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  • 🧠 Fed Enforcement on Customers Bank + The role of private credit in Fintech

🧠 Fed Enforcement on Customers Bank + The role of private credit in Fintech

Is the fed action operation chokepoint or a nothing burger?

Welcome to Fintech Brainfood, the weekly deep dive into Fintech news, events, and analysis. You can subscribe by hitting the button below, and you can get in touch by hitting reply to the email (or subscribing then replying)

Hey Fintech Nerds 👋

The enforcement actions just don’t stop.

The US Federal Reserve announced an action against Customers Bancorp for deficiencies in AML and risk management. Crypto bro’s are howling about “operation chokepoint,” but they’re wrong. Why? You’ll see in Things to Know this week 👀

Google’s new alternative to 3D Secure is another brick in the wall of all payments heading toward branded checkouts and wallets. Because incentives matter. 👀

If the future of embedded finance is lending, who’s the ultimate lender and what’s their incentive? 📣 Rant this week is about the crucial role of private credit in the Fintech ecosystem.

PS. Huge thank you to Moov and the Fintech Devcon team for having me this week. The keynote was a blast, Devcon is easily my favorite community and ecosystem show on the annual Fintech calendar.

Here's this week's Brainfood in summary

📣 Rant: Fintech’s messy relationship with Private Credit

💸 4 Fintech Companies:

  1. Numeric - Accounting Workflow and AI 

  2. Anon - Plaid for everything else

  3. Origin - If an RIA, Turbotax, Wealthfront and PFM had a baby

  4. Roam - Mortgage assumption service 

👀 Things to Know:

Weekly Rant 📣

Private credit is everywhere - Will it enable embedded lending?

To oversimplify,

Private credit is a type of lending in which a loan is created, packaged, and sold as an investment instead of being held on a bank's balance sheet.

For investors private credit feels like a sure thing. It offers

  • "Inflation beating" 10% returns (on average)

  • Over 30 years, it has lower volatility and loss ratios than fixed-income instruments like high-yield bonds or syndicated loans (bank loans)

  • Higher returns are achieved than with leveraged loans or high-yield bonds because borrowers are willing to pay a premium for the speed, flexibility, and customization lenders offer.

  • Nonbanks spread risk among institutional investors, potentially stabilizing the banking system.

The private credit market is expected to grow from $1.6 trillion in 2023 to $2.8 trillion by 2028.

(Sources: 1234, 5)

It’s created, sold, and managed by hedge funds, private equity, venture capital, or fintech firms. The industry is dominated by firms like Apollo, Blackstone, and KKR, lending to mid-sized companies with below-investment-grade ratings (typically for a higher price than a bank would lend).

US regulators manage finance via the banks. Capital requirements came in after the financial crisis to make them safer, restricting how much they could profitably lend.

Private credit now has a much bigger role in the wider economy.

  • Pre-2008: Banks dominated mortgage originations, with Wells Fargo leading at 16% market share. Eight of the top ten mortgage originators were banks, holding nearly 70% of the market.

  • Post-2008: Only three banks remain among the top ten originators, collectively holding just 8.7% of the market.

  • Nonbanks control significant portions of other markets:

         - 64% of commercial loans.

         - 58% of consumer credit.

         - 50% of commercial real estate lending.

(Source: Bank Director)

Now bankers, regulators, and even industry commentators are suggesting there might indeed be a bubble that could burst. Nonbanks operate outside traditional regulatory frameworks. Organizations like the Financial Stability Board (FSB) and IMF are concerned about the lack of comprehensive data and potential contagion risks.

Whenever something seems too good to be true, it usually is.

What if Private credit is a bubble? And what if it burst?

That would be bad given the critical role it plays for Fintech and the economy.

  1. Manufacture: How private credit enters Fintech lending

  2. Distribution: How Fintech lenders distribute private credit

  3. Failures: What happens when things go wrong

  4. Regulation: Regulators are not doing much, frustrating banks and potentially we will face issues down the road if it blows up

  5. So is private credit a bubble? Possibly, we won’t know until it goes wrong.

1. Manufacture: The role of Private Credit in Fintech.

Private credit funds and banks provide liquidity to Fintech companies. 

That loan from your favorite B2B Fintech or Neobank is likely sourced from a private credit fund. Your repayments are then made to the fund, who then returns them.

These loans have historically been a fantastic investment opportunity. 

But is it starting to unravel?

A cohort of pandemic-era loans will mature in the next few months , and things could get interesting.

The signs are starting to show in Fintech and beyond.

  • Triple Point Capital may be exposed to up to $9m of the Synapse bankruptcy (among others).

  •  Nosh reported that consumer goods B2B lender Ampla is in survival talks after taking a $258m credit facility (largely driven by private credit firm Atalaya) in late 2023.

  • Moody's downgraded 3 major private credit funds from Blackrock, KKR and Oaktree (to Baa3, just above junk)

Is this the beginning, or is it just a red herring? Every lending business will have losses; some are priced in.

The truth is we just don’t know yet. What we do know is that private credit has filled the gap left by banks since the financial crisis. In turn private credit's has helped unlock innovation in lending.

2. Distribution: Lending innovations rarely come from banks these days.

a) BNPL is the big winner in "Innovation" for Fintech's latest era. BNPL offers "0%" at checkout (online or in-store) to enable merchants to make more sales and users to manage their cash flow. Despite criticisms and often bad PR (via the bank lobby), the delinquency level and consumer health of users appears to be better than with credit cards based on our available data. (Go deeper on BNPL in BNPL is good; I will die on this hill)

💸 Who's buying these loans? BNPL often uses banks as loan originators but then securitizes them to sell them to investors. For example, Affirm uses Celtic, Lead, and Cross River Bank and its own origination capabilities and then creates Affirm Asset Securitization Trust 2023-X1 to sell those loans. The private credit investors are the same ones as the private credit funds court. And as of last year KKR had bought more than $40m of PayPal's BNPL loans from Europe.

Affirm's overall credit quality and delinquency rate are solid, especially when compared with sub-prime credit cards.

b) Tips and earned wage access have unlocked a new type of subprime lending. Chime, the inventor of "get paid early" is now moving into term lending as it considers its IPO. Dave and Moneylion just delivered exceptional quarters. As I wrote last week.

In case you missed it, Dave and MoneyLion, arguably Chime's most likely competition in the public markets, are up 915% and 263%, respectively. Dave's performance is driven in large part to its ability to get lending right. 

Between the first quarter of 2023 and the first quarter of 2024, Dave reduced its 28-day delinquency rate from 2.60% to 1.83%

📣 Mini tangent: While the name "tips" may be irksome, if there are low defaults and consumers understand the tip, surely that's better than higher-rate credit cards that revolve and come with plenty of late fees and hidden fees!

💸 Who's buying these loans? Dave secured its first major credit facility from Victory Park Capital in 2021. As of September 2023 this was increased to $150m. Funds like Upper 90, Atalaya, Coventure and the i80 group are fond of this asset class. You also see the usual crop of specialist lending banks, but they prefer BNPL or major platforms to Neobanks and sub prime.  

c) Growth Companies, and embedded finance are fuelled by lending. Consider that in 2024, an e-commerce business can get growth capital from its web hosting provider (Shopify), use real-time sales data to pay back lending (revenue-based finance) and operate on a charge card instead of a credit card to make accounting easier.

And they buy none of that directly from a bank.

And their venture debt? Now comes from a multitude of places.

A decade ago, this lending was the home court advantage for SVB and First Republic. Growth companies raising rounds from VCs (clients of those same banks) would add fuel to their growth with venture debt or a growth facility.

💸 Who's buying these loans? It's now much more open season as this tweet summarizes

When SVB died, a natural power broker in the valley went with them. The VCs stand to lose more if the company goes under (debt is senior to equity; the lender usually gets paid back). But SVB would see all of that VC portfolio and not be as accommodating if a board member VC had pushed a company into a bad debt position.

It's here that we see the influence of private markets most clearly.

Private credit is driving innovation. 

And when it goes right, it's incredibly lucrative.

But what if it goes wrong?

.Maybe we'll find out soon.

3. The first failures are here

a) Not all companies that embed lending are created equal, leading to failures. When Banking as a Service and API-first distribution became possible, everyone could become a lender. In the best case, this is a well-run program with a scale company like Intuit, Affirm, or PayPal. 

But tomorrow's PayPal is today's smaller company, and 1,000s of hopeful Fintech companies are born yearly—not all with world-class underwriting teams. Banking-as-a-Service companies like the now ill-fated Synapse were revolutionary in allowing companies to get to market faster and for 10% of the cost it used to take.

This helped innovative ideas come to market on many levels. As per section 1, innovation is generally a good thing.

While a software company can just go bankrupt or get acquired, lenders are much more complicated. When a start-up lender fails, a few things get tested

  1. The oversight of their capital provider (private credit or bank)

  2. The record-keeping of their underlying bank

  3. The patience/skill of the VC

This is the case with some Synapse clients, as we now see in court documents (made worse by the bank outsourcing its record-keeping to Synapse?!!). 

b) Many tech companies relied on private credit to survive the 2022 winter, and this is starting to unravel. If the only choices were to go bankrupt, fire sale the company for 5% of the last round value, or take on debt, many founders would have taken the debt route. Some credit funds have become the Venture Debt provider of last resort or a sub-prime venture debt player (not in all cases!). 

They charge a premium to companies banks might have declined for Venture Debt and remember, the SVBs and FRBs have new owners and aren't as active as they once were.

👉 Take a scenario in which Growth Company A has taken a facility from Credit Fund B. and received an interest-only period. 

Now wind the clock forward two years, and growth hasn't arrived.

The Growth Company will continually try to refinance (refi) before its interest-only period ends. Otherwise they have to pay dues on lending they can't afford.

What we see in the headlines are the tip of the iceberg. 

Tweets like this illustrate how debt can also be a lever used by board members in lots of not-so-nice ways.

c) Moody's is sounding an alarm on private credit funds. Moody recently rated direct lending funds from Blackrock, KKR, and Oaktree as Baa3 (just above junk) with a negative outlook. The agencies are concerned about borrowers' ability to continue making repayments in this higher-rate environment. 

Are we facing a refinancing cliff edge?

Private credit has been such a sure thing that competition has increased, hurting some of the margins. Credit quality could start to suffer, and we don't know how many funds would be impacted by a handful of bad loans.

Most loans are spread across multiple funds for risk management, but it only takes one or two to impact the wider batch.

4. Regulators reactive not proactive.

Despite the howls from the banking industry, the regulators seem to have not prioritized regulating private credit. 

The OCC has warned that, based on historical precedent, things can go wrong whenever commerce gets too close to credit (like embedded lending). But the OCC regulates banks.

The FSOC (Financial Stability Oversight Council) can designate nonbank entities as systemically important, bringing them under Federal Reserve supervision. But that hasn’t happened.

Perhaps they view the risk of sitting with professional investors like pension funds, insurance companies, and large public funds as big enough to shoulder the loss. 

Perhaps it’s just not a priority until something goes wrong.

(This has always felt weird to me since, ultimately, consumers lose if their pension fund does).

In a best case we're facing something like the commercial real estate crisis, where returns to higher rates and new office behaviors forced banks and funds to react and adjust. If that happens across venture debt and other private credit types, there will be consequences, but hopefully not earth-shattering.

But what if it's worse?

As we saw in the wake of FTX, the collapse of SVB, and now the unraveling of Synapse, Evolve, and the mess in between, companies going bankrupt has consequences that take time to show.

The Government bailed out SVB, FTX may end up paying back all of its customers in full, but in the case of Synapse, teachers won't make payroll because nobody can figure out what the heck was supposed to happen.

The fact that the US system requires regulatory arbitrage in order to innovate tells you how unbelievably messed up the state and federal-level regulations are. The alphabet soup of laws, agencies, and compliance requirements hasn't solved the fundamental issue.

What happens if a private credit firm goes under and it breaks the economy?

What happens if the Fintech companies have a domino effect, and the constant attempts to refinance by companies who can't raise their next equity round eventually all comes out in the wash?

Consumers will be harmed as private credit unravels. 

Last time we had a major issue, the regulators could kick the banks into sorting it out.

This time, it's all investors, private credit funds, and regulatory arbitrage. 

5. It's a story as old as time

Pension funds, endowments, insurance companies, etc., deploy their capital through middlemen (funds). They allocate across a range of asset classes, such as private equity, venture capital funds and private credit funds.

Their goal is to maximize returns for the lowest relative risk. VC was attractive until it wasn't (when rates changed), but with rising rates, credit seems like a no-brainer. Money followed the return potential, but as always, late-to-arrive money loses. 

When supply outstrips true demand, we get an oversupply.

That means too many ZRIP era overfunded tech companies, and now, it could mean too many bad loans?

There's a storm brewing in private credit.

Maybe the bankers have a point.

Private credit might not be everything.

But it has supplied the companies distributing lending innovation.

If I had to guess, we'll see some pain in private credit, but the long-term trend is still positive for the asset class and Fintech.

More lenders + more distribution = more innovation opportunities.

ST.

Recommended further reading:

4 Fintech Companies 💸

1. Numeric - Accounting Workflow and AI 

Numeric helps finance teams automate month-end closing, identify discrepancies (variances), and explain them in plain English. It also helps teams build a single view by integrating with accounts and accounting software. The goal is to save finance teams days of manual work per month. Today, they're live with Brex, Plaid, Wealthfront, and "hundreds of companies."

🧠 The CFO spreadsheet SaaS and AI is now a game-changer. This SaaS for CFOs has existed for a while, but none seemed to stick to the landing. While many of the "spend management" platforms do this as an add-on, the reality is that most finance teams still have a spreadsheet pivot table trying to keep track of it all. Numeric is by accountants for accountants. GenAI has also changed what's possible in this category. Creating a first-pass explanation of variance won't be right 100% of the time, but 80% is still a huge time-saving. 

2. Anon - Plaid for everything else

Anon manages user permissioned access to mobile apps and websites that do not have an API. It never sees or shares user credentials but follows the user session into a service. Customers can then build agents to perform actions like flight booking, subscription management, or aggregation of social media messaging.

(I know this isn't strictly a Fintech, but imagine the implications for Fintech).

🧠 This feels like the infrastructure that unleashes AI. Plaid was just super early and narrow, but it unlocked the data, and now, it can make payments with it. Then, along comes payroll automation that manages deposit switching, subscription management, or even tax filing. What happens when I can give an AI agent access to my Gmail to pull together all the receipts I forgot about? The what-ifs for this and anything else are intriguing.  

3. Origin - If an RIA, Turbotax, Wealthfront and PFM had a baby

Origin is a service that helps users track their net worth, recommends ways to optimize investments, budget, or save more, provides an AI sidekick (with RIA oversight), and automates investing. 

🧠 Some services do pieces of this, but Origin has put it all together. Origin claims to combine the capabilities of Turbotax, Rocket Money, Wealthfront, and SecFi. If the user experience lives up to that, and the AI is any good at all, this could actually help RIAs become fractional RIAs. I guess every job title will be fractionalized. 

4. Roam - Mortgage assumption service 

Roam helps families with a property they need to leave, sell their house to buyers who can "assume" their mortgage at a much lower rate than those offered by banks today. Sellers can also potentially achieve a much higher valuation for their property than they would have otherwise.

🧠 What does this company become if interest rates drop again? All Government-backed home loans are eligible for an assumed mortgage, but often, the buyer and seller have a discovery issue. By listing these in a marketplace, Roam definitely helps solve that problem. This makes complete sense in the current rate environment, but I wonder what the value proposition is beyond that. There are plenty of 30-year mortgages out there, but what are the odds rates stay where they are for the next 28 or so?

Things to know 👀

The Fed says Customers Bancorp had "significant deficiencies" in risk management and anti-money laundering practices. The stock fell 20% on the news before closing the day 13% below its open. The order specifically directs the bank to focus on risk management and resourcing around its digital asset payments and tokenization business.

🧠 Customers Bancorp has digital asset clients like Circle and Galaxy Digital. It offers only domestic U.S. dollars and a novel payment system, the "Customer Bank Instant Token," which lets clients make 24/7 payments. The action highlighted that service.

🧠 The Fed noted the bank has started to fix these deficiencies. The risk of doing anything novel is you don't get it right first time. When you're offering a 24/7 payment service that's not ACH, Wire or Cards there's no playbook.

🧠 When your clients offer U.S. Dollar Stablecoins that trade 24/7, globally, there is a real material risk. While Customers Bank only offered domestic payments, their clients facilitated transactions where the source of funds may not be known. As an MTL, they have to perform some level of KYC, but as a bank, how are you overseeing that?

🧠 The Crypto bros are howling about "operation choke point" and a threat to Crypto, but they're wrong. It's not an existential threat when you compare this action to what's happening with the Evolve and Synapse trainwreck or in the broader novel activities space. This stuff happens everywhere.

🧠 We do need a better approach to novel activities and crypto-friendly banks. The market wants Crypto; this product exists, has demand, and will continue to exist. Banks that engage with it have a huge commercial opportunity. Regulation by enforcement can't be the only answer; we need better dialogues about best practices for any novel activity.

Google Pay users can now use fingerprints, Face IDs, or device PINs to secure checkout online. Checkout.com claims that testing, this increased checkout speed by 30% and a 3% higher authorization rate. This service is an alternative to 3D Secure, where merchants ask for a one-time PIN (e.g., SMS), which often leads to a poor experience.

🧠 What makes the solution novel is this works on desktop not just mobile. Google has built this bound to the device via Google Chrome (h/t Tom Noyes)

🧠 Cart abandonment is massive in 3D Secure transactions, leading to lost sales in e-commerce. For that reason, many US-based merchants simply don't bother using it, even if it means potentially higher fraud losses.

🧠 However, if the card issuer and merchant are based in Europe, a step-up verification is required. Strong Customer Authentication (SCA) means going through an extra step to authenticate is common. Some issuers made this lightweight (like Neobanks) simply asking for biometrics, but for most, it's still horrific.

🧠 The card networks have “click to pay.” This uses biometrics + passkeys as a secure authentication. Solutions like this are becoming more of a default, and its an open battleground for who gets market share in Europe. The US is a much tougher nut to crack but I think its possible.

🧠 The liability shift is huge. If a user uses step-up authentication like 3D Secure or Google Pay, the fraud liability shifts to the issuer. Therefore, US credit card companies haven't been very keen on 3D Secure becoming the norm.

🧠 Wallets + branded checkouts are becoming the rulers of e-commerce. From a wallet perspective, if a user tries to checkout at a merchant without that wallet (e.g.) Apple Pay. But then, it hits a step-up authentication that just happens to be Apple Pay; Apple gets more revenue and more market opportunity. (The same applies to any branded checkout + wallet, such as Shop, PayPal, or even Paze).

🧠 This is a service PSPs will likely want to sell. The commercial incentives and Wallet dominance make it possible for this type of alternative to 3DS to become more common in the US. If the merchants have less liability and higher authentication, this becomes a no-brainer.

🧠 Where does this leave Paze? It’s hard for Paze's owners to want to shift liability to themselves or launch a branded checkout that also performs a step-up verification in a wallet from a cold start. EWS got a lot of adoption with Zelle, so it’s clearly possible.

Good Reads 📚

The largest private equity fund for retail consumers Partners Group Private Equity (Master Fund) LLC is now available for any "accredited" investor. The threshold for "accredited" is any consumer making over $200,000 per year, and hasn't changed since the 1980s. That now covers 1 in 5 US households. Retail currently contributes just 16% of assets managed by alternative funds, but how will that change as inflation bites?

Tweets of the week 🕊

That's all, folks. 👋

Remember, if you're enjoying this content, please do tell all your fintech friends to check it out and hit the subscribe button :)

(1) All content and views expressed here are the authors' personal opinions and do not reflect the views of any of their employers or employees. 

(2) All companies or assets mentioned by the author in which the author has a personal and/or financial interest are denoted with a *. None of the above constitutes investment advice, and you should seek independent advice before making any investment decisions.

(3) Any companies mentioned are top of mind and used for illustrative purposes only.

(4) A team of researchers has not rigorously fact-checked this. Please don't take it as gospel—strong opinions weakly held 

(5) Citations may be missing, and I've done my best to cite, but I will always aim to update and correct the live version where possible. If I cited you and got the referencing wrong, please reach out