New Accounting Guidance Seeks to Clarify Three Big Questions

The Office of the Chief Accountant has provided new insight into three of the biggest questions posed in recent months by banks and financial institutions. Publishing in the 2021 edition of its annual Bank Accounting Advisory Series (BAAS) OCC Bulletin 2021-37, the chief accountants office shared guidance covering:

  • Loans held for sale (Subtopic 2E)
  • Employee stock options (Subtopic 8C)
  • Grants received by banks (Subtopic 11E)

The three are among the Accounting Standards Updates (ASU) issued by the Financial Accounting Standards Board prior to March 31, 2021. The annual bulletin addresses the topics that are most relevant to national banks and federal savings associations, and it promotes consistent application of accounting standards and regulatory reporting among OCC-supervised banks. Below is an overview of the three key items in the latest accounting bulletin update:

Loans held for sale (Subtopic 2E, Question 4)
If a bank has adopted Accounting Standards Codification (ASC) Topic 326 and decides to sell a loan that was originally marked as held for investment (HFI) whose fair value has declined because of negative trends in credit quality, the bank should apply a two-step process to account for the transaction. First, it should apply a regulatory charge-off, in accordance with the interagency guidance on held for sale. Second, after the write-down, the bank should apply the guidance for HFI to HFS transfers in ASC 310 or ASC 948.

Employee stock options (Subtopic 8C, Question 2)
A bank may participate in and sponsor an employee stock ownership plan (ESOP) solely for the benefit of bank employees. When the related ESOP trust borrows funds from the related holding company and is considered an internally leveraged ESOP, the loan is generally not required to be recorded at the subsidiary bank level under ASC 718-40. It is permitted if, based on the judgment of management or the external auditor, it is needed to accurately report the subsidiary bank’s financial condition in the call report or the subsidiary bank’s audited financial statements, both of which are presented on a bank-only level.

Grants received by banks (Subtopic 11E, Questions 1-2)
For regulatory reporting purposes, banks should account for any non-governmental grants received in accordance with ASC 958-605. While Topic 958 applies specifically to nonprofit entities, the guidance on accounting for contributions received (such as grants) applies to all entities. Banks that receive governmental grant proceeds, such as grants from the Community Development Financial Institution fund, should apply ASC 958-605 by analogy for call report purposes. The recipient bank should first determine if there are any donor-imposed conditions; revenue is recognized for grants without conditions when it is received.

When donor-imposed conditions exist, revenue is recognized when those conditions have been substantially met. In this situation, the grant should be recognized as deferred revenue with a related receivable, cash or other contributed asset recognized. For call report purposes, grant revenue should be included in Schedule RI, “Other Non-Interest Income;” if thresholds are met, it should be disclosed on Schedule RI-E, “Explanations.” Unearned grant revenue should be included in Schedule RC-G, “Other Liabilities.”

Additionally, the 2021 Bank Accounting Advisory Series includes Appendix A, “Newly Issued Accounting Standards.” The appendix describes new accounting standards applicable to this edition of the BAAS and the first call report for which calendar year-end institutions must adopt the ASUs.

Fintech Acquisitions Are Rare Among Banks; Here’s One Exception

Few banks seem interested in purchasing financial technology firms. Just five such deals were announced this year as of July 14, based on a list of acquisitions compiled by Piper Sandler & Co. for Bank Director, using data from S&P Global Market Intelligence. Six of these deals were announced in 2020. Bank Director’s 2021 Bank M&A Survey found that a paltry 11% of respondents — primarily representing banks above $1 billion in assets — said their bank was likely to purchase a technology company in 2021.

Piper Sandler Managing Director Chris Donat believes banks are more interested in the tools and the solutions — more easily obtained through vendor relationships and collaborations — than in owning these companies outright.

Our list of recent fintech acquisitions by banks finds that as a group, big banks are the most active acquirers. But one small bank has been exceptionally active in this space: $2.7 billion MVB Financial Corp., based in ​​Fairmont, West Virginia. Working with fintechs has become a core element of the bank’s strategy.

MVB’s strategic shift dates back to 2016, when CEO Larry Mazza and CFO Don Robinson were trying to come up with a strategy to generate deposits to fuel the bank’s loan growth. They were inspired, says Robinson, by companies outside the banking sector that were housing deposits in loyalty programs and digital apps.

Examples include Starbucks Corp. and DraftKings, a sports betting app that reported $288 million in “cash reserved for users” — essentially deposits — in its 2020 annual report. Meanwhile, Starbucks recorded $1.6 billion in “stored value card liability” as of June 27; these funds are tied to the coffee purveyor’s prepaid cards, which customers can purchase and replenish online or in stores. Neither of these companies aim to be a bank, but they do draw dollars that their customers can use to buy coffee or gamble online — money that isn’t going to their primary bank account.

To better understand this evolving landscape, Robinson and Mazza reallocated marketing dollars to invest in fintech companies, viewing it as research and development. They took an active role in their investments, sitting on their boards. “We had a day-to-day involvement, kind of front row seat to their interactions,” says Robinson.

Today, the bank provides banking-as-a-service (BaaS) to fintech clients such as the personal finance company Credit Karma, which was itself acquired by Intuit last year. (Other BaaS banks include Coastal Financial Corp., NBKC Bank and Celtic Bank Corp.) The business has led to a huge increase in deposits. Fintech deposits totaled $533 million at the end of 2020, an increase of $382 million (255%) over the previous year — accounting for more than a quarter of MVB’s $1.98 billion in total deposits. Most of the fintech deposits ($358 million) come from the gaming industry. MVB’s return on average equity has more than doubled in the last two years, to 16.7% in 2020. Its return on average assets was 1.7%, up from 0.7% in 2018.

MVB has specific requirements for investing in fintech companies. There needs to be a market for the solution, which must solve problems faced by the industry or the bank’s clients. The management team should have a proven track record and resources for growing and scaling the company. And MVB wants to see what it can bring to the table. “We’re looking at that strategic partnership,” says Robinson. “How can we work with this [company]?”

The approach has resulted in a diverse array of acquisitions and investments, including Invest Forward, which offers a digital savings account; Paladin, focused on fraud prevention; and Trabian Technology, a software developer.

In a release explaining the rationale behind the Trabian acquisition, Mazza noted that the company adds “a new revenue stream and profit center and technological expertise that will benefit MVB and all of our stakeholders.”

Acquisitions that extend MVB further into areas like software development and fraud protection help the bank turn cost centers into profit centers, explains Robinson. “Trabian does work for, not only MVB, but it also does work for third parties,” he says. “As we look at the fintech world, one of the key pieces for us was looking at, how do you bring that expertise in house?”

The bank launched MVB Edge Ventures in June to oversee its technology investments and tackle two challenges that would vex any bank considering putting its capital into a fintech: valuation and culture.

To address valuations, MVB does its homework. “These are not public companies, right? So there’s a lot of diligence we have to do to make sure we understand the overall market,” says Robinson. “[We] try to stay away from pre-revenue companies, and we don’t invest in concepts.”

And the new venture arm addresses the cultural piece, along with regular communication with Robinson and Mazza.

“We have a team [that] work[s] together on a regular basis [to] integrate the companies and provide that platform,” says Robinson. He and Mazza regularly communicate with their portfolio fintechs, and Robinson says they have a lot to learn from one another. “They’re sharing the challenges and pitfalls they’re seeing,” he says, “and also the opportunities.”

Of course, MVB is not the only bank looking to fintech acquisitions to fuel growth. Earlier this month, Fifth Third Bancorp closed its acquisition of Provide. The digital platform offers deposit accounts, insurance coverage and financing to healthcare providers, originating $300 million in loans in the first half of 2021, according to Fifth Third’s July 21 earnings call.

“Our focus is on nonbank transactions that enhance our product and service capabilities,” Fifth Third CEO Greg Carmichael said on the call. “Provide would be a great example of that.” Fifth Third started investing in the company in 2018, and began funding loans through the platform around two years later. Provide will continue to operate as a subsidiary of the Cincinnati-based regional bank, which expects the platform to generate around $400 million in originations in the second half of 2021 and $1 billion in 2022.

2020-2021 (YTD) Fintech Acquisitions by Banks

Acquiring Bank Name Ticker Fintech Target Announcement Deal Value ($M)
Fifth Third Bancorp FITB Provide 6/22/2021 Undisclosed
Axos Financial AX E*TRADE Advisor Services 4/20/2021 $55
MVB Financial Corp. MVBF Trabian Technology 4/16/2021 Undisclosed
Bank of America Corp. BAC Axia Technologies 4/1/2021 Undisclosed
PNC Financial Services Group PNC Tempus Technologies 1/27/2021 Undisclosed
Alliance Data Systems Corp. (Comenity Bank) ADS Lon Operations 10/28/2020 $450
CRB Group (Cross River Bank) n/a Synthetic P2P Holdings Corp. (d/b/a PeerIQ) 8/21/2020 Undisclosed
American Express Co. AXP Kabbage 8/17/2020 Undisclosed
MVB Financial Corp. MVBF Invest Forward 8/7/2020 $1
MVB Financial Corp. MVBF Paladin 4/17/2020 Undisclosed
Bank of Montreal BMO Clearpool Group 1/22/2020 $147

Source: Piper Sandler & Co. using data from S&P Global Market Intelligence.

The Unbankey Bank: Coastal Financial’s Evolution

Coastal Financial Corp., a $2 billion community banking company in Everett, Washington, was a typical community bank seven years ago. It wasn’t looking to launch a banking-as-a-service (BaaS) division, where the bank would lend out its charter, payment rails and other bank exclusive products and services to third parties.

But that is exactly what the bank did.

When asked if he knew anything about BaaS prior to 2015 — the launch year of Coastal’s BaaS program — CEO Eric Sprink confessed, “Nope — we stumbled into it.”

In 2015, Sprink met Arkadi Kuhlmann, former CEO of ING Direct USA and ING Direct Canada, who was looking for a bank partner to offer banking services on the back end for his financial technology company, Zenbanx. The fintech offered deposit accounts, international currencies and money transfers.

This was the first time Sprink had heard anything about BaaS. He was interested, the board was interested, the executive team of Coastal was interested; so, the bank started an almost 15-month process of engaging investment bankers and consultants, speaking with regulators and preparing to enter into this new line of business.

But then, Coastal lost the bid to do business with Zenbanx to the personal finance giant SoFi Technologies, which later bought the fintech. Six months later, SoFi announced it was shutting down all Zenbanx accounts.

Instead of opting for resignation, Sprink — with the blessing of his board — continued to chase down new technology leads and partners. In the words of one of Sprink’s board members: “‘We’ve got to find out more about this … start running.’”

And Sprink hasn’t stopped running since. Along the way, Coastal recruited multiple new board members — one about every 18 months, and four in total — who have helped build Coastal’s BaaS strategy from the ground up. Sprink explains the process as being, “evolutionary, not revolutionary … We’ve intentionally looked really hard for expertise that we’re lacking in the evolution of our BaaS group.

That expertise, in part, is coming from its newest members: Stephan Klee; venture capitalist veteran and current CFO of Portage Ventures; Sadhana Akella-Mishra, chief risk officer at alternative core provider Finxact; Rilla Delorier, a former innovation executive at Umpqua Bank and PNC Bank; and Pamela Unger, a former tax manager at PwC, who brings understanding of direct venture capital accounting and oversight.

Coastal is dedicated to partnering with fintechs that are not only unwavering in their mission, but that are compatible with Coastal’s core values: stay flexible, embrace great thinking and be “unbankey,” as Sprink says. In what he describes as their “emotional gating criteria,” the bank sits down — or Zooms in, post-March 2020 — with these fintechs. They want to better understand the business, review their performance and investors, and, most importantly, find out what they want to accomplish. The key is to find partners that will reach and embolden specific communities through financial products and services tailored to their needs.

“We try real hard upfront to make sure we’re picking the ones that best fit us and that have the most likelihood of success,’’ he says. “With limited resources, you really have to stick to your gating criteria and believe in what you’re trying to accomplish.”

The whole process, from initial discussion to commercial launching, takes upwards of one year to 18 months. As of July, Coastal was working with 24 fintechs, half of them actively offering banking products and services through Coastal.

It takes a lot of effort to get to that stage. Out of the more than 1,100 fintechs vetted, only about 2% became fintech partners.

And in regard to the 12 active fintech partners, Coastal just recently crested the $1 million in revenue mark. Coastal’s BaaS revenue for the quarter ending June of 2021 was $1.4 million, a 50.2% increase from the prior quarter. Included in Coastal’s overall BaaS revenue, the bank reported $110,000 in interchange income for the quarter ending in June, up from $35,000 in the prior quarter. The bank isn’t tracking profitability of the division yet, but plans to break it out next year for analysts and investors.

In a 2020 survey, venture capitalist firm Andreessen Horowitz found that out of those surveyed, half of the BaaS banks were seeing above-industry average rates on their return on assets and equity, calculated from 2017 to 2019. The firm says that these returns are two to three times the average industry rate.

When Bank Director magazine launched a study to determine the top 10 fastest growing U.S. banks in 2020, it found that two of the banks listed are BaaS providers: NBKC Bank, with $1.2 billion in assets, placed at the top of the list, while $4.7 billion Celtic Bank ranked fifth.

A BaaS division could lead a bank to new revenue and deposit sources, growth and access to new customer segments, but it does not have the sole capability to turn a bank profitable. It takes good timing, patience and a healthy bank with curious leaders — a combination that Coastal seems to flourish on.

The bank’s second quarter 2021 investor presentation also reports that 73% of Coastal’s fintech partners are headed by a diverse CEO, those who identify as a minority or female. Eighty-eight percent have a diverse co-founder. Partners include Greenwood, Cheese, Fair, Aspiration and Ellevest, some of which reach underserved communities or offer mission-based banking practices.

“At the end of the day, we’re still a community bank, and we’re trying to give that [community banking] experience to others [who] haven’t had it yet,” Sprink says. “And we’re using partners to deliver it.”

Getting Faster, Simpler, Cheaper and More Secure

In June 2020, Coastal Financial Corp. began onboarding financial technology clients to ramp up its banking as a service (BaaS) business.

The $1.8 billion community banking company in Everett, Washington, would lend its bank charter, compliance program and payment rails to nonbanks for a fee. Nine out of 10 of those clients are unregulated by any financial regulator; one out of 10 might be a regulated entity such as a broker-dealer. This arrangement means the bank must monitor its nonbank customers for compliance with anti-money laundering, foreign sanctions and Bank Secrecy Act (BSA) laws.

Andrew Stines, the chief risk officer of Coastal Financial, and his staff of BSA experts keep track of a fluctuating amount of flagged transactions per month, about 3,000 to 4,000, on everything from ACH and loan payments to debit and credit card transactions. It’s a lot. From the bank regulators’ point of view, “I’m the one who really owns that risk,” Stines says.

The company previously had manually pulled flagged transactions for further investigation  with Excel spreadsheets. But that didn’t work anymore, given the workload. So Coastal turned to Hummingbird, the winner of Bank Director’s 2021 Best of FinXTech Award for compliance & risk.

Hummingbird automatically pulls flagged transactions from the bank’s core, Neocova, and automates compliance reporting. It sends suspicious activity reports (SARs) to regulators after Coastal Financial conducts investigations. Hummingbird also creates an auditable trail of each case.

The bank is not alone in trying to ramp up its fraud and compliance monitoring and reporting using new software. Financial institutions are under increasing pressure to update their fraud technologies with machine learning, robotic process automation and other tools to combat increasingly sophisticated criminals and higher use of digital services, according to a February 2021 report from the research firm Celent.

Celent Head of Risk Neil Katkov projects that North American financial institutions — which are the greatest targets for global fraud — will spend $3.1 billion on fraud technology in 2021, or 16.1% more than the year before. Spending on fraud operations will amount to another $4.55 billion, he wrote.

The marketplace for fraud and compliance software has become crowded, which benefits banks, says Kevin Tweddle, the senior executive vice president for community bank solutions at the Independent Community Bankers of America.

“People ask me what’s a fintech,” he says. “It makes [banking] faster, simpler, cheaper and more secure.” An especially active group right now are cybersecurity companies, all vying to monitor threats for financial institutions and to help with compliance and reporting requirements.

Finalists in the compliance and risk category for the Best of FinXTech Awards included IT compliance company Adlumin, which uses machine learning to detect threats, malfunctions and operations failures in real time, and the cybersecurity provider DefenseStorm, which is a cybersecurity compliance platform built for banks and credit unions. For more on how Bank Director chose winners, click here.

But Hummingbird was clearly a stand-out for Coastal Financial. The software program was cost competitive, although Stines declines to name the price. Using the software clearly pays for itself, he says. But he admits the company might not need Hummingbird if not for its BaaS business, which adds to the company’s reporting requirements. Stines estimates he’d have to hire four to five additional full-time employees without it.

The drawback is that Hummingbird’s software doesn’t include every tool the banking company needs. But there’s a roadmap to adding functionality, and Hummingbird sticks to its promised dates, Stines says. The real selling factor was the user interface and the fact that Hummingbird seems eager to make changes as needed, and understands Coastal Financial’s technology clients. “They are more forward-thinking and more in tune with digital and fintech services than traditional players in the space,” he says.

This may just be the beginning. For Tweddle, banks and credit unions are enjoying an early to middle development period for fintech. “There’s a lot more interesting things to come,” he says.