The new bank application department at the FDIC was a little slow in 2014. Before the recession, it was common for the FDIC to get 250 applications per year and approve 159 of those. In 2014, only Primary Bank (in organization) filed an application (still pending). Part of the issue is that if you are crazy enough to want to start a bank you are probably too dysfunctional to handle the management of a bank. Given average ROE below the cost of capital, tight margins, low interest rates, tough competition and too many banks, it is no wonder why more bankers have not applied.
The only bank to get approved since 2010 is Bank of Bird-in-Hand, a community bank catering to the Amish. The Bank underscores what it is going to take to get approved over the next five years. It is going to take not only banking experience and a higher than average amount of capital, but a demonstrable need for a specific community. Given the consolidation in metro areas combined with the number of existing banks and branches - that need will be hard to prove.
Compounding the problem is that the FDIC still has a geographical view of community banking - a view that is dated, in our opinion. A community can be defined as a need from a particular industry (e.g. car dealers), demographic (e.g. woman-owned businesses), lifestyle (e.g. the LGBT set), business profile (e.g. small business startups) or any number of non-geographic dimensions. While the FDIC may take these particular customer segments into account, a bank needs to demonstrate that particular need in a particular geography to at least be able to prove the business model. As such, that need and projected profitability will be harder to prove going forward and will keep a limit on both bank applications and bank approvals.
All this is good news for existing banks, as it means that one of the greatest barriers to entry that any industry enjoys will be stronger than ever. This will continue to limit competition and increase the price of every bank’s existing charter. Over the next five years, more banks will consolidate making a bank that can deliver a clear value proposition to a particular market or customer segment more valuable than at any time in the history of banking. As bank earnings improve, investors’ desire to own banks will increase. Higher rates, a steeper yield curve and low credit defaults will further fuel this trend.
The future of bank values looks extremely bright and we predict that banks will routinely trade at multiples of 3x tangible book price.
Submitted by Chris Nichols on December 29, 2014