BankNotes ...

De Novo Strategy is a supporter of CREED and its nonprofit work; we invite you to participate in this project that CREED has just launched. It is a project that every entrepreneur should be a part of and enjoy supporting! Maybe a banker would catch the vision on and support this too!

CREED, a non-profit 501 (c)3 corporation, is launching a crowdfunding initiative to jumpstart small business in the U.S.　Crowdfunding　involves collecting small donations via grassroots marketing campaigns. The donations will be used to fund $5,000 in free start-up capital, awarded to the entrepreneur who sends in the most compelling business plan.　

Crowdfunding or crowdsourcing programs have been run successfully by two organizations in Ireland,Outvesting　and　iQ Prize. The two entities raised an aggregate 15,000 euros, by way of 50-euro pledges, to fund small business start-ups.　

CREED's effort will be similar. The non-profit is currently accepting $50 pledges, with a goal of accumulating $5,000. Once this pledge goal is reached, CREED will publish business plan submission guidelines and begin accepting business plan entrants. Everyone who pledges $50 to the effort receives one vote to help determine the best business plan among those entered. The plan with the most votes will be awarded $5,000 in start-up capital, with no strings attached.　

Please visit　Crowdfunding　to learn more about CREED's this great American opportunity.

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In the beginning of 2009, the media was pushing the idea that this would be the year for the community bank. Many smaller banks had not weighted down their balance sheets with subprime loans, asset-backed securities and complex derivatives. In theory, they had the stability to pick up loan customers that had been turned away by larger institutions. Columbus Business First published an article entitled, "Larger competitors' retrenchment may give smaller banks opening." And Business Week said, "As big banks struggle, community banks are stepping in to offer loans and lines of credit to small business customers."

Getting in to the banking industry during a power shift from big banks to small ones would appear to be an attractive opportunity for bank executives and community leaders who wish to be bank investors. But the predictions of a few publications don't sufficiently address the risk involved in buying a bank. Bank investors need to have some framework for separating the good targets from the bad ones.

Characteristics of at-risk community banks

In a speech made last July, San Francisco Fed President Janet Yellen summarized the characteristics of at-risk community banks. She cited:

• High concentrations of construction loans for speculative housing projects
• Concentrations of land acquisition and development loans
• Poor appraisal systems
• Weak risk-monitoring systems

Looking ahead, Yellen also identified "income-producing office, warehouse, and retail commercial property" as an area of potential risk. She cited rising vacancies and poor rent dynamics, which are putting negative pressures on property values. These value declines can be particularly problematic for maturing loans that need to be refinanced. Community banks that maintain large portfolios of commercial property loans should be proactively managing these risks. Bank acquisition groups should verify that target banks are updating property appraisals, recognizing impairments early, and negotiating work-outs with borrowers when appropriate.

Tim Coffey, Research Analyst for FIG Partners, LLC, agrees that commercial real estate is the next area of risk for banks. In an interview, Coffey said,

I think the residential portion of this correction has been dealt with and recognized by bankers and market participants alike. The next shoe to drop is going to be commercial real estate. I don't think there is really any kind of argument about that. How messy it's going to be compared to the residential part remains to be seen.

Coffey's comment was included in a report by The Wall Street Transcript that also quoted commentary from other banking analysts. The consensus among them was that some community banks are still facing potentially disastrous problems ahead.

Separating the good acquisition targets from the bad ones, then, requires careful analysis of the balance sheet, loan portfolio and the bank's current risk management practices. If the bank isn't managing risk proactively, there could be unknown problems brewing within the loan portfolio. Buying a bank with known problem assets is a manageable challenge-but buying a bank with unknown problem assets is something else entirely.

An early decision bank organizers must address is whether to buy an existing bank or create a de novo bank. The right choice among these two options is always dictated by the particular set of circumstances faced by the group. At times, as circumstances and opportunities develop, bank organizers may even switch strategies in the middle of the process.

If the decision is made among the organizers to buy a bank, certain steps must be completed in order to get the transaction finalized. While each bank acquisition is unique, the steps generally fall into four major phases.

Phase One: corporation formation

Once the decision is made among the organizers to buy a bank, the group members create a stand-alone corporate entity. The newly formed corporation has two purposes: to purchase a bank and manage the organization’s funds. Other steps that are completed during this phase include:

•    Identification of the target bank
•    Negotiation of the purchase agreement
•    Sourcing and hiring of executive officers
•    Selection of a new bank location, as dictated by the business plan and/or assess the condition of the existing bank location

Phase Two: application

After the target is identified and the stock purchase agreement is in place, the group begins on the change of control application. The business plan within the application includes 10 separate sections; these sections are broken down and worked on until each is at least 80 percent or more complete.

Typically, each organizer must also complete an Interagency Biographical Financial Report (IBFR). This can be one of the most difficult sections; it must include each organizer’s personal and financial records for the previous two years and the current year, as well as projected records for the next year. The organizers should be compiling this information while the other sections of the application are being completed.

Phase Three: pre-file and comment letter  

Once the business plan is 80 to 90 percent complete, the organizers schedule a meeting with the regulating agency. At this meeting, the organizers must explain and defend their business plan to the regulators.

After the pre-file meeting, the group fine tunes and completes the business plan and sends it off to the regulating agency. The agency then has 30 days to make comments and request additional information. Once that request is made, the organizers have 30 days to compile the requested data.

Phase Four: Sell stock/capital and open doors

Often, when a bank is being purchased, a substantial amount (greater than 75 percent) of the capital must be raised by the time the application is filed with the regulators. In the current economic environment, regulators only want to approve “sure deals.” They are so busy with all the banking issues, that capital uncertainty is one issue they do not want to worry about in a purchase transaction.

For this reason, the organizing group is typically left with a private placement offering as the simplest way to raise the capital. Often this is done amongst the organizing group plus a few outsiders. The amount of capital required is dependent on the business plan approved. Typically, the regulators will require additional capital above the purchase price of the target bank to ensure that the new business plan has enough capital to succeed.

Once the capital has been transferred to the sellers of the bank, the doors may open “under new ownership.”

This is just a broad overview of the bank purchase process; each deal has unique circumstances that must be addressed. These circumstances could be legal in nature and involve counsel. Others are small details that can be easily overlooked by organizers. De Novo Strategy, Inc. has the experience and dedication to make the bank purchase project a reality and to help with every step.

Whether you intend to start a new bank or buy an existing one, you’re going to need some help. That help is found in the form of qualified organizers—the entrepreneurial individuals, who pursue the business plan relentlessly and, eventually, create value in the new banking entity.

The organizer’s responsibilities are varied and time-intensive (usually 10-20 hours per month). A de novo or purchased bank project doesn’t get off the ground well unless the team of organizers is focused and unified. This means the organizers must be ready to contribute productively to committee discussions and assist in making informed planning decisions. Those decisions cover a variety of topics, from branding to operations:  

•    Branding: The organizers build the new bank’s brand from the ground up, deciding what the bank’s mission will be, how it will differentiate itself, what the logo will look like, etc.  

•    Human resources: The organizers must recruit and hire a qualified management team.

•    Project management: A branch location must be selected and modified or built to suit the bank’s purposes. IT systems and other support vendors must be priced and selected, etc.

•    Operations: The team must select the products and services the bank will offer and strategize on how those products and services will be distributed and fulfilled.  

•    Bank Policies: The organizers/new board of directors assist management in drafting and approving the bank’s policies and procedures, a very critical part of banking.

Contributing insights and shaping decisions are just the beginning of the organizer’s responsibilities. However, a pivotal part of what the organizer does is raise capital—both by investing his or her own money and by recruiting more investors to the project. The recruitment process begins with the organizer contributing a sizeable list of names of potential investors. Once the capital campaign gets started, the organizers must be willing participate in their share of the weekly meetings to pitch the investment opportunity.  

The ideal organizers and where to find them

Obviously, not everyone is well suited to be a bank organizer. Decisions need to be made, networking needs to be done, and money needs to be raised. These tasks are not easily accomplished by someone who doesn’t have the right characteristics and skill sets. Ideally, your organizers will be:

•    Visible in the community
•    Opportunistic
•    Task-oriented
•    Motivated by challenge
•    Outgoing, enthusiastic
•    Able to juggle several projects at once successfully

Knowing what to look for is half the battle; the other half is knowing where to look to find it. The simplest means of locating potentially suitable organizers is to recruit within professions that typically attract the above qualities; below is a short list of professions:

•    B2C service providers: Contractors, plumbers, dry cleaners, car dealers, insurance agents, general contractors, financial planners, doctors, dentists, real estate agents

•    B2B service providers: CPAs, marketing consultants, real estate brokers, pharmaceutical account representatives, office supply representatives  

•    Niche business owners: franchise owners, hotel operators, ethnic market owners, retail store owners, technology providers

Here’s the big picture to remember when seeking out organizers. The organizers you select should operate successful businesses and have access to and represent the segments of the community your bank will serve. In addition, they must be motivated enough to stick with the project for the long-haul. And finally, it takes the right person to understand that starting a bank, or re-branding a purchased bank, is an enormously challenging, but ultimately rewarding endeavor.

With megabanks struggling to achieve profitability, the opportunity is ripe for savvy banking entrepreneurs to create nimble and modern community banks from the ground up. Unfortunately for banking customers around the country, the pace of bank start-ups has actually slowed down rather than ramped up. Several issues are to blame, but a significant obstacle is the challenge of finding and recruiting willing bank organizers. The same challenge can throw a wrench into an organization group’s plans to purchase an existing bank as well.

The team of organizers provides the de novo bank with insights, contacts, talent, direction and, of course, organization capital. The right team can turn the vision of a banking start-up, or a purchased bank, into a profitable and satisfying local community investment.

When the business plan is solid, the arguments for becoming a bank organizer are compelling: the experience can greatly enhance the organizer’s position in the community as it helps the community thrive and grow. The ability to become part of such a project at the ground level and, ultimately, create a powerful investment are often reason enough for the right personalities to jump on board.

In today’s world, however, potential organizers have been reluctant to commit. In general, they’re nervous about dedicating the time and resources to the project. That nervousness is likely rooted in a few different issues, including:

•  Excessive media coverage about the supposedly unstable state of the banking industry

•  The performance of the prospective organizer’s own business; organizers who are struggling to keep their own businesses afloat in this economy won’t want to dilute their focus by committing to a new bank project

Sweetening the pot

To be successful in recruiting qualified organizers, the individuals spearheading the project must recognize these challenges and address them with prospects immediately. Some talking points that might be helpful in this regard include:

•  The media’s coverage of the banking industry is over-simplified; the majority of community banks and balance sheet lenders are effectively managing through this current economic cycle.

•  The new bank has the opportunity to operate at a significant competitive advantage, because it opens its doors with a clean balance sheet.

•  Devoting time and capital to a new bank project is an investment and, as such, adds diversification to the organizer’s assets.

•  The success of the new bank can add stability to the organizer’s existing business by solidifying that organizer’s position and visibility within the community.

Finally, while it is important to build an organization team quickly, it’s also crucial to select organizers who will be committed and involved throughout the process. Overselling the opportunity and understating the commitment when recruiting organizers is a strategy that’s likely to backfire.

Next week I’ll discuss the primary responsibilities of the organizer and what characteristics might qualify an individual to be an effective bank organizer.