Fintechs are buying established lenders to secure bank charters while avoiding a long and increasingly scrutinized application process.

Five fintechs have announced bank purchases this year, according to data compiled by S&P Global Market Intelligence, giving the buyers access to a bank charter, which eases lending across state lines and gives account holders access to federal deposit insurance. By contrast, several fintechs have withdrawn their charter applications with the Office of the Comptroller of the Currency since October, including U.K. challenger bank Monzo Bank Ltd., fintech lender Oportun Financial Corp., and bitcoin payment service provider BitPay National Trust Bank. These actions came as acting Comptroller of the Currency Michael Hsu conducted a review of fintechs' bank charter applications.

Higher regulatory hurdles

More fintechs want their own bank charter because they have outgrown startup partnerships with existing lenders and are now seeking to retain more of their revenue and gain greater strategic freedom. Investment dollars have been flooding the fintech space — venture capital funding reached $9.33 billion in the third quarter, more than double the year-ago period — encouraging new entrants and enabling more aggressive strategic plans. Buying an existing lender is appealing because there are a host of potential targets among community banks struggling to keep pace with online competition, and M&A offers an easier regulatory pathway than spending at least $10 million on a charter application that may be rejected.

"The political winds on Capitol Hill and so forth very much seem to be blowing against fintech," said Jonah Crane, partner at advisory firm Klaros Group. "There are reasons to think that M&A will continue to be a more viable path than de novo charters for a little while, but it's definitely not a free path."

Fintechs looking to form a bank typically need approvals from the OCC for the charter, the Federal Deposit Insurance Corp. for insured deposits and the Federal Reserve for the Fed membership, or from a state regulator, the FDIC and the Fed. In comparison, a bank acquisition could help reduce the number of required regulatory approvals, and fintechs have the flexibility in deal structures to bypass certain regulators since only the approval from the chartering authority is needed to close such a deal, Crane said. The FDIC declined to comment. An OCC spokesperson said that "all applications for full-service national bank charters are subject to the same rigorous standards."

For example, if a fintech deems it difficult to get approval from the FDIC based on their profile, it can choose to buy a state member bank, so that only the state authority and the Fed are needed to greenlight the deal.

Applying for a bank charter is never easy for fintechs and has become even harder under President Joe Biden's administration, leaving bank acquisitions as the apparently faster track. KBW CEO Tom Michaud said during a November podcast with S&P Global Market Intelligence that he expects to see more fintech acquisitions of banks over the near term.

Behind the uptick of M&A is the reality that many fintechs want to improve their business models, and owning their own charters enables greater revenue retention. Further, banks face risks when backing fintechs as a partner since regulators scrutinize risks introduced via third-party relationships. In addition, fintechs could find regulators' tone equivocal or discouraging under the new administration.

"I continue to take companies that crossed the proverbial river during the Trump administration ... as the proverbial winners," said Isaac Boltansky, director of policy research at BTIG. LendingClub Corp. was an early mover on the trend when it bought Radius Bancorp in 2020. Boltansky said the digital lender did well to secure a charter before the regulatory crackdown, as did Block Inc., formerly known as Square Inc., which secured an industrial loan company charter. Varo Bank NA and Nelnet Bank also secured banking charters since 2020.

The trend of fintech-bank deals will continue since there is a good amount of overvalued fintech firms seeking expansion and a large pool of potential targets, said Emmett Daly, managing director at Piper Sandler. To close a deal, fintechs need to understand what it means to be a regulated depository and make an honest assessment of whether their business model is ready for it, said David Sandler, the firm's co-head of financial services investment banking, in a joint interview. Daly and Sandler said they have received several calls from fintechs seeking bank acquisitions over the years.

"We always felt like the responsible answer was, 'We can find you a bank to buy. That's not a problem,'" Sandler said. "Once you're prepared. Let's talk about what you're trying to achieve and how prepared you are from a regulatory standpoint."

Piper Sandler advised SoFi Technologies Inc. on its acquisition of Golden Pacific Bancorp Inc. The deal was announced in March and is pending regulatory approval.

Bank partnerships less suitable as fintechs grow

Early-stage fintechs often look to sign partnerships with a bank as the charter access allows them to competitively take deposits and offer loans. The drawback is that the fintech hands over some revenue to the bank as part of the arrangement, said Luvleen Sidhu, CEO of banking-as-a-service provider BM Technologies Inc. The banking-as-a-service provider announced in November it will buy First Sound Bank, partly to eliminate this cost and to gain full control of its strategy.

The complexities of bank partnerships can worsen once the fintech passes the initial customer acquisition phase and seeks to expand beyond selling a single financial product. The push into new areas can lead to multiple partnerships for different functions, which increases costs for operations and compliance, said Rutger van Faassen, head of product and market strategy at financial data and consulting firm Curinos.

Adding a card program, for instance, is easily a several-million-dollar commitment since banks often set a minimum length of time in the contract and a minimum charge to support the fintech's card processing, said Michael Panzarella, chief product officer at investment app Rocket Dollar. The only way to make the expenses worthwhile is to drive up the volume. Panzarella previously oversaw Square's deposit operations and was an executive in product development at Green Dot.

Meanwhile, banks are wary of execution and regulatory risks potentially passed along by fintech partners, according to Patriot National Bancorp Inc.'s chairman Michael Carrazza. The Stamford, Conn.-based bank decided not to "rent" its charter to any fintechs. Instead, to pursue a digital strategy, it has agreed to a reverse merger with fintech bank American Challenger Development Corp.

For many banks, fintech partnerships have not been appealing because it is purely transactional without building customer relationships, Piper Sandler's Daly said, adding, "Very few of my traditional, very plain vanilla community and regional bank clients are willing to do that." Some would rather take the very expensive first plunge to pay up for a technology acquisition, Daly said.

Even for banks interested in such partnerships, the bar is high to achieve success. While several banks have established the specialty in sponsoring fintechs, including Bancorp Bank, Celtic Bank Corp., Cross River Bank, Medallion Bank, Meta Financial Group Inc. and WebBank, it is a result of their enduring dedications in policies, procedures, talents and compliance — a playbook that does not work for every bank, Sandler said.

"It is an absolute business line and specialty," Sandler said. "The mistake that I think a lot of banks make is they look at the success of some of those companies that are providing those services and saying, 'We should dip our toe into the water.'"