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 FDIC has just released the results of a national survey pertaining to banks’ efforts to reach unbanked and underbanked individuals and households. This demographic is widely recognized as untapped potential for the banking industry—but industry efforts to move unbanked customers into traditional checking, savings and credit products have not been consistently successful.
The survey, conducted by Dove Consulting, was designed to quantify the efforts of banks to meet the needs of the unbanked/underbanked demographic, to identify the challenges associated with serving this market, and to identify innovative products and services which appeal to this target customer.
Outreach plays pivotal role
More than 25 percent of respondent banks recommended the use of outreach programs to bring unbanked households into the conventional banking system. The bank employees tasked with designing appropriate outreach programs can turn to local employers, labor unions and community organizations to gain deeper insights into the needs and motivations of the targeted group. Alliances with these local organizations can also be leveraged by the bank to build awareness and trust quickly within the community.
The traditional bank branch, with its limited hours and relatively formal setting, may be off-putting to this customer demographic. To address these concerns, banks might consider broadening customer access via kiosks, extended hours, web access and phone service. Some banks also reported success with hiring staff members who are fluent in foreign languages.
Specialty products and services
Banks nationwide recognize the importance of the check-cashing service to unbanked customers. Many institutions, unfortunately, are reluctant to take on the risk associated with offering this service. A secondary barrier is the inability for many unbanked individuals to produce acceptable forms of identification.
Money orders, international remittances and bill payment services were also identified as service offerings that would appeal to unbanked individuals. Of the banks that responded to the survey:
• 49 percent offer check-cashing to non-customers. • 37 percent offer bank checks and money orders to non-customers. • 6 percent offer international remittances to non-customers (32 percent of respondents cited regulatory concerns as a barrier to offering this service.
Downsized credit products
Entry-level credit products are useful in helping the unbanked individual enter or re-enter the economic mainstream. Prepaid cards and debit-card accounts are two services that often resonate well with this customer segment. Secured credit cards, tax refund anticipation loans and other advances on funds that are due to arrive were also recommend, although these services are not widely offered by mainstream banks.
Banks’ interest in providing these alternate services varies widely. There is a perception that the costs and risks associated with catering to the unbanked group will fall outside the bank’s strategic parameters. The FDIC’s survey did reveal, however, that 77 percent of banks had not conducted any research on the potential unbanked customers in their areas—which could mean that the reluctance to provide tailored products and services to this group is largely based on unproven assumptions.
The FDIC’s survey did not delve specifically into the long term value of the unbanked customer—but it is generally believed that these individuals, once obtained, can be transitioned into conventional banking services over time. Survey methodology
The surveys were sent out by mail to a nationally representative sample of 1283 banks with brick-and-mortar branches. Six hundred eighty-five surveys were returned; at the time the survey was conducted, the respondent banks represented $8.3 trillion in assets or 70 percent of the total assets within FDIC-insured institutions.
Reports Continued Deterioration in Earnings Performance, Asset Quality
FDIC’s third quarter, 2008 Quarterly Banking Profile was released on November
25, 2008. The industry snapshot shows a continuation of negative trends, including
depressed earnings and deteriorating asset quality. The report also provides
detail on the proposed changes to the FDIC’s assessment system.
than 58 percent of member institutions reported year-over-year declines in
quarterly net income, while 64 percent generated a reduced quarterly return on
assets (ROA). Profitability issues appear to be magnified at the larger banks;
institutions with assets greater than $1 billion experienced a 47-basis point,
year-over-year ROA decline. Community banks fared somewhat better with a
25-basis point decline. Nearly one-quarter of member banks failed to earn a
profit in the quarter; this is the highest level for this metric since the
fourth quarter of 1990.
Income a mixed bag
banks reported declines in several categories of noninterest income, including
securitization income and gains on sales of assets other than loans. Losses on
sales of bank-owned real estate increased almost six-fold to $518 million. Loan
sales, however, showed a marked improvement with net gains of $166 million.
This compares to net losses of $1.2 billion in the third quarter of last year.
interest income also improved by 4.9 percent versus a year ago. The average net
interest margin (NIM) remained flat with last quarter, but rose 2 basis points
relative to the year-ago quarter. This trend was more pronounced among larger
Credit losses still
expected, expenses related to credit losses drove much of the earnings decline.
Industry-wide, credit loss-related expenses topped $50 billion, eating up about
one-third of the industry’s net operating revenue. Aggregate loan-loss
provisions tripled from the year-ago level, reaching $50.5 billion in the
quarter. Net charge-offs increased by 156.4 percent to $27.9 billion, with
two-thirds of the increase related to loans secured by real estate. Charge-offs
related to closed-end first and second lien mortgages, real estate construction
and development loans, and loans to commercial and industrial borrowers all
showed increases well in excess of 100 percent. The quarterly net charge-off
rate jumped 10 basis points sequentially to 1.42 percent; this is the highest quarterly
net charge-off rate since 1991.
loans and leases, defined as being 90 days or more past due or in nonaccrual
status, increased by $21.4 billion sequentially to $184.3 billion. Nearly half
of this growth came from closed-end first and second lien mortgages. The percentage
of loans and leases that are noncurrent rose to 2.31 percent, which is the
highest percentage recorded since 1993.
reserves ticked up by 8.1 percent, bringing the ratio of reserves to total
loans and leases to 1.95 percent. Reserves to noncurrent loans fell to $0.85, which
is the lowest level recorded since the first quarter of 1993.
Watch list grows 46
percent, number of new charters shrinks
banks collapsed during the third quarter, and another seventy-three were merged
into other institutions. While the number of failures marks a high point since the third quarter of 1993,
the growth of the FDIC’s list of problem banks indicates that there are still
rough times ahead; an additional fifty-four banks were added to the watch list,
bringing the total number of problem banks to 171.
new institutions were chartered during the quarter. This marks a decline from
the twenty-four new charters that were added last quarter.
deposits rise, DIF reserve ratio declines
total assets of all FDIC-insured member institutions rose 2.1 percent to $273.2
billion during the quarter. Most of the increase, some 57 percent, came from
noninterest-bearing deposits. Interest-bearing deposits on the other hand
showed a slight decrease of 0.3 percent.
deposits continued an upward trend, rising 1.8 percent on top of a second
quarter increase of 0.6 percent. Fifty-eight percent of member institutions
reported an increase in insured deposits, 42 percent reported a decrease and
the remainder reported no change.
Deposit Insurance Fund decreased by $10.6 billion, primarily due to an $11.9
billion increase in loss provisions for bank failures. As of September 30,
2008, the reserve ratio was 0.76 percent, down 25 basis points from three months
prior. Nine insured institutions failed during the quarter, bringing
year-to-date failures to thirteen; those thirteen failed institutions had
combined assets of $348 billion and are estimated to have cost the DIF $11
involves increases, changes to risk-based assessments
FDIC adopted a restoration plan on October 7 to increase the DIF’s reserve loss
ratio to 1.15 percent within five years, as required by Federal Deposit
Insurance Reform Act of 2005. In accordance with the plan, the FDIC Board
approved the publication of a notice of proposed rule making to increase the
assessment and shift a larger proportion of that increase to riskier
institutions. For the first quarter of 2009, the FDIC seeks to increase
assessment rates by 7 basis points across the board.
proposed assessment system, to be effective April 1, 2009, establishes base
assessment rates ranging from 10 to 45 basis points for Risk Categories I
through IV. Those base rates would then be adjusted for unsecured debt, secured
liabilities and brokered deposits. The adjusted assessment rates would range
from 8 to 77.5 basis points.
As the shake-down in the financial services industry continues, traditional banks may find themselves losing customers to healthcare providers.
Health insurer WellPoint Inc. recently received conditional approval from the FDIC to open ARCUS Bank, which will be a Utah-chartered industrial loan company (ILC). The approval was obtained despite an FDIC moratorium on deposit insurance applications for ILCs that would be operated by firms which participate in non-banking business activities. The underwriting and selling of health plans by WellPoint wasn't the problem; it was the company's retail activities, primarily pharmacy services and disease management operations.
WellPoint appealed to the Federal Reserve Bank to get around the moratorium, arguing that the company is, first and foremost, a financial services provider. The Fed agreed, with the stipulation that WellPoint has to keep its pharmacy and disease management revenues in check-specifically, less than 15 percent of total sales.
WellPoint isn't the only health insurer that's moving into the banking industry. OptumHealthBank, which is part of the UnitedHealth Group (NYSE: UNH), has been providing "health care banking" services since 2005. And last year, a group of Blue Cross and Blue Shield Association member plans chartered Blue Healthcare Bank. Blue Healthcare Bank's mission is to "help participating Blue companies offer their members state-of-the-art healthcare savings and payment options...facilitating members' choice of high-quality, self-directed accounts..."
It is the growing popularity of high-deductible health plans (HDHP) that's driving these health insurers into the banking business. HDHPs generally charge lower premiums in exchange for coverage that doesn't kick in until a very high deductible is met. Having an HDHP gives the insured the right to maintain a tax-advantaged savings account to hold funds that are earmarked for healthcare expenses. So-called health savings accounts (HSAs) share characteristics with IRAs: contributions can be invested in securities and the earnings are tax-free until the money is withdrawn.
The company providing the HSA has the opportunity to collect account fees, management fees, investing fees, etc. OptumHealthBank, Blue Healthcare Bank and Arcus Bank believe that offering HSAs and related financial services is just a natural extension of their current health insurance offerings; they're simply providing another tool to help their customers manage ever-rising healthcare expenses.
The evolution of banking
For the traditional banking industry, this development presents yet another argument for banks to reassess their innovation efforts. Customers need to have a compelling reason to choose one service provider over another. For some, a negative perception of the traditional banking industry may be enough. Traditional banks stand to lose out on HSA-related revenues and, possibly, revenues related to other financial services as well. Now, and for the foreseeable future, the pressure is on banks to develop strategies that will drive innovation, develop new and improved products and services, and enhance efforts to build deep, lasting customer relationships.