Tech Banks: Will Fintech Dethrone Traditional Banking?

On Halloween, 2014, a largely unknown, Boston-based financial institution, First Trade Union Bank, embraced high-technology, went paperless, and officially adopted a new name: Radius Bank.

In reinventing itself, Radius did more than dump its dowdy moniker. It shuttered five of its six branches, re-staffed its operations with a tech-savvy team, instituted “anytime/anywhere” banking services, and offered customers free access to cash via a nationwide ATM network. And it teamed up with a fistful of financial technology companies to offer an impressive array of online lending and investment products.

Today, the bank’s management boasts that, using their personal mobile phones, some 2,700 people per week are opening up checking accounts, funneling $3 million in consumer deposits into the bank’s virtual vault. That’s a stark contrast from a decade ago when the financial institution was being rocked by the financial crisis and “we couldn’t get anybody to walk into our branches,” says Radius’s chief executive, Mike Butler.

“We tried to leave that old bank behind,” he says. “We’re a virtual retail bank now, an efficiently run organization that offers high levels of customer service and Amazon-like solutions.”

Radius Bank is not alone. At a moment when there is much discussion — and hand-wringing — over the future of seemingly outmoded, highly regulated community banks, a coterie of small but nimble banks is exploiting technology and punching above its weight. Almost overnight, this cohort is combining the skill and hard-won experience of veteran bankers with the lightning-fast, extraordinary power afforded by the Internet and technological advances. As a result, these small and modest-sized institutions are redefining how banking is done.

In addition to Radius Bank, independent banks winning recognition for their bold, innovative – and profitable — exploitation of technology, include: Live Oak Bank in Wilmington, N.C., which adroitly parlays technology to become the No. 2 lender to business and agricultural borrowers backed by the U.S. Small Business Administration; Darien Rowayton Bank in Darien, Conn., which is making a name for itself with coast-to-coast, online refinancing of student loans; and Cross River Bank in Fort Lee, N.J., which does back-end work for a passel of fintech marketplace lenders.

Interestingly, there’s not much overlap. Each of the banks goes its own way. But what all the banks have in common is that each has struck out on its own, each hitting upon a technological formula for success, each experiencing superior growth.

“These are companies that understand the value of a bank charter,” says Charles Wendel, president of Financial Institutions Consulting in Miami. “They have to work under the watchful eyes of state and federal regulators. But their cost of funds is low and they can offer more attractive rates. Because they’re less likely (than nonbank fintechs) to disappear, run out of money, or get sold,” the bank expert adds, “they also have the image of stability with customers.”

These modest-sized banks are emerging as not only pacesetters for the banking industry. Along with making common cause with the fintechs — which had promised to disrupt the banking industry – they’re even beating the fintechs at their own game.

Above: Cary Whaley, First VP, ICBA

“Classically, community banks have looked to technology partners to provide technological innovation,” says Cary Whaley, first vice-president for payment and technology policy at the Independent Community Bankers of America, a Washington, D.C.-based trade group representing a broad swath of the country’s 5,800 Main Street banks. “They still do. You’re seeing more partnerships. But now you also see community banks building innovative products and services outside of that relationship. You see forward-thinking banks developing their own technology to support big ideas like marketplace lending, distributed ledger technology, and emerging payments technology.”

With its extraordinary skill at exploiting technology, Live Oak Bank – which trades on the Nasdaq and is the only public company encountered in the cohort — has become a Wall Street darling. “While several banks have adopted an online-only model, and nearly all banks are shifting more and more delivery through online channels, Live Oak was built from the ground up as a technology-based bank,” Aaron Deer, a San Francisco-based research analyst at Sandler O’Neill Partners, wrote in a recent investment note.

Driving the success of Live Oak, which operates out of a single branch in the North Carolina seacoast town and has only been in business for a decade, is the explosive growth in its SBA lending, the bank’s “core strategy,” Deer notes. Last year, Live Oak lent out $709.5 million in SBA loans in increments of up to $5 million, the federal agency reports, making it the country’s No. 2 SBA lender. It trailed only megabank Wells Fargo Bank, the third largest bank in the U.S. with $1.5 trillion in assets, which made $838.93 million in SBA-backed loans last year.

As its SBA lending has taken off, Live Oak, which qualifies as a “preferred lender” with the federal agency, boasts assets that have nearly tripled to $1.4 billion in 2016, up from $567 million two years earlier. Those are flabbergastingly fantastic growth numbers. But just as incongruously — by nipping at the heels of Wells Fargo — Live Oak has been challenging a bank more than a thousand times its asset size for dominance in SBA lending.

And, interestingly, the bank is able to book those outsized amounts of SBA loans while lending to only 15 industries out of 1,100 approved by the government agency, slightly more than 1% of the universe. That’s up from 13 industries in 2015, and Live Oak is adding two to four additional industries yearly for its SBA loan portfolio, Deer reports. Included among the industries to which the bank made an average SBA loan of $1.29 million last year: Agriculture and poultry, family entertainment, funeral services, medical and dental, self-storage, veterinary, and wine and craft-beverage.

The bank has a team of financing specialists dedicated to each of the designated industries. Among Live Oak’s current SBA borrowers are Martin Self Storage in Summerville, S.C.; Utah Turkey Farms in Circleville, Utah; Pinballz Arcade, Austin, Tex.; and Council Brewery Company in San Diego. Steve Smits, chief credit officer at the bank, told NerdWallet: “When you specialize in something, you become efficient. Because we do it every day and we have professionals and specialists, we tend to be more responsive and quicker.”

The heady combination of technological sophistication and banking expertise has allowed the lender to slash its loan-origination time to 45 days, about half the three-month industry average for SBA loans. To speed up loan sourcing and generation, the bank developed its own in-house technology, which led to the formation of the Wilmington-based technology company nCino, which was spun off to shareholders in 2014.

Live Oak did not return calls to discuss its lending strategies, but in SEC filings bank management declared: “The technology-based platform that is pivotal to our success is dependent on the use of the nCino bank operating system” which relies on Force.com’s cloud-computing infrastructure platform, a product of Salesforce.com.

Natalia Moose, a public relations manager at nCino told deBanked in an e-mail interview: “We work with Live Oak Bank, in addition to more than 150 other financial institutions in multiple countries with assets ranging from $200 million to $2 trillion, including nine of the top 30 U.S. banks. nCino was started by bankers at Live Oak Bank who found the logistics of shuffling paperwork among loan stakeholders to be unwieldy, inefficient and time-consuming.

“nCino’s bank operating system,” Moose adds, “leverages the power and security of the Salesforce platform to deliver an end-to-end banking solution. The bank operating system empowers bank employees and leaders with true insight into the bank, combining CRM (customer relationship management), deposit account opening, loan origination, workflow, enterprise content management, digital engagement portal, and instant, real-time reporting on a single secure, cloud-based platform.”

Live Oak, meanwhile, is not resting on its technological laurels. According to Deer’s report, the bank’s parent company, Live Oak Bancshares, has formed a subsidiary to inject venture capital into fintech companies. It’s already taken a small equity stake in Payrails and Finxact, “the latter of which is developing a completely new core processor to compete against the old legacy systems used by most banks,” the Sandler O’Neill analyst writes. “Quite simply,” he asserts elsewhere in his report, “the company is far beyond any other bank we cover in its technical capabilities and the growth outlook remains outstanding.”

Five hundred and thirty-three miles due north along the Atlantic coast in southeastern Connecticut, Darien Rowayton Bank is also experiencing tremendous success as a lender using a home-grown technology platform. State-chartered by the Connecticut Department of Banking and regulated as well by the Federal Deposit Insurance Corp., the $600 million-asset bank is winning attention in banking circles for its online student-loan refinancing.

A few years ago, DRB, as it is known, was looking to go beyond mortgage and commercial lending — “the bread and butter for most community banks,” bank president Robert Kettenmann explained to deBanked in a telephone interview – and was somewhat at a loss. The bank considered but then rejected the credit card business. Finally, DRB struck paydirt refinancing student loans. “Our chairman really seized on the opportunity,” Kettenmann says, adding: “It’s a $35 billion market.”

Thanks to the National Bank Act, it’s able to operate in all 50 states. As a regulated commercial bank with a strong deposit base, DRB can also offer low rates well below any state’s usury prohibitions.

What is most striking about DRB’s program is its nationwide targeting of upwardly mobile, affluent young professionals. According to a PowerPoint presentation obtained by deBanked, all of the bank’s super-prime borrowers, who are mainly in the 28-34 age bracket, have a college degree and a whopping 93% have graduate degrees. Average income is $194,000.

Forty-eight percent of those refinancing student loans with DRB are doctors or dentists and another 22 percent are pharmacists, nurses or medical employees; only about 20% are paying off their law degrees or MBAs. The heavy concentration of refinancing in the medical field reduces economic risk in an economic downturn. Forty-three percent of the borrowers are home-owners, the rest are renters – and prime candidates for an online, DRB-financed mortgage.

(Once known as “yuppies” today this cohort is “known by the acronym ‘HENRY,’” remarks Cornelius Hurley, a Boston University banking professor and executive director of the Online Lending Institute, explaining the initials stand for “High Earners Not Rich Yet.”)

The Connecticut bank partnered with a third-party on-line vendor, Campus Door, when it commenced making student loans in 2013. In the fall of 2016, however, DRB built out its own, proprietary loan-origination system, Kettenmann reports, emphasizing that CampusDoor had been an excellent partner but that the bank wanted to exercise end-to-end control over the process. DRB employs a seven-pronged, “omni-channel” marketing approach that includes interactive marketing, affinity partnerships, digital/online advertising, direct mail, mass-media advertising, and public relations/brand awareness campaigns.

DRB’s online enrollment provides “pre-approved rates” in less than two minutes with final approval on rates in 24-48 hours. Refinancers can complete the online application at their own speed. Through May, 2017, DRB had made $2.48 billion in refinancing to 20,000 student-loan borrowers, with only ten defaults, five of which were attributed to deaths or “terminal illness.”

On Yelp! the bank has received a batch of reviews ranging from very favorable, five-star (“I had a truly wonderful experience”) to one-star (“awful” and “truly a nightmare”). Many fault the application process as laborious, describing it as “time-consuming.” But for those who have succeeded, like the reviewer who counseled “patience,” the result can be “the lowest rate with DRB…my loan payments went down $100 a month.”

Just about an hour’s drive south and taking its name from its proximity to New York city just over the George Washington Bridge is New Jersey-based, state-chartered Cross River Bank, which has a reputation as a partner-in-arms to fintech companies. “We’re both users and producers of technology,” declares Gilles Gade, the bank’s chief executive.

The bank provides “back-end” and infrastructure support to 17 marketplace lenders that offer a suite of lending products including personal loans, mortgages and home-equity loans. Following loan origination by a fintech company – Marlette Funding, Affirm, Upstart, loanDepot, SoFi, and Quicken Loan, among other partners — Cross River does the actual underwriting. Last year, Gade reports, the bank underwrote 1.9 million loans valued at $4-4.5 billion, about 10% of which Cross River kept on its books. The bulk of the loans are sold “back to the marketplace lenders” or to a third party. “We’ve created a high-velocity automated system,” he says.

Gade is manifestly unapologetic about the bank’s role in assisting fintechs in their competition with the banking establishment. “We’re a banking infrastructure services provider for those who want to disrupt the banking system,” he says. “Consumers expect a lot better than they’ve been getting from traditional banking services.”

Back in Boston, Radius Bank’s chief executive reports that forging partnerships with fintechs to provide the full panoply of online banking services was no easy proposition. In its mating ritual, Radius not only had to determine that a fintech company’s offerings were sound and that it had the right characteristics – most especially “a long-term, sustainable business model” – but that its corporate culture meshed comfortably with Radius’s.

After meeting with as many as 500 fintechs and after a fair amount of trial and error, Radius formed partnerships with LevelUp, which enables customers to make mobile payments; with online lender Prosper, for refinancing consumer debt and “credit rehabilitation”; with SmarterBucks, for refinancing student loans; and with online investment firm Aspiration Partners – which allows investors to name their own fees and markets itself to a predominately middle-class audience as the firm “with a conscience.”

Radius employs advertising on social media websites and employs “psychographics” to appeal to “anyone who is zealous about using technology, not necessarily millennials,” Butler says. The data show that 65% of adults in the U.S. would prefer to use a traditional bank and have face-to-face interactions with a teller, he notes, leaving the remaining 35% as Radius’s target audience.

Christopher Tremont, executive vice-president for virtual banking, told deBanked that a typical Radius customer is 42 years old, lives in Boston, New York, Chicago “or one of the bigger cities in the West,” is a “technophile,” earns $75,000 a year, and has $100,000 in personal assets.

Radius’s performance since it went paperless has been stellar. The bank has seen a rapid rise in deposits, spurting to $782 million through the first quarter of 2017, up from $565 million at year-end 2014. With little fee income but ample deposits and low-cost funds, Radius realizes the bulk of its revenues – and profits — on the interest-rate spread generated from its loan portfolio.

The bank booked $43.5 million in SBA loans last year, ranking it in the top 50 banks on the SBA’s league tables, while carrying another $105 million in its commercial leasing business at the end of the first quarter this year. Loan generation is driving asset growth, which are currently at $973 billion, up more a third from $726 million in 2014, and Butler expects the bank’s assets to top $1 billion sometime this year.

“Community banks love that part of the business—lending money,” Butler says.