Fintech 🧠 Food - 25th July 2021 - Visa buys Currencycloud, Square launches a bank & can a bank ever be a growth stock?

Hey everyone 👋, thanks for coming back to Brainfood, where I take the week's biggest events and try to get under the skin of what's happening in Fintech. If you're reading this and haven't signed up, join the 6,950 others by clicking below, and to the regular readers, thank you. 🙏

Plug: On the 11:FS blog this week, I wrote about creating a financial services operating system (FS OS). It brings together a lot of the thinking you've read here on Brainfood, so you might enjoy it :). 

Weekly Rant 📣

Could a bank ever be a growth stock?

Fintech is a growth monster. Banking isn't. Why? I mean it’s all finance, right?

PayPal, Square, and the big techs have arrived in Fintech, and there are no signs of Fintech's momentum slowing down. Quite the opposite.

1 in every 5 dollars of Venture Capital is now invested in Fintech, making it by far the hottest sector in all of tech. Meanwhile, the world's largest VC funds have just closed some of the largest funds in history. a16z, Index, General Catalyst, and more now have massive pools of capital to deploy, much of that pointed at Fintech.  

And Fintech is attacking bank revenue and profitability. The threat to banks from Fintech is enormous already. But now, more VC capital = more Fintech companies. More Fintech companies = more of a threat to banks

Take Square, who just this week announced their checking account for SMBs. With no minimums, no account fees, no overdraft fees, this account becomes the natural home for Square's millions of SMB customers. 

Square doesn't have to monetize through minimums, fees, or overdrafts because it is a broader offering.  

Banks have woken up to the Fintech threat; during earnings season, Execs from Capital One to JP Morgan to Goldman have all talked up the need to partner, acquire and invest in Fintech due to the massive threat and opportunity for their business.

But banks need to find a new way of approaching the market. It can’t be the same old shit different decade anymore.

Temporarily, banks are having a bit of a moment.

As the economy re-opens and the possibility of interest rate rises, bank stocks had an excellent few weeks. But bank fortunes always followed the economy. When the economy is up, so are banks; when the economy is down, so are banks.

Banks rebounding off a very low base isn't the beginning of a growth movement for them, but some banks have been doing well for several years.

Banks doing well longer term.

If you zoom out over the past 5 years, you'll find a small cohort of bank share prices moving up and to the right.

1. Partner/community banks

2. Banks that serve the tech sector

3. Banks that have their tech act together

1. Partner/community banks

Community banks (with sub $10bn in assets) benefitted significantly from the Durbin Amendment. Banks like Bancorp, Celtic, Evolve, and Sutton sponsors some of the world's largest companies' debit card programs (like Doordash, Instacart, and even Square). 

Last year a16z published a piece showing the community banks that are partnering are trending towards a much higher Return on Equity (ROE) and Return on Assets (ROA). Some of the smallest banks in the US serve the largest tech and Fintech businesses and benefited from their growth. 

But these aren't "growth stocks." They're successful and growing, but they've become niche players by their nature, and there are lots of them. They're not equal (some support more with lending like Cross River, and some have more in-house tech like Green Dot, for example). But as a general rule, their growth will be limited by focussing on their niche, the size of their balance sheet, or both. 

The niche means, even if they had all of the big tech companies processing card payments through them, their portion of those transactions is tiny. And the nature of a balance sheet requires; balance. Becoming a specialist lender is great, but you will need to fund that lending with deposits (or market funding) which can be expensive. Taking all of the deposits is fine, but can you deploy enough lending to make that worth your while as a small bank?

The very nature of the banking business model and economics mean it's great to be a niche product player, but it's hard to dominate at it.

Lesson: Solve a problem others can't (or won't) 

2. Banks that serve the tech sector

There is another kind of niche, which is focussing on a client segment and becoming the default partner. Banks like Silicon Valley Bank (SVB) and Silvergate have carved out a spot as the tech-friendliest among the banks.  

Silvergate has become one of (if not the) default choice for Crypto companies looking for the on / off ramp between Crypto and regular fiat currencies. It has become a partner bank to the Crypto industry and grown with it by specializing in this sector.

SVB, in particular, has positioned itself as the default partner to some of the world's largest funds and accelerators and carved out a position as "the bank that can make it happen." This is especially appealing to Fintech startups who get little support from the larger banks, but SVB is positioned as a bank with VC instincts. By spotting promising startups, they will issue lending in the form of convertible loan notes. This means when a company hits IPO, SVB does exceptionally well.

SVB is the more interesting case study in this mold because it has altered its business model, perhaps historically due to how close it has always been to Silicon Valley itself. SVB differentiates because it actually understands its customers and will put in massive effort to overcome the complexity of the banking system and industry for its clients.  

SVB is perhaps the closest thing to a growth stock in banking. But it's still a bank, and it's still a regional player. It can grow, but nowhere near what the next big Fintech company can achieve. 

Lesson: Understand your customers and remove complexity

3. Banks that have their tech act together

Some of the world's biggest banks are notoriously bad, just awful at technology. Being good at tech in banking is like being one-eyed in the land of the blind. Two names spring to mind for being pretty good at tech in banking, and they have something in common.

Capital One was founded in 1994 by Richard Fairbank and Nigel Morris (now a partner at Fintech VC QED Investors) and is famous as the 5th largest credit card issuer in the US. Capital One is famous for its focus on data and diligence. They can price risk others can't and see opportunities where others don't. Capital One pre-dates the .com boom (with 700+ branches, not a "digital" company as such), but it had a blank slate to build tech from in the 90s. Capital One has outperformed its peers in recent months (although, like most banks, it suffered during the pandemic). 

Goldman launched Marcus by Goldman it's direct-to-consumer offering. While it has acquired several Fintech startups (and even the GE book), Goldman built much of its technology greenfield with the latest available software from providers. Marcus itself hasn't set the Goldman share price on fire, but it has enabled Goldman's investment bank to be more efficient in the short term. Longer-term, Goldman's strategy tells the market it intends for the Marcus platform to be the core of its embedded finance offering.  

Lesson: Start without legacy tech

What about the megabanks?

For the most part, the megabanks are rising and falling with the market, but one stands out. The juggernaut that is JP Morgan Chase has consistently outperformed its peers with a strategy it calls "fortress balance sheet." By maintaining solid capital reserves, JP Morgan has been able to have some of the most affordable capital and been seen as an ultra-low credit risk. In turn, this makes their lending much more profitable than others. 

JP Morgan has also been the most vocal lately about the lack of a "level playing field" with Fintech and how Fintech companies benefit from not following the same stringent capital rules as banks. The megabanks are unlikely to be a growth stock any time soon, but the balance sheet focus has worked.

Lesson: Use your balance sheet as a competitive advantage

The four lessons

If you look outside of Fintech, the best (or least worst) performing banks do one or more of the following.

1. Solve a problem others can't (or won't) 

2. Understand your customers and remove complexity

3. Start without legacy tech

4. Use your balance sheet as a competitive advantage

What if someone put all of those together?

It's hard to have both a massive balance sheet (which reduces the cost of funding for lending) and be an agile, tech-savvy business. Those with an enormous balance sheet tend to have legacy tech, and those that are great at tech don't often have a massive balance sheet. 

What's more, the nature of having a huge balance sheet makes you a GSIFI (globally significant financial institution). Being a GSIFI dials up regulatory scrutiny two or three notches.  

Balance sheets are a blessing and a curse

The blessing of a massive balance sheet is the much lower cost of funds (CoF), which enables more profitable lending. The curse is ROTE.

Banks are measured on Return on Tangible Equity (ROTE). To cut a long story short, this means sometimes profitable businesses (like payments) are unattractive to banks because it would negatively impact their ROTE. Banks have to turn away exciting and massive Fintech revenue opportunities because of how they're measured and the capital constraints placed upon them.

As a result, most large shareholders see banks as yield stocks, unlikely to drive share-price growth, but profitable and able to generate dividends.

But why can't we have nice things?

After the Global Financial Crisis (GFC), many banks built a "bad bank" or non-core part to their business. The idea was to put much of the high-risk debt or bad performing parts of the bank into one organizational bucket that would be sold, dismantled, or wound down slowly.

Couldn't that work for banking tech and business and operating model too? You wouldn't end the ROTE challenge, but you would open the door to things the bank hadn't done well historically (like originate to distribute lending models, for example). 

We're on the cusp of a massive shift as finance becomes embedded and invisible. There has never been a better reason to break from the existing culture, business model, and operating model of the legacy bank.

The existing banks that have leaned into Fintech have done exceptionally well; they understood their superpower and executed.

What if you did that, but with a massive balance sheet, no legacy tech, a deep customer understanding, and started with a problem others can't or won't?

Maybe banks won’t be growth stocks. But my goodness the embedded finance opportunity has to be worth grabbing with both hands.

Or maybe, Fintech who’s already a platform will back its way into being a bank over time.

ST.

4 Fintech Companies 💸

1.Chaka - Robinhood for Africa

• Chaka allows its users in Nigeria to access US-based stocks and ETFs from both the NASDAQ and NYSE and local Nigerian stocks. Chaka serves both individuals and businesses and offers a white-label version of its platform (to become a Drivewealth for Nigeria). Chaka has partnered with the local Citi branch to ensure FINRA compliance.

• Nigeria (and many African economies) have been hit hard by food price rises and inflation since the pandemic. Inflation has run close to 12% for a decade and 22% in the past year. Individuals and businesses demand stable assets, and investments and US dollar-based investments fit that bill. This internationalization of fintech trend is one to watch.

2. Seon - eCommerce fraud prevention

• The Seon Sense platform will identify a user's device and provide a score based on their ML algorithm.  They can identify suspected account takeovers, virtual machines, and browser activity to ensure users are who they say they are.

• Device profiling has been around in eCommerce for ~15 years, but Seon is API-driven, and the "white box" lets users see how the ML is performing and operating.  This move to more headless SaaS for functions like fraud eCommerce gives the merchant much more control and flexibility.

3. Paystand - Zero fee B2B Payment Network

• Paystand charges a flat monthly fee for accounts receivable. Users can take payments via bank, card or ACH, or embedded invoice link. Paystand also has integrations with popular tools like Netsuite, Xero, and Quickbooks. 

• Digging deeper, it seems, Paystand actually has its own (custom, permissioned) Blockchain called Asurety, which acts as a side-chain to Ethereum. This Blockchain isn't making payments.  Paystand's model is to pass through the cost of "legacy payments" like ACH without markup.  It has then created its own B2B payments network (similar to say PayPal), where transfers using that payment type are free. Then the Blockchain they built is performing an assurance function, with Ethereum acting as a public auditor to the private Blockchain.  

4.Titan - Active fund management for Gen Z

• Titan is an app-based active fund management platform with 30,000 customers. They describe themselves as a "world-class hedge fund in your pocket."  Users invest their funds into one of three strategies (Flagship, Opportunities, and Offshore) and can access research from the team via the app.

• Unlike passives, active funds are regularly changed to respond to market conditions and are intended to beat an Index (e.g., the S&P 500). In 2019 more than 70% of active funds actually underperformed the S&P, so there is an element of risk involved. Most active (and passive) funds are often bought via platforms like Vanguard or Fidelity. When buying on one of these platforms, you're inviting a series of middlemen into the process who all take a small fee, hurting your returns.  What makes Titan interesting is the consumer-first approach to active management. Given that investing is now culture, this is zeitgeisty. 

Things to know 👀

1. Visa acquires Currencycloud

• Visa will acquire Currencycloud, the platform API-driven FX and cross-border payments for £700m (~$960m).  Currencycloud provides API-first FX, multi-currency wallets, and virtual accounts. In the release, Visa notes 43% of small businesses perform cross-border payments.

• 🤔 My Analysis: International payments are still way too hard.  Have you ever tried to send money cross-border using your bank? Good god, it sucks. 

• 🤔 My Analysis: Quietly Currencycloud is a massive player; on their homepage, they list companies like Revolut, Starling, and Nium as customers sure. But last time I spoke with one of the founders, I brought up a few companies as possible competitors, and nearly all of them were Currencycloud customers.  

• 🤔 My Analysis: Currencycloud essentially built an API-first correspondent bank.  To replicate what Currencycloud has done, you'd need to build integrations to countless global banks, build a sophisticated FX desk and then get distribution. That's a challenging game to break into historically. This made me think this is a cheap acquisition for Visa? Not on revenue or on fundamentals, but in terms of market value for someone like Visa. Huge.

• 🤔 My Analysis: Visa is now absolutely swinging for B2B international payments. They've been pushing its blockchain-based Visa B2B connect (with many successes) for five or so years. It's essentially their version of SWIFT, connecting banks and merchants as a network.  

• 🤔 My Analysis: Given just how massive the TAM of B2B payments are, it's no surprise Visa is making a play.  The addition of Currencycloud gives them an existing fintech client base and a suite of other value-added services (like multi-currency wallets).

• 🤔 My Analysis: Other little snippets. Fun fact. Nigel Verdon (now CEO and co-founder of Railsbank, was also a founder of Currencycloud) Fun fact 2, £700m is what JPMC paid for Nutmeg, is that the going rate for UK based Fintech companies looking to exit? 

2. Square launches banking

• Square has launched business bank accounts to bring together payments, cash flow, and banking to one screen. The bank account combines checking, savings, debit cards, and loans. The aim is to convince customers it's just easier to bank with Square. Funds from sales are immediately available in the Square checking account. 

• 🤔 My Analysis: Banks should be terrified of Square. Square is inching towards being the complete finance platform for SMBs. They consistently reach deeper into the SMB problem space and have much better data about their customers than a bank would. This means Square can build some unique lending products, and over time build some interesting underwriting capabilities.

• 🤔 My Analysis: Square is well-positioned to become a significant lending business with its Industrial Loan Charter (ILC).  Its lending product is quite unique in that it takes a percentage of daily card transactions (meaning you pay more when you have more sales). Sort of like how revenue-based financing works. It's this sort of user-centric feature that a bank would never dream of rolling out. They're slowly backing into banking from being a Fintech company (e.g. they still use Sutton for debit cards), but over time, they can gradually reduce their reliance on partner banks.

Quick hits: 🥊

• Starling results: Starling announced nearly £100m ($137m) in revenue over the past 16 months, with a loss over the year of £23m. Starling has been profitable in all of the last 8 months and now has more than £5.8bn in deposits (that's nearly 6x YoY). Starling did £2bn of lending and now has 2.1m consumers and 370,000 SMB customers. 🤔 Starling has quietly built an effective, increasingly profitable bank with a capital B. Given how terrible UK interchange and interest rates are, that's quite some achievement.   Starling did well from the UK government COVID-relief lending, but you still have to applaud the execution. 

• Mastercard piloting USDC:  In this pilot, card issuers (e.g., a Crypto wallet with a debit card) will be able to settle more easily against the Mastercard network. 🤔 Mastercard has been the go-to brand for Fintech cards but got caught napping on Crypto.  Visa now partners with some of the largest crypto wallet providers. Interesting too that both major networks are piloting USDC, despite some protests that it's "not risk-free." USDC has momentum.  

Good Reads 📚

1. Not Boring: Axie Infinity - The Play to Earn game with explosive growth

• Axie Infinity is a "Pokemon-like" game built on Ethereum where people buy, trade, breed, and battle digital pets called Axies. Sounds cute? Axie just did $79m of revenue in 18 days.  Axie takes a 4.25% fee when people buy, sell, or breed the Axie pets. If it continues with this momentum, Axie Infinity will have a $1.1bn year.  

• Fads come and ago (and maybe that will happen to Axie), but what's exciting here is the introduction of "play to earn." Players in Vietnam or the Philippines can, through playing the game, generate $20 a day income (which is 4x higher than minimum wage). Unlike the "free-to-play" games that make revenue with in-game purchases, the Axie economy is player-owned. The holders of the AXS tokens are "the government" that collects taxes in fees (4.25%) when people buy or sell on the platform.  95% of the revenue goes to the players.

• 🤔 My Analysis: If the iPhone had Angry Birds, then Crypto has Axie Infinity.  The famous Chris Dixon quote "it always starts out looking like a toy" absolutely applies here.  

• 🤔 My Analysis: If cryptokitties foreshadowed NFTs, then Axie Infinity is foreshadowing play to earn. Axie compares well against Roblox and Fortnite for revenue and growth yet gives 95% of that back to its players.  

• 🤔 My Analysis: The big possible downside risk is that Axie's are now at least $200, so getting started isn't exactly permissionless. (In his piece, Packy notes the evolution of Axie scholarships which is fantastic, but what about your average middle-income teenager who just wants to be involved?) 

• 🤔 My Analysis: Packy did such an excellent job on that write-up; it's well worth a click and reading when you have 20 mins.

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 :)