The future of retail banking appears to be going in three distinct directions: 1. Big tech companies partnering with regulated financial institutions; 2. Fintech companies acting as banks with real banks in the background; 3. Traditional institutions updating legacy business models to meet an increasingly digital world.
Yet there is a fourth choice: Complete transformation, turning a legacy institution into what in essence is a chartered, regulated challenger bank. Few banks and credit unions go this route, perhaps because it means leaving so much behind.
One such pioneer is Quontic Bank, a New York City-based community bank. And while the strategy is still ongoing, the plucky little bank with $394 million in assets, that bills itself as “The Adaptive Digital Bank,” is quite far along the path. NBKC Bank, Kansas City, Mo., is another example.
Interestingly both institutions began their reinventions from a specialty focus on mortgage lending. In Quontic’s case, a successful niche strategy of concentrating on non-qualified mortgage lending as a for-profit Community Development Financial Institution (CDFI) has enabled it to make the necessary investments in people and technology to become a digital-first institution while remaining profitable, as CEO Steven Schnall explains.
Stage One of a Two-Part Transformation
Quontic began life as Golden First Bank, a troubled community bank operating in the New York City suburbs that Schnall, who had previously been a mortgage banker, acquired in 2009.
The first part of the bank’s transformation occurred when Schnall and his management team recognized the huge opportunity to help meet the mortgage finance needs of the underbanked community. At the time, Quontic was headquartered in Astoria, part of the New York City borough of Queens — and home to a huge and varied immigrant population.
Quontic created a series of products for self-employed people, immigrants, gig economy workers and others who can’t necessarily document their income sufficiently to “fit the box of Fannie Mae and Freddie Mac requirements,” as Schnall describes it. The bank requires a significant down payment (35%) and good credit (680 FICO score or higher), but does not require income verification. (As a CDFI, the bank is exempt from the Dodd-Frank Act requirement to use tax returns and pay stubs.)
In 2019 the bank expanded its mortgage lending by launching a wholesale lending operation nationwide. It also deployed an online mortgage application process, which enables the bank to make nonconventional mortgage loans online that the big digital lenders like Quicken and digital lending platforms like Blend don’t do.
This CDFI mortgage niche has been vital to Quontic’s digital transformation. The reason is straightforward: Revenue. The bank charges a higher rate for these loans than it could for a conventional loan, and by selling off a high percentage of them, mostly to private equity firms, the bank earns significant fee income. (Typically nonconventional loans cannot be sold into mainstream secondary mortgage markets.)
“That fee income provides us with the resources to be able to build the technology we need to be a digital bank,” states Schnall, “without going out and raising a lot of capital and diluting equity ownership.” It has also turned the bank around financially.
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Becoming ‘The Adaptive Digital Bank’
When Schnall purchased Golden First Bank, he decided he would not open any branches because he believed that branching would become obsolete. He admits now that he was a little early in that prediction. “Maybe we should have opened branches,” he tells The Financial Brand. “Our core deposit growth was probably slower than it could have been. But I don’t think I’m early anymore. Everything now is digital, digital, digital.”
More and more, he says, banks and credit unions are struggling to acquire deposits from their physical communities and are looking online for the funds.
Quontic now operates completely online except for its original banking office in Astoria and three mortgage offices. The bank offers “Amplify Interest Checking” plus high-yield savings, CDs, and money market deposit accounts. In addition to the standard mobile banking features, its app is integrated with Zelle, and with Apple, Google and Samsung Pay. The app also includes a receipts-management solution from Sensibill.
Online deposit-gathering is “a rate-sensitive game,” Schnall states, “but we’re not hamstrung by the brick and mortar overhead, so we can create deposit products where we can pay people many times what they are being paid by Wells Fargo or BofA.” Quontic’s core account, Amplify Checking, pays 2% (as of November 2019).
“We’re giving that interchange income back to our customers in the form of a 2% interest rate on their checking account.”
— Steven Schnall, Quontic Bank
“Any time somebody swipes their debit card the bank gets paid interchange fees,” Schnall explains. “So we’re giving that interchange income back to our customers in the form of a 2% interest rate on their checking account. If the customer is creating value for you, pay it back to them. You can do that if you don’t have expensive branches.”
Regarding the “adaptive” part of the bank’s slogan, Schnall says that it applies more on the lending side. “Our whole DNA is to adapt our products and services and underwriting guidelines to the unique circumstances that exist in our customer’s lives — to be able to provide them with solutions to empower them financially.”
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The Two Biggest Challenges to Bank Transformation
Becoming a true digital financial institution is a steep climb, and a great deal of work went into the process before Quontic’s new tagline was adopted in 2018. Furthermore, it’s an ongoing process.
“A financial institution can’t just say ‘Hey I want to be a digital bank’,” says Schnall. “They have to go through a learning curve just like we are. We’re not the first to do this, but we’re in the first wave. I think banks in five years will say ‘Geez I wish we had started this sooner’.”
The two biggest challenges for a traditional community bank to become a digital bank are technology and staffing, which includes training and customer service, Schnall maintains.
With technology, the CEO says that the key is the ability to have open APIs (application programming interfaces) enabling the bank to add “a robust suite of products and services.” The big banking technology vendors often use almost exactly the same words to describe their capabilities, but Schnall maintains they are inflexible and move too slowly. The bank’s mortgage platform and core banking system, for example, still “don’t talk to each other,” making it difficult to extract useful data.
Quontic invested a year’s time and considerable resources building a cloud-based “wrapper” — basically middleware that sits on top of their other systems enabling the bank to connect directly via APIs to various specialized tech vendors.
Regarding people, Schnall says this is a critically important part of digital transformation. Ideally a consumer should be able to handle a digital transaction without any further contact, Schnall observes, but that doesn’t always happen and support is needed. As Quontic began to do more banking online they discovered that handling online chat is a “whole different mentality.”
“It requires that you be there right this second, not “I’ll get back to you in five minutes” or by the end of the day, the CEO states.
In its first attempt to resolve this dilemma Quontic hired actors and actresses to handle chat and calls — New York is rife with people working between roles or waiting for their break. These people are outgoing and articulate and the move worked well with simple questions.
However, when the bank added more complex products like Amplify Checking, problems developed and the bank began evolving back toward using people with banking experience. The ideal, says Schnall, would be people with a combination of personality and banking experience, who are comfortable operating in an online environment. This is just one example of why digital transformation is a such a complex process.
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Up Next: Online Consumer Loans and a Contactless Ring
Quontic’s metamorphosis into a digital bank is not simply an niche-mortgage play. Schnall says the bank is currently conceptualizing what a new online consumer lending product should look like. “We don’t want to be in the triple-digit APR consumer lending business like a lot of online lenders are,” the banker states. He says they’re about a year out from coming out with the right product.
Somewhat sooner, the bank plans to deploy what is essentially a contactless debit card embedded in a simple, wedding-band style ring.
Schnall thinks Quontic will be the first U.S. bank to launch such a product, though it is in use in Australia and Europe. The ring uses the same RFID technology as a contactless card.
In answer to the question some bank and credit union executives might be asking — “Why a debit ring?” Schnall says that when you’re at a transit pay terminal or at the airport and have a cup of coffee or an umbrella in your hand, it’s a pain to dig the debit card out of your wallet or even fish out your phone if it’s not in your hand. It’s pretty easy to just tap the ring and move on, says Schnall, who has used it. The same would apply to smartwatches, but many of them are expensive.
Schnall believes Americans’ use of contactless payments will explode over the next couple of years, “and we’ll be out ahead with this product.”