Starting your own bank is laborious but profitable.
The financial crisis may turn out to be a blessing for Michael Wagner, a 37-year-old financial advisor with Joseph Gunnar & Co., a broker/dealer based in downtown New York City. Wagner is in the process of opening two nationally chartered banks, one in Nassau County, Long Island, the other in upstate New York. In the current environment, it can take about two years and $2 million to find qualified organizers, management and get approved by government regulators. (And before you take in depositors' cash, you have raised millions in seed capital from investors.) And yet, despite the credit crisis, this is the ideal time to start a bank. Or so say the people who help people start banks.
The events that literally shook the foundations of the financial system hardly need repeating. And while the news has brightened recently, we may still be facing a procession of regional and community bank failures. In fact, 77 banks have failed this year through mid-August, 24 of them in July alone, and that marks the highest bank failure rate since 1992. The majority of this year's bank failures are small to regional in size. At the big banks — 19 of which control 91 percent of the nation's $13 trillion-plus deposits — continued negative press chronicling bank misdeeds and poor judgment is hurting their reputations. Those “troubled assets” TARP was supposed to take care of? They are still there: $657 billion worth at the 19 largest banks, according to the Congressional Oversight Panel (COP), the committee that oversees TARP and other government efforts to stabilize the financial system. It's no better at the smaller firms: Portfolios of commercial real estate and construction loans are undermining long-standing regional and local banks. A report from COP says a worst-case scenario of losses from these loan types may reach $81 billion across 700 banks. Others project $100 billion in losses at 900 banks, the report notes.
Amid the carnage, Wagner sees a marketplace ripe for strong new entrants. And so do bank analysts. “Think of what you can do with a clean balance sheet, sound lending and real customer service in this environment,” says Wagner, who recalls that not a single person in the local branch of the large bank where he used to hold a seven figure account balance knew his name. He foresees launching a bank where customers know the staff and vice versa. He also sees his bank making sound loans to small business owners (those with less than $100 million in revenue). That's the vision. And if the economy is truly bottoming and a recovery (however tepid) is in the making, small businesses will ultimately be the engine that drives that recovery.
Wagner is not the only one who is bullish on banking. Gerard Cassidy, managing director of bank equity research at RBC Capital Markets, calls it “the best” time to start a bank. But Cassidy is also clear that his assessment comes with some big “ifs” attached. Making sure he has those “ifs” covered is why Wagner hired a consultant to guide him through the bank opening process. Although Wagner has been on the financing side of bank start-ups before (he helped raised $26 million to capitalize USA Bank in Port Chester, NY, in 2005), the process of opening a bank is quite a bit more complex than merely raising funds.
Among the questions that a consultant can help answer: Is there a need for a bank in your market? Is proposed management experienced and do they have untarnished reputations? Are the organizers and directors reputable, with strong relationships in the target marketplace? Can sufficient capital be raised from an investor population weary of financial institutions? And, finally, is all of this solid enough to get regulatory approval from an overburdened, skeptical regulator? Wagner thinks he can do all these things, but not alone. If he's done his homework, he will eventually be approved, say attorneys, but it could take around two years.
“I've always wanted to be involved in lending. But I never said, ‘Gee, I'd really like to own a bank someday,’” Wagner says. He nevertheless found his calling. His experience with USA Bank piqued his interest in starting his own. Soon thereafter he found, online, Dan Hudson, founder and CEO of Nubank, an Irvine, California-based firm providing everything from consulting to marketing to education throughout the process of opening and operating a bank. Since 1979, Hudson says he has had a hand in opening 146 banks across the country. He says typical aspirants to bank ownership are entrepreneurs or veteran commercial bankers, but he's seen more interest in the past year from others in financial services. At a recent conference NuBank held in New York, he guessed one-third of the audience were investment bankers and wealth managers from big firms like Goldman, Barclays and Merrill. “They're not traditional entrepreneurs, but they understand risk and they have a high net worth clientele,” says Hudson. “And a lot of them were fed up with their own banks — the ones they work at.”
Phasing In Success
Currently, Wagner, a native of Melville, Long Island, is in “phase 1” of what Hudson says are the five phases of starting a bank (see sidebar). He's one of 25 people in the organizing group for a bank planned for Nassau County (Long Island). Hudson describes the Nassau bank-to-be as a “commercial bank with certain specialty financing products” such as insurance premium financing that caters to high-net worth individuals. No exact location has been chosen yet — that will be decided after an analysis of the bank deposits in the various zip codes, competition from other banks and other demographic research that will go into the overall business plan that is part of the official application to the OCC. Wagner and his organizing group are also in the process of selecting the C-level management, another critical step. Hudson will be in charge of recruiting and providing the organizers with a number of choices. “Our goal is to find people who match the business plan with their experience but also have clean records and will be approved,” he says. (For added oomph, Hudson employs two former OCC Deputy Comptrollers.) All senior executives, from the CEO, CCO (chief credit officer), COO and CFO to perhaps even a chief technology officer, need prior experience in those roles at accredited banks.
What makes this especially important and difficult is that there's a shortage of people that fit that description, says Ed Carpenter, founder of Carpenter & Co., a private equity firm that is classified as a bank holding company — one of four such firms in the country. “If you don't have management lined up, don't get started,” warns Carpenter. Carpenter & Co. is the largest player in the bank consulting space, having launched more than 715 banks in the past 33 years.
When management has been sorted out, Wagner will be officially ready for “phase 2,” the application phase. The OCC, along with the FDIC, are in charge of approving applications for national charters like Wagner's. But that's a long way off — 9 to 12 months says Hudson — and Wagner knows how important it is just to get the right people involved and committed to the organizing group.
That's because he's been here before. He and a client of his from his days at Laidlaw & Co — a person who was also involved in the USA Bank financing — were well into phase 1 with a bank planned for Rockland County in upstate New York. Hudson approved the location and the organizers, many of whom were cohorts of Wagner's client and well-connected members of the target market's community. Indeed, all 17 seemed committed and ready for the long-haul. But Wagner says he quickly realized only a handful wanted to be part of building the bank; the others just wanted to invest and come along for the ride. Currently, Hudson says he is helping find a more committed group of organizers for the Rockland County bank.
According to Hudson, getting the organizing group right is essential. It is this group of two dozen or so individuals — banker(s), a CPA, lawyers, doctor(s), a religious leader, others with deep financial and social networks in the community where the bank will be located — that will determine the success of the IPO and business thereafter. “These are the people who will bring you the 600 to 1,200 investors when the bank goes public,” says Hudson. And those shareholders will bring three friends over the next year or two. So the ability and connections of those people are crucial. So much so that Hudson says he will happily dismiss a client if he feels the organizing group isn't good enough. According to Hudson, taking the bank public is largely an issue of practicality — “There's no liquidity in a private deal,” he says.
Wagner hopes to raise $30 million in his bank's IPO. Typically, Hudson's fee for service is around 5 percent of the money raised. (Because of regulatory rules and the fact that Hudson does not have a b/d, he cannot say what his exact fee will be.) “We've never had a bank fail and we've never failed to open,” boasts Hudson, a claim that he includes in his marketing materials. But besides finding qualified management — there are a lot of people out there who've succeeded in blowing up their banks — Wagner still faces the formidable tasks of raising capital and attaining regulatory approval.
James Rockett, a partner at Bingham McCutcheon who works in the firm's San Francisco branch and specializes in bank start-ups, says Wagner's right — starting a bank in this environment could be an enormously successful venture as the economy heals. But the current period reminds him of the late 1980s and early 1990s, when the government was still trying to clean up after the savings and loan crisis. Investors were shell-shocked. Nearly 600 banks failed between 1989 and 1991. Rockett remembers not having a single bank open in California between 1989 and 1994. “I think you're seeing the same reluctance now to devote capital to banks,” he says, adding that some clients have told him the impression they've got from the FDIC is one of discouragement for new bank applications.
It's easy to see why. According to the FDIC, 305 banks were on its list of problem institutions at the end of the first quarter with expectations of failures to cost it $70 billion through 2013. The more than 70 banks that have failed this year have cost the FDIC more than $12.5 billion, cutting its reserves to $13 billion. To combat this, FDIC asked Treasury for emergency funding at the end of the first quarter and recently raised deposit insurance rates on all banks. Small banks say the insurance rate increase is unjust and harmful to balance sheets, but given the FDIC's position, a rate increase could become a regular ocurrence, say bank analysts.
“Still, if you have those critical elements, the business plan, management and capital raising ability, it's a great time,” says RBC's Cassidy. “You can pick and choose your customers, charge wider spreads and you don't have the burden of the credit problems facing banks that are up to their eyeballs in bad CRE and construction loans.”