Fintech deals for banks still make sense despite scrutiny, advisers say

Previous efforts by fintech acquiring banks give deal makers greater clarity on how to navigate the regulatory approval process and whether the combinations are right for the parties involved.

Bank regulators remain concerned about potential risks that financial technology companies can pose as they increase their exposure to banking, and deals don’t just get an approval. An extended approval process led to BM Technologies Inc. reconsider its strategy and then terminate the agreement for First sound bank in December 2022, a little more than a year after the companies announced the deal.

David Sandler, co-head of financial services investment banking at Piper Sandler, said regulators are focused “on who should be and who shouldn’t be a bank.” But those in the industry are getting a better understanding of what regulators are looking for.

“These companies are better advised, in my opinion, about what is approved and what they can get done and in what time frame,” Sandler said in an interview.

Several recent regulatory approvals of fintech acquiring banks showed that it is possible to execute such deals quickly. In particular, fintech investor group Luna Parent Inc.’s acquisition of Kansas City, Mo.-based bank Lead Financial Group Inc. took the fewest days to complete among all select bank deals closed since 2021, according to an analysis by S&P Global Market Intelligence . The deal was announced on May 16, 2022, approved by regulators in June, and closed on August 1, 2022. It was an unusual timeline in the current environment when bank deals are often extended.

Regarding the proposed acquisition of National Bank of New York City, business development company Newtek Business Services Corp. received the approval from the Federal Reserve in November 2022 and a conditional approval from the Office of the Comptroller of the Currency in December.

“I feel very strongly that a non-bank or an investor group that is prepared to embrace compliance will be able to get approved to be a bank. They just need to do it the right way and really embrace compliance and regulation,” Sandler said.

A benefit-cost analysis

But regulatory approval is not the only factor that can prevent a fintech acquisition by a bank. In July 2022, fintech group American Challenger Development Corp. received conditional approval from the OCC for its proposed acquisition of Patriot National Bancorp Inc., although the parties ended up terminating the deal due to disputes over a loan sales contract with Credit Suisse.

BM Technologies, or BMTX, now believes that working with a sponsor bank is the best way to maximize the value of its serviced deposits, the company said in the press release announcing the termination of the First Sound deal. BMTX noted that it signed a letter of intent with a new sponsor bank that is a bank exempt from the Durbin Amendment, meaning the undisclosed bank has under $10 billion in total assets and is eligible to pay higher interchange fees from processing debit card payments. BMTX’s sponsoring bank, Customer bankpassed the $10 billion mark in 2019.

Nevertheless, many see that the financial advantage of owning a charter also applies to many fintechs and will continue to drive fintech interest in buying a bank. Many fintech business models require access to a banking license, and owning a charter helps fintechs reduce expenses paid to sponsor banks and control their long-term strategy, said Jonah Crane, partner at advisory and investment firm Klaros Group.

“I think there continues to be interest among fintechs in buying banks,” Crane said. “You can get a partner or you can get a charter, and I think for a lot of people the charter will make sense.”

Different drivers

The appeal of banking-as-a-service has been a theme in recent fintech acquisitions of banks. These fintech banks aim to leverage the bank takeover to attract fintech customers, combining the bank’s balance sheet and access to the Federal Reserve’s payment rails with the fintech’s technology development and commercial skills.

It is a different growth path than using the banking unit to attract depositors and borrowers. SoFi Technologies Inc. and LendingClub Corp., for example, are actively growing the consumer deposit base of their bank subsidiaries following their bank acquisitions.

Buying a bank to turn it into a backbone of fintech partnerships can hardly be a shortcut compared to forming such a bank via a de novo application, said Clifford Stanford, a partner at Alston & Bird. Regulators typically require the fintech buyer to post the business plan for review and demonstrate the likelihood of success.

“You still have to jump through the same hoops because the regulators see it almost as de novo in itself,” Stanford said.

Lead Bank, a unit of Lead Financial Group, ramps up its banking-as-a-service programs supporting fintech under new owner Luna parent, according to press releases. Luna Parent is a shell company headed by Jacqueline Reses, a former executive at Square Capital, which is the small business lending arm of Block Inc. under an Industrial Loan Company bank charter.

Banking-as-a-service provider Column NA was also formed this way, through the acquisition of Northern California National Bank by an investor group led by Plaid co-founder William Hockey and his wife, Annie Robertson Hockey.

Figuring out profitability, compliance

Deals could face approval roadblocks if regulators are concerned about the soundness of the fintech buyer’s business model, particularly for those that anchor their business on one primary product or customer base, Crane noted.

“It’s something that regulators have historically viewed as very risky,” Crane said. To increase the chance of approval, the parties should think through ways to diversify the business areas as a combined entity, he added.

A solid framework to ensure regulatory compliance is another important factor, not only for the merger review, but also for convincing a bank seller to merge, Sandler noted.

“What you don’t want to do is put a non-bank in that business or tie up capital for investors; get the deal done; and then have the regulators say you’re not doing it,” Sandler said. “It’s a huge waste of time, effort and energy.”