Note: PeerIQ will be announcing a significant bank / FinTech partnership this Tuesday. Stay tuned!
Equity and credit markets recovered this week as the S&P500 posted its best 5-day rally. US consumer sentiment rose to 99.9, the second-highest level since 2004, signaling that the US consumer is still optimistic about the economy.
The 10-year treasury yield flirted with the 3% – levels rarely seen in the last five years – driven by central bank tightening and inflation risks. Consumer inflation picked up 50 bps MoM. Retail sales declined by 0.3% in January and were revised lower for December. Rising inflation and weak spending make for a treacherous “stagflation” combination, but market participants don’t believe these readings constitute a trend.
In regulatory news, the House passed a bill that ensures that loans retain the original interest rate issued by a bank, even if they are sold to nonbanks, which unlike nationally chartered banks are bound by state interest-rate caps. If passed by the Senate, the new rules would bring clarity to loan sales and improve access to credit and investor confidence.
Earnings season continued this week with OnDeck and SoFi reporting. OnDeck announced that the company had achieved GAAP profitability for 4Q17 with a net income of $5 Mn. ONDK’s stock soared 20% since earnings to close the week. The WSJ’s Peter Rudegair reports that SoFi’s earnings missed its internal projections. SoFi retains tranches of loans that it securitizes, and the company cited “lower-than-expected credit performance” which may have hampered the fair value of retained securities. LendingClub reports next Tuesday.
This week we explore the increased potential for M&A between banks and Fintech lenders amidst a backdrop of rising rates, volatility, and rising deposit-funded competition.
Special Topic: The Case for M&A (Why Banks Should Buy Online Lenders)
It’s a truth universally acknowledged that online lenders stand to benefit from bank partners: banks enjoy low and stable funding, a long duration deposit base, unique household data, and national banking charters.
But why should banks that lack an unsecured lending business buy online lenders? We show below that banks have a strong financial and strategic motivation. We illustrate that the ROE potential for deposit-funded banks is compelling. We also argue that bank that do not have an unsecured lending capability risk losing control of the customer to bank competitors that partner with “Big Tech” firms.
“Big Tech” firms – including Amazon, Square, Apple, PayPal, Intuit, and Ant Financial – are transforming retail and payments. Expanding to seller-based financing is as familiar as decades-old ‘lay-a-way’ loans or private label credit cards. Borrowing, savings, and investments – the province of traditional financial services – also present attractive adjacent profit pools for “Big Tech”.
Tech firms have already demonstrated they can open these markets. The largest money market fund in the world, Ant Financial’s four-year-old Yu’e Bao, was built on a sweep from the AliPay payments product. Intuit can utilize proprietary accounting and tax data to underwrite (and acquire) borrowers in novel ways. Amazon can underwrite small businesses using inventory turnover and reams of customer data.
“Big Tech” firms also have proprietary platforms and channels – in-home (think ‘Alexa’), apps, in-car, and mobile to name a few. However, in the US – at least for now – Big Tech firms lack a regulatory “swimlane” to compete with banks in lending and payments on a national scale. Their non-bank and commercial status confines their activities to narrow forms of lending, affinity partnerships, and lead generation. Until that impediment is dissolved, “Big Tech” firms need to partner with national banks with unsecured lending capabilities to fully unlock these markets.
Over the last few months, we see several nationally chartered banks taking advantage of their unsecured lending capability to partner and access these new customer channels. Bank of America this week announced a partnership with Amazon to fund small business loans. Barclays announced a credit card targeting Uber riders. GS reportedly is financing iPhones for Apple.
Our argument is that banks without an unsecured lending capability risk losing long-term customer relevance. Banks that do not have an unsecured lending business do not have a seat at the table.
Battle for the Customer: Big Tech, Banks, and Online Lenders
Which Banks are the logical buyers?
Banks that have the following characteristics would make a short-list of likely acquirers:
- Are active in lending, but have a gap in unsecured consumer loans
- Banks with asset management or structured products arms that can package loans into new products (e.g., ABS offerings, investment vehicles, etc.). Also, banks that have aspirations to develop a robo-advisor
- Banks that have a demonstrated history of partnering with FinTechs
Several of Top 10 banks satisfy at least one of these criteria.
Top 10 Banks by Assets – Gaps In Unsecured Lending
Source: PeerIQ, SEC filings, bank corporate websites
What is the hypothetical ROE of a bank that acquires LendingClub?
As a thought experiment, what would the marginal ROE look like for a bank that acquires an unsecured lender? We use LendingClub for convenience due to the public reporting of financial statements and loan data.
We assume underwriting and loan terms similar to those today (e.g. ~700 credit score, 15% coupon, $15k principal, 3 to 5 year term). We assume annual charge-off rates of 5%. We assume a 1.5% deposit funding charge and a leverage ratio of 15%.
We find that a bank can generate 10% NIM, 2 to 3.5% ROA, 15 to 20% marginal-ROE during good times. We also find that these statistics are consistent with the management objectives of GS Marcus (see our Marcus “teardown” for more). These metrics are enviable. They are well in excess of those generated by any major bank today. By contrast, the ROA and NIM for GS today is less than 1%. In five years’ time, we would expect that GS Marcus drives a significant increase in ROE and other banks will take notice.
Buy or Build?
Building a lender from scratch makes sense when lender valuations are 20x forward revenue, as was the case several years ago when Marcus was conceived.
Today, many online lenders trade at a multiple of book value. Acquiring a lender provides immediate scale ROE-accretive impact, access to existing customers, underwriting history, and risk infrastructure.
Using LendingClub as an example, an acquirer would secure access to ~$8 Bn in annual personal loan origination – 4x the size of Marcus in a fraction of the time – along with LendingClub’s technology platform and regulatory compliance infrastructure. The origination pipeline would require only ~$1 Bn in equity with the rest financed by the bank’s deposit base.
The Consequence of Bank M&A
Most M&A to date has been of the ‘aquihire’ variety. We believe true M&A will highlight the scarcity of technology assets.
Attractive valuations, the desire to improve ROE, and an imperative to maintain long-term relevance are strong factors for why we expect banks without an unsecured lending capability to acquire FinTechs.
- Ashish Dole will speak on the “Marketplace Lending Snapshot: Performance, Review, ABS Issuance Outlook and Funding Trends, and Bank Partnerships” panel at SFIG Vegas 2018 on Wednesday, February 28 at 9:15 AM.
- Kevin Walsh will speak on a panel at SFIG Vegas 2018 titled, “Predictive Modeling: The Role of Big Data and Machine Learning Across the ABS Market” taking place on Monday, February 26 at 4:35 PM.
- Finalists Announced for Second Annual LendIt Fintech Industry Awards(PRnewswire, 2/16/18) PeerIQ is a finalist for “Most Promising Partnership” for our partnership with Macquarie.
- Fintech-friendly Cross River Bank partners with PeerIQ on loan data(AmericanBanker, 2/16/18)
- S&P 500 Caps Best 5 Days Since 2011 as Oil Jump (Bloomberg, 2/14/18) S&P500 posted its best 5-day rally to recover above 2700.
- U.S. CPI Tops Estimates as Apparel Costs Jump Most in 30 Years (Bloomberg, 2/14/18) US CPI increased by 0.5% MoM driven primarily by apparel prices.
- Retail Sales in U.S. Decline After December Revised Down (Bloomberg, 2/14/18) Retail sales declined by 0.3% in January and were revised lower for December.
- U.S. Consumer Sentiment Jumps After Tax Cuts Blunt Stock Gyrations(Bloomberg, 2/17/18) US consumer sentiment rose to 99.9, the second-highest level since 2004, signaling that the US consumer was still optimistic about the economy.
- Three Gauges Show Prices Rising in U.S. Production Pipeline (Bloomberg, 2/15/18) US CPI, PPI and the Empire State Manufacturing Index point to higher inflation.
- House Backs Bill That Would Benefit Fintech Partnerships With Banks (WSJ, 2/14/18) The House passed a bill that would ensure that loans retain the original interest rate issued by a bank, and clears a lot of regulatory uncertainty around the Madden vs. Midland issue.
- B of A’s Moynihan: Big banks are ‘fine’ with Dodd-Frank (American Banker, 2/15/18) Moynihan said that Dodd-Frank had made the financial system safer but would work on rationalizing capital ratios to spur loan growth.
- Americans Can’t Get Enough Consumer Debt (WSJ, 2/14/18) Consumers borrowing is approaching 30% of non-mortgage debt.
- SmartBiz Loans Surpasses JP Morgan Chase as Number One Provider for SBA 7(a) Loans Under $350,000 (Businesswire, 2/14/18) SmartBiz Loans has outpaced many national banks, to become the top facilitator of Small Business Loans for 2017.
- MoneyLion Reaches 2 Million Customer Milestone As Growth Accelerates(Businesswire, 2/13/18) Rapid customer adoption reflects demand for financial products that address the challenges of the financial middle class.
- SoFi Reports Disappointing Earnings as Loan Performance Suffers (WSJ, 2/9/18) Lower-than-expected credit performance hampered the returns on the retained securities.
- Review of OnDeck Q4 2017 Earnings Results (Lend Academy, 2/13/18) OnDeck delivered its first GAAP profit with net income of $5 Mn.
- Citi, PNC invest in B-to-B payments fintech (AmericanBanker, 2/14/18) Citi Ventures and PNC on Wednesday announced a strategic investment in the payments firm HighRadius, continuing the trend in partnerships between banks and fintech firms.
- Podcast 138: Vishal Garg of Better Mortgage (Lend Academy, 2/9/18) CEO and Founder of Better Mortgage explains how his company is making it easier to buy a mortgage (Transcript)
- The Songs That Bind (NYT, 2/11/18) Data drawn from Spotify listeners reveal we stick with the music that captured us in the earliest phase of our adolescence.