🔒A New Frontier: Amid tech disruption, community lenders launch ‘digital banks’

When Michael Carrazza, the CEO of a private equity firm, became board chair of Stamford-based Patriot Bancorp Inc. in 2010, his top priority was to recapitalize and rescue the bank, which had fallen victim to the financial crisis of 2008.

“I stepped in to execute a turnaround … and bring the bank back to strong financial and regulatory health,” he said.

A decade later, Carrazza is helping Patriot Bank, with $952 million in assets, pivot to address a new challenge — changing technology and consumer demands — by launching a digital bank from the ground up.

In November, Patriot announced an agreement to acquire American Challenger Development Corp. – a digital-first national bank, also based in Stamford, that will operate as a wholly-owned subsidiary under Patriot’s banking charter.

Pending regulatory and shareholder approvals, the $119 million deal is expected to close and the new digital bank launch in the first quarter of 2022. Additionally, Patriot announced it will enter into a separate agreement with investors — through private placement — to raise north of $890 million in stock.

The move, Carrazza said, reflects a recognition that the banking sector is moving toward a digital world, a reality that has been trending for years, but was accelerated by the pandemic.

In fact, according to Deloitte research, across all age groups, bank branch usage has declined by more than 30 percent since 2016, with brick-and-mortar visits by 18- to 24-year-olds dropping by nearly 50 percent.

“COVID provided validation of where the markets are going,” Carrazza said. “The [younger] generations that are coming in are conditioned and comfortable with doing everything online … and what’s important is convenience.”

That’s helped ignite a digital banking model that has grown substantially: Since 2016, digital banks have achieved a more than 14 percent deposit growth rate versus 5.4 percent growth for traditional banks, according to the Federal Deposit Insurance Corp.

Digital banks are also expected to grow in overall market size from $35 billion in 2020, to more than $720 billion by 2028, according to projections by Statista.

Frictionless experience

Patriot isn’t the only Connecticut-based bank getting into the digital-only business. Middletown-based Liberty Bank is building its own digital bank, planned for a phased launch in a handful of states in the second half of 2022, with a full national rollout scheduled for 2023.

David Mitchell, Liberty’s chief digital officer, is leading those efforts and said the digital bank will cater services to small and medium-sized businesses, with a focus on automating financial-related transactions — like invoicing and payment tracking embedded in tech-driven project management tools — that customers see as pain points.

“It’s about making [the experience] frictionless and simple,” Mitchell said.

Carrazza said Patriot Bank was drawn to American Challenger for its technology capabilities, executive team and its ability to scale nationally.

“The technology is best-in-class,” said Carrazza, noting American Challenger’s proprietary systems, for instance, can help with opening an account in less than a minute and obtaining a mortgage that closes in less than 20 days.

By comparison, data from Ellie Mae show conventional loans take roughly 50 days to close.

American Challenger’s technology platforms will also be available to traditional branch customers.

American Challenger Bank Chairman and President Felix Scherzer said his company has built its operating system around its own research- and survey-based input from more than 6,000 consumers.

“They are not getting a good rate [from] their current banks and they want a better digital experience,” Scherzer said. Increasingly, that’s a key driver of customer satisfaction, according to survey data from Deloitte, which found that a poorly-designed mobile platform was the most important factor in the likelihood of customers switching banks.

Scherzer said one of the key differentiators of American Challenger's tech-fueled business model is the economics driven by net interest income.

The model is based on equity through depository and lending operations, as opposed to charging consumers interchange — the fee paid for card-based transactions — or other fees.

“We charge no fees,” Scherzer said. “We share the cost efficiencies [of digital banking] that we have created with the consumer.”

While Carrazza said American Challenger’s technologies and data architectures — developed in partnership with a handful of fintech partners — will appeal to all demographics, one of the biggest target markets is Gen X consumers.

They were born between 1965 and 1980, are currently the highest-earning generation and will outnumber Baby Boomers by 2028, according to Pew Research.

With 24 percent of their household incomes topping $150,000, Gen Xers, Pew found, have the most accounts and use the most financial services products compared with other generations, but 75 percent said convenience and digital services are a top need.

Natural transition

Carrazza said Patriot’s innovation — even at the branch level — has been building over several years. He points to the bank’s transition from automatic teller machines (ATMs) to interactive teller machines (ITMs) that provide live video-based support to answer customer questions.

“It’s just part of the natural transition [to technology] in the sector overall,” Carrazza said.

And the speed, convenience and technology solutions will only be expanding with American Challenger’s digital launch in early 2022.

The digital bank will start with nationwide high-yield savings accounts and mortgage loans as well as commercial banking with a focus on small businesses, a key target market for the bank.

In 2017, Patriot launched a Small Business Administration lending division that now includes lending offices in Stamford, Florida, Georgia and Ohio, with an operation center in Rhode Island.

In addition, under its digital bank model, American Challenger has struck a tentative, but currently non-binding deal, with Sunlight Financial, a financing platform for U.S. residential solar and energy-efficient home improvement products.

“The American banking system has a lot of [opportunity] to give consumers better products and a better experience,” Scherzer said. “That’s the fundamental driver of why we embarked [to create American Challenger].”

It’s also, in part, to address the existential challenges that technology and consumer expectations have placed on banks.

“The banking sector is changing daily,” said Carrazza. “Every day there is one less person going to a branch and one new person receiving a smartphone.”