A Federal Reserve
The order details the extent to which the crypto-focused investors that purchased Farmington State Bank in 2020 flouted their commitments to regulators to preserve the institution's long-running business model, which centered on deposits, mortgages and farm loans.
Within a year of receiving their final regulatory signoff, according to the order, the new owners were engaged in a wholesale repositioning of the bank as a service provider to "fast-growing innovative and disruptive sectors." This included a business agreement to design and issue stablecoins, despite an explicit ban on such activity in the acquisition approval.
"That level of disregard is unprecedented and really quite astonishing," said Michelle Alt, co-founder of the advisory firm Klaros Group and a former regulatory lawyer at the Office of the Comptroller of the Currency.
The bank was purchased by GUVJEC Investment Corp. — now FBH Corp. — a Maryland-based company led by Jean Chalopin, a crypto investor and chair of Bahamas-based Deltec Bank, which caters to the digital-asset industry. Chalopin did not respond to multiple requests for comment this week.
Given that Farmington, at just $22 million of assets, was among the smallest banks in the country at the time, Alt said it should have been clear that the investors were angling for a so-called charter strip, in which a purchaser targets a bank solely for its license to take deposits and engage in other bank-exclusive activities. Indeed, regulators might have been on alert to this possibility, she noted, pointing to the numerous conditions tacked onto the acquisition approval.
Yet, because those caveats did not prevent the bank from abandoning its long-standing business model, Alt and others worry the episode will result in an overcorrection from regulators, one that makes the banking sector's high barrier to entry even higher.
"I've never seen such blatant disregard of approval conditions, so it's my view that Farmington is an aberration," she said. "My concern is that this will put a further chill on regulator responses to innovative business plans instead of being treated like the aberration it was."
Charter stripping is a relatively new term and controversial in some circles, but it describes an activity that has long worried regulators: an acquisition changing a bank's relationship with its surrounding community. Typically, the moniker is applied when a tech-focused nonbank buys a small bank to gain entry into the banking system.
Fed Gov. Michelle Bowman put the term on the map in April in a speech on "the consequences of fewer banks in the U.S. banking system." In those remarks, she argued that charter stripping weakens local banking.
"The target institutions for charter strips are often the smallest banks," Bowman said. "Acquired banks may provide services in small towns or rural communities, areas that may lack robust competition. Even when these legacy bank businesses continue to operate as an add-on to the new charter-strip business model, the institution as a whole tends to become riskier, jeopardizing the long-term viability of the legacy banking business and its ability to continue providing services to the local community."
But some say the term charter strip merely casts a negative light on a legitimate business practice.
"The term charter strip is a pejorative. It's just buying a bank in order to change its business plan," said Todd Baker, a business and law professor at Columbia University and managing principal at Broadmoor Consulting. "The only reason why it's at all controversial is that we've made it so difficult to get a de novo charter, that it's effectively, by far, the better method of entry into banking if you have an existing financial business."
As a consultant, Baker said, he often warns clients about the arduous process of seeking a de novo, or brand new, banking charter from regulators. Not only is it time-consuming, but it usually comes with growth restrictions that are unappealing, he said, especially to the type of fintechs most likely to seek them. An acquisition saves time, has fewer limitations and offers the benefit of a ready-made core banking system.
Baker added that there are few business reasons to buy a small community bank simply to maintain the status quo, pointing to narrowing profit margins in the space.
While bank acquisitions have been scarce this year, with only 54 closing thus far, nonbank investors have made up an outsize share of the market — five completed deals, said Nathan Stovall, director of financial institutions research for S&P Global Market Intelligence. Typically, such transactions make up around 2% of acquisitions.
Stovall said the current environment, in which many banks have unrealized losses on their balance sheets and valuations are down overall, a purchase by a nonbank investor is more feasible than a merger with another bank. Mergers, he noted, require the assets of the target bank to be marked to market. That could dilute the value of the purchasing bank's stock, which is often already depressed.
"With an investor, they don't have the accounting issue because they're starting from scratch, in a sense, and they're paying cash," Stovall said. "They don't have the issue of value dilution like a bank buyer would, so they can be more competitive for transactions and they're still buying at a cheaper price than they would have a year or two ago."
In her speech, Bowman said the emphasis by new entrants on existing charters rather than applying for new ones is a product of the de novo process being too difficult. She argued that, all things being equal, firms should prefer obtaining a charter of their own to enter the sector with a clean slate and no legacy costs.
Like Alt and Baker, Bowman believes the solution to rising instances of charter stripping is not a more onerous process for acquisitions, but rather a leveling of the playing field between new and existing charters.
"Of course, I am not suggesting that the solution is to make bank mergers and acquisitions more restrictive — these, too, are part of a healthy banking system," she said. "Instead, I would suggest that the regulatory framework should at least be more accommodative toward the de novo process."
Still, Farmington stands as a cautionary tale of how quickly a small bank can be transformed regardless of the assurances regulators secure from the acquirers.
Chalopin's firm agreed to seek prior approval before changing the bank's business model, specifically saying that it would not enter into digital banking or touch digital assets without getting the OK from supervisors.
The bank's final approval from the Fed came in June 2021. But in March 2022, FBH had changed the institution's name to Moonstone Bank and announced an $11 million investment by Alameda Research, the hedge fund arm of the since-failed crypto exchange FTX.
Baker said the Alameda investment alone should have set off red flags for supervisors, as it should have clearly surpassed the 10% threshold to be considered a controlling stake. The fact that it wasn't, he said, is evidence that the bank's valuation was inflated and that bank supervisors allowed such a markup.
Baker said he expects regulators to learn from the episode, but he hopes they do not go too far as a result.
"It's a lesson for the regulatory agencies, and they'll be very, very careful, as evidenced by their more recent pronouncements on partnerships with fintechs and crypto companies. They won't make the same mistake twice," he said. "But Farmington was unusual, and I don't think it should be used as a model of the so-called charter strip, because the ones that have actually happened and have been more successful have been much more straightforward."
