a really
important part of attracting sophisticated bank stock investors," he
So what does the future hold for de novo banking?
said that advances in affordable technology have in many ways leveled the
playing field between small community banks and larger regional institutions,
and he expects this to provide future succor to the de novo movement. The Hunts
said the level of sophistication of de novos today should continue into the
future, creating even stiffer competition for larger, more established banking
"Due to the fact that management teams are a lot more experienced
and aggressive and are backed by a lot more capital, you're not seeing a de novo
start off with a branch and then have two or three by year five or six. Now,
you're seeing de novos starting off sometimes with two or three branches right
away," said Russ Hunt. He believes that because of this stronger starting
position, de novos are able to more quickly grab market share, and he sees that
as a trend that should continue in the future.
For his part, Hudson is
looking to new banking segments. The de novo banking phenomenon is at present
focused on a community banking model, but Hudson said there is room for others
to enter the space, including financial entrepreneurs already operating in a
financial services-related field who see starting a bank as a natural next step,
as well as specialty areas like ethnic banking that could themselves include
niches, like African-American church companies.