Five Star to phase out its banking-as-a-service program in 2025

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UPDATE: This article includes commentary from Bryan Mulcahey, Jason Henrichs and Damon DelMonte, and additional thoughts from Martin Birmingham.

The parent company for Five Star Bank in Warsaw, New York, is winding down its modest banking-as-a-service business.

On Monday, Financial Institutions Inc., which has $6.1 billion of assets and is the parent of both Five Star and Courier Capital, said Five Star would quit this line of business fully in 2025 to focus on its core community banking franchise. Five Star launched its first partnerships of this nature in late 2022.

This decision took several factors into account including "the contribution of BaaS to our core financial results, evolving regulatory expectations and a proposed rule regarding the re-classification of BaaS deposits as brokered, in addition to the future investments in talent and technology necessary to achieve scale," said bank CEO and President Martin K. Birmingham in a press release.

In an elaboration via email, Birmingham added, "The regulatory and risk-management goalposts keep moving for U.S. financial institutions in this business, and ours is not the first bank to announce plans to begin winding down its BaaS offering. At the same time, this has been a relatively low-cost, break-even business to date."

Five Star's exit is another sign of turmoil in the BaaS space. Some banks, including Metropolitan Commercial Bank and Summit National Bank, have left the business entirely; others, including Blue Ridge Bank, Lineage Bank and Evolve Bank & Trust, have been forced to shrink or curtail their programs. Many, including Thread Bank and Piermont Bank, have been penalized by regulators but remain in the game.

It's also not a sign of the sector's demise. Many others remain committed to the space, even though they contend with several of the issues Birmingham referenced in his statement, including fuzzy expectations from regulators, the cost of specialized technology and the need for specialized, but elusive, talent. In fact, "we are seeing more banks than ever beginning to engage in partner banking and expect the net number of banks in the space to grow over time," said Bryan Mulcahey, managing partner at FS Vector.

"The banks that are contracting right now are the ones that weren't fully committed to it," said Jason Henrichs, founder and CEO of community bank consortium Alloy Labs Alliance. "It looks easy on the surface to say we do compliance, we open accounts, we do these things already, but it's a completely different business." 

He estimates the initial investment for launching a program in the first place, between staffing, training and infrastructure, to be $2 million. The reasons Five Star outlined in the press release about why it is leaving the space make sense to him. 

"The banks that do [BaaS] well are going to absolutely crush it," said Henrichs. "But you have to be committed."

In Five Star's case, the BaaS business accounted for 2% of total deposits and less than 1% of loans. Of the 12 fintech partnerships Five Star had forged, only four are currently live; the other eight are in various stages in Five Star's pipeline. 

"Given the modest size of the business, the financial impact of the wind-down is expected to be immaterial," said Birmingham via email.

The bank is "working to support orderly transitions for its BaaS partner firms," according to the press release.

"We see significant opportunity and growth potential for our retail banking, commercial banking and wealth management business lines within our existing geographic markets," Birmingham said in his statement. "This decision allows us to continue to nurture those lines of business and drive value into the Company." 

The company expects to retain all employees in the bank's BaaS business and redeploy them, according to the press release. In 2023, the bank cut its workforce by 3.4%.

Damon DelMonte, managing director at Keefe, Bruyette & Woods, believes that Five Star was committed to the model and saw it as a way to both increase loans and deposits as well as differentiate itself from other community banks in its upstate New York footprint. But he is not surprised by the decision.

"At the end of the day, they are probably looking at the opportunities in front of them and saw the reallocation of resources to their traditional core community banking lines of business as a better avenue to generate more profitability and better returns for the shareholders," he said.