The vertical integration of SoFi has the core entry point right!

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There is a question that beckons for an answer.

In this fluid world, owning the customer is the challenge.

Each individual is managing a balance sheet, e.g. assets and liabilities.

Serving which side of the balance sheet, will prove to be the best entry point to develop a long lasting relationship with the end-customer?

Tech-enabled financial services are not a dream anymore. From telcos, to internet providers, to social networks, they can all aspire to offer financial type of services. Starting with basic personal financial management tools (PFM), to transactions services, all the way to investments. Most PFM and transaction related services are already very low margin services and heading to zero. The remaining higher margin services are further down the value chain and mainly related to investments. Despite the fact that margins in some segment of investment services, are being squeezed from low cost online offerings (robo-advisors), there are still substantial margins that remain. Even though they are decreasing also, they don’t seem to be heading to zero.

Markets are efficient but the time needed to reach this equilibrium type of state, is uncertain. Technology is altering the investment segment of financial markets and creating havoc for financial advisors and asset managers alike.

Seems like there is a new segmentation being formed in the investment segment of the market, with one part of it being cannibalized and another part not. But the latter one, has no other option but to redefine its value proposition and is being pushed towards some kind of Vertical Integration.

At the same time, we have to admit that technology has not been able to sweep the unadvised assets, still sitting around despite the negative deposit rates in most of the world and despite the old-fashioned vault keeping services that deposit taking institutions offer. We have been pointing to this fact,

The Unadvised Assets, and the quarterly data that we collect show no significant change in the “Lazy Cash” figures.

(Read Oh, the things you could do with the enormous Cash pile!). That covers the asset side of most balance sheets of individuals.

On the other side of the balance sheet, there are our liabilities or our debt. This is the part that actually weighs more than saving and investing. From a more holistic perspective, the debt side of our balance sheet is heavily defining our decision making, our life-style and is more sticky. Debt decisions and debt management, affect much more our life. They not only are typically, larger in size, both absolute and percentage wise, but our life is much more sensitive to these factors.

In other words,

allocating capital and managing the risk on the debt side of our balance sheet is larger, more complex, and determines whether we reach our goals or how far away do we end up. This is primarily where we all need advice (human, bionic, hybrid) in the first place, and subsequently in the investment segment of our finances.

Incumbents and Fintechs, for the most part, have got this order of priorities wrong!

Incumbents have a long history of silos between business units, segmentation by product areas, and very low cross-selling rates. The large ones are struggling with the daunting task of integration, platformification, or a holistic approach to the existing large customer base.

Lets watch and see, whether Marcus for example, the consumer lending innovation from Goldman Sachs truly succeeds in destigmatizing personal debt (check out Will Goldman become a verb? Watch the Marcus ads!)? And then, in an invisible way, manages to simplify your first mortgage. And create a full stack for the customer, by integrating their deposit taking offering, their debt offering and management, and their investment capabilities.

On the Fintech side, will it be Betterment which is investing its recent large (for the robo space) funding round into the investment segment of our financial needs, that will invisibly move from its current Home improvement loan offering in certain states, to a full fledged mortgage offering?

Or will it be SoFi, who is investing its ten fold recent funding, into the mortgage segment already, that will easily move into the investment robo-offering later?

SoFi has been growing through the refinancing part of the value chain starting from student loans. From that same niche, they have been growing for more than 3yrs, their mortgage business. In other words, they have been advising their customers on how to manage their debt, from student loans to mortgages! In November, SoFi announced a partnership with Fannie Mae and a new offering, the Student Loan Payoff ReFi.

With SoFi’s new offering, the Student Loan Payoff ReFi, homeowners will have the ability to refinance mortgages at a lower rate and pay down the balance of an existing student loan. With its cash-out refinance student loan payoff plan, SoFi will pay down the student loan by disbursing payment directly to the servicer of the student debt. SoFi is a Fannie Mae approved seller servicer. Source

 This is not just another offering that is cheaper and faster. This is about parents who have co-signed student loans, that will be able to free up their digital assets. It is also about homeowners that manage student debt, being able to optimize the way they manage their capital and risk.

While the headlines are focused on the Zenbanx acquisition (covered in SoFi buying Zenbanx either signals the first Mega NeoBank or a unicorn losing the plot), what is really happening is

the creation of a platform business that is about managing both sides of the balance sheet for retail customers, that has been built around the core business of advising retail on the debt side.

SoFi is a business innovator because it has the priorities right in building a successful business to serve retail customers.

SoFi has realized early on, that the value lies in managing the debt side of the balance sheet for retail customers.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

SoFi buying Zenbanx either signals the first Mega NeoBank or a unicorn losing the plot

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SoFi became famous for raising $1 billion in Q3 of 2015. Unicorn valuation is big club (with more hype than reality as we said during the mega hype phase at the end of 2014), but a unicorn round (raising $1 billion in a single round)  is a very elite club. We normally only see unicorn rounds in China, where the investors are big companies rather than funds. This story also has a China twist, read on for that.

SoFi timed their $1 billion raise perfectly in late 2015 when Fintech was still in Wave 1 (the “this is revolutionary” wave as defined in this post). Since then Market Place Lending (MPL) hit some problems that dragged down the whole Fintech market and we went through Wave 2, when the conventional wisdom was that entrepreneurs should knock politely on the doors of the incumbent banks because they control the pace of change.

The news that SoFi was buying Zenbanx signals that SoFi has no plans to knock politely on the doors of the incumbents – they want to compete head on with the banks.

This could mean we are witnessing the birth of a Mega NeoBank. Or it could mean we are witnessing a company that raised too much during the hype cycle and is now losing the plot. This is post shines a light on that question. The answer will reveal a lot about the state of the Fintech market as well as the specific fate of SoFi.

This post will cover

  • What do Zenbanx do?
  • Who funded Zenbanx?
  • What comparable events help with analysis?
  • The TenCent China part of the story
  • Our take

What do Zenbanx do?

In the words of Mike Cagney, CEO of SoFi, when announcing the deal, Zenbax offers a “mobile banking account that lets people save, send and spend in multiple currencies.”

Save, send and spend has a nice ring to it. It describes quite simply why we use a bank. Oh and borrow and that is what SoFi already enables.

Two key things about this:

  • This is not just a Current/Checking account, covered by some payment license and using a pre-paid mobile wallet. It is also a Deposit account which as per the Zenbanx FAQ is FDIC insured. That is a big deal for a Market Place Lender like SoFi. It means they can get a low cost of capital. This looks like a head to head competitor for the Goldman Sachs Marcus service.
  • It is a multi-currency account. It will be interesting to see what SoFi does with this. It may simply remain a cross border money transfer service to American customers; SoFi is totally focused on the American today. Or they may use it at some stage to go global.

Who Funded Zenbanx

Crunchbase does not show the Zenbanx investor. Possibly it was changed post acquisition. So we went to CB Insights and found three Seed Investors:

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  • DCM is a classic Silicon Valley VC.
  • TenCent is the T in BAT (more on them later).
  • Recruit Strategic Partners is less well known. They come from Japan but invest globally. They are a 100% subsidiary of Recruit Holdings, a diversified company that began in the 1960s as an advertising agency that specialized in university newspapers.

What comparable events help with analysis?

  • BBVA acquisition of Simple in 2014. BBVA paid $117mn in 2014 and has since taken impairment charges but claims to be happy with the deal and to continue investing. The great results of a digital bank incubated by an incumbent such as ING (see interview here) indicates that they could be successful.

The TenCent China part of the story

TenCent was a Seed Investor in Zenbanx. In December, Zenbanx announced how they are using WeChat to offer what they call “conversational banking”.  Expect Facebook to be paying close attention as they figure how to monetize that $19bn WhatsApp deal. Alibaba is already the dragon in the room with their acquisition of MoneyGram.

The long-awaited move of GAFA and BAT into payments is happening now.

Our take

Banking is a service business not a winner takes all network effects business (see this post for more on that theme).

So we expect a number of full stack global Neobanks to be successful. So both N26 and SoFi can be success stories, albeit with different strategies. As can Neobanks incubated within an incumbent such as BBVA and ING. Whether the starting point is a VC backed startup or a legacy bank, the end game is the same. This is the convergence thesis we first outlined here.

Image Source

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Why the reputation economy is central to fintech

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Photo by Denis Dervisevic

In a two part series, we delve into the reputation economy and its impacts on small business finance and banking. In today’s first post we explore the basic concepts and thinking behind the reputation economy and its growing relevance in B2B and B2C transactions.

If you’ve ever been fortunate enough to see David Birch from Consult Hyperion speak, you’ll hear him argue that if you really want the big picture stuff when it comes to upheavals in finance, you shouldn’t really listen to the technologists, you should listen to the social anthropologists. In his opinion, they help technologists understand the impacts of technological change.

And one of the growing areas of discussions taking place across the anthropological community right now is the rise of the reputation economy, and its increasing intersection with technology.

It’s evident that more and more of the offline activities we engage in, especially those that add or detract from our reputation, can and are being digitised. Our reputation is becoming a digital asset, which we can trade off in order to grow our wealth. We see this in play today when we choose to transact with Airbnb hosts with good reviews, or book a ride with an Uber driver with a five star rating. A better reputation is a golden ticket to wealth creation for many small business owners or ‘sidepreneurs’.

The idea of reputation being intrinsically linked to our ability to ‘get ahead’, either personally or in business, is hardly new. But the ability for us to harness and amplify the digital version of our reputation out to hundreds, if not thousands of weak connections is. And the impact of this on small business owners and their customers is profound.

Take Uber for example. Through its rating system, drivers can harness the power of the crowd through passenger reviews to increase their rating, making them more likely to be selected by people like me for future bookings. The irony is such systems work just as well in reverse, with Uber drivers able to rate their passengers as well. Say I were to upset or disagree with a driver, it’s quite possible I may receive a negative review, resulting in being denied passage in the future, or during peak times.

The old dictum of ‘the customer is always right’ is vanishing. Now the degree to which both parties – seller and buyer – demonstrate mutual accountability towards each other is tracked for eternity online. Many argue these advances are a good thing for the social fabric of society, allowing us to engage safely in global commerce like we would with trusted business owners in our own immediate village or town.

But is there a dark side to the digitisation of the reputation economy? Literary giant Bret Easton Ellis certainly thinks so, making a strong case in an article for the New York Times titled Living in the Cult of Likeability. His argument is summed up eloquently in the following quote:

“The embrace of the reputation economy is an ominous reminder of how economically desperate people are and that the only tools they have to raise themselves up the economic ladder are their sparklingly upbeat reputations — which only adds to their ceaseless worry over their need to be liked.”

Easton Ellis’s article deserves to be read in full so as to truly appreciate this passage in context. Ellis also speaks to the online ‘gaming’ of our reputations – in which many of us engage in to some degree via social networks.

But to step away from the subjective elements of our reputation to the objective ones, then there are often cold, hard facts that can be found that do define whether or not we stack up in the eyes of others. And when those others are banks and the reputations in question are those of small business owners, then generally speaking this is our credit score.

Today the standard industry credit scoring model is one dimensional and lacks nuance. The bank views the word ‘reputation’ as to how its deposit or loan book contributes to its standing in society, rather than how it can meaningfully contribute to the standing of the businesses it serves in the wider community.

The first wave of innovation in fintech will see banks and financial providers find better credit scoring models that use alternative data. Companies like Aire and Sofi fall into this category. Kreditech is another, as covered by Bernard back in June.

The second wave of innovation will be fintech banks that want to find ways to use data to enhance the reputation of their own customers. Today the most basic form of this idea in action is comprehensive credit scoring. However the applications and arguments around this are generally skewed towards helping financial institutions better price their own risk, rather than actively improve the reputation of a small business owner.

I think there is room for a fintech bank who’s reputation improves when their customers’ reputations improve at an individual level, not a macro one. I’m imagining a bank that actively participates in helping a small business owner build a valid, verified and non-gamified reputation that they can use to enhance their interactions with their own financial web of customers and suppliers. This is what we’ll explore in next weeks post.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Jessica Ellerm is a thought leader specializing in Small Business.

Searching for the Priceline of Fintech after Lending Market Meltdown Week

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You could have bought Priceline stock below $10 in 2001. For many years you had little to show for it. From then until 2008, you had some appreciation, but not much. Then the stock shot up above $1,000 (as of writing it is $1,261). Yes that is 100x return from a liquid public company! Could Ondeck ($ONDK) or Lending Club ($LC) be a similar story today? Or could one of the still private ventures such as Prosper, SOFI, Funding Circle and Kabbage seize the day?

Ondeck – first in, maybe first out.

Ondeck was the first Lending Market to go public, before Lending Club. Both have been hammered since their IPO and last week was a blood bath that we call Lending Market Meltdown Week, with gloomy news from Lending Club and earlier layoffs from Prosper and an earnings miss from Ondeck. There are three scenarios for Ondeck. One is that Ondeck is the bargain of a lifetime, like buying Priceline after the Dot Com crash. The opposite scenario is that Ondeck is headed to the deadpool. Or Ondeck could be bought by a bargain hunting PE firm for a small premium – possibly after further pain.

We outlined the Ondeck bear case when Ondeck did its IPO.

In November 2014 we took a negative view of Ondeck based on an analysis of their Customer Acquisition Costs and their APR %. Investors who heeded that warning would have saved a bundle. Sign up for Daily Fintech by email so you get your insights ahead of the pack – its free.

In Nov 2014 we wrote:

“The weakness in the Alternative Credit model is a very old-fashioned metric – Customer Acquisition Cost. If they have to pay a lot of money to brokers or to advertise, their CAC maybe too high.

A high CAC is fine if you get a lot of repeat business. That translates to a high Life Time Value (LTV). The metric to track is CAC/LTV. That works in a SAAS business. You spend a lot of money to acquire the customer because the churn rate is low, your CAC/LTV ratio is still OK. If you spend a lot of money to acquire the customer and the churn rate is high, your CAC/LTV ratio will be bad and that translates into a profitability problem.

This is where Alternative Credit businesses that offer short term “stop gap” funding have a fundamental CAC/LTV issue. When pressed about the high APR rates (which you get to by multiplying the interest on a 30 day loan by 12 or a one day loan by 365), the response from Alternative Credit businesses is that the APR rate does not apply in their case because the borrower only needs that “stop gap” financing occasionally.

If that is true, they have a churn problem aka a CAC/LTV issue. If it is not true, because borrowers become reliant on “stop gap” funding, then those APR rates are true and that puts the borrower into financial difficulties. That is where you can end up on the front page in a bad way, like Wonga. Reputation risk and regulatory risk are closely related in the social media age.”

We went looking in the latest 10Q to see if anything has changed in those 18 months.What we wanted to see was whether they were either getting more repeat business (ie lower CAC) or making money on lower APR % (ie getting higher credit quality borrowers). Either is fine and might signal opportunity.

The Priceline story

That 100x return from a liquid public company had three ingredients:

  • Total crash in sentiment (all tech was dead).
  • Fundamental tail winds – the Priceline model was right and the Internet was just getting started.
  • Patient smart management that executed well.

Could that be the story for Ondeck? Or Lending Club?

Most likely Ondeck scenario is a cheap buyout

We discarded the quick trip to the deadpool thesis because Ondeck has plenty of cash compared to any that it might be burning.

Nor did we see any evidence of the big upside Priceline of Fintech story. We don’t see any evidence of a big uptick in credit quality or of repeat customers. It is possible that Ondeck is doing this but the results are not yet visible. If you have some insights in that regard, please share them in comments.

So, Ondeck is a boring story – no sudden death and no rebirth to greater glory. Some sharp-pencilled analyst at a PE fund will figure out a value story and take it private. At below $400m market cap, Ondeck is too far below the small cap hell threshold of $2bn to survive as a public company unless there is evidence of a Priceline type story. We suspect that many PE firms had been looking at Ondeck before last week and the valuation just became more compelling. This is all about valuation and timing. Wait a bit longer and you may get it cheaper. Wait too long and somebody else snaps it up.

Kabbage is hoping to shred Ondeck into coleslaw

Kabbage is in the same game as Ondeck – SME loans – but they stayed private. Their marketing emphasises the K in their name – cute does sell as anybody who looks at kittens online will attest – or should I say kute? However an SME owner will go for a really boringly named venture if their lending terms are even fractionally better. No matter who wins the SME lending market (it is big enough for multiple winners), the SME owners will benefit from the competition and that will be good for the overall economy.

The Daily Fintech thesis is that SME Lending is a market opportunity big enough to drive a truck through. Looking globally we see the micro entrepreneur intersecting with what we traditionally call consumer lending. That is why we devote one day a week to this subject – Wednesday’s coverage by Jessica Ellerm.

Priceline had a unique model. If you have a unique model you are ignored, laughed at, fought and then you win (in the 0.1% cases where a unique model is actually correct – you have to be contrarian and right). It is unclear that Ondeck has a unique model. The basic value is faster, more efficient loan processing than banks using digital forms and big data analytics. That is valuable. There is an arbitrage between what it costs a bank to process a loan and what an AltFi originator such as Ondeck, Kabbage or SOFI manages. The inefficiency of bank loan processing leaves plenty of room – but like all arbitrage plays, winning is about speed of execution.

This leaves Ondeck vulnerable to a better, faster, cheaper alternative. The technical innovation around digital forms and big data analytics makes it possible for many new entrants. One is reaching some reasonable scale – Kabbage. This Atlanta based private venture raised a $135m Series E in October 2015, so they are well capitalised. Investors were already in a “show me” mood in October 2015, so although we do not have access to the financials because Kabbage is private, we take the $135m Series E as a proxy for good traction.

Nerdwallet has a good comparison of Kabbage vs Ondeck vs Paypal. FitsSmallBusiness adds PayPal into the SME owners short list. WeRockYourWeb adds Lending Tree and Lending Club into the mix. SME owners who know how to use Google can quickly add FundBox, Prosper, CAN Capital and Funding Circle into the mix. In short, SME owners who annoyed their local bank manager by beating them at bridge have more options (ok, enough Mr Smith Goes to Washington fantasies, we understand that Banks have depersonalised service and you are unlikely to ever meet a bank manager).

One venture success mantra that works is “build xxx that does not suck”. The AltFi Loan originators are doing “loan application processing that does not suck”. Google with email and Amazon with hosting are examples of hugely competitive markets that rewarded a better, faster, cheaper alternative. They also had patient capital – you know, like somebody buying Priceline in 2002 and waiting 14 years for a 100x return. VC funds are constrained by need to give liquidity to to LPs and public market investors think they have to exercise the liquidity option (unless they are Warren Buffet); but that is another story. The point is that a great user experience and great customer service is what matters. Zappos is another “build xxx that does not suck” in an overcrowded competitive market. Banks and Altfi management teams should study Zappos more than Lending Club as this is a service business.

SOFI shows how fast follower should be done 

Sofi (as in Social Finance) bills themselves as “a modern finance company that’s fueling the shift to a bankless world”. SOFI is a startup financial services business that uses technology. This is an example of what we call the Great Fintech Convergence  – who cares whether it is a tech powered Financial Institution or a tech company that is regulated, as long as the terms are right? You can come from Fin or you can come from Tech – the destination is the same.

SOFI made a smart move. They started with student loan refinancing. The bet was that this would lead them to consumers who would become good credit risks, because their earning power would increase as their career took off (as the ROI on education is still strong because the R part is good even if the I part has suffered from horrendous inflation). From this market entry they moved into Mortgages and now their site is also talking about Personal Loans and Wealth Management. This HENRY strategy (High Earning Not Rich Yet) is explained well in this A16Z post.

SOFI is not touting any tech secret sauce. Nor is this a network effects game. This is a strong management team using everything in their arsenal to go after the big picture – the vertically integrated bank model morphing into a networked marketplace model.

Founded a few short years ago in 2011, SOFI raised a whopping $1 billion in September 2015 (billed at the time as enabling them to delay IPO until the market is ready). Although SOFI is based in San Francisco, the approach feels more like a Wall Street approach, with seasoned ex Bankers on the team. For another big shot at this brass ring, this time from core Wall Street, see Goldman Sachs moving into retail banking.

Could Lending Club be the Netscape moment in a bad way

When Lending Club had their IPO we called it the Netscape moment for Fintech. The first part of that story played out. Venture capital rushed into Fintech in 2015. Students of tech history will recall that the Netscape story did not end well  – they ended up being crushed by Microsoft.

We see no signs of the second part of that story in the case of Lending Club. There is no equivalent of Microsoft – a single behemoth competitor run by a brilliant and tough CEO. Lending Club has over $600m in cash with a cash burn that puts the company in no danger of a liquidity crisis. At a market cap around $1.5bn they have moved into small cap hell territory and trader’s mantra is “don’t catch a falling knife”, so we can expect further pain in the stock price. Lending Club is now a cheap stock. Wow.

Lendacademy has a good summary of what went wrong that led to the CEO resignation as well as a look at their latest financials.

The positive way to read the announcement was that Lending Club has an active and responsible Board that came across something bad and took quick action. There is always the suspicion that “if you see one cockroach, there must be more” and that suspicion will be a drag on the stock for a bit longer; but if you take a longer term view (like those smart enough to hold onto Priceline) you could be handsomely rewarded.

Unlike Ondeck, Lending Club has network effects on its side. This could be a a Priceline story. Two out of three ingredients are here:

  • Total crash in sentiment. Tick – all Lending Marketplaces are dead.
  • Fundamental tail winds. Tick – we are not going back to a vertically integrated bank model and Lending Club has enough network effects to be at least one of a couple of big global winners.
  • Patient smart management that executed well. TBD. Lets see who the new CEO is.

If you incline to the view that Lending Club’s trajectory is southbound, this HBR article about negative network effects will reinforce your thinking. TL;DR, network effects are about trust and trust can be lost. One assumes that the Lending Club Board fully understand this. The new CEO will come in after this Tylenol Moment. The immediate actions of the new CEO will be interesting to watch.

Prosper could have it right with Prosper Daily

Prosper started even earlier than Lending Club – in 2005. They went through a near death experience thanks to a brush with regulators that they did not handle well and re-emerged in 2013 with new investors and new management. This is a battle-tested team. They clearly opted to stay private and they got their painful cuts over before the Lending Club scandal broke.

The reason I think Prosper may have got this right is their acquisition of Billguard in September 2015.  This Israeli venture found a clever way to find all those small errors in your credit card bills. They offered it free, because this was a networks effects game – other users saw a wrong charge and highlighted it so that you could take action. In March 2016, post acquisition, it was rebranded as Prosper Daily.

The name Prosper Daily signals that Prosper aims to pass the  toothbrush test.  The reason this is so important is that regular use means low CAC – see our November 2014 analysis of why Ondeck was flawed. This is why banks have done so well for so long. Because we used them all the time for our current account needs, we were more likely to turn to them when we wanted a loan.

The sort of customer who checks for small errors in their credit card bills is more likely to be the kind of prudent customer who is a good credit risk and who may still want loans when other have become credit averse – a subject we covered here.

Funding Circle

In our 2016 Predictions we had # 9 as “Calls for regulating Fintech startups more intensely will follow at least one high profile blow up.” Tick that box after Lending Club CEO resignation (actually two ticks as the Zenefits story has the same trajectory). The regulatory backlash after Lending Market Meltdown Week will take time to play out, so more pain is to come.

This is were Funding Circle is interesting. We wrote about Funding Circle in October 2015 as the only UK lending marketplace crossing the Atlantic to take on the US market; all the other big players are American. Funding Circle has done a lot of innovation in this market  – the first listed investment vehicle to buy lending marketplace loans, Europe’s first peer-to-peer ABS – but it is their proactive leadership in setting up the Peer to Peer Finance Association (together with Zopa and Rate Setter) that may help them stay a step ahead of the regulatory mess coming out the Lending Club news.

Lending Marketplace Meltdown Week caused blood in the streets, which brings out those who  are greedy when others are fearful.

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech. Bernard Lunn is a Fintech thought-leader.

Who’ll help small business get credit-score ‘fit’?

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As consumers, many of us are in the dark about our personal credit score. Sure, we can probably find it out, but how many of us would know, off the top of our heads, where on earth to start?

And it’s not just consumers that need to take a more active interest in their credit history. Personal checks are usually part and parcel of any small business owner’s finance application. In fact, having a good credit score can mean tens of thousands of dollars saved each year on borrowing costs.

In what has to be one of the greatest fintech growth marketing hacks in recent years – well in Australia anyway – personal lender SocietyOne launched a campaign in 2015 offering Australians free access to their personal credit score. Within days, 50,000 Australians had logged on to the site to claim theirs, generating millions of dollars of publicity for the company in the process.

While getting consumers engaged about their credit score has no doubt helped SocietyOne spruik their personal loans, other startups like Credit Savvy in Australia and Credit Karma in the US are helping consumers not only access their score, but shop it around multiple providers. It’s truly the beginning of a serious credit revolution.

So in the interests of firsthand research, I decided to try it out myself via Credit Savvy.

It was, as it turns out, relatively painless. After inputting a few details about myself and providing my passport number, within 2 minutes, there it was, staring back at me: my credit score.

The results however were moderately underwhelming. Turns out I’m ‘Okay’ – not ‘Good’, ‘Very Good’ or even ‘Excellent’. A terminal high achiever in other aspects of my life, I was rather disappointed in my averageness. So I dug a little deeper. And of course, it just kept getting greyer. The only real clue as to my middle of the road result were a number of credit card applications. No glaring defaults, or serious credit infringements.

So I started hunting around, for tips and tricks I could do to increase my score. Needless to say, most of the advice I found was directed at individuals with serious faults to their name. Given that wasn’t me, what next?

The next port of call was my bank. Looking at my thin credit file, it appeared there was no positive reporting regarding my timely credit card repayments. Comprehensive Credit Reporting (CCR), which documents both positive and negative information about an individual can help consumers like me drive up their score. After further investigation, it appeared neither of the major financial institutions I banked with had chosen to ‘voluntarily’ participate in Australia’s CCR regime.

After this I got a little mad. There’s so much more to me! What about my wage, my level of education, my service provider loyalty? Or my multiple income streams, hedging me against economic downturns? Surely all of this paints a very different picture of me as a borrower?

Well, it turns out more and more fintech startups agree. In fact some online lenders, like SoFi are eschewing traditional credit scores altogether, claiming they aren’t ‘a real driver of credit performance’.

Then there’s startups like Aire, who are stepping into the ‘grey’ void in an effort to try and humanise credit scoring for other companies. Aire generates its own score after assessing responses to simple questions around financial behaviour. Coupled with machine learning, the company looks to partner with companies who after trying the ‘traditional assessment route’, hit a grey zone, or ‘marginal decline’.

There seems to be an opportunity for a fintech startup to grab the bull by the horns when it comes to credit scoring. Helping people like me – who in theory could be the small business borrowers of the future – get credit score ‘fit’. What about an online lender that promised to help its borrowers do exactly that? It’s a reversal of protectionary bank think, which looks to keep its borrowers on a need to know basis when it comes to their credit score. If, heaven forbid, it might help them negotiate a little harder.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Jessica Ellerm is a thought leader specializing in Small Business.

5 Opportunities as Lending Marketplaces enter hyper growth 

By Bernard Lunn

Marketplace Lending

Image courtesy of Ethos Private Wealth 

Thesis: hunger on origination side from small business + hunger on investor side starved of yield by prolonged ZIRP + banks withdrawing due to balance sheet and capital ratio issues = window of opportunity big enough to drive a truck through.

Evidence:

+ Lending Club valued over $5 billion in public market after their Netscape moment for Fintech IPO.

+ Prosper $5 billion loaned to 250,000 people.

+ Funding Circle going global. 

+ $1 billion raised by SOFI.

+ 2 year old Avant raising $325 million at a $2 billion valuation.

= investors willing to write really big checks to back the big winners.

Prize:

These businesses are scaling like crazy and are still no more than 5-10% into the market. This Morgan Stanley report has the data.

5 Opportunities: 

It looks like the big marketplace winners have already been declared. Before the SOFI and Avant announcements, I would have said the same thing. If there is another strong team with great traction out there, expect to see open check books being waved around. It is certainly too late to start a marketplace from scratch – those days are over. I also see the end of niche plays. SOFI may have started with student loans but all marketplaces win on network effects and volume. So whether you are consumer or a business and within consumer whether you are a Millennial Student or a Baby Boomer refinancer does not matter.

However here are 5 second order impact type of opportunities. Moving into a hypergrowth market is great if you have a unique proposition. You don’t need to worry about market demand, only about how you get traction with a new service.

  1. More innovation on originations front. Today we are seeing relatively simple digital data entry by borrowers and basic data science as the key innovation. That was enough to get traction in the early days simply because the lumbering paper driven process at banks was so bad. Now that a digital origination service is the baseline, we can expect to see more innovation on both the data capture side and the data science part. Innovators that we are seeing on this front include Kreditech and IWOCA. It is likely that some of these innovators will be acquired by the big marketplaces.
  1. Serving entrepreneurs in the “markets formerly known as emerging”. These entrepreneurs have been even more badly served by banks than their peers in the West and they have high GDP growth economies on their side. For example, see what this entreprenur turned VC turned entrepreneur again – Alok Mittal – is doing in India.
  1. Banks will find a role to play by being the low cost capital provider. This is what Banks do in Corporate Lending – a low margin high scale game where cost of capital is the primary issue. They will mostly exit the originations business; some may decide to be a player in originations by buying one of those innovators. Banks never liked serving small business anyway. Now they can just lend to bundles of small businesses as if they were one large Corporate.
  1. The Wealth Management industry reshapes around this new reality. They will work with the emerging breed of micro asset managers who know how to process the data streaming out of lending marketplaces using their APIs to offer their clients a better risk adjusted return on capital.
  1. The move from short term lending to term lending. Nobody wants to repeat the Wonga debacle. Merchant Cash Advances are not much better. Term Loans at transparent APR is what any prudent small business owner wants. That is why we highlighted Dealstruck a year ago. The firms offering short-term loans will move more into term loans as competition and transparency puts the focus on APR. The short-term lenders making that transition will have one big advantage – data. The data on who repaid short-term loans and how much revenue and cash flow coverage they had to do that is key to assessing their credit worthiness for term loans.

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech.

$1 billion raise by Sofi heats up the Uber of marketplace lending battle

By Bernard Lunn

Although the Uber of Banking tag does not make sense, narrow it to marketplace lending and the tag is certainly appropriate.

The reason is simply network effects. Banking as a whole is a service business not a network effects business. My decision to use bank x rather than bank y does not influence anybody else’s decision.

Marketplace lending is different. More borrowers attract more lenders and vice versa.

In a network effects battle, the players amass massive war chests. The recent $1 billion raise by Sofi shows that they have joined Lending Club and Prosper in an intense network effects battle.

Lending Club was the first to IPO and that certainly gave them name recognition and it became the Netscape moment for Fintech. Although the stock has not performed well, Lending Club is still valued at nearly $5 billion. Many great companies had bad stock performance and recovered when they reported good results (Facebook for example).

OnDeck is a different story. Not only has their stock performed badly, but their market cap is now so far below $2 billion that they fall into small cap hell (ignored by most funds) and few stocks emerge from small cap hell. When OnDeck first came out to IPO, we figured they had a problem with Customer Acquisition Cost (CAC).

The giant Sofi raise ends the niche marketplace story. Sofi started in student loans, but that was simply a market entry strategy as we reported here.

Mortgages will be the next big battle ground that has so far been relatively untouched by innovation.

Working capital finance is the massive opportunity that many have attempted but nobody has got right yet.

All these massive markets are niches within marketplace lending. When you realize how massive these markets are such as student loans, mortgages and working capital finance, it is strange to think of them as niche, but within the context of a marketplace that is what they are. If you are a lender, you want to define things like % return, maximum drawdown, loss rates and liquidity ie risk adjusted return on capital. You don’t care if the underlying asset is a student loan, mortgage, invoice finance or whatever. Similarly a borrower simply wants lots of lenders competing to get a low rate and does not care if that lender is an individual or an institution.

Prosper will be the one to watch now. They were the early pioneers,  they have done $5 billion in loans and have top tier investors. The game plan used to be to do an IPO at this stage to get the branding value, but they may decide to stay private. If they do, expect some aggressive moves – remaining private no longer means thinking small..

This is not game over for banks – far from it. Marketplaces are good for service businesses and vice versa and service businesses are usually valued more than marketplaces in the long run as we report here.

Banks and marketplaces are natural allies. This is the kind of strategic Fintech dealmaking that we focus on at Daily Fintech Advisers.