This first appeared in the monthly a16z fintech newsletter. Subscribe to stay on top of the latest fintech news.
IN THIS EDITION
- Fintech makes a play for Gen Z
- What Rocket Mortgage can teach us about the future of financial services
- Assessing COVID-19’s impact through the banks
- An emerging model for high-yield savings
- The allure of new credit builder products
Fintech makes a play for Gen Z
As we’ve written previously, COVID-19 has accelerated the digitization of finance. Nearly 20 percent of consumers who opened an account in the past six months did so at a purely digital bank. But beyond the spike in online banking by existing customers, “shelter in place” is also accelerating the early banking adoption of an entirely new customer base: Gen Z.
In the pre-digital age, you’d give your kid a certain amount of money as an allowance and the physical presence of cash in a piggy bank (or lack thereof) would teach him or her early lessons in the value of money and saving. After some reasonable accumulation of cash, perhaps you’d take your kid to the local bank branch to get them a bank account. But how do we accomplish this progression in a purely digital age?
A number of companies tackling this challenge have seen a recent surge in demand: Greenlight is a prepaid debit card that enables kids to track savings goals and allows parents to set spending controls and allocate cash for chores. Step targets teens with a spending account and easy p2p transfer.
One of the biggest unanswered questions for these new companies is whether they will be able to retain customers after a certain age. Does an 18-year-old heading to college want the same bank account that helped her keep track of her chores when she was 12? Unlikely. But these early digital challengers have additional product levers they can pull — for example, the ability to unlink one’s parents from your account when you turn 18 and to get a new personalized card, or to graduate users into new credit-building features. Even if the first kid/parent banking app is not able to retain its customers past a certain age, that teen is likely more apt to choose a newer banking player over a traditional default like Chase, Wells Fargo, or Bank of America. Another challenge for Gen Z-targeting companies has been that kids’ comparatively low spending power breaks many traditional interchange-based revenue models. With that in mind, some of these early players are betting that the value they provide parents and kids will merit a monthly subscription fee.
So should traditional incumbents be worried? Traditionally, larger financial institutions could afford to wait and target customers at inflection points later in their lives: say, graduating from college, or starting their first job. Very young customers were seen as unprofitable (savings from babysitting money does not typically drive high balances) and, regardless, there were not enough startups targeting this audience to pose a credible threat. That seems to be changing. An increased focus on boosting kids’ and teens’ financial literacy — spurred, in part, by COVID-19 — is now pushing parents over the inertia hump. In the future, as more and more companies offer financial services, non-fintech companies are likely to make a play for the loyalties of younger and younger customers, as well. This means that your child’s first bank may someday look more like a debit card with loyalty points for Robucks, rather than a piggy bank.
—Angela Strange, a16z fintech general partner
What Rocket Mortgage can teach us about the future of financial services
Mortgages underpin a major component of the American Dream: homeownership. They’re also integral to financial markets — residential mortgages are one of the largest asset classes in the world, with over $10 trillion in debt outstanding (that’s 10 times more than credit cards and student loans). And, of course, a functioning mortgage market is hugely important to the health of the American economy (see: 2008). Rates are now at an historic low, falling below 3 percent for the first time in history and driving origination volumes to all time-highs. (Take this seemingly rosy news with a grain of salt: that drop has triggered stricter underwriting criteria, which prevents many from being able to benefit.)
Against this backdrop, Rocket Mortgage, owned by Quicken Loans, is filing for an IPO. Rocket is the largest mortgage broker in the country — it grew in market share from 1.3 percent to 9.2 percent between 2009 to 2020 — and going public means they are releasing some hitherto private metrics on their business. Understanding Rocket Mortgage is vital to understanding the mortgage market and contains important lessons as we think about the impact of technology in finance, not to mention what it means to build an enduring company.
The first and most obvious trend is that investing in technology delivers better consumer experiences. Rocket has won awards for consumer satisfaction in mortgage origination, a complex process with lots of edge cases. By integrating software end-to-end to support the more esoteric aspects of underwriting, Rocket eliminates those headaches. Yet even that well-regarded product is far from perfect. Rocket received a lot of flak in 2016 for a Superbowl ad with the tagline “Push button. Get mortgage.” (Commentators: “Wait, isn’t that what caused the great recession?!”) In reality, getting a mortgage is still nowhere near a “push button” experience. A refinance typically takes more than 30 days with Rocket, which is roughly in line with industry averages. As a result of this inherent friction, many Americans — even those with stellar credit — don’t refinance even when it could be advantageous to do so.
Second, Rocket demonstrates how, at scale, large finance companies (be they fintechs or incumbents) seek to expand into adjacent product areas. Some expansions are obvious. In addition to being an originator, Rocket Mortgage also has a servicing business that retains servicing rights on 92 percent of their originations and today supports 1.8 million clients. Other expansion areas are less obvious. For instance, Rocket will also help you with a personal loan (Rocket Loans) or even sell a used car (Rocket Auto). In the era of rebundling, every company is striving to own the full customer experience and deepen that relationship.
Third, at a granular level, Rocket reveals how automation in finance may lead to job losses for workers, but savings for consumers. Rocket’s software-assisted loan officers are 3.5x more productive than their peers: they close 8.3 loans per month, compared to 2.3 for the rest of the industry. That gap is likely to increase over time. In the personal loan space, lending is nearly 100 percent automated; in the long run, the same will eventually be true for mortgages. What does that mean for the 400,000 loan officers in the country? There will be substantially fewer of them. The good news for consumers is that fewer loan officers means lower costs and more savings. Mortgage origination costs have remained stubbornly high, topping $10,000 in 2018. Ultimately, those costs are borne by consumers.
The mortgage industry is ripe for further innovation, and we’re eager to see which companies will define the next generation. Mortgage businesses are not easy to build: it took 500 Rocket Mortgage employees years. But for those companies that endure, the payoff — both in customer impact and financial success — could be considerable.
—Rex Salisbury, a16z fintech deal partner
Assessing COVID-19’s impact through the banks
If you looked solely at the stock market, the economic view would seem oddly optimistic. Since March lows, you’d see a record-breaking 45+ percent increase in the S&P. That narrow lens would indicate a seemingly strong economy and tremendous growth momentum. However, the stock market is rarely a good indication of what is actually going on in the economy. In a world where over 30 million Americans have lost their jobs and many businesses remain closed, a simplistic view of market data is insufficient. Many of the big banks reported earnings this month, and their income statements and balance sheets paint a much clearer picture of what’s really happening. After digging through their reports, comments, and balance sheet movements, here are some high-level takeaways:
- Record revenues: Banks posted record trading profits in the last quarter, fueled in part by bond trading. Goldman Sachs, for example, saw a 93 percent yearly increase in trading revenue and a 150 percent yearly increase in bond trading revenue. In part, that can be attributed to the large increase in debt offerings in recent months (over $5.1 billion in new debt offerings by businesses in the first half of the year). Citi, JP Morgan, and Bank of America also saw trading revenues surge. That continues to bolster their revenues, even as the reduction in the Federal funds rate means they cannot count on net interest income to contribute to their top line.
- Preparing for the worst: Banks are increasing their provisions for bad loans on their balance sheets. These provisions are reserves against future write-offs, if and when consumers are unable to pay off their loans. Last quarter alone, for example, JP Morgan added an impressive $10.5 billion in provisions for bad debt. Combined with Citi and Bank of America’s provisions, that totals over $28 billion for future loan losses. On top of this, many banks are expecting double-digit unemployment for the rest of the year. Recent balance sheet movements indicate their desire to stay out ahead of further economic distress.
- Consumers’ behavior is largely positive: Interestingly, many major banks have not yet seen a drastic change in consumers’ ability to pay off their loans. JP Morgan reported payment deferrals of 2.1 percent for consumer cards and 4 percent for business cards; 90 percent of those deferrals are for less than 30 days. All in all, net charge-offs at JP Morgan increased by 6 percent last quarter — more than $1 billion short of expectations. One possible explanation is that expanded government programs and stimulus measures have helped keep consumers afloat. That bears the question: Will consumers plunge into debt if these programs dry up in the coming months?
While the economic fallout of COVID-19 is yet to manifest in the stock market, banks are making significant moves to prepare for worsening conditions. The good news, if you can call it that, is most banks are better prepared than they were in 2008 — and are guarding against an extended recession.
—Matthieu Hafemeister, a16z fintech deal analyst
An emerging model for high-yield savings
We called 2019 the year of high-yield savings accounts, as companies including Betterment, Wealthfront, SoFi, Robinhood, and Credit Karma pursued prime customers. However, the collapse of the Fed funds rate to near zero caused fintech companies to likewise drop their yields. As a result, consumer interest in these accounts dried up, creating a crunch for companies who target prime consumers. Despite this (or perhaps because of it) a new category of companies is emerging that delivers high yields via a different vehicle.
Broadly speaking, fintechs have had difficulty attacking the prime market. Wealthfront and Robinhood have arguably achieved the most success by focusing on millennial savers and millennial (day) traders, but even these products are relatively small scale in comparison to Chime or Credit Karma. Discerning readers will rightfully point out that a small prime audience can be highly valuable. And given the intense competition among financial services providers to win the loyalty of the “future rich,” incumbents like Chase, Bank of America, and SVB already provide relatively robust experiences for prime customers.
So what’s a fintech founder to do? Companies like Donut, Outlet, and Dharma are advancing a new model in which they provide >2 percent yield on deposits by incorporating crypto securities lending. Specifically, users deposit USD to earn interest, just like a savings account. On the back end, those deposits are converted to cryptocurrencies, which are then loaned to hedge funds looking to leverage their trades. These hedge funds are willing to pay a high interest rate and typically overly capitalize the loan, thus mitigating loss risks. Though the yield is higher, the corresponding risk is higher, as well, since these accounts are not FDIC insured and depend on third party insurance to protect against theft or other losses.
Though there’s regulatory uncertainty around this model, it’s interesting on two levels. First, it’s an excellent example of the intersection of crypto and fintech, where crypto is an invisible enabler of a core consumer value proposition. Second, this model provides the potential for an emerging player to build a prime-focused offering that encompasses more complex sources of higher yield — everything from securities lending to active trading strategies. It combines the intuitive, user-friendly UI/UX of a neobank with the rich, composable set of financial products being built in crypto.
While we’ve likely achieved saturation in large-scale US neobanks focused on subprime consumers, the near prime and prime consumer segments are still up for grabs. We’re watching companies like Outlet and Donut carefully to see which value props reignite interest for these segments.
The allure of new credit builder products
In the past month, Chime and Apple both launched credit builder products. Chime brought its Credit Builder secured credit card out of beta and Goldman Sachs and Apple introduced the “Path to Apple Card,” a four-month program that offers rejected Apple Card applicants monthly advice on what they need to do to be approved. What are credit building products and what explains the recent interest?
It’s no secret that 62 million Americans are “thin file,” meaning they have less than four credit accounts or less than six months of credit history listed on their credit report. Another 26 million Americans are “no file,” with no credit history. With a very thin file, a bank or lender often does not have enough credit history information to offer a loan. And as millennials increasingly prefer debit cards, they aren’t building a credit history either. As a result, when it comes time to apply for a mortgage, credit card, or other personal or business loan, getting a low interest rate — or getting approved at all — is difficult.
There are some existing options for building credit, such as credit builder loans and secured credit cards. While credit builder loans are not new products — they’ve been offered by community banks and credit unions for years — finding and qualifying for them is difficult and often has relied on having a personal relationship with the bank. With credit builder loans, consumers make monthly payments, which are typically held in an interest-bearing account by the bank. The bank reports the on-time payments to the credit bureaus, adding to the consumer’s positive repayment history on their credit file and boosting their credit score. (Repayment history comprises 35 percent of a consumer’s FICO score.) At the end of the term of the loan, the customer’s summed payments, plus interest, are returned to them. Alternatively, secured credit cards, like Chime’s offering, typically require a minimum deposit, which sets a spending limit (e.g. a $200 deposit allows you to spend $200). If the consumer doesn’t pay their bill, it’s low risk for the card issuer: they can take the money from the consumer’s deposit and charge interest (the Chime card is 0% APY). These payments are also reported to the credit bureau, which helps the consumer build their credit file. Neither of these options, however, gives consumers guidance on how to improve their credit scores.
A number of rent reporting companies like RentTrack, PayYourRent, and Pinch (acquired by Chime), enable consumers to report their on-time rental payments to the credit bureaus. More recently, companies like Self Financial and SeedFi — as well as Chime’s card and Goldman’s “Path to Apple” advice — have been focused on helping consumers build credit through loan repayments.
Loan repayment history is more effective in improving access to credit than rental and utility payments. Why? Because credit is a measure of the consumer’s willingness to pay, not ability to pay. Paying rent and utilities doesn’t assess consumers’ willingness to pay because they have to pay them to maintain housing. Thus, most traditional lenders don’t give consumers as much credit for paying rent and utilities as they do for making more discretionary payments to cards and loans. Therefore, rent and utility payments are often not factored into underwriting models. So while newer FICO models do incorporate alternative data, like rental and utility data, into a consumer’s credit score, without improving a consumer’s access to credit, that alternative data is currently of limited use — particularly since most lenders are still using an older, traditional FICO version. For now, credit builder loans often offer a better path to helping consumers achieve financial progress.
—Seema Amble, a16z fintech deal partner
More from the a16z fintech team
The a16z Podcast: Real Estate in a Pandemic
How has social distancing shaken up the market to buy? How can tech streamline the inefficient process of renting, buying, and selling a home?
By Alex Rampell, Lauren Murrow, Tushar Garg, and Malloy Evans
Big Fintech Goes Global
Plus: a contrarian take on recovery prospects; the controversy behind the Hertz stock snafu, and more.
By the a16z fintech team
35 Fintech Companies Aiding in Coronavirus Relief
From Propel’s part in Project 100 to Square’s role as a stimulus lender, here’s how U.S. fintech companies are stepping up to help those feeling the impact of COVID-19.
By Seema Amble and the a16z fintech team
The CFO in Crisis Mode: Modern Times Call for New Tools
Many businesses are reassessing their 2020 projections as the pandemic unfolds. Yet despite an influx of data on which to base decisions, the tools at the CFO’s disposal have not kept pace.
By Seema Amble and Angela Strange
Small Businesses Depend on the Stimulus Package. The Stimulus Will Depend on Fintech.
The government is unprepared to identify, adjudicate, and disburse $350 billion of aid to small businesses without a sea of fraud. Tech is the answer.
By Alex Rampell
The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation.
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments for which the issuer has not provided permission for a16z to disclose publicly as well as unannounced investments in publicly traded digital assets) is available at https://a16z.com/investments/.
Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see https://a16z.com/disclosures for additional important information.