Bank startups still all the rage

Banking does not sound like a very exciting business. You bring in money at the lowest possible interest rate and then lend it or invest it at the highest possible interest rate. The difference is your profit, minus the cost of staff, rent, and equipment. Basically that’s it. There is nothing to podcast, no superswift software to market - just deposits and withdrawals. And yet, more than 150 banks in the U.S. opened their doors last year, 17 of those in California, and the number is likely to be just as large in 2007. Small, independent banks have been popular startups for several years - mostly because of a formula in which shareholders are expected to nudge their friends and clients into taking out loans or depositing money. I have a piece in the February issue of Los Angeles magazine that focuses on Alan Rothenberg's 1st Century Bank in Century City:

There are relatively few independent banks based in Los Angeles because regulators make it tough to get in the game. The industry’s desirable metric is one bank headquartered in the state per 40,000 people. California has only one bank per 131,000 people, and L.A. County has one bank per 160,000. You get the picture—limited supply and unmet demand. When word of Rothenberg’s bank began making the rounds in 2003, he quickly lined up more than 120 investors willing to put down seed money of several thousand dollars each to bankroll the regulatory process. Among the early entrants: real estate mogul Ed Roski, divorce attorney Dennis Wasser, M*A*S*H star turned investor Wayne Rogers, radio tycoon Norman Pattiz, and Oakland A’s owner Lewis Wolff.

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It can take well over a year to open a bank—and that assumes regulators don’t give you a hard time over location, market niche, or the board’s makeup (it must include at least a few directors who have experience in managing a bank). But once in business, it’s a remarkably smooth ride. For a bank the size of 1st Century to turn a profit in its third year (most independents lose money in their first 12 to 24 months), loan volume must be around $150 million. That won’t be tough. Assuming an average loan on the Westside runs $1 million, the bank would need 150 referrals to get the job done. Many of the 400 shareholders are only too happy to recommend “their” bank to a client or friend because of what Carpenter calls the “E2G formula”—education, ego, and greed. “You only sell stock to people who you think will do business with the bank,” he says. “And the people who will do business with the bank are the people in the community. So everybody on the outside is frozen out because all these offerings are oversubscribed.”

Too good to be true? Well, maybe. Increased competition, growing credit quality problems and a riskier interest rate environment have some experts wondering if the independent bank craze has peaked out. Banks that focus on real estate are considered especially vulnerable. From the WSJ:

The tough environment ultimately could force some fledgling institutions to put themselves on the block, at a time when takeover premiums are lower than when the industry was flying high. Last year, small banks fetched an average of 1.8 times book value, down 22% from 2.3 times book value in 2002, according to SNL.