For American Challenger Development Corp., the first step to challenge banking is to become a bank.
Formed in January 2020, the Stamford, Conn.-based fintech company has agreed to merge with Patriot National Bancorp Inc., a community and commercial bank headquartered in the same city. The deal is expected to close in the first quarter of 2022 pending approval by regulators and Patriot's shareholders. Patriot's shares were up as much as 49% following the announcement Nov. 15, and have since retained the gains.
Unlike its neobank peers that rely on bank partnerships, American Challenger believes in the most fundamental economics of banking driven by net interest income, Chairman and President Felix Scherzer said in an interview Nov. 16. The business is rooted in creating return on equity through depository and lending operations, as opposed to charging consumers interchange or other fees, he said.
"We don't believe that there are shortcuts. We do not believe that the rent-a-bank model is a sustainable model long term. And this is why this team chose to go down the path of working with regulators of building a bank from scratch," Scherzer said.
Not a rent-a-bank scheme
Patriot, meanwhile, decided not to be a bank for rent. Although it had been exploring digital transformation "for quite some time," it did not rush into any fintech partnerships to be a sponsor bank, said Michael Carrazza, Patriot’s current chairman. Opportunities of successful fintech partnerships are limited in the industry, and many fintechs may not have a robust platform that can handle a nationwide rollout. The fintechs' potential failure poses risks to their bank partners, Carrazza said in an interview.
The appeal of American Challenger is its readiness to be operable, which also mitigates Patriot's execution risk compared to building digital banking in house, Carrazza said. "It is not a merger of consolidation, but a merger of growth and building," he said.
After the deal is closed, the combined entity will operate as two divisions under the bank holding company for American Challenger to initially focus on product rollouts, Carrazza said. While Patriot continues to use the branch network since it is proven profitable, American Challenger's technology will also be available to Patriot's customers, he said.
American Challenger, currently pre-revenue, will start with nationwide high-yield savings and mortgage products in its proprietary digital application as well as commercial banking business as a subsidiary of Patriot. It plans to originate deposits and loans organically through its own marketing efforts, and the recapitalization as part of the reverse merger agreement will fuel the expensive growth pattern, Scherzer said. It is raising at least $890 million in fresh equity capital to recapitalize Patriot.
Rebuilt from scratch
With the purely digital approach and better efficiency, American Challenger aims to reduce the operating costs significantly compared to traditional banks. In this way it will be able to improve the cost-to-income ratio without taking additional investment risks, Scherzer said.
"The reason we can compete with banks is because we rebuilt the bank from scratch. The reason we can compete with neobanks that have a rent-a-bank model is because we are actually built to be a bank," Scherzer said.
The board of the combined entity will be comprised of Scherzer and Carrazza, along with financial services veterans like former E*Trade CEO Karl Roessner, former Discover Financial Services CFO Mark Graf, former Sallie Mae CEO Raymond Quinlan and former Capital One Commercial President Dean Graham.
American Challenger obtained conditional approval from the Office of the Comptroller of the Currency for a de novo charter in December 2020. It has also filed an application with the Federal Deposit Insurance Corp. in November 2020 but has not completed the process.
