21 minute read
FINTECHS AND NEOBANKS IN FOCUS
As the focus of this year’s report is on innovation and what’s new in securitisation, it was natural to spend quality time talking to industry participants about the emergence of FinTechs and NeoBanks. While they are not currently generating a large volume of securitisation deals, and the majority are using warehouse funding if they’ve reached sufficient scale, the number of new entrants is significant.
Of course, COVID-19 may completely shift the trajectory of this segment, but it’s worth establishing whether the conditions that have given rise to their emergence are likely to be sustained through this new decade and also whether they can begin to extract market share in the same way that non-bank lenders have successfully done in recent years.
A MATTER OF DEFINITION
The term FinTech has been used for at least a decade and is now freely used both within and outside the financial services industry. The term NeoBank is commonly held to be a FinTech with a banking licence. But use the term to describe FinTech-like participants and they are not always thrilled.
“I think the first time I met them I talked about FinTech and they said, stop right there.” Intermediary
The point being that many don’t like being so easily classified and all are keen to speak about their point of difference. To arrive at a single definition is difficult but this one most closely sums up the way securitisation participants describe them.
“It’s a broad term. I just look at it simply as anyone that’s using technology to enhance old processes, but also to some extent that definition needs to acknowledge it’s more like the start-ups. That is, the business is new as well, in terms of what they’re doing.” Warehouse
Others claim you can differentiate between FinTechs along lines of whether they are utilising technology to improve the process for traditional products or they are offering a totally new product (e.g. ‘buy now pay later’). Both FinTechs and NeoBanks rely on technology to deliver solutions in ways that have not been done or at least not done well by existing providers and this is often what FinTechs see as their competitive advantage.
“I think every new lender that enters the market has the fundamental benefit of starting from a clean sheet of paper. What I mean by that is that they are not encumbered by legacy system processes that make change inside of large institutions very difficult. When you have that strategic advantage it means that you can engineer a process for customers that is much more aligned to what customers are interested in. That is faster, easier, more convenient, simplistic and so on. That is a significant advantage for new lenders in this market and other markets.” FinTech
Many of the people starting up or working in FinTechs and NeoBanks have been in the financial services industry for a long time and/or specifically in the securitisation industry for a long time.
Overall, there is a lot of experience among these new players and that is helping them define a better experience for customers and have success in seeking funding right through to the warehouse level.
One thing many are finding challenging is the need to be as hands on as is required to manage all aspects of their business in what are typically quite lean organisations. Many come from large bank backgrounds, where resources including colleagues with specific expertise are often readily accessible. In FinTechs and NeoBanks it’s important to be able to wear many hats and have no fear of getting your hands dirty.
“Ah it’s a lot of work. We all come from a credit background. From the beginning we really had very consistent credit performance. I would say for us, it’s a lot of work, doing anything with the banks is a lot of work but we had the credit performance to demonstrate. We’ve raised enough capital to be able to fund it. We’ve got a management team with deep expertise.” FinTech
There is an advantage to those who have come out of the securitisation team in a large institution and not all have.
“They’re very experienced. I mean, we’ve had the young guys knock on our door with an idea and a dream but the ones that have gotten off the ground are very experienced, one way or another they’ve got a lot of experience behind them.” Intermediary THE POINT OF DIFFERENCE
Surprisingly, the way the market believes FinTechs and NeoBanks differentiate is not dominated by innovation in technology but more so in their ability to engage with customers both personally and through delivering a friendly interactive experience.
Flexibility is cited as a key feature of the way many FinTechs and NeoBanks do business and there is a belief several are championing the return to traditional bank practices and values. Whether the way FinTechs and NeoBanks interact involves personal contact or an entirely interactive experience, there is a strong belief that their focus is single-mindedly on the customer experience. This extends to their approach to assessing credit for the SME market in which there is a willingness to consider loan applications on a wider variety of bases than typically occurs in dealing with traditional lenders.
“The combination of a curated loan experience that is quick and simple, along with compelling and competitive interest rates makes it a pretty attractive proposition for consumers looking for an alternative.” FinTech
“Their whole platform is about bringing the business and the personal back into business banking. You can’t call them a FinTech. Their approach is about the connections with the borrower. It’s about going back, almost to how it used to be.” An intermediary speaking about a NeoBank
A common thread in many comments about FinTechs and NeoBanks is the advantage of not being encumbered by legacy systems. It means they can design the customer experience with the customer in mind. This extends to the way they do business and what they choose to do themselves and what they outsource.
“They can start afresh and they don’t actually have to do everything either. They can buy stuff in as well or outsource things like servicing, whatever as well, so in many respects there’s that flexibility.” Warehouse
Investors are inherently discerning and expect transparency from issuers. There is cynicism of new players who are reluctant to reveal their approach to assessing credit quality and as a result they tend to avoid FinTechs with ‘black box’ solutions. In contrast they can be surprised by the emphasis of some FinTechs on a more hands-on approach with less reliance on the ‘system’ to make decisions for them.
“I think, not to be ungenerous, there are a lot of FinTech issuers with an app and a dream. Within that app and a dream mentality there is a considerable divergence of quality and rigour of a credit model. The only way you find that out is to be under the hood of the issuer and ask a lot of questions.” Investor
“Some of the SME lenders who may be classified as FinTechs do seem to be much more hands on and not as much about computer systems as people would think.” Investor
An associated benefit of creating systems from scratch is the ability of FinTechs and NeoBanks to use data more efficiently. Not only can they innovate in the data they collect but also in the way they use that data. Most participants commented on FinTechs’ use of technology in creating the application and onboarding process and few mentioned this potential advantage in data modelling and management.
“Whereas particularly like NeoBanks and the FinTechs, they‘ve designed these platforms now to capture all this different data points in, some sort of cloud technology system. Their ability to capture the data and generate it is a lot cleaner and faster than what some of these banks can do. They don’t have the history, but what they currently are producing is in a much better format, more comprehensive, easier to use and read and captures more relevant data points than what some of the banks can.” Trustee
Implicit in the creation of systems that potentially better meet the needs of customers is a strong sense of who their target market is. And with that comes a dedicated approach to marketing.
“For us, like anyone, you’ve got multiple marketing channels. So it could be direct mail. It could be the comparison sites like RateCity. It could be TV or radio. You’ve always got a different approach I suppose. It could be display ads on the internet. There’s a bunch of marketing channels that I wouldn’t say are unique to credit or lending. Everyone is trying to attract customers to their website.” FinTech
Of course, marketing doesn’t start and finish with the customer. There is a strong recognition amongst FinTechs that they must be good at selling their story to capture the attention of warehouses and other potential funders.
“To build their business they have to convince other people of their story and why they are going to be different from the other FinTech that opened up down the road as well.” Trustee
Growth is never far from the mind of the FinTech or NeoBank as they need scale to get cheaper funding and eventually become profitable. They also often start by servicing the riskier end of the market and the achievement of scale allows them to access cheaper funding, broaden their client base and slowly begin to reduce risk.
They are highly conscious of relationships with consumers but equally with funding partners. They recognise the need for flexibility and are ready to adapt at any time. While they may be focused on the long term, in reality their planning is very much for the short term simply as a result of the immediate need to drive the growth that will lead to sustainability.
Here are some of the ways FinTechs describe their growth objectives and experiences:
“You start off doing whatever you can do to survive, and your business model evolves.”
“If we had implemented today all the improvements we know we want to implement over the next 12 months, I think we’d be funding 30% or 40% more loans. So, in some ways it feels like a race against the clock in terms of technology.”
“It’s a bit of a dark tunnel until you come out to break even.”
“We’re acutely aware that if you’re playing at the lower risk end where everyone wants to play because it’s less chance of incurring credit losses, then the margins will be tighter and that means you need to generate the volumes.”
“If you started at the riskier end with a more intensive credit servicing model, higher arrears and loss rates in general, it is more difficult to head down the curve to lower risk products.”
“Obviously success is going to be in writing more widgets.”
“What gets me excited is actually thinking about our first term out. That’ll be, you know, for us, that’ll be a big win.”
“I’m looking forward to getting rated. I’m looking forward to filling up my warehouse. I’m looking forward to my first term issuance. It’s a different way of thinking. It’s fantastic.”
COVID-19 has not diminished FinTech’s appetite for growth but it has tempered their expectations. Many have had to rapidly change their business model and refocus their attention on new segments and new borrowers.
“We are a company that was looking to get to term markets this year so I think the world has changed for us obviously in terms of pushing that back but it has also caused us to pivot quite dramatically in terms of our lending product and to shift focus in terms of the industries that we would have had appetite for and also to shift focus in terms of the borrowers that we have appetite for.” FinTech
FinTechs point to the reduced interest amongst banks for certain types of lending and the ever-present investor as being the two factors that make them believe new opportunities will emerge from the crisis.
“We have seen a pullback from what you would probably have called competitors like the banks and a real opportunity to expand into prime lending. So, in a lot of ways COVID has caused us to re-evaluate our strategy but also far from presenting a crisis, we see it as an opportunity.” FinTech
“I think there is appetite from the funds and investors who would be backing these new entrants to really participate and pursue the opportunities in small business lending.” FinTech
CHALLENGES FOR FINTECHS AND NEOBANKS
Starting any new business has challenges and these businesses are no different. The dominant challenges for FinTechs and NeoBanks are; the ability to secure funding, the difficulty in achieving scale, their lack of a track record and the need to learn how to do new things fast.
FinTechs and NeoBanks are typically confident in their ability to attract customers and many have strong relationships with key people in the industry who are open to hearing their story, but with so many moving parts, a FinTech or NeoBank founder needs to wear many hats to be successful.
Most are following a similar path to growing the business, often starting with private equity, then moving to secure a warehouse and dreaming of the day they can bring a deal to the market. Very few have arrived at the third stage with the greatest challenge being scale, yet to achieve scale most are dependent on support from private funders and the public.
“FinTech lenders have to demonstrate the performance of their books in order to give confidence to an institutional investor that a warehouse facility is appropriate. The warehouse facility also requires that FinTechs have a reasonable amount of excess working capital sitting in that warehouse to provide the appropriate credit support or subordination levels. Those are often times not conditions that relatively new FinTech lenders are able to meet and that’s a challenge." FinTech
FinTechs and NeoBanks understand that potential investors need the confidence of hard evidence to be willing to support them. But demonstrating their ability to succeed takes time.
“Ultimately institutional investors need to be confident that they will be paid back and that requires a bit of time and seasoning for the FinTechs to demonstrate their ability to appropriately manage risk.” FinTech
“I think one of the challenges for the emerging players, the FinTechs and the challengers etc is a lack of data and not having been through a full credit cycle. A lot of these companies have only been lending for two or three years. So you can extrapolate from what they’ve done now, but they don’t have full loss curves which probably means that there’s going to be some conservatism built in as you extrapolate out.” Intermediary
FinTechs and NeoBanks, like most new business, start very lean. It means the people running the businesses are very hands on and they have to deal with aspects of running a business they may never have dealt with personally in the past. This means they have to learn fast and rely on their business partners to a greater extent than established participants.
“I think the biggest challenge for Neos is the fact that we’re new. It’s been really good, the relationship with our trustee. My background is as a treasurer in a major bank. You’d think I’d be across some of this stuff but it is mind blowing. It’s starting from scratch. It’s one thing managing the treasury functions. It’s a total different thing setting them up from scratch. I know how a warehouse facility works. I know how the investment market works and how the deals go, but I’ve never had to negotiate one.” NeoBank
With most FinTechs and NeoBanks setting a path to come to market with term deals, achieving scale is a primary focus, although there are different approaches to achieving it. Some are targeting those segments which tend to be avoided by traditional lenders and in which exceptionally high rates are common due to the risk associated with them and others are hoping to extract market share by offering cheap rates. A smaller number are using a different approach, for example buying existing books.
“These businesses are very capital intensive, and the ones that have got out of the ground fast have been ones that have charged exorbitant rates in the early days. Everyone else trying to do it the other way around giving good cheap rates. Scale is a huge challenge for them.” Investor
Funding has its challenges for FinTechs and NeoBanks no matter what stage they are at and initially there is a strong reliance on personal networks. Most have their sights set on warehouse funding in the short to medium term as they are well aware of the scale required to start offering term deals.
The influx of overseas based warehouses and open-minded warehouses within Australia has made it easier for FinTechs to reach that stage.
“We’ve certainly been fortunate to work with some partners that are happy to sort of lean into that and try and think of what are innovative ways that we can do warehouse funding in the first instance, but the term market, I think is, there’s probably still some education that will need to happen there before we’ll be able to access that.” FinTech
Intermediaries have also lent a hand with sound advice which helps to ensure these new businesses get suitable warehouse deals.
“The natural evolution of a FinTech funding strategy typically begins with access to private capital, typically through ultra-high net worth family office type investors. If you look globally, the vast majority of FinTech’s really start with that as a funding source. Often the next stage of that process is for the lending FinTech to secure capital via specialty finance firms and the trade-off there is that the cost of capital is often times quite high and perhaps not reflective of the true underlying risk of the asset. However, as these lending FinTech’s are immature and their books have not seasoned they ultimately have to pay a price premium in order to access the capital they need to grow their businesses. Usually the third step in that process is some form of warehouse facility, a securitised warehouse facility and that obviously comes at lower rates and then the fourth step is the traditional term out and access to the public debt markets via bond issuance. What you’ve seen globally are those FinTech’s who’ve been able to move along that spectrum of funding sources quicker, tend to do well because they secure a lower cost of funds which gives them a sustainable cost advantage and that stable cost advantage ultimately leads to a margin advantage and things play out quite nicely when you can manage your margins effectively.” FinTech
Investors are seeing a lot of FinTechs knocking on their door and are quite willing to hear what these new business have to say despite finding that the demands on their time can be challenging. They love a FinTech with a strong plan but do find many would benefit from a more realistic view of what it takes to achieve scale.
The problem with those smaller players, they can’t get scale. We’ve seen a lot of them come through the business and the conversation often goes like this:
Investor: “This is a really good program, how much have you written?”
FinTech: “Oh we’ve written $10 million.”
Investor: “How big is your market?”
FinTech: “Ah look if we can get to 30.”
Investor: “Over what timeframe?”
FinTech: “A year.”
Investor: “That’s no good mate, there’s no scale, no matter how good your product is, you’ve got no scale. You need to put some more fat in the sausage.”
FinTech: “What do you mean?”
Investor: “You need to get some really bad stuff and mix it with your really good stuff because that’s how a sausage is made, it’s just not all good meat, you need some fat so when you cook it, it sizzles a bit and the sizzle is where you can get your scale. If you’re going to write 100% of the really good loans, it’s a really small market, so you’ve got to expand your credit criteria and write some stuff that is just near those good loans, then some stuff that sits near that, but you don’t want to write a lot of that, you just want to write enough of it so you can get to 50 and then you can get to 60, because if your current market opportunity is only 30 how are you going to get the 300?”
Not all these new players are entirely reliant on external funding. NeoBanks offering deposit products are optimistic that their relative success in capturing deposits will satisfy their funding requirements as they begin to grow.
“Right now deposits will for the foreseeable future meet our funding requirement, but as any half decent treasurer would want to do is diversify their funding base and to look at tapping into different channels to be able to both diversify but also to optimise on cost of funds.” NeoBank
STRENGTH AND QUALITY OF THE MANAGEMENT TEAM STRONG FUNDING
DEEP, TECHNICAL UNDERSTANDING OF LENDING, RISK AND PRICING ABILITY TO ORIGINATE AND SERVICE WELL
MARKETING PLAN HEALTHY DISTRIBUTION CHANNELS
And here are some ways they expressed these requirements:
“Fundamentally it’s demonstrating that, of the many different options that institutional investors must fund, why is your model and your mouse trap a little better than the other guy’s." FinTech
“It’s always some combination of credit quality and pricing. Those who are able to understand the interplay between those two things do really well.” FinTech “You’ve got to keep your servicing history great, so you ultimately get rated.” Intermediary
“They need to have a facility that’s going to stand the test of time and not be one of those facilities that are wound up in the GFC.” Intermediary
“They are well-capitalised, have proper infrastructure and proper long-term goals and they have an approach that understands the customers’ needs and delivers them with a degree of simplicity and transparency.” Non-bank Lender STRONG GOALS AND BUSINESS PLAN
OPERATIONAL INFRASTRUCTURE
UNDERSTANDING CUSTOMER NEEDS
“The quality of the management of people. Can they handle, not just the origination front but at the backend, have they got the systems that track the risks, you know the servicing component?” Warehouse
WHAT INVESTORS ARE LOOKING FOR
Investors are excited about the growth in participation particularly as they expect to find more value opportunities, but this hasn’t changed their approach to evaluating new deals. They use just as much rigour, perhaps even more, as they seek confidence in the business models being presented to them and they come to grips with the assets being offered.
FinTechs can get a little frustrated at the caution in the market but most understand what’s driving it.
“It is like everyone sitting around the pool trying to work out who is going to jump in first to see how cold the water is.” FinTech
“Realistically the more simple and plain vanilla we can prepare our offering for them, the more likely it is that they'll buy it.” FinTech
“People are going to look at your arrears track record and your loss history and how the portfolio has performed, and does it do what it says on the tin. And if the answer to that is no then, you know you understand you’re going hit some pretty serious questions from investors.” FinTech
Here are some of the ways investors describe their needs from these new businesses.
“For us, it’s a multi-faceted call on the quality of the people, the experience of the people behind, and the underlying ability of systems and credit processors, and the appeal to the end customer.”
“Having a core base of expertise, a clear set of parameters, a very well-defined process. These are the things which, when we look at them, will give us the comfort level.” “They were saying that they had a prime deal but somehow the arrears were not matching the prime parameters. That was a big flag to us.”
“How quickly do they write the deals, because essentially if they are too slow then they are never going to grow. But if they are too fast, are they really doing all the work?”
“I saw one structure which was a securitisation of a large number of loans, but effectively a lot of these loans were written by a few different businesses. They would not, they could not provide enough details about the individual companies for me to be comfortable. That kind of disclosure is the kind I want, and when it gets to that sort of level it can be a deal killer.”
One thing that has not changed since COVID-19 has been the focus of investors on credit quality. They are cynical of new entrants’ ability to introduce technology that allows them to more accurately assess risk. Similarly, they believe the government stimulus is making it difficult to accurately assess risk and this in turn affects the price they are will to take.
