Silicon Valley banking collapse produces an early winner: Digital banks

The flood of new account requests began hitting San Francisco-based Mercury last Thursday morning, the day after Silicon Valley Bank announced it had sold $21 billion in securities at a $1.8 billion loss and needed to raise more capital. Over the weekend, as federal banking regulators sought to ensure that SVB’s failure did not trigger a broader bank run, Mercury’s workers also scrambled; the normal account opening staff doubled to 60, as risk and compliance professionals, plus volunteer software engineers and salespeople (who received a crash course in how to verify and approve new customers), signed on.

In both cases, the extraordinary measures seem to have paid off – at least for the time being. Regional banks have stabilized. And according to venture capitalists, Mercury has probably been the biggest winner so far among fintech digital banks.

Immad Akhund, Mercury’s 38-year-old CEO and co-founder, reports that in just six days his 470-person company has added more than $2 billion in deposits and thousands of customers to the 100,000 accounts it had before. He started Mercury six years ago, he says, precisely because he thought a technology-based banking platform could provide better service to startups than SVB. “I had a lot of respect for [SVB]. I used them in my previous company,” he says. “I’m sad about it personally. It’s been a real mix of emotions.”

Mercury is hardly the only fintech that has taken advantage of the SVB failure. San Francisco-based credit card startup Brex, which offers a business bank account, has added 3,000 new customers in the past week and has also reportedly taken in billions in new deposits, though the company declined to confirm any dollar amounts. Brex also provided loans to former SVB customers to help them meet wages.

Meow, a New York start-up that allows companies to earn interest on their money through US Treasuries, has seen “hundreds of millions” [of dollars] in daily demand” this past week, the company claims. Arc, which allows software companies to sell their future revenue streams in exchange for upfront cash, has seen “500 startups apply for a combined more than $150 million in equity funding since Thursday,” says CEO Don Muir. The New York-based digital bank Rho has also seen a wave of new customers.

While the digital banks have been quick to attract new deposits and customers, it is difficult to say whether they will be able to retain them. “I question the stickiness of some of the flows that have happened in the last week,” said Merritt Hummer, a fintech investor and partner at Bain Capital Ventures. “It is far too early to declare victory.” She believes many companies will choose to put their money in the largest American banks such as JPMorgan, Bank of America
BAC
and Citi.

The biggest beneficiary of this crisis is likely to be JPMorgan, the largest US bank that already has more than $2 trillion in deposits. But the banking giants often cannot open accounts as quickly. “We had some companies that thought it was a smart, high-quality move to open a new account with JPMorgan,” says one venture capitalist. “They’re still waiting, and they’re going to be waiting for a week.” A spokesperson for JPMorgan declined to comment. In contrast, Mercury has opened some new accounts in less than an hour, it says.

In addition to being slower, the banking giants may not offer startups and the venture capital community the same level of attention and focus and the customized products that SVB did (and the digital banks aspire to). “I still think a lot of people will go to the big four banks. It’s a shame because these banks are not good for us,” says Sheel Mohnot, an early-stage fintech investor. “They don’t really even. want our business.”

Of course, almost all digital banks aren’t technically chartered banks with FDIC insurance—instead, they work with traditional banks that hold customer deposits in insured accounts. Here, too, Akhund acted quickly; on Monday, Mercury began offering up to $3 million in FDIC insurance coverage, up from $1 million last week. With the federal insurance limit still reportedly only $250,000 per depositor (although the government’s decision to cover all deposits at SVB and Signature Bank calls that into question), fintechs like Mercury are expanding the safety net by spreading customer funds across a network of dozens of banks.

Mercury launched its business account in 2019 and a business credit card for startup customers just last year. (It has raised $152 million from Coatue Management, Andreessen Horowitz, CRV and others and was last valued in July 2021 at $1.6 billion.)

Mercury’s primary banking partners are Memphis, Tennessee-based Evolve, which had $1.5 billion in deposits at the end of 2022, and Fargo, North Dakota-based Choice Bank, with $3.8 billion in deposits at the end of last year. Here’s how the partnerships work: When a company registers with Mercury, the customer initially chooses either Evolve or Choice as the domicile for their money. If the company deposits more than $250,000, Evolve or Choice will “sweep” the extra funds to the other banks in the network.

For example, Evolve has about 40 banks in its sweep network, ranging from credit card giant Capital One to Pennsylvania-based Quaint Oak Bank. If a Mercury customer chooses Evolve and has $3 million to deposit, Evolve will split the money between 12 different banks it works with. (Choice currently offers only $1 million in FDIC coverage for deposits, though it is working to increase that amount.)

Other fintechs like Brex also offer more than $2 million in FDIC coverage through the same setup — by cutting up deposits and sending them to multiple banks.

This web of interwoven companies raises an important question: why should customers feel safe putting their money in the small banks Mercury works with? Technically, no institution is completely safe from a bank run, since even the most irrational rush to the exits by too many customers can bring a bank down, and there is no guarantee that all deposits in a small bank will be covered by the FDIC as they were . at SVB. That is why the digital banks divide the deposits into 250,000 dollar chunks and distribute them. (Mercury suggests that funds over $3 million be placed in Vanguard’s Treasury Money Market fund and offers an interface for clients to do just that.)

But the small banks Mercury deals with reject any suggestion that they are riskier than their much larger rivals. Choice CEO Brian Johnson argues that his bank did not make long-term investments like Silicon Valley Bank did. “We are not only well capitalized, but privately held,” he adds. Being private means it doesn’t have as much pressure to increase quarterly results as public companies like SVB did. “You tend not to panic when you have long-term shareholders versus institutional money that has to perform in their stock portfolios,” he says. Johnson says Choice saw about $1.5 billion in new deposit flows in the past week, about 90% of which came through Mercury.

Evolve, Mercury’s other banking partner, issued a statement Monday saying it was “strong and stable” and that, unlike SVB, “Our securities portfolio, which consists primarily of U.S. Treasuries and Treasuries, has a short duration and is highly liquid .”

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