Grasshopper’s Judith Erwin leaps into innovation banking

In the years following the financial crisis, de novo bank activity in the US slowed to a trickle. But as memories fade, the economy expands and the potential of tech-powered financial services marches forward, entrepreneurs have once again been asking the question, “Should I start a bank?”

And by bank, I’m not referring to a neobank, which sits on top of a bank, or a fintech startup that offers an interesting banking-like service of one kind or another. I mean a bank bank.

One of those entrepreneurs is Judith Erwin, a well-known business banking executive who was part of the founding team at Square 1 Bank, which was bought in 2015. Fast forward a few years and Erwin is back, this time as CEO of the cleverly named Grasshopper Bank in New York.

With over $130 million in capital raised from investors including Patriot Financial and T. Rowe Price Associates, Grasshopper has a notable amount of heft for a banking newbie. But as Erwin and her team seek to build share in the innovation banking market, she knows that she’ll need the capital as she navigates a hotly contested niche that has benefited from a robust start-up and venture capital environment.

Gregg Schoenberg: Good to see you, Judith. To jump right in, in my opinion, you were a key part of one of the most successful de novo banks in quite some time. You were responsible for VC relationships there, right?

Judith Erwin: The VC relationships and the products and services managing the balance sheet around deposits. Those were my two primary roles, but my background is one where people give me broken things, I fix them and give them back.

Schoenberg: Square 1 was purchased for about 22 times earnings and 260% of tangible book, correct?

Erwin: Sounds accurate.

Schoenberg: Plus, the bank had a phenomenal earnings trajectory. Meanwhile, PacWest, which acquired you, was a “perfectly nice bank.” Would that be a fair characterization?

Erwin: Yes.

Schoenberg: Is part of the motivation to start Grasshopper to continue on a journey that maybe ended a little bit prematurely last time?

Erwin: That’s a great insight, and I did feel like we had sold too soon. It was a great deal for the investors — which included me — and so I understood it. But absolutely, a lot of what we’re working to do here are things I had hoped to do at Square 1.

Schoenberg: You’re obviously aware of the 800-pound gorilla in the room in the form of Silicon Valley Bank. You’ve also got the megabanks that play in the segment, as well as Signature Bank, First Republic, Bridge Bank and others.

Where do you fit in this spectrum between being a small business bank for digitally savvy entrepreneurs versus a true innovation bank for unicorn-aspiring start-ups and their backers? Because sometimes they get confused.

Erwin: I view us as really focused on the innovation ecosystem versus a specific type of entrepreneur. And the reason I want both is that I have felt the pain points of both types of entrepreneurs. We’ve also opened an account for a nonprofit that’s focused completely on improving diversity and the talent pipeline. That is someone who’s going to contribute to this ecosystem, so I want to bank them.

Schoenberg: Can you characterize, then, your initial clients?

Erwin: They have included a company that is moving here from Egypt, which had to get an EIN number and will have three people to begin with. We also have some venture firms, seed-stage and angel-backed companies. However, I’m also opening an account next week for a company closing a $40-million Series C.

Schoenberg: With respect to the VCs, why are they interested in coming over to Grasshopper?

Erwin: The common point is that they know no one at their bank to call to ask for a loan. All of them have banking relationships, but they will tell you, “I don’t know who my person is. I tried calling, I gave up. My investors told me to call you.”

Schoenberg: Let’s turn to your infrastructure and tech. In my experience, a discussion about bank core processors is better than Ambien for its intended purposes.

Erwin: Ha. Yes, or for totally pissing people off.

Schoenberg: Depending on the audience, that’s true. I know that you have gone live with a cloud-based Temenos core. Why should your customers care about this choice of a next-generation core processor vs. those that have opted for one of the big three cores?

Erwin: So there’s a neobank focused on start-ups that recently raised capital. This company built the front end, which they put on top of another bank whose core happens to be one of the big three. In fact, it’s the most primitive of the core providers out there.

Schoenberg: How does that choice manifest itself?

Erwin: The banking rails that this start-up is running on will have high costs, which means that the start-up will have a higher expense base. It also means that this neobank won’t be able to provide same-day ACH anytime soon, because the core sitting on top of it won’t support it.

Finally, there’s the data that’s captured by the core. The neobank will have no control over that.

Schoenberg: But how does your core gives you an edge in serving your clients?

Erwin: Take incoming wire information. If it came with 7,000 characters, I could provide all of it to customers. In the example I just mentioned, maybe they could provide a hundred characters.

Schoenberg: You’re saying a customer might care because—

Erwin: —They may ask, “How can I reconcile this?” There are other things too. Will this neobank be doing anything innovative around cross-border payments?

There’s no way. Will they have a multi-currency wallet anytime soon? A letter of credit? Probably not.

Schoenberg: Wouldn’t they be able to pull in fintechs to help?

Erwin: Over time, they may be able to pull in third-party providers. But those efforts will be restricted by the core’s capabilities.

Schoenberg: As an all-digital, OCC-chartered bank, how will you look different under the hood vs. a new bank that has a physical presence?

Erwin: The way you staff is greatly different. Ultimately, we’re going to be heavily loaded on client-facing staff and developers, and we’re not going to have as much of a need for operations people. Also, my real estate expenses will be much smaller. At Square 1, we had $4 to $5 million in real estate expenses. Now, my real estate costs will be a million dollars a year.

Schoenberg: How does your open API play into your ability to offer up new features?

Erwin: I’ll give you a specific example. We are integrating remote deposit capture via your phone. Originally, when we put out our statement of work for this project and got the bids back, many of them had incorporated six to 12 months for delivery because they thought they were providing the developer requirements. But because we’re doing it ourselves, it’s going to take 30 days. So speed to market is a big part of it.

Schoenberg: My understanding is that you’re coming out of the gate with a user-friendly checking account, low-cost wire transfers and same-day ACH and cash flow management tools.

Erwin: Right, but not same-day ACH yet.

Schoenberg: And in terms of your loan product, what’s the sweet spot?

Erwin: Under $5 million. I do have a larger loan request, but as a de novo bank, I’m going to keep my portfolio really granular. So $5 million and under, revolving or non-revolving lines of credit and term loans. And I love $2-million loans. We can do them quickly. We issued a term sheet recently that was a million-and-a-half-dollar loan. We got the package on Thursday, and I gave them a term sheet on Monday. So the perfect client is one where speed matters.

Schoenberg: Do you worry about not having the scale to keep up with your clients as they grow?

Erwin: That’s actually a big reason why we raised so much money. In fact, I have a pretty decent-sized lending limit. It’s over $15 million, which enables me to stay with clients for a long time. Because of our huge deposit generation, I also have a lot of banks interested in partnering with us.

Schoenberg: With respect to the macro environment, when you began the process of standing-up Grasshopper, it was a couple of years ago. Putting myself in your shoes for a moment, I’m thinking that you probably thought Grasshopper was looking at a steady succession of rate hikes. But lo and behold, the fed funds futures market is now pricing in rate cuts.

Erwin: It’s definitely had an impact in that the upside potential is slowed down because so many of our earnings drivers are deposit-based. But the page in our investor pitchbook was done before the last two rate hikes, which means our investors actually bought into a bank with a lower income, and the two rate hikes we’ve had since have been a bonus.

Schoenberg: You’ve mentioned to me your interest in working with fintech partners. Names like Ripple and Lighter Capital come to mind.

Erwin: We’re having great conversations all the time, and it comes back to the ecosystem.

Schoenberg: I get that, but then I look at Brex or Bento or others that have figured out how to add value-added SMB services without being a bank. Isn’t it true that while fintechs can be a friend, they can also be a problem for you?

Erwin: They can, but I’ll tell you the big attraction they should have for Grasshopper is their cost of acquisition is going to be zero with clients I bring them. And that’s actually a big issue for fintechs.

Schoenberg: It’s huge.

Erwin: Right now, they have pots of money, which covers a lot of ills. But I think that if we are super easy to work with and they can just plug in and get clients at zero cost, why wouldn’t they? Especially if I’m bringing value to their clients.

Schoenberg: Who would be a good example?

Erwin: Look at Acorns. You would think I wouldn’t care about Acorns because I’m a business bank. But for my own personal reasons, I’m very cognizant of the impact of student loans. If I could partner with some of the folks who are focused on the employees of entrepreneurial companies, that could be a new avenue for a company like Acorns.

Schoenberg: Many people in the tech world don’t appreciate how hard it is to build a bank from scratch. On top of that, I think New York has a “Knicks problem.”

That is to say that many great basketball players won’t come to play for the Knicks because the pressure cooker here on day one is extraordinary. Did you get pushback for starting a brand new bank here?

Erwin: I did — big time. In addition to the reason you said, the tax burden on New York business is ridiculous. There are also a lot of banks here. But I have such an affinity for the way New Yorkers go about doing their thing: collaborative, outspoken and transparent. So yes, while I got pushback, the mitigant was the opportunity.

Schoenberg: Have you had to make adjustments to your culture given the war for talent and everything else that comes with managing people here?

Erwin: We have become much more amenable to remote employees then we were when we started. Plus, it was quite a mental transition to go from a super sweaty co-working space with 12 people to our beautiful space. So mistakes were made and solved around forming, storming, norming and performing.

Schoenberg: How about staff attrition?

Erwin: As most companies do, we made a couple of misfires on the hiring side. We’ve since had very limited attrition and have tried to get much better at interviewing.

Schoenberg: We talked previously about the potential opportunities in cannabis and crypto banking. One thing that they have in common is that there’s a bit more clarity at the state level, but the threat of federal preemption looms large for an OCC-chartered bank like you.

Erwin: You’re right. It’s definitely more difficult for us.

Schoenberg: Regarding cannabis, will you touch companies that don’t touch the plant?

Erwin: We will.

Schoenberg: Are you currently?

Erwin: Not yet. We’re actually taking the SAFE Banking Act to the board next month to determine our view as it moves through Congress.

Schoenberg: It’s cool that a grasshopper can only move forward and I know this biological observation was a factor in your name; however, I really love that your bank’s name also pays homage to Grace Hopper. Can you talk about how that came about?

Erwin: One of the things that I became acutely aware of — and I’m frankly disappointed in myself that I didn’t come to this realization earlier — is that there aren’t enough women in senior management roles. I then watched some of those shows about the quiet voices, the ones who developed the code for NASA for us to land on the Moon.

That caused me to go looking for other women I never knew anything about. One of them was Grace Hopper, who has had such an impact on the industry I grew up in. I love her quotes. Hopper was a tiny woman, and I’m short. I just wished I could have known her.

Schoenberg: In the years leading up to the financial crisis, if half of the CEOs of America’s top 20 financial institutions in our country had been women, do you believe that the crisis would have been as harsh?

Erwin: I’m always really careful about making generalized statements about gender or race. But any time you’ve got a lack of diversified voices with opinions, you create significant risk of leaving out a viewpoint that could mitigate risk.

One of my never-ending questions for banking colleagues is, “Why does it matter that we grow and grow and grow and that the balance sheet gets bigger year over year?” It doesn’t mean you make more money, and you actually create the risk of new competitors coming in who are smaller and more focused on eating your lunch.

Schoenberg: This is what I was getting at. The idea that when you have only testosterone sitting around the table — maybe there should be a bank ratio for that — it can lead to a wild-eyed growth-at-any-cost mindset. And what you’re saying is you have a lot of reservations about that approach.

Erwin: Exactly. It’s my job here to build a franchise that brings tremendous value to my clients, engagement from my employees and an excellent return to my shareholders who took a big risk in investing in me, especially my seed investors. And I put all my net worth into this company.

Schoenberg: Why did you do that?

Erwin: So that my investors felt like I was totally all in.

Schoenberg: On that note, Judith, I wish you good luck.

Erwin: Thanks, Gregg. It’s been great coming to know you.

This interview is edited for content, length and clarity.