The Fintech is dead meme is now in full flood. Authoritative sources such as this Deloitte report (with sensationalist headline from Business Insider) add credibility to this meme. This feels like the Internet is dead consensus in 2002. At the time I vividly recall the relief with which media companies and retailers greeted the demise of the Internet – “phew, pleased that craziness is all over and we can get back to business as usual”.
This time is NOT different.
These boom and gloom cycles are the norm. 4 of our 2016 Predictions in December have already come to pass (updates in italics):
# 3. Momentum Capital (short term hype chasing) into Fintech will slow down but Innovation Capital (funding long term value creation) will increase because the reality of the opportunity is not impacted by the hype cycle. The crash was obvious but we are also seeing new VC rounds getting done and Lending Club stock bouncing off the bottom.
# 5. Consolidation will start in Lending Marketplaces. There will be a fierce battle for a winner takes most network effects market (similar to what we saw in ride sharing in 2015). This is happening now. It looks like Lending Club and Prosper will survive and thrive unless the whole model is flawed (which we do not believe for reasons explained below).
# 6. The strange inversion we saw in 2015, when private companies were valued higher (on paper at least) than public companies, will end in 2016.The headlines will refer to Unicorpses. This is happening but is not yet over. It means private valuations have further to fall and public valuations (of a few winners) will rise.
# 9. Calls for regulating Fintech startups more intensely will follow at least one high profile blow up. The Lending Club blow up qualifies and has led for calls for more regulation.
3 Predictions for 2016 still to come
(Apart from predictions relating to Bitcoin and XBRL which do not impact this story)
# 7. Analysts covering Banks will start referencing Fintech disruption when referring to a drop in profits at a major bank. This will happen if Banks start losing depositors (see later).
# 8. Moves by Big Tech and Big Retail into Financial Services will eclipse moves by Fintech startups and will worry bankers a lot more. This could come from Western Big Tech (Google has big ambitions & can play a major role in origination and comparison) or from Chinese Big Tech (Alibaba has already demonstrated big ambitions in Finance)
# 10. The Great Convergence between Banks and Fintechs commences, as both get judged on the same metrics by consumers,regulators and investors. Growth, gross margin, Customer Acquisition Cost, Churn, Lifetime Value are metrics you can use to evaluate Banks or Fintechs or Tech Enabled Financial Institutions (aka grown up Fintechs or efficient digital banks).
The Mortgage Elephant in the room
Mortgages dwarf all other lending at over $1 trillion per year in the US alone. No wonder Wall Street chose this market for securitisation. No wonder that this market could blow up the global economy when it went wrong in 2008.
As long as lenders don’t do anything silly with loan to value ratios, it is a great business. For consumers it is all about the best % rate. Making the process easier (classic Fintech advantage) is minor compared to best rate. With good collateral (if loan to value ratios stay sane) banks and AltFI can offer low rates. Which means that lowest cost of capital wins. Which means that Banks will win. It is simple. If you stacked up these two players, which will win:
- Player # 1 has lower processing costs.
- Player # 2 has lower cost of capital.
That’s right Player # 2 (ie banks) win that race.
Not quite. This is why the headline focusses on deposits.
Would Sir like some NIRP?
It has not escaped the attention of some savvy folks like Warren Buffet that paying a Bank to keep your cash is pretty weird. As Berkshire Hathaway has $63 billion in cash reserves, what Mr. Buffet decides to do with the cash has some ramifications. Even if we don’t stay long in the strange world of NIRP, investors are looking for better than zero or close to zero interest rates. So if lenders can find good risk adjusted returns on Lending Marketplaces they will seize that opportunity. If the borrowers are willing to put up their house as collateral, the risk adjusted return looks a lot better than bank deposits.
Lending Marketplaces have two sides. If Lenders move to these markets looking for better risk adjusted returns than bank deposits, then Lending Marketplaces will thrive (and Banks will suffer).
Disclosure: the author was lucky enough to buy Lending Club stock at $3.51 on May 17 (after writing this post).