Why OakNorth is posting profits when other challenger banks aren’t

While the break-even point is a major win for digital challenger banks, three-year-old U.K-based OakNorth reported an annual profit in its second year of operations. This week, the company reported a pre-tax profit of $15 million, with a net interest income $35 million. OakNorth's quick path to becoming a profitable business stands in contrast to its peers, many of whom, including Monzo, Tandem and Starling, have yet to see a month without losses. The key has been focus on mid-sized businesses rather than individual consumers. Revolut recently reported it had broken even. "I don't think having a really cool deposits strategy is the way to build a good business by itself, you need to have that paired with a good assets strategy," said co-founder and CEO Rishi Khosla, pointing to OakNorth's business lending as its core profitability driver. OakNorth grants businesses loans valued from $700,000 to $42 million. It also offers personal and business savings accounts and property financing. The company said its "sweet spot" is small to medium-sized business customers that have a turnover of a few million to $140 million dollars. The bank currently has a loan book of more than $2 billion and 250 business borrowers. While its competitors are big banks, many of its customers feel underserved and overlooked by them, the company said. "We compete with everybody and no one -- at the end of the day on the lending side in the U.K. at least, the big five banks get 90 percent of market share," said Valentina Kristensen, director of growth and communications at OakNorth, adding that big banks aren't really competition as business customers choose OakNorth because they can get a much quicker and simpler assessment process with the challenger bank. U.K. challenger banks like Atom are starting to build lending into their business models too. Starling Bank has said it would launch a business loan product in October and Monzo, whose revenues are dependent on overdraft loans, is currently in the market for a consumer lending vp. OakNorth also white labels a cloud-based technology platform called Acorn that sources data on small businesses and uses machine learning algorithms to turn them into business insights. Currently, five banks have adopted the platform, according to Kristensen. Unlike many larger institutions that focus on collateral, OakNorth focuses on understanding the business with the help of its tech platform, she added. OakNorth has the advantage of a low cost of operations with only two offices in the U.K., and a reliance on its tech platform that facilitates quick credit decisions. The loan approval process isn't entirely digital, however; applicants meet with loan officers to pitch why they need the funds. "[For Oaknorth] the instructive thing goes back to challenger banks needing to become experts in lending, and having not only the technology but the staff to mange the risks," said Focardi. "That deep domain expertise is critical to the long term growth of OakNorth." OakNorth believes in going for a niche market while operating as efficiently as possible is the path to success. But a robust lending business is a critical factor for the success of challenger banks when revenue from deposits alone isn't enough to sustain the business. Over time, more challengers will pivot towards various underserved segments, said Scott Tullio, partner and U.S. digital lead at Capco. "While the underserved small to medium-sized business segment seems to be a popular niche now for challengers, we will continue to see other untapped markets pop up to further accelerate growth and profitability," he said. "You could consider the student lending and mortgage lending markets ripe for challengers – with moderately low customer acquisition costs in these markets coupled with innovative ways of underwriting, faster processing times and flexibility in pricing."