online lending

PAYMENTS: Is Digital Banking hurting the Underbanked?

Here's a conundrum. You don't have a bank account and therefore cannot set up a digital payment option. Now try ordering and paying for an Uber! This example reveals a simple truth: digital services -- and in particular digital financial services -- can be regressive (benefit the haves, hurt the have-nots). As countries like the United Kingdom, China, India and the Nordics move towards demonetization, driven by technology and policy, the social and structural implications of getting rid of cash could make things a lot worse for the most vulnerable. Based on a recent UK report linked below, lowest grade workers and the unemployed use cash 49% of the time for their purchases, while those in the highest professional occupations use cash only 39% of the time. And conversely, card use is split at 37% (low income) vs. 44% (high income).

Weird. Fintech is supposed to be a democratizing force that allows anyone, regardless of account size, to access quality financial product. Let's stick with the UK for a clean analysis. If you look at penetration of mobile devices, 85% of the populace owned a smartphone in 2017, massively up from 52% in 2012. So that means, generally speaking, most people have some payment-enabled digital hardware that they can lug around in their pocket. And yet that device is not the financial key (yet) for the unbanked and underbanked. Why? One hypothesis is to look closer at the rails on which money travels, and their interoperability.

The first is paper cash. It requires no intermediaries, at least in concept, and therefore 100% of the population is able to "self custody" a little bit of it under their bed, and use it for commerce. The second is banking. Banking intermediates the financial system, and allows for modern services to function and thrive. But it also has an onboarding cost, set by the banking industry's risk tolerance, set by the legislator and the regulator, which may be prohibitive to some share of the population. It excludes "bad risks" by design. Banking also introduces costs into moving money around, which must be covered through business activity, and often warps into unethical economic rents (i.e., overdraft fees). When we talk about mobile payments, what we are really talking about is extending the banking system into the population that has adopted mobile phones -- and this excludes unbanked mobile users. As homework, we suggest the reader think about WeChat (mobile UX, media industry intermediation, government rails) and Bitcoin (mobile UX, hardware industry intermediation, blockchain rails) as being a solution to avoiding the regressive outcome. 

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Source: Access to Cash (Report), Consultancy UK (2017 mobile penetration), Latin America's Banking Revolution (Euromoney)

ONLINE BANK: Varo Money Banking License and the OCC Charter

Let's review. In the US, the OCC hands out national banking licenses at the federal level. States also regulate and charter banks at the State level. Such regional banks and credit unions are subscale relative to players like Bank of America or Wells Fargo that have a national branch footprint and digital apps. But these small banks have community ties and are protected business interests within the States through lobbying. If the OCC makes it too easy for digital players to create online banks that live in our pockets through mobile phones, regional banks (with poor technology and digital client experience) will lose out. That dynamic actually has not at all played out with roboadvisors, who face the same regulatory jumble with the SEC and local Registered Investment Advisors, but so the story goes. 

Digital lenders perform a banking function (i.e., lending), but don't have a banking license or FDIC insured deposit capital. Their money comes mostly from investment funds, which is a shadow banking set up. They got around licensing by partnering with Bank-as-a-Service players. Some, like Square and SoFi, have looked at becoming an Industrial Loan Company in Utah -- a sort of quasi bank entity -- but haven't been able to pull the trigger. Neobanks in Europe got around licensing by riding the rails of pre-paid cards from the likes of Visa and MasterCard, pretending to have checking accounts while really just digitizing gift cards. Until now, as Monzo and Tandem have powered up the ability to take deposits via the FCA. So now we come to the point.

Recently, the Treasury encouraged the OCC to issue Fintech bank charters, and the OCC opened its doors for business. And immediately, the Board of Directors of the Conference of State Bank Supervisors (CSBS) announced that it is moving forward with litigation against the OCC. Way to kill the vibe! But that has not stopped fintech Varo Money / Varo Bank from getting a conditional de novo national bank license -- it can take deposits, move money and underwrite lending. Almost none of these have been granted since 2008, and so such a charter going to a digital-first player is a shot across the bow (granted, Varo needs to raise $104 million). The other interesting piece is that Varo is going to use Temenos, a European B2B2C bank platform for its core processing. Not FIS and Fiserv, the US versions of the same that power that long tail of State banks and credit unions. That's a big shot across the bow.

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Source: CrowdfundInsider (Varo Money), CSBS (States suing OCC), Davis Polk (Varo Charter)

ONLINE LENDING: $65 Million Venture for Lending Club CEO's "Upgrade".

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The world is full of second chances it seems. Renaud Laplanche is a rare entrepreneur, building Lending Club into a public company ($575mm in revenue, $1.6B market cap), and kickstarting the P2P lending industry. But he was also caught up in a governance scandal in 2016, which resulted in a resignation and questions around ethical conduct. Within two years, Laplanche has raised $142 million of venture funding for his new company, Upgrade, of which $62 million came in this week. The startup, which (similar to Lending Club) offers personal loans, already has over 100,000 customers and more than $1 billion in loan originations. This man knows how to build a digital lender!

Another persona that knows how to build a digital lender is Mike Cagney. Cagney was the founder and CEO of SoFi, the student lending giant known for its $1 billion investment round from SoftBank. But, he too was ousted from the seat in 2017, amidst allegations of sexual harassment and problems with an aggressive culture. Cagney's new startup is called Figure, which is a home-equity lender leveraging a blockchain infrastructure, funded to the tune of $50 million. It is a smart bet on just how unprepared people are to retire -- likely needing to extract value out of their homes, without selling them. 

What's going on here? Online lending is a mature theme, where even Goldman Sachs is originating personal loans to consumers. And didn't the IPOs of Lending Club and OnDeck fall 80% since the offering? Yet, from the Fintech Treasury report, we see that US originations are showing healthy growth, from less than $5 billion in 2013 to nearly $40 billion in 2017 across consumer, student and SME financing. That's a far cry from the $200 billion addressable market we identified in 2015. Software can be better at customer acquisition than the retail footprint, and it can also be better at underwriting the risk, using machine learning. Sure, we have not seen the other side of the credit cycle. But so far, digital lenders are one of the few categories in Fintech that have generated cashflows (e.g., Elevate Financial at $670mm) because they manufacture an asset class, which solves an accute pain point for the borrower. 

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Source: TechCrunch (UpgradeSoFi), Bloomberg (SoFi), FigureUpgradeTreasury Report