Are de novos making a comeback?

CEO Judith Erwin sees a bright future for Grasshopper Bank, which launched in 2019. Photo: Dan Bigelow

After the recession, de novo applications slowed to a trickle. But as successful de novos have upped the ante in raising capital, adopting innovation, hiring talent and finding their niche in the industry, that trend appears to be reversing.

By Karen Epper Hoffman

Walt Disney once said, “The way to get started is to quit talking and begin doing.”

Among the banking industry’s upstarts, this has been particularly relevant over the past decade, as de novos have had to endure additional hurdles to prove themselves to regulators, potential customers and would-be employees. The market for de novo banks was uprooted in the wake of the financial crisis, as regulators and customers feared the potential fallout of a poorly planned financial institution.

Judith Erwin, CEO and founder of $100 million-asset Grasshopper Bank in New York City, says the landscape for de novos has proven “very difficult” in recent years, not only due to the financial crisis but also the inverted yield curve in today’s interest rate climate. “It’s very difficult for any bank, never mind a de novo,” she says.

Like many—if not most—recent de novos, Grasshopper Bank has set its sights on a lucrative niche market. Its chosen niche is the U.S. innovation ecosystem, including startups and venture capital firms, starting with New York. It’s also used a nontraditional core system, Temenos, on an efficient cloud-based infrastructure. Erwin says appealing to a niche audience differentiates a de novo from other, well-established competitors. “Otherwise, you’re playing to the lowest-common denominator,” she adds.

Wendy Cai-Lee, president and CEO of Piermont Bank, keeps a laser focus on small and medium-sized business customers.

Wendy Cai-Lee, president and CEO of Piermont Bank in New York City, says the market is ripe for new banks “after a decade-long hiatus from having more de novos and having more consolidation in the industry.” For Piermont Bank, which focuses on financing and deposit services for privately owned multigenerational businesses that are entrepreneur-led, knowing the “pain points” of its small and medium-sized business customers has helped it target potential clients. Piermont Bank offers loans in the $1 million to $10 million range to small businesses.

“The everything-to-everyone bank is costly to build,” Cai-Lee says, “and inefficient to run and no longer relevant to clients.”

Starting from scratch

Having a blank technological canvas means de novos can embrace a simplified infrastructure, she adds. In many cases, successful de novos are utilizing new financial technology, cloud-based systems and artificial intelligence to remove silos and reduce underwriting and processing time.

Lori Maley, president, CEO and vice chairman of $450 million-asset Bank of Bird-in-Hand in Bird-in-Hand, Pa., points to the importance of the initial business plan. In its case, launching in December 2013, the acceptance curve was fairly steep: Bank of Bird-in-Hand was required to raise between $16 million and $20 million to meet capital requirements, Maley says. It raised $17 million. “In those formative years, you need capital to grow,” she adds.

Maley says the FDIC is looking more carefully at how the capital level for these new de novos supports their business plans. When Bank of Bird-in-Hand was approved, the FDIC had the de novo period set at seven years. The FDIC has since ratcheted it back to three years.

Many successful de novo business plans are built on finding their own peg in the industry. Bank of Bird-in-Hand is largely focused on a niche market: nearby Amish and Mennonite communities (see sidebar below). “The people in this area needed someone who understood them,” Maley says, adding that a top executive at the bank had more than 30 years of experience with this community. At least half of Bank of Bird-in-Hand’s customers are Amish or Mennonites.

“We offer very simple products. There’s nothing fancy in our repertoire,” Maley says. In addition to the unique needs of the Amish and Mennonites communities, offering agricultural loans is critical, too, because many Amish are tobacco farmers, dairy farmers and organic produce farmers.

Focused business plans like this are emerging due to more stringent rules on de novos, according to Thomas Ko, a partner at Stroock & Stroock & Lavan in New York City and a bank regulatory attorney for the past 20 years. “The criteria are much tougher, and the [regulators] expect much more capital from de novos,” he says.

“The criteria are much tougher, and the [regulators] expect much more capital from de novos.”
—Thomas Ko, Stroock & Stroock & Lavan

Bank of Bird-in-hand: Banking on a niche market

It’s often said that a bird in the hand is worth two in the bush. For Bank of Bird-in-Hand, in Bird-in-Hand, Pa., that launched in 2013, appealing to underserved Amish and Mennonite customers was its bird in the hand. Bill O’Brien, the community bank’s chief lending officer, had worked with the Amish for three decades. The last bank to cater to the local Amish community had been acquired, then the acquiring bank was in turn bought by a multinational bank.

“They had lost touch with their Amish customers,” says Lori A. Maley, president and CEO of Bank of Bird-in-Hand. “We felt there was a need here and that the Amish were an underserved population.”

Understanding this market allowed Bank of Bird-in-Hand to meet their specific needs. For example, many Amish customers do not have a credit score, since they tend not to borrow money often or use credit cards. And since they typically travel by horse and buggy, these customers recognized the appeal of having branches closer to their communities so they don’t have to travel on highways. Luckily, the bank has a mobile bank unit—a 29-foot RV—that covers nine different locations each week. Bank of Bird-in-Hand also uses a courier service to deliver documents to Amish customers and businesses, since they don’t use the internet. The bank processes about 500 pieces of mail per month so customers don’t have to travel to do their banking, Maley adds.

Another banking anomaly is the community’s tight integration. The Amish tend to self-insure and will set up an independent bank account that many people will contribute to if someone in their community is having a serious medical or personal crisis. Bank of Bird-in-Hand accommodates that.

Here’s Maley’s advice to other new banks looking to graduate from de novo status: “Know what you plan to do and know your customers. In the beginning, we were running around like a chicken with its head cut off. You need to keep focused and not deviate from the core mission.”

Bank of Bird-in-Hand caters to Amish and Mennonite customers, who have unique needs.

Technology, people and funding

Despite challenges in recent years, successful de novo banks are emerging in today’s market. What separates the wheat from the chaff often comes down to a few key factors, according to industry participants.

Several de novo leaders cited the same strategies: cater to a typically underserved niche market; utilize cloud computing and other new technologies to boost efficiency; raise more funding than what may have been previously necessary; and get experienced top leaders and board members on board.

Cai-Lee launched Piermont Bank in July 2019. It was the first de novo in a decade to receive both regulatory approval from the New York State Department of Financial Services and the FDIC. A former executive vice president for East West Bank, Cai-Lee helped assemble an executive team with vast experience at community banks and other financial institutions, as well as a board with deep banking experience and extensive subject-matter expertise, as well as diverse backgrounds.

Using cloud computing and digital platforms has allowed Piermont Bank to quickly meet the needs of its primary target customers: privately owned, entrepreneur-led businesses.

“We can turn around commercial loans from application to funding in a much-reduced timeframe than what you typically would experience,” Cai-Lee said in a July 2019 press release. “We are combining the best of two worlds—we automate and digitize everything non-client-facing and invested outsized human resources in client-facing functions. This approach allows us to deliver services with a fully dedicated relationship advisor, one meeting at a time, with greater time and cost efficiency.”

Erwin of Grasshopper Bank advises new banks to focus on communication. She says they should keep regulators abreast of potential changes in the business plan, gather feedback and connect with existing and potential customers. “Every bank needs to be transparent,” she says. “Our relationship with regulators and investors is 100% transparent. Even our most junior person at the bank is aware of what we’re doing. Clients can ask us anything and we will tell them within privacy and regulatory constraints.”

“Every bank needs to be transparent. Our relationship with regulators and investors is 100% transparent. Even our most junior person at the bank is aware of what we’re doing.”
—Judith Erwin, Grasshopper Bank

The success of today’s de novo does not rely solely on the business plan, Ko says, but is “heavily dependent on the organizers and their ability to raise capital.” Experienced bankers should be on a de novo’s launch team, too. He adds: “What really, really helps … is people who can understand risk and have a clear business plan with clear sources of funding.”

Grasshopper Bank: Life after the financial crisis

In the wake of the Great Recession, the number of new bank launches took a sharp dive. Yet, de novo leaders say the quality of de novo banks has increased in terms of technology, funding and lending focus.

Judith Erwin, CEO and founder of Grasshopper Bank in New York City, points to a couple of initial challenges in the wake of the financial crisis. First off, regulators set a larger requirement for capital than they likely would have before the crash. “The requirement for capital was high; $97 million is quite a bar to overcome. It took us a year,” says Erwin, who helped start Square 1 Bank in 2005 and ushered it through an IPO in 2014 before it was sold in 2015. Yet, Grasshopper Bank raised $15 million in seed financing and another $116 million in its first capital round in 2019.

Another early hurdle was the time it took to gain regulatory approval. While the bank’s focus on risk management monitoring and niche lending put it in a solid position, it still took roughly 18 months from its initial application in October 2017 to final approval from the FDIC and the Office of the Comptroller of the Currency (OCC) on April 30, 2019. Part of the issue was the dearth of recent de novo applications. Erwin says very few people at the OCC had done that before. There was a learning curve to the process.

She projects profitability by early 2021. “[We’re] off to a solid start and the market reception has been very strong,” she says.

Experience matters

Maley of Bank of Bird-in-Hand has been part of a de novo launch before. She says the main asset a de novo has isn’t in “the assets on the balance sheet, but in your people”—a belief echoed by other de novo CEOs. In the first year, Bank of Bird-in-Hand hired just 10 people, largely managers for lending, technology and other departments. Maley looked for bankers with startup experience who were “rainmakers in lending and deposit-gathering,” as well as those with a desire to be progressive.

Like other successful de novos, Bank of Bird-in-Hand aimed early on to “foster a positive regulatory relationship and communicate with [regulators] regarding any divergence from the business plan.” Many employees Maley hired have worked with her at as many as four banks before joining the new bank.

“We were lucky to get that kind of talent. … They knew how to accommodate for growth,” Maley says. “Like being the oldest child, we hope to pave the way for everybody else.”

As a fresh de novo in 2013, Bank of Bird-in-Hand originated $30 million in loans that it participated out. “Satisfying the loan demand was the main thing,” Maley says. “We needed to make these loans to get a shot at the customer [accounts].” Eventually, other players came to realize that while Amish and Mennonite customers often lacked a credit history, they had a “pristine” loan quality and repayment history, Maley adds. The bank has reduced its loan participations to just $21 million.

Erwin sees a lot of available niches to would-be de novos. “Even a regular [commercial and industrial] bank using cloud providers can have the flexibility and nimbleness to serve huge swaths of this country that are under-banked,” she says. “With machine learning and artificial intelligence, we can go into markets that were previously deemed risky.”

Cai-Lee says Piermont Bank “reverse engineered” the process of building a business plan to serve clients’ pain points. “I’d like to take credit for being different,” she says, “but we literally took the most complained-about areas and looked to those.”

1. FDIC, Sept. 30, 2019
2. S&P Intelligence, Oct. 22, 2019

Building credibility as a new bank

Despite the recent uptick in de novo bank launches, challenges remain that often stymie would-be startup banks, whether it involves raising capital or their business plan.

Ko believes that in this environment, many would-be de novo launches are limited by funding. To face funding and liquidity needs, there needs to be a business plan to account for initial losses during start up and get stable and profitable, he says. His advice: People should have their ducks in a row and know how to capitalize a bank, and the banking regulators are likely to be very receptive to a well-planned and well-prepared application and business plan.

Cai-Lee says the biggest challenge is establishing credibility. Piermont needed to earn customer trust one client at a time. “We needed to show them what we could deliver,” she adds. “We have to be able to execute on what we say we’re going to do.”

“We needed to show them what we could deliver. We have to be able to execute on what we say we’re going to do.”
—Wendy Cai-Lee, Piermont Bank

Maley points out that Bank of Bird-in-Hand is “careful not to deviate from the initial business plan” in this environment. She says de novos tend to lose money in the first three years, but Bank of Bird-in-Hand was “lucky” to get $17 million in investment for its initial offering. With its second offering, which sold out in two months, it added only 130 more shareholders.

“In the initial offering, for shareholders, it is a leap of faith” Maley says. “We start off with a clean slate.”

Karen Epper Hoffman is a writer in Washington state.