Acquiring a bank with an eye on making an impact in underserved customer groups
Bank investors and organizing groups know that to be successful in today’s environment, a different type of strategy is required. Acquiring a financial institution with an unhealthy balance sheet and anemic profit potential taps more than investors’ wallets; it can tap their creativity too. One challenge lies in developing a business strategy that can win, and keep, new customers.
Untapped potential
Lena Robinson, of the Federal Reserve Bank of San Francisco, identifies four areas of untapped customer potential for the banking industry: the unbanked, underserved, emerging and immigrant markets. Unbanked consumers are those who have no existing banking relationship. Underserved consumers maintain only a checking account. Emerging consumers who use minimal banking products, but could be ready for more sophisticated debt or investment services. And immigrant consumers are generally migrant workers who have historically been unresponsive to traditional bank marketing initiatives. All of these segments represent opportunity for a newly acquired bank to create value. (http://www.frbsf.org/publications/community/investments/0311/article1.html)
Rewriting the rules
The FDIC’s survey on banks’ efforts to serve unbanked and underbanked consumers, published in February, indicates that addressing these segments efficiently has long been a problem for the banking industry. (http://www.fdic.gov/news/news/press/2009/pr09015.html) Unbanked consumers are hard to locate and not generally interested in traditional banking products and services. Underserved, emerging and immigrant consumers may be more open to the idea of banking, but they have often have little money and minimal interest in borrowing. Those two characteristics are problematic for the traditional banking business model, which emphasizes deposits and lending.
Because these untapped segments aren’t well addressed by traditional banking operations, efforts to court them must take a different approach. This approach should:
• Clearly identify the wants, needs and aspirations of customer being targeted
• Involve the creation of specialized products and services that match those customer needs, and distribution channels to match those customers’ lifestyles
• Incorporate innovative outreach programs to establish lines of communication with those target customers
• Find a way to develop trust among consumers who may be leery of financial institutions in general
• Consider the development of new ways to measure creditworthiness; consumers in untapped segments may not “pass” traditional credit tests
• Address the profit challenge associated with serving customers who aren’t likely to produce large deposits or request large borrowing facilities
In the introduction to Untapped: Creating value in underserved markets, (http://ca.csrwire.com/pdf/Untapped-excerpt.pdf) authors John Weiser, Michele Kahane, Steve Rochlin and Jessica Landis recommend businesses focus on creating win/win situations—where value is generated for the community and for the business. They also argue that it’s important for businesses to create strong partnerships with other organizations that can bring new insights and knowledge to the outreach effort.
As the banking industry continues to evolve through this period of change, new management teams and investors have the opportunity to create a new kind of value. To date, the banking industry has struggle to realize the potential in these segments—but if there ever was a time for change, it is now.
Next week, we’ll discuss specific geographies where these underserved groups are likely to exist, as well as how you can use that information to target your bank acquisition search.
While the current economic and regulatory environment poses challenges for start-up banks, it also creates some unique opportunities for bank acquisitions.
A few years ago, comparing the potential of bank start-ups to that of bank acquisitions might have quickly led an investor to believe that de novo was the way to go. But as desperation and uncertainty in the industry rise, seller price expectations have fallen. Combine this trend with regulators’ increased scrutiny of new bank applications, and the scales are tipping in favor of buying a bank, rather than starting a new one.
Selective purchase, short timeline Investing groups have two ways to go in a bank purchase: participate in an FDIC-assisted transaction or buy a bank without the government’s help. In an FDIC-assisted transaction, the buyer can acquire deposits, branches and, maybe most importantly, customer relationships, without getting stuck with bad assets. This is an advantage, but the buyer must also contend with public opinion related to the former bank’s failure. Once the transaction becomes public, those purchased deposits may shrink as customers head elsewhere.
Assisted transactions also present a very short window of opportunity. The FDIC notifies and collects blind bids from suitors within just a few weeks. Further, due diligence and negotiations occur before any public announcement is made.
Trends in the FDIC’s “Problem List” indicate that the availability of FDIC-assisted transactions will likely increase this year. As of the end of the first quarter, the problem list included 305 banks and thrifts. That’s up from 252 at the end of the year and 171 in September of 2008.
Taking the bad with the good Many insured institutions will remain off the problem list, but will seek a change in ownership or additional capital anyway. Opportunistic organization groups that are willing to dig in and evaluate asset quality, stability of deposits, and the competitive landscape, among other things, could turn up some workable deals. Unlike the assisted transaction, the unassisted deal rarely presents the chance to buy assets selectively. But, if the publicity is properly managed, buyers can minimize customer defections related to the “failed bank” stigma.
Clearly, due diligence in these transactions must be extensive. In the current environment, pricing cannot be justified by multiples; buyers are tasked with looking beyond book value and earnings to evaluate a bank’s incremental earnings power. This is no small task, given the uncertainty about economic conditions, collateral values and the regulatory environment. Since due diligence may actually lead to more questions than answers, buyers must be highly disciplined in valuating their prospective targets and ready to walk away from deals that don’t make sense.
FactSet Mergerstat LLC has reported that at least 285 U.S. financial institutions were sold last year, which is just 54 percent of the number of transactions reported in 2007.
The Wall Street Journal has reported that the Obama administration will recommend an overhaul of the current bank regulatory system to replace several regulators with one super-agency. The plan is said to involve the creation of a systemic regulator and a new consumer protection agency as well.
Currently, banks can be chartered as national banks, state banks, federal savings banks or state savings associations. Each type of charter involves a different set of regulators. For example, national banks are regulated by the Office of the Comptroller of the Currency or OCC. Federal savings banks, however, are regulated by the Office of Thrift Supervision or OTS. State banks can be jointly regulated by the state and either the FDIC or the Federal Reserve Board (FRB). State-chartered thrift holding companies and state savings associations, however, are regulated by the state and OTS. The bank’s organization group selects the type of charter and chartering group within its bank application during the formation process.
Competing agencies create gaps and leniencies Critics of the current system argue that this regulator mélange lacks comprehensive, systemic oversight and creates regulatory gaps that have been exploited by financial companies.
Also at issue is whether the current system sufficiently motivates regulators to provide careful oversight. New banks represent new funding for regulators; since bank organizers tend to gravitate towards the regulator of least resistance, regulators actually benefit on some level from offering greater leniency.
A systemic regulator would eliminate this competition for leniency. The agency would be tasked with identifying and addressing regulatory gaps in areas such as mortgage banking, hedge funds, credit default swaps and other specialty financial products. As well, the entity would be responsible for recognizing risks and problems within financial companies that are heavily entrenched in the industry—to properly manage or even avoid failures of Lehman’s magnitude.
ABA warns of ending dual-bank system A single-agency system would require the unification of oversight functions currently managed by the OCC, OTS, FDIC and FRB. In a letter written to Treasury Secretary Timothy Geithner, ABA President and CEO Edward Yingling expressed the banking industry’s opposition to this concept. According to Yingling, such a system would favor federal banks over state banks, and eventually lead to the end of the dual banking system. The dual banking system, says Yingling, isn’t the enemy; it creates competition and stimulates innovation in financial products and evolution of regulatory systems.
Yingling also argues that the proposed model is based on the U.K.’s Financial Services Authority, which was not able to avert that country’s financial crisis.
The single regulator concept is still just a subject of debate on Capitol Hill. Senator Christopher J. Dodd and Representative Barney Frank have both spoken out against the idea. Press reports indicate that the administration will publicize a proposal later this month.