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Are De Novo Banks Ready for a Comeback?

(This story originally appeared in Exit Planning Exchange.)

By Eric Segal

The banking landscape has consolidated in the last three years.

Maybe it was runaway inflation that caused cost-cutting branch closings. Or it was bigger banks gobbling smaller banks for quick market share. And let’s not forget the industry’s ongoing march toward digital transformation, which grabs more traction each month.

Whatever the cause, several data points tell us that we may have reached an inflection point in the business cycle. Earlier this year, the Federal Reserve Bank of Philadelphia issued a report that found the closures of bank branches in New Jersey, Pennsylvania and Delaware have more than doubled since the pandemic. The three states lost a combined 627 branches during that time period, increasing the number of “banking deserts” to 63 areas in the region.

Recent bank and branch consolidation have created some pockets of opportunity and could trigger the next wave of de novo banks. But here’s the catch: You may only need to raise $30 million of capital to open a bank, but you will need a lot more to make it successful.

Crown Bank Vice Chairman Paul Fitzgerald says, “due to ever increasing compliance costs, banks need to reach a critical mass sooner rather than later. The first target is usually $100 million in assets. Banks will not need a branch on every corner, but a well-defined branching strategy is still important. Technology can help reach the target critical mass right from the start.”

For startup banks, it’s not a straight line to success. Here are four factors a de novo bank needs to be part of in the next wave:

De Novo Bank Insight: The Right Team

If you have the right senior management team, they will hit the deck with existing relationships.

Stocking the board with experienced directors who believe in the mission, however, could be the factor that turns a startup bank into a major success. Fostering unity on the board—with everyone on the same page supporting the business plan—would create a constructive environment.

There is a period in the beginning when banks are on “probation.” When you give regulators a business plan, they view it as a contract. You are communicating to them what you will do in the first three years, which means you will have to explain every variance. If the board is not aligned on the plan, then you will have a problem. A supportive board can be the X-factor.

Engaged board members will open doors and share their business relationships, which can give a de novo bank instant credibility within the community. And that’s an important thought when you consider the history of de novo banks driven by local business owners who felt their community was ignored by mergers that left their region without access to banking decision-makers.

De Novo Bank Insight: The Right Area

Location. Location. Location.

To be successful, you will need to launch your de novo bank in an area with attractive demographics for both consumer and commercial business, and that also has an abundance of experienced talent with industry experience.

When it comes to winning over your new customers, make operations revolve around them.

“When I started a bank in northern New Jersey, my office was visible from the main lobby,” Fitzgerald said. “People could talk to me when they wanted. In large banks many of the credit decisions are now made out of state by anonymous back-office people. There are a significant portion of business owners who appreciate access to senior management.”

Successful new banks don’t really start from scratch. The right relationships with other banks in the market could also yield participation loans, which are funded by multiple lenders to reduce risk and manage liquidity. These facilities can help startup banks generate interest income on the first day.

Access to the right lending, operations and senior management team also plays a large role in selecting the right trade area for a startup bank.

De Novo banks can benefit from outsourcing some finance, accounting, balance sheet management and credit administration tasks until the core team has the bandwidth to take them on.

One of my colleagues, Larry Davis, who has more than 25 years of senior financial management experience in commercial banking and manufacturing, has worked to train and mentor a de novo bank finance team with virtually no bank experience.

“The regulators didn’t believe they had enough banking experience on the accounting team, so they called us,” Davis added.

De Novo Bank Insight: The Right Technology

In today’s digital, on-demand world, banks must give serious thought to the right array of fintech providers, a daunting task. CFO Consulting Partners is part of the advisory board for Bankable Fintech, which can help management sort through fintech options.

The FDIC recently issued guidance for banks working with third-party fintech partners. In the last three years, almost two-thirds of banks have partnered with at least one fintech company, according to a report from Cornerstone Advisors. Banks that have already started their digital transformation are experiencing improvements in deposit account opening productivity (42%), loan productivity (33%), operational expenses (29%), customer/member retention (29%) and loan volume (29%).

Surveyed community banks are planning to invest or have already implemented cloud computing (70%), application programming interfaces (APIs) (68%), robotic process automation (39%) and chatbots (30%), according to the “What’s Going on in Banking 2023 – Fighting the Headwinds, Riding the Tailwinds” report by Cornerstone Advisors.

De Novo Bank Insight: The Right Data

To ensure senior leadership is receiving meaningful information in a timely fashion, your accounting platform must be robust and flexible as possible.

Set up the system to produce the numbers from three critical inflows to ensure the bank’s financial house is in order.

  • Cash flows must be managed closely. If you don’t control them, they will control you. Reconcile cash transactions on a set basis based on volume and the nature of your business.
  • Information flow, ensure that the operating platform can provide data for accounting entries, management reporting and regulatory reporting, and that it communicates with the accounting system.
  • Accounting flows are a series of processes and controls that validate and capture information from daily business operations, which include bank account reconciliations, ledger reviews and comparison of financial results to the budget and forecasts.

Regulators will not approve a banking license unless your senior management team can demonstrate they know what they are doing.

Knowing the numbers—as well as your people—will go a long way.

(Eric Segal, who is a partner at CFO Consulting Partners, leads the firm’s Financial Institutions and Insurance practice. He has more than 25 years of experience in senior financial management positions with companies ranging from Fortune 500 to community banks.)