An analysis of fintechs with bank charters found that the companies posted a wide range of fiscal performances during the first quarter, underscoring why the segment draws enthusiasm and doubts.

Square Financial Services Inc., the Block Inc. unit with an industrial loan company charter, generated a return on average assets of 32.7%, while neobank Varo Bank NA recorded a negative 51.2% ROAA. LendingClub Bank NA grew deposits by 68.6% year over year and loans by 63.9%. Mid-Central National Bank, which kept its brand and banking operations after its 2020 sale to fintech money management company Jiko Group Inc., posted a negative ROAA, loan and deposit growth in the first quarter.

Financial technology companies have been increasingly pursuing bank charters, which can be a lengthy and complex process. This analysis aims to examine the profitability of the fintechs based on metrics commonly used to compare the performance of banks. The companies in the analysis were screened and identified by industry sources as fintechs with a bank charter. While many of the fintechs have been pursuing different business models, having a charter reflects their belief in the benefits of the bank strategy even though it comes with more robust regulatory and reporting requirements.

The performances of the fintech banks provide the market with some case studies on the models, but it is too early to draw conclusions on the success of the strategies, industry experts said. Many of the companies use distinctive approaches, and the increase in fintechs seeking charters has been a more recent development.

Six of the fintech-owned or -operated banks — LendingClub Bank, SoFi Bank NA, Varo Bank, Nelnet Bank, Square Financial Services and Mid-Central — in the analysis began operations or sold to a fintech after the start of 2020. Since then, the operating environment has not been a typical one.

"We're coming right out of the pandemic and it's just not normal times in terms of deposit and loan growth," said Ron Shevlin, chief research officer at Cornerstone Advisors. "Does the charter pay off? I just think it's a little too soon to answer that question."

In comparison, institutions that have built a reputation in providing purely digital experiences to consumers — like Ally Bank, Axos Bank and Live Oak Banking Co. — generated higher ROAA and NIM with lower efficiency ratios compared to the industry median.

It indicates the promise of the branch-light model that can replace the functions of physical locations with digital solutions in a bid to reduce costs without undermining their capability to attract and service customers, said Suraya Randawa, head of omnichannel experience at Curinos, a data company for financial institutions.

"We're at that still somewhat experimental stage where we haven't necessarily settled on what that final banking model is," Randawa said.

To be or not to be a bank

The priority of fintech innovation has been to polish a product that brings users a more digital-savvy experience than what banks offer and to institute a business model that relies on revenue interchange or origination fees instead of interest income. The fintechs would typically partner with sponsor banks — instead of pursuing a bank charter as a startup — to remain more agile. But more fintechs have found that such bank partnerships are less suitable as they scale and add new products. Instead, they have sought to own a charter through applications or bank acquisitions.

Buying a bank charter gives fintechs the stable funding source of deposits with lower cost and better regulatory structure in order to continue to do what they are already doing, but they don't necessarily plan to become banks in a traditional sense, said David Jegen, managing partner of venture capital fund F Prime Inc., which does business as F-Prime Capital.

LendingClub Corp. and Square, the payment business of Block, are great examples of fintechs that managed to build up an attractive fintech business and then filled it with a bank charter, Jegen said. LendingClub secured a charter through its acquisition of Radius Bank in February 2021. Square Financial Services began banking operations in March 2021 with an industrial loan company charter.

"It's not about being a bank," Jegen said. "Square retains the economics of a great payment business. None of that changed because they got a charter."

Having a bank balance sheet enhanced LendingClub's ability to set prices and gave confidence to its loan buyers that it is being disciplined about credit, LendingClub CEO Scott Sanborn said on the company's first-quarter earnings call April 27. The marketplace lender was also able to pivot to an investor base with more stable funding sources, including banks and asset managers using lower leverage, Sanborn added.

Radius Bank had $1.39 billion in assets at the end of 2019 while the acquisition by LendingClub was announced in February 2020. At the end of the first quarter, LendingClub Bank's total assets stood at $5.17 billion, with a NIM of 8.59% and an ROAA of 3.14%, both far higher than the banking industry median.

"The bank acquisition is paid for itself within just a year," Sanborn said on the earnings call.

A future far beyond banking

For fintechs exploring new banking models, their ambition spurred excitement as well as doubts. They still have a long way to go to solidify that the early achievements can be sustained and to prove the viability of some of their pitches.

Fintechs' pitches to improve financial services include higher efficiency to acquire and service customers, and the possibility to use enhanced technology to improve the approach to credit underwriting, said David Sandler, co-head of investment banking in the financial services group at Piper Sandler Cos.

Neobanks, such as Varo Bank and Chime Financial Inc., are among the fintechs particularly facing questions about whether they can eventually fulfill the promises with sustainable profitability. Most of the neobanks were founded after the Great Recession in a benign credit environment with generous venture capital investments pouring into fintech. They tend to be heavily centric on payments and thus interchange revenues, which carry downward pressures, Shevlin said.

"The reality is that as a market grows and the number of transactions grows, the amount of the ability to maintain margin on transaction costs diminishes over time," Shevlin explained.

In addition, their niches targeting specific customer bases, such as those with lower income and credit scores, made it almost impossible to rationally value them as much as diversified and large financial institutions, Shevlin said.

One way to break through is to innovate beyond pure financial services and offer ancillary products that are digital and related to money management, such as cell phone damage protection or travel insurance, Shevlin said. Consumers have expressed interest in getting these kinds of products from their banks, Shevlin said, citing his research.

"I think they have to think about a different business model to generate revenue beyond simply being a pseudo bank," Shevlin said.