Zach Bruhnke was thrilled when the challenger bank he co-founded,
HMBradley's sponsor bank appeared to be less enthused.
According to Bruhnke, its
"Either they were going to shut it down or we were going to slow down ourselves," said Bruhnke, who is also CEO of HMBradley.
The company shifted to invite-only mode in July 2021 until customers exhausted their three referrals, and then opened a waitlist.
"It was a weird scenario we never expected," said Bruhnke. "All we could do was maintain our customer base" rather than add new customers.
In an emailed statement, the $177.9 million-asset Hatch Bank said, "While Hatch Bank does not share confidential information about its partners, we can confirm that we were their first banking partner and wish them success in the future."
HMBradley's subsequent choice of sponsor bank in early 2022, New York Community Bank in Hicksville, New York, is unusual in the banking as a service space. Most financial institutions that provide underlying banking services for fintechs have less than $10 billion of assets, which means they are not subject to debit interchange fee caps under the Durbin amendment. In fact, Bruhnke said he spoke with 20 potential partners, but most had hard deposit caps because the Durbin exemption requires them to contain asset growth, and thus deposits have to be reined in, too, to maintain proper asset-to-liability ratios. NYCB, a division of Flagstar Bank, holds $90.1 billion of assets and, as a result, much more capacity for deposits.
Although the situation HMBradley ran into is atypical for a challenger bank, startups with similar ambitions of accumulating millions or even billions of deposits might share the struggle.
"Traditionally, the sponsor bank space has been dominated by banks under $10 billion [of assets]," said Alex Johnson, author of the Fintech Takes newsletter. "What HMBradley indicates is there may be a growing need in the market for sponsor banks with more than $10 billion of assets that can support different business models and product propositions from fintech companies," such as lending.
At the same time, banking as a service may become increasingly appealing to midsize banks such as NYCB.
Financial institutions such as Encore Bank, Central Pacific Bank, Climate First Bank and Lead Bank are in various stages of exploring or accelerating relationships with fintechs, even as market conditions make the Baas business model less attractive.
"As quantitative easing has reversed and stimulus from COVID has worked its way through the system, you see loan-to-deposit ratios at banks drop significantly and rates on deposits spike up," said Brian Graham, a managing director at Klaros Group. "Deposits are worth something again. The smaller the bank, the more awash they are in deposits. The largest banks have all sorts of non-deposit funding sources. It's the guys in the middle that have significant amounts of lending volume and not as much in deposits to fund them naturally."
NYCB has been taking on banking as a service clients for about a year and a half now.
"It's a great opportunity to grow deposits," said Douglas Pagliaro, deputy chief digital and banking as a service officer at NYCB. "Banking as a service is a way to diversify the way we add deposits onto our balance sheet. It also gives us a front-row seat at some great technology minds that know how to deliver financial service products to their customer bases."
NYCB felt HMBradley had a solid management team, strong backing from venture capital, a proven track record, and an appealing customer base with high FICO scores and large average balances. Pagliaro also notes the company takes
"We are aware of their projections," said Pagliaro. "We will allow them to grow without any restrictions."
Unlike more "typical" challenger banks, which operate mainly as a checking account and where customers transact frequently and avoid storing high balances, HMBradley's blended checking-savings deposit account encourages its users to stash their wealth and earn high interest rates.
"HMBradley's business model and product make it difficult for traditional banking as a service," said Johnson. The challenger bank is paying more to attract deposits, which could cause a smaller bank to exceed its Durbin cap.
HMBradley structures its interest rates around the idea that "the more business you do with us, the more we pay you," said Bruhnke. Customers who open a deposit account earn 2% on their funds up to $250,000. Those with a positive monthly cash flow and more than $500 of total monthly deposits snag a 3.6% rate. Finally, customers who spend more than $500 each month on their HMBradley credit cards get the top rate of 4.2%; paying off the balance does not count against the $500.
It also uses a system it calls "one-click credit." Users consent to HMBradley doing a soft pull on their credit once a month, which the company will use to underwrite its products — currently a credit card, but it hopes to offer mortgages and other loans in the future, through partners or on its own — and offer a guaranteed line of credit and annual percentage rate, which the customer can claim right away. Bruhnke says another benefit of this system is it lets HMBradley experiment and tweak offers if a customer does not accept the first one; for instance, it might then offer a higher credit line. It uses Alloy, a company that helps financial institutions automate identity and risk decisions, for onboarding and credit underwriting.
Another unusual element is HMBradley's decision to purchase a new core system. Previously, HMBradley integrated directly into Hatch Bank's core.
"We needed to build everything soup to nuts so we could be a full stack bank and our partner should be a partner," said Bruhnke. "Our bank partner is in essence an SFTP [Secure File Transfer Protocol] drop."
The company selected Thought Machine in early 2022. Bruhnke was impressed by its smart contracts feature that lets banks write their own code to build their own financial products. Plus, in its demo to HMBradley, the core provider replicated HMBradley's
HMBradley quietly started taking customers off the waitlist in mid-January of this year. Currently it has tens of thousands of active customers who use at least one of its three products: the credit card, deposit account or credit monitoring. It earns money from debit interchange and the spread on deposit rates and its 1.5% cash-back credit card.
Johnson wonders if HMBradley's high-yielding account will maintain the same allure that it did in 2020, when it was pitching high returns in a low-rate environment.
"The new challenge will be now that the cap is gone, can it grow?" said Johnson. "There are a lot more places where I, as a consumer, can get 3%, 3.5%, maybe 4% without going to HMBradley."
