Finding new ways to spend money you do and don't have makes up the two largest segments in consumer finance: payments and credit, respectively. Finding new ways to save money - for a large purchase, a rainy day - is a barren landscape. Of course, saving is like flossing your teeth: you know you should, but ignoring it won't kill you.
Ironically, it can and will, as we see non-savers on the cusp of financial ruin with frequency; more likely to file for bankruptcy; more likely to default on a mortgage. And the macro-economic consequences are big, too: Chinese savers own trillions of US debt; excess credit reliance causes things like recessions. American's savings rate are amongst the lowest of all developed countries.
So, oddly the most innovative and active import of ideas on how to save are both ancient and originate from the developing world. And a pool of companies are introducing their spin on the idea of pooled savings as a way to effectively change behavior and provide immediate benefits of stuffing a little dough away.
The idea is that if you band with a group of people you know and trust and each agrees to contribute a fixed amount every week for a number of weeks equal to the size of the group, every person can have their turn to take the collective pool. Let's say 5 people agree to contribute $100 per week for 5 weeks. The first week I could get access to $500 - to buy that iPad I wanted. The next week, the next person gets $500, etc.
At least six companies are all building out this basic idea: Yattos, puddle.io, ClearStreet, eMoneyPool, OurSusu, and PeoplePoweredSavings. Some fairly straight forward - and stalling. Some with cool bells and whistles, like offering a premium to group members to take their bout towards the end (and charging those who want early access - but still less than interest on a prime credit card). Some integrate into social networks, like Facebook, partially or completely.
Using the internet and bank connectivity to leverage and old, and sound, idea makes perfect sense - on paper. Using modern social media to extend the ancient power of guilt and pride is very cool - in theory. Our nanny, from Trinidad, religiously participates in a "susu" - as they are called in the Caribbean. Would she do it online? Nope. Should "westerners" learn and benefit from this idea - absolutely. But will we? I doubt it.
If any of these sites will make it to any scale, they will need to be great marketers. They'll need to start with net-savvy, but older immigrants, for whom this model was native, but who aren't rebelling against the "old world ways." They'll need to appeal to introduce a complex idea to well intended, but disinterested group of Westerners to make it big enough to matter. I sure hope someone does: I need it personally, as does this country. If I were to bet on one of these, it would be Yattos.com, despite the fact that I set up a group, invited people and failed to get any interest, including people close to the company. So I'm left to save on my own, the old-fashioned way, and pine for Susu's not just being a silly lyric in a Phil Collins song.
The past two years Core Innovation Capital has issued a national challenge for who makes the most innovative product or service serving the emerging middle class, aka the un- and underbanked, the cash-preferred, the credit underserved. Sign up here at corevc.com/megachallenge.
This year, we're improving and expanding. It's not just a Challenge; it's a Mega Challenge. Instead of four finalists, we'll pick 10-12. Instead of the last day, we'll feature finalists on the first day of the Underbanked Forum. Instead of one hour, this Mega Challenge will last three hours, in front of the largest group of industry experts ever assembled.
At stake are fun, fame and fortune. A live demo before 800+ executives is pretty exciting for even the most seasoned entrepreneur. National recognition for being the most innovative product for the underbanked in 2013, as determined in real-time by senior leaders in retail, banking, payments, alternative finance, regulation and consumer advocates. And $10,000.
Nominate your company - whether large or small - at www.corevc.com/megachallenge. We've had finalists as large as FIS, or as small as the one-man Juntos Finanzas, who won by a land-slide).
The Challenge has introduced mobile check cashing for the underbanked, payroll-based short-term loans, social media-based underwriting, better sub-prime auto lending, SMS-based financial planning, and micro-investments.
We're eager to see what financial innovation is being cooked up in 2013. We've seen some glimpses and it's pretty exciting!
So if you're working on something great that serves the emerging middle class, whether in payments, in credit, in planning or saving - and if you're able to show a live demo by June, nominate your product or service. It's free, will take 5 minutes and could offer unprecedented exposure: corevc.com/megachallenge.
Goal and resolutions? Too personal. Predictions for this coming year? Too much pressure. Post mortem on last year? Too boring. So, instead, here is my wish list for our industry for the year of the Snake.
An Iconic Brand. Confidence in banking is at historic lows. Perception of alternative financial services are even lower. I would like to see a Great consumer finance brand emerge. And with Great I mean: aspirational to its customers, trusted to manifest the Golden Rule, able to scale. Keep your eye on Progreso Financiero.
Big Bank Backoffice Leadership. With a couple notable large (Chase), medium (Regions), and small (Carver) exceptions, I've long believed most banks shouldn't try too hard to serve the underbanked: oil and water. Instead, I think the best way banks can serve this customer is to serve businesses who serve this customer. Bank great Money Service Businesses. Provide debt to great short-term lenders. Sponsor great remitters. Lobby for non-bank innovators. Partner closer with retailers. I'd love to see a big bank fund and create such a line of business. There's a billion dollar opportunity for someone to go big.
A Short-term Lending Leader. Payday is an ancient game: 1.0. Since around 2010, some new tech players have created the next generation, 2.0, marked by better underwriting, greater transparency, online distribution, and more liberated loan structure (think Zest, BillFloat, LendUp). I'm holding out for 3.0 of short-term unsecured lending, based on my TRUST principles: even better underwriting, risk-based pricing, clear rewards for on-time repayment, lower customer acquisition cost, even lower default rates, the ability to scale big, and solid, mature leadership in this fractious business. It could be one of the above...
Mobile Remote Deposit Capture. Mobile? Talk to the hand! Banks have been rolling out MRDC the past couple years. Last year, it was all the rage to promise it to prepaid card customers. The big deal is that MRDC gets cash onto the phone, which you'd otherwise have to do at a retail location (in which case why use the phone if you can just do everything else at that same retail location?). The big difference is that MRDC for the cash-preferred customer needs to clear immediately, not over 5+ days. The big problem is that comes with a ton of risk. Cool companies, like Chexar, have solutions. I hope this year of all checks "cashed", more than 5% will be "cashed" onto a mobile phone.
Regulatory Clarity. I don't exactly blame your garden variety entrepreneur for starting anything but a financial technology company. It is highly regulated, complexly regulated and unclearly regulated. That Dood Frank? Office of the Comptroller Who? CFP-Why? When and what will they do to me? Fortunately, the CFPB is quite progressive. I hope they will lay out clear principles this year, even before they write the rules, on things like credit reporting, prepaid, short-term lending, and remittances.
New Lingo. The language of unbanked and underbanked has run its course. We need something new. The old lingo is limiting - it assumes banking status is the most important determining factor. It's inaccurate - underbanked suggests people should be banked, which for many in this population is not and will never be the case. It's a bummer - people aren't inspired to dig out from under something. Instead, building towers in the sky is the currency of the entrepreneur (and intrepreneur). At Core, we're trying to re-invision this market in entirely new ways and by the end of this year, I hope we'll have the beginnings of a new lingua franca.
What's on your list?
People generally assume serving the underbanked is a noble thing to do. And it is, if you do it right. You can make an incredible difference in the lives of a quarter of the US population by providing them with better tools with which to spend, borrow, plan and save. Check out CFSI's Compass Principles if you're looking for a roadmap on "doing it right."
But I am not noble. I'm a capitalist. And for the third year in a row, I've been tracking the size of the underbanked opportunity. We all know it's a lot of people (but then, many people have brown eyes). We all know their lives aren't easy (so they should help themselves, or charities can help those who can't help themselves). We assume that in aggregate they earn and move lots of money (over $1 trillion, in case you were curious). We hear immigrants send tens of billions abroad and cash billions of checks. But how much do people who rely primarily on alternatives to banks actually spend on fees and interest for basic financial services is the final measure of whether there is a market here. The answer, of course, is yes, big time.
About $78 billion was spent in 2011 by members of the American emerging middle class - also known as the underbanked - on fees and interest on basic consumer products. Together with my partners at CFSI (and thanks to the sponsorship from Morgan Stanley and Herculean efforts of CFSI's Summer Associate Eva Wolkowitz), we updated last years' study entirely. We took out some stuff, added in some stuff, mined all the best research out there, validated it with public data and insider insights. The result is impressive, I think. You can download it here.
Rather than regurgitate what you can read in the Knowledge Brief we've made for your reading enjoyment, I will instead focus on my point of view about all this. $78billion - so what?
First of all, it is a lot. To put it in perspective, this means that a quarter of the US population spends about 7% of their hard-earned paychecks just to conduct their financial lives. Ignoring management fees on securities and such, I would estimate I personally spend about negative 1-2% on my financial life. Right, I earn money to house it somewhere, pay my bills, service my credit and purchase the things I need.
Second, this is just scratching the surface. We left out costs associated with long-term debt like mortgages and education, any kind of insurance, or any costs associated with the small businesses millions of people run to stay afloat.
Third, it's incredibly inefficient. A huge amount of this relates to high losses and high fixed-overhead. The Digitization of Everything has yet to arrive here at scale. Just look at subprime auto-lending here - $26 billion in fees and interest here alone. This is a securitized loan. But imagine the cost to go repossess a car if someone fails to pay. Better, smarter underwriting - like that of innovator Neo Loan - along with a $5 widget that would turn off the car when a payment is missed, would dramatically decrease defaults and program management costs.
What if we could drive efficiencies that offer more people better service and cost them only $39 billion in fees and interest, in a way that yields better gross margin and puts $39 billion back into the economy? This is no Herculean task. Ping Core if you're working on it. You can be noble and capitalist.
About a year ago, a friend set up a call for me with Suze Orman, while she was still planning her Approved Card. She was somewhat weirdly obsessed with the vision of a digital cash economy. No paper. No credit. Also, not realistic.
General purpose prepaid has basically gotten a bum rap. The press still thinks it's all Kardashian cards, while a big majority offer simple, clear pricing and would cost significantly less than either checking or check-cashing, assuming normal use cases. Suze was no exception.
Then Green Dot didn't do its industry any favors by scaring its investors to drop the company's value 60%. Netspend is doing better, but is hardly a Wall-Street darling. So the category appears out of favor.
I'm super bullish on prepaid and believe it's going to become much bigger than most people seem to think. Here's why:
Checking and check cashing substitute. As reiterated in the Journal today, "Free" checking is only for those who can keep a substantial balance. I believe prepaid accounts will remain an attractive alternative to those who are fed up with banks and those seeking better alternatives to check-cashing. Despite all the above, prepaid continues to grow at breakneck speeds in the "underbanked" demographic (and includes many fully banked customers).
Third party banking. There are many big companies who enjoy substantial payments relationships with consumers. Just like Wal-Mart was really seeking a banking license to decrease their interchange fee losses, many others can and will own their payments relationship with their customers, and leverage their trusted brand. A AAA account or Apple account or New York Life account are not far away, I believe - and prepaid makes this possible. My friends at Rev launched an innovative boarding pass/debit card for Air New Zealand. We see prepaid companies looking to white label a program for third parties, and I think that makes a lot of sense.
Mobile. This awesome mobile wallet you've been reading about? Chances are it will be based on prepaid. There may or may not be a card involved, but prepaid is not a physical card as much as it is a technical and regulatory variation on how traditional bank accounts are managed. Note the Google Wallet team recently bought prepaid processor TxVia to juice up its efforts.
Real-time fund transfer. Ever wondered why in 2012 we still have to wait 3-5 days for checks to clear? Or worse, to pay a bill electronically? Or even worse, transfer funds to and from yourself between banks electronically? The culprit, among other things, is a creature called ACH! How do we make payments real-time? Prepaid.
The House Financial Services subcommittee contemplated a new Act today. It goes by H.R.6363, but its friends know it as Credit Access and Inclusion Act. Basically, it encourages utilities to report to the credit bureaus information about whether I pay, or do not pay said utility on time. This is interesting because usually utilities (and many others) only report "derogatory" information, or only when I don't pay on time. This Act recognizes the importance of nontraditional data for millions of Americans and that the majority who pay on time never get the benefit of doing so, if only non-payment is reported.
About 80 million Americans don't have a lot of information about them at the credit bureaus. This means they aren't able to get mainstream credit, and more likely to enjoy obstacles when renting an apartment, applying for a job and seeking insurance. This is a big bummer for millions and millions of responsible people who don't happen to have enough "trade lines" at the big three bureaus (TransUnion, Equifax and Experian). It's also a big bummer for lenders (and landlords and insurers) who can't approve these people in an automated fashion, for lack of this traditional data.
Enter non-traditional, alternative, data. Predictive. Potentially inclusive - but often not. Unless utilities, and other alternative data providers, report "full file" - or both positive and negative behavior - most of these new data will only benefit the industry, but not many consumers (unless, of course, the new data are used in a waterfall, see below).
The point is not to approve bad risk consumers. The point is to dramatically improve our ability to determine who is a good or bad risk. This will benefit millions of consumers and represent new business to industry. Some innovators in this field are Experian (which recently launched a new First View alternative score), L2C (in which Core has an investment), LexisNexis (which uses a ton public record data), Zest Finance (which is also an online lender), Sociogramics (focused on social media data), and DemystData (same).
If the Act passes, it's a good thing. For people and for business. Here's the thing itself.
The FDIC updated its 2009 figures (based on 2008 Census data) of who uses what kind of basic financial services and released them yesterday. It's not just any four years later, but marks a period that represents significant change in the economy and individual American's lives. What did we learn? Basically, there are more people who underutilize traditional financial institutions (banks and credit unions) and rely more significantly on alternative financial services (check cashers, payday lenders, etc) - but not dramatically more, 2011 vs 2008.
"More than one in four households (28.3 percent) are either unbanked or underbanked, conducting some or all of their financial transactions outside of the mainstream banking system."
We're talking about 68 million people. Honestly, this is smaller than I would have expected, but perhaps doesn't yet fully reflect some of the regulatory changes that were introduced in the wake of the financial crisis. Certainly, bankers like Jamie Dimon, who have been crying foul that they will be forced to let go of their low-end customers as a result of draconian new rules seem overly dramatic. And the growth in prepaid and anger in banks, while real, are not as exaggerated as I had expected. I think this is good news for people who think of this segment as "underserved." Relative to the dramatic times in which we live, even lower income people are maintaining a relative equilibrium in how - and with whom - they manage their day to day finances.
We will soon share an update on Core and CFSI's market size for fees and interest charged to the underbanked, to show how the industry is changing at a more granular level.
Download the FDIC report here, if you're interested.
Today's WSJ headlines with a story on how even the mass affluent are struggling with student debt. Our summer associate, Aaron Mercurio, has been working on a private student lending investment thesis for us, and opines the following:
We know student loans are important and we’re often reminded that they’re big business: The student lending market recently exceeded total credit card outstandings by surpassing $1 trillion in debt on the heels of $110 billion in new debt issued in 2011. Meanwhile, tuition increases don’t seem to be slowing down.
If students and parents are voting with their wallets, then federal loans are the preferred means of borrowing both for students and the universities that push them. 93% of new debt in 2011 was issued by the Department of Education under the Federal Direct Student Loan Program. But federal student loans come with a myriad of challenges:
Overview of Terms of a federally student loan issued after July 1, 2012 (simplified for brevity):
|Type of Loan:||Subsidized and Need Based (Stafford, Perkins):||Unsubsidized (Stafford, Direct, PLUS, Parent-PLUS)|
|Loan Amt. Limit||$3,500 - $6,500 / year||Based on school tuition + expenses|
|Interest Rate||3.4% - 5% Fixed||6.8% Fixed|
|Origination Fee||0% - 1%||Up to 4% (w/ 1.5% rebate)|
|Collections||Cannot be discharged in bankruptcy, wage garnishment allowed|
Source: Department of Education, Direct.ed.gov website
The average student has $25,700 in debt, including graduate school debt, according to the Department of Education. While subsidized Stafford/Perkins loans are attractive – students need to qualify and it may only cover a small amount of tuition.
Key issues with Federal Student Debt today:
- Not all loans are created equal: Fixed, flat rate loans are inefficient; don’t account for risk, macro-environment, or student/university performance
- Lack of price competition: Up to 4% origination fees and fixed-rate loans in a market where prime has remained flat at 3.25% since Jan, 2009
- Extreme collection practices: Defaulters are almost never able to discharge loans in bankruptcy and co-signers credit is impacted
- Inconsistent borrowing caps: Like the rates, desire for simplicity creates inefficiency in terms of meeting students’ individual borrowing needs
The silver lining? Major problems drive major opportunities, and this market is ripe for innovation. With start-ups like Fynanz creating a platform for credit unions to aggregate lending power to compete, SoFi connecting alumni with current students to create lower cost opportunities, and Tuition.io providing sophisticated software for managing student debt and repayment, I’m excited to see if these and other companies can drive the PSL market and compete head-on with federal loans.
Dating back to the 12th century, western medical professionals have signed the Hippocratic Oath. Most US medical schools require their students to sign some form of this oath, swearing to practice medicine ethically and honestly, and never to do harm to anyone. While the Oath has been modernized and is not a requirement to be board certified, it remains a common practice.
Doctors and healthcare professionals are imbued with a real responsibility over our lives. But what about those people who are imbued with a responsibility over our livelihoods? Can livelihood not meaningfully effect the quality of our life? Why is there no equivalent Hippocratic Oath for business school students, or more specifically for bankers?
With the massive move to bank consolidation and the emergence of secondary markets, banks relied more on automation. The banker of yore, who knew your mom and your kids, barely exists today, not even in small community banks. That banker of yore was not only able to underwrite you without the presence of a FICO score, but assumed some sense of responsibility for his/her clients. Perhaps this is a romanticized picture of yore; I wasn't around back then. I'm from the generation of automation and no Golden Rule.
Given that all we have to show for the global financial crisis here in the US is Dodd-Frank, CFPB, Volcker Rule and other miscellany - much with real unintended consequences yet to bear out on the most vulnerable - we are certainly due for another, much worse economic crisis, for business is mostly same as usual. I'm not sure that we have learned what the Greeks did 1000 years before their recent troubles: that a Hippocratic Oath for banking is not just good for you and me, but for our global economy. I found a funky, but interesting website - www.financialhippocraticoath.org - that promotes the same idea. Glad I'm not alone.
I try to avoid eating food that "may or may not" contain some ingredient, especially if it's not even clear what that ingredient is (milk product?). Barclay's new Ring credit card, I'm afraid, looks tremendously tasty and innovative, but while poking through their Terms of Service over lunch just now, proved themselves no better than a Twinkie. In fact, far worse, because Twinkies don't pretend to be healthy.
Barclay's pitches the Ring credit card as "crowdsourced" and "community powered." They're keeping it "simple" and touting unprecedented candor: "For the first time ever, we're going to give you a look at our profit and loss statement, which shows you how we make money from Barclaycard Ring. And with Giveback™, you'll even get to keep some of the profits for yourself." This is cool stuff! If they would actually share their (card's) P&L statement, it would be a historic first. I love the idea of being a customer and an owner, and if they do it right, I might actually choose features or economics that aren't strictly in my myopic self-interest.
They keep their promise with low, flat rates, a clear fee schedule, even beyond the basic Schumer box requirements. The Terms of Service is easily accessible, plain English, short and to the point. But reading past the fee schedules and basic disclosures, comes my tremendous disappointment:
This profit sharing feature is not based on the actual profits of the program. Instead, the Giveback™ program contains a transparent calculation that is used to determine what will be shared with the community members and which may or may not approximate actual profits. The Giveback™ program and the profit sharing features are offered at our sole discretion. We may discontinue the program at anytime.
They will "transparently" disclose what amounts to a deceitful claim. They will not share their P&L. They may give something back, but it may or may not approximate actual profits. It could be a lot less than your garden variety non-social, non-transparent credit card. They may, in fact, give nothing back, at their discretion. But the fact they promote this as the vanguard of transparency, the epitome of modern, youth oriented social media savvy strikes me as incredibly cynical.
Why not actually disclose the P&L, even if just for a particular product? Why not actually share a portion of the profits that could amount to more than the perfunctory "2% cash back"? Why not actually open source functionality? Why not actually use our social media networks to strengthen our financial agreements? Why fake it, Barclays?