Financial technology companies are still looking to buy banks, even though the bar is even higher for such deals to get blessings from investors and regulators, industry experts said.
The current funding squeeze and heightened regulatory scrutiny in the fintech sector have slowed the pace of fintech firms buying banks. In 2022 and 2023 year to date, five fintech-related entities or investor groups announced acquisitions of US chartered banks, according to data compiled by S&P Global Market Intelligence. In comparison, in 2021 alone, seven fintech-related parties announced bank acquisitions, and five of them obtained regulatory approvals.
Despite the slowdown, the pipeline is still active, said Jonah Crane, partner at advisory firm Klaros Group. Funding costs, which have increased with the interest rate hikes, have underscored the advantage of accessing bank deposits that offer a less-expensive funding source.
"We are working with multiple fintechs interested in acquiring banks," Crane said. "Applications are not public yet because the agreements haven't been reached."
Another driver behind those talks is the correction of fintech companies' valuations. Previously, fintechs that were valued at higher multiples as a technology company would not want to add balance sheet exposure and be valued at lower multiples as a bank. But valuations of fintech companies have plummeted overall over the last year, and the disincentive that stemmed from the perception that owning a charter means lower valuation has gone away, Crane said.
Fintechs interested in a charter will have to think through their core competencies and be prepared for the operational changes that will come with the charter, said Ahon Sarkar, general manager at Helix of banking software company Q2 Holdings Inc. Sarkar said the changes can be costly and time-consuming, and the charter comes with new regulatory requirements.
"[There] are the growth limitations that come with being a bank; and then the operational compliance responsibilities that you will take on when you become a bank," Sarkar said on the sidelines of Tearsheet's The Big Bank Theory Conference.
Challenges after the banking turmoil, funding squeeze
Given the recent turmoil in the banking industry, the bar is higher for a fintech buyer to convince regulators that its acquisition of a bank will not comprise the bank's safety and soundness, said Steve Allocca, president and US managing director of Funding Circle Holdings PLC, a nonbank commercial lender.
"I do like the model. At some point, when your loan origination business grows to a certain scale, it's something that you'll have to evaluate," Allocca said in an interview. "But the environment is a little less open right now to mergers."
Investors' growing focus on profitability also adds more pressure on fintechs to prove the value of their strategic decisions, which could create an obstacle for fintechs to deploy capital in bank acquisitions right now, Sarkar said. The process could be lengthy and even unsuccessful, and the monetization of a bank charter will take time.
"The pitch of: 'I want to buy a bank so that two and a half years from now or three years from now I can be more profitable,' is a really hard sell when you are still struggling with profitability yourself," Sarkar said.
In the latest example, it took fintech company NewtekOne Inc. over 17 months to complete the acquisition of National Bank of New York City, which is now Newtek Bank NA. In addition, KMD Partners LLC and Liberty Bank Inc. had withdrawn the change of control application for the bank target in July 2021, according to an online database operated by the Federal Deposit Insurance Corp. BM Technologies Inc. announced the termination of its proposed acquisition of First Sound Bank in December 2022, citing the lengthy regulatory approval process.
A clear path to profitability is more important when raising capital is difficult, as it is in the current environment. Funding into fintech startups fell by one-third in 2022 after a bull run in 2021, according to S&P Global Market Intelligence's 451 Research.
"What we're seeing today is an increased emphasis on business fundamentals, an emphasis on profitability by demonstrating the capability to have long-term sustainable growth at strong unit economics," said Jordan McKee, fintech research director at 451 Research.
2023 deals
Two fintech-related entities proposed to acquire a bank in 2023.
On Feb. 22, FBBT Holdings Inc. announced plans to acquire Illinois-based State Bank of Nauvoo. On Feb. 1, LevelField Financial Inc. announced the proposal to buy Burling Bank, which is also based in Illinois.
FBBT Holdings was formed by executives at Metallicus Inc., a technology provider leveraging blockchain to develop financial applications. FBBT plans to focus on traditional depository and lending services for a diverse customer base among family offices, investment companies, venture capital-backed companies and fintechs, which potentially include cryptocurrency companies, said Irina Berkon, co-founder of FBBT. Berkon is also a board member and CFO of Metallicus. Moreover, there are opportunities to grow in the local market where State Bank of Nauvoo currently serves, Berkon said.
"We're going to establish a due diligence process and KYB (know-your-business) for everybody who walks in the door," Berkon said in an interview. "We do know a lot about fintech and financial services. So we'll be able to do good due diligence on the companies that we can onboard."
LevelField Chairman and CEO Gene Grant II has said the company wants to provide traditional banking services to crypto-savvy customers and will not intend to hold cryptocurrency on the bank's balance sheet.
Both announcements were made before the existential crisis in cryptocurrency banking with the liquidation of Silvergate Capital Corp. and the failure of Signature Bank in March. Silvergate and Signature were the largest players providing banking services to cryptocurrency companies. Although they initially benefited from the rapid growth of crypto-related deposits, their struggles in late 2022 and early 2023 left banks questioning the earnings power of serving the crypto industry, with many suspecting more stringent regulatory scrutiny in banks' engagement with crypto companies.
Despite the market turbulence, FBBT and LevelField will continue their efforts on the bank acquisitions.
"Our application hasn't experienced any slowdown or change," Berkon said. "We weren't deterred in the slightest."
A spokesperson at LevelField also confirmed on May 31 that LevelField is moving along in the process to acquire Burling Bank.
Regulators have warned banks of the risks with a high concentration on crypto, evidenced by the collapse of Silvergate. In addition, the concentration risk is not the only concern in crypto banking. Signature had already made efforts to serve multiple industries but still did not survive the bank run in March, Crane noted.
In general, bank M&A plans with crypto ties will attract questions from regulators, and those fintech buyers could be asked to agree to strict limits on their business with crypto companies, such as a cap on the number of crypto customers relative to the broader business, Crane said.
"Their best hope to get approved would be to agree to some pretty strict limits, and probably some pretty conservative growth assumptions," Crane said.
Still, the fintechs see the benefits of the bank deals and are pursuing them even though they face regulatory hurdles.