Hey everyone 👋

This week 11:FS published the sequel (well, it's more DLC) to the bank as a service report; Embedded Finance, better banking business models, and it would mean the world if you check it out. 

Market Narrative 

Banking's core business model is so broken. Net interest margin (USA) has fallen from an average of 4% in 2000 to 3% in 2020, and it continues to fall.  

Banks play inside their "target windows." Most major banks want mass-affluent customers; inside a credit score window, where cross-sell is an opportunity. But this window is getting smaller and less profitable as income equality grows.

Banks carry all of the cost of being regulated, a legacy product set, aging technology, and obsolete infrastructure (like ATMs, branches delivering diminishing returns).  

Price transparency has become normalized as services like NerdWallet, Credit Karma, or Money Supermarket.

Banks are now a commodity with a high cost of acquisition.  

You can see all of this in their share price.

Banks believe the competition is left and right in the market (other banks).

But the new threat comes from above and below.  

From below, payment networks are adding ever more value to market participants. Visa's acquisition of plaid is making the data and payments they can provide much richer. Even players like Marqeta make the rails easier to access (forcing three-quarters of banks to change their strategy). Stripe is making payments a genuinely global platform (see: acquisition of paystack in Africa) 

From above, Neobanks and non-bank brands are adding more value as they get closer to the customer problem or serve segments the banks can't. It's not just left and right anymore. Look up, look down. That's where the threat is; that's where the opportunity is.

The market has changed, and the first step is accepting the new reality. The banks are stuck in the middle with no earnings growth, stuck in their "target window" managing decline. But there are better banking business models out there.

4 Fintechs 🤑

1. Argyle - "Plaid for employment records."

• Allows banks, lenders, and insurance companies a way to access employment records (and proof of income), competing directly with credit bureaus. Bureau's buy data, house it, and then charge for access (often without user consent). Much like plaid, when a consumer applies for a loan or even car rental, they'd click a link and consent to pull the data from their employer's system. Something is going on with companies named after patterns. 😁

• I immediately thought of Pinwheel, who popped up a few months ago when seeing this, but the investor's view is that Argyle's access to 40m accounts and time in the market is advantageous. 

2. Alpaca - Equities trading as an API

• Like competitor Drivewealth, Alpaca offers equities trading as an API. In September this year, Alpaca did more than $2bn in trades through their platform, up from $388m in January. That's investor catnip.  

• Their goal is to win enterprise clients (e.g., bigger banks or Neo's who want to expand into commission-free trading). It gets fun imagining this in other contexts. The PFM apps? The big tech wallet? Alpaca just raised $10m, so I don't think we've heard the last of them for sure.

3. Clair - Instant payment for hourly / gig workers

• Clair embeds "get paid" (and in future other finance capabilities) inside workforce management, payroll, and gig platforms. When a worker chooses Clair as their direct deposit account, they get "free" advances on income that is deducted from their account on the next payday. The idea is this competes with payday lending, and Clair may have a USP in working not just with big gig platforms but also small businesses.  

• Clair aims to help users with savings reminders and say, "success is when you no longer need wage advances," but with 78% of Americans living paycheck to paycheck, they have their work cut out for them. Unlike generic budgeting tools, Clair is well-positioned to solve the immediate problem of getting paid. It can then use that to build savings habits slowly.  Clair just raised a $4.5m seed, and it will be interesting to see how effective they are at disrupting payday lending.

4. Bella - The NeoBank that will prove it loves you 

• Bella aims to compete on Amex like service in the Neobank world.  They want to prove they care about you by helping with lifestyle services (like ideas for gifts, birthday parties, or helping when you lose a passport). This service model sounds expensive, but their goal is to stay ultra-low-cost in their infrastructure and monetize via credit much earlier than most Neobanks (for example, they've gotten as far as they have on 3.5 FTE).  They're aiming for a Nov 30th launch, and this will be one to watch.

• Bella believes Neobanks are all becoming much the same, get paid two days early, credit builder, but no real service differentiator. A Bella like service could well be a gap in the market, but check out their website; the brand is unique.  

Things to know 👀🧠

1. Robinhood Margin calls its customers with 24 hours notice

h/t PackyM

• On top of having 2,000 accounts hacked this week, Robinhood dropped notice of this margin call on all its users via email. Given the recent PR history Robinhood has with customers not understanding the impact of trading on leverage leading to a very unfortunate suicide, this could all go sideways quickly.

• 🤔 My Analysis: Margin calls with 24-hour notice is routine in institutional trading. Chances are Robinhood is technically within the rules of the market.  What's not routine is letting consumers access such complex products without knowing what they're doing. It's like sending someone blindfolded into a minefield.

• 🤔 My Analysis: Robinhood is still massive and is growing, but it's undoubtedly a matter of time until the regulatory snap back here.  The SEC itself came from consumers taking a bath in the 1929 crash. If we see a significant correction as the pandemic economic data starts to hit, things could get ugly.  

• 🤔 My Analysis: Robinhood's learning portal has many definitions but almost nothing about best practices for managing risk.  There's so much that could improve this situation proactively. Imagine a Coursera / learn mashup where getting to trade more advanced products was something you had to graduate to in the product.

PS. Things you'll never see on the Robinhood learn portal.  

1. Front Running.

2. Killer Mike's Greenwood bank has a waiting list in 10s of thousands

• Killer Mike, Bounce TV founder Ryan Glover, and former Atlanta Mayor revealed their platform this past week after raising more than $3m. The Neobank has features familiar to Chime and Varo users (get paid early, etc.). Still, the bank targets Black and Latinx communities or anyone who wants to support black-owned businesses. Black and Latinx entrepreneurs still struggle to secure loans from mainstream banks. To build wealth, you need capital.  

• The name comes from the Greenwood district of Tusla Oaklahoma, nicknamed "Black Wall St," destroyed by a mob of racist white Americans in 1921. There were 23 minority-owned banks in the USA (out of 5,000+), now there are 24.

• 🤔 My Analysis: I love this. It's a business that creates an opportunity for other companies by just being fair and addressing a part of the market that doesn't fit inside the megabank "target window." That target window is getting narrower every day with wealth inequality, and the opportunity for Neobanks gets larger.

3. Revolut announces intent to apply for California and UK charters

• Revolut has 13m users across Europe, is making an application to the Fed Reserve of San Francisco and the California Division of financial services "within weeks" according to "sources" (read: Revolut themselves).  

• 🤔 My Analysis: This is quite different from Varo, Chime, and others heading for a federal license.  Revolut believes interstate licensing will allow them to operate in most US states.  For the pros and cons of this approach, this @regulatorynerd Twitter thread is a phenomenal read.

• 🤔 My Analysis: Revolut is struggling to blitz scale in the US as it did across Europe, and I don't think this license will help them grow users directly. The UK license, however, could be crucial to its medium-term profitability.

Good Reads 📚

1. Biden "may" outlaw overdraft fees if elected  - CNN Editorial

• US banks make $11 billion on overdraft fees annually. 9% of all accounts pay 79% of those fees.  People who frequently go overdrawn have lower credit scores and are credit constrained.  

• 🤔 My Analysis: We've seen this movie before; in the UK, the regulator normalized fees for overdrafts, insisting banks charge one fee for overdrafts and price it in APR (APY equivalent). The FCA estimated that the average consumer overdraft fees dropped from £5 ($6.46) a day to 10p ($0.13) per day.

• 🤔 My Analysis: This story speculation for the US, but even if they don't receive this regulatory pressure, there may be a market solution. Square, Chime, Current, and now Greenwood are all targetting do more for customers with less. These companies are just the start; these businesses are growing, proving what banks leave behind is an opportunity for growth.

• 🤔 My Analysis: Compare the earnings growth of Square vs. the big banks (pictured below). Starting at the customer problem and solving that is a better business than starting at your "target window." (Can you tell that phrase rubbed me the wrong way this week?)

2. Recurring revenue rise of an asset class - By John Street Analysis

• Companies that have recurring revenue as a business model are usually category leaders. Now read that again. Recurring revenue isn't just for startups. Adobe is an excellent example of a company transitioning from a software license model to a SaaS model. In that time, Adobe's P/E multiple has grown from the ~6/8x to 32x (hey banks 👋). Even the mighty Apple is aiming to expand its services revenue.

• The article asks, what if these subscriptions themselves could be isolated and turned into an asset class? Software contracts are better than first-lien debt; software contracts get paid first. The article talks about Pipe, a two-sided marketplace that treats recurring revenue contracts as an asset. Pipe connects companies that have recurring revenue with investors who bid to purchase the revenue SaaS contracts upfront.  Everyone thinks this is Clearbanc; it's not; Clearbanc is still doing a term loan, and customers of that product could end up paying 2x to 3x principal. 

• 🤔 My Analysis: Investor appetite for loans in a low yield environment has been phenomenal. Sovereign wealth funds, pension funds, endowments should love this if Pipe can get any volume coming through its platform.  

•  🤔 My Analysis: When a SaaS / ARR business scales does it still need this type of financing? Surely there’s an upper limit on the supply of this asset?  I can see the need for funding when these businesses are younger, but not when they're much larger and more lucrative, or am I missing something?  

•  🤔My Analysis: wouldn't it be interesting if someone like Carta got into this? They have the LPs already on their platform to do it.

3. Buy Now Pay Later - teardown by Net Interest

• The credit card market is worth $100bn in revenue annually in the USA, but in 2005, the retail credit market changed with the launch of Klarna. Klarna paid merchants immediately but gave consumers a 14-day window for payments if they didn't like the goods to manage delivery in the early days of e-commerce.

• Fast forward to 2020, and Klarna claims a 68% higher conversion rate for merchants who offer Klarna at checkout, a 58% boost in order value, and a 20% increase in repeat purchases. Klarna has a banking license and is a bank, just a specialized one. With 44% YoY revenue growth, Klarna is growing by solving a merchant problem (conversion) and a consumer one (delivery risk). Credit losses are "high" at 7.6%, but that is trending down.

• 🤔 My Analysis: Visa, Paypal, and even Citi are getting into BNPL, but they're coming at a crowded market.  Visa and PayPal may do well given their existing positioning with merchants, but I worry for the banks now trying to buy their way back into this segment. The banks didn't see this threat coming because it was "outside their window."

• 🤔 My Analysis: The biggest threat to BNPL is consumer backlash.  This backlash has already started in the UK and, to a lesser extent, the USA. These companies have a lot of work to do to convince consumers that they're both safe and put customers in control.  In the never-ending unbundling/bundling cycle, I wonder how long it is until BNPL balances show up in your favorite big tech-powered PFM.

Tweets of the week 🕊

That's all folks. 👋