What can a zero emission, entirely crowd-navigated road trip teach us about the future of financial services?
Friday, I went on a limb and took a road trip of exactly equal length to my electric car's battery capacity - 200 miles - to meet with one of our investors. I enjoyed zipping by traffic in the carpool lanes (an EV perk) and when everyone came to a stand-still, my new iPhone app, Waze, helped me utilize the power of the crowd to take faster side streets in the foreign hinterworld between LA and San Diego.
Beyond the opportunity to brag about my next gen transportation prowess (which I do with some humility, as I sat sipping a milkshake at Carls Jr while my car sips power outside - just 20 miles from home), I am struck how this trip is fundamentally different from others, even if it looks the same to anyone I share the streets with - and that there are parallels to next gen consumer finance. So what's different and what are those parallels?
A fundamentally new engine. Even though my car as four wheels and four doors and headlights and bumpers, its engine is a total departure from the 150 year old internal combustion engine that powers 99.99% of other cars on the road. In consumer finance, I continue to be shocked at the antiquity of basic banking. Why can't checks clear in real-time? Why are core banking costs so high? Why is the basic functionality so profoundly limited? At risk of lacking greater imagination, I continue to believe that prepaid - done well - offers a panacea to these and other ails. Of course, a completely new engine would go farther than Simple and others who are just building on top of the old. More lenders are starting from scratch, including LendUp, BillFloat and Progreso. CBW Bank, some-Weir in Kansas, is working on this as well.
Zero emissions. Even though the energy electronic vehicles consume almost always do create pollution, the environmental impact is de minimis compared to "normal" cars. So, the externalities to just getting around are net-positive given today's broader global warming crisis. In other words, a better, faster motor can actually be good for the environment. The financial services parallel, plays to our fund's philosophy on impact alignment. We believe that companies that make financial products that will help improve consumers' lives will make better returns in the long-run. It can't just be consumer friendly, as there are clearly infinite ways to lose money doing that, but smarter products that create upward mobility and save costs will be the ones that pass regulatory scrutiny and will sell and trade for more when they're acquired or go public. Square is a good example.
People powered. Paper maps are all but gone and Google Maps is being upstaged by Waze, a mashup of GPS data, public traffic data, digital maps and the real-time contributions of millions of people (in fact, Google just bought Waze last week for a cool billion). People can contribute passively while driving with the Waze app open, or actively by pointing out everything from a stalled car to a cop. Bundle and Mint started doing this in consumer finance: people like you spent $X on gasoline and $Y on restaurants. CreditKarma lets users rate offers, giving it a more democratic vibe. Barclaycard's Ring card hyper-engages with their users. But where is the power of people in financial planning, product selection, vouching for my responsibility, sharing risk and avoiding the most common pitfalls of too much debt and too little saving? P2P lending, nowadays, is neither P, nor P. Social media may be used to underwrite and market, but doesn't help me (although Lenddo is trying to buck that). I wrote about social savings recently. Lots of potential here.
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.
Yesterday, back-end processor TSYS and prepaid card proprietor NetSpend announced the former would buy the latter for $1.4 billion. This is not just another acquisition. It's interesting because it affirms the value of the much beleaguered general purpose reloadable prepaid (GPR) card industry, it concedes value to a much maligned consumer segment - the emerging middle class (aka the underbanked) - and it signals the commodification of the financial processing business.
GPR grew out of the gift card business as a checking-account and check-cashing alternative, and had its hayday in 2010 when both Green Dot and NetSpend went public on the New York Stock Exchange and NASDAQ, respectively. Since then it's been downhill. Green Dot lost over 60% of its already post-prime value last summer and NetSpend was never a Wall Street darling with its check cashing distribution partners and second fiddle position. GPR was in the doldrums the past 12 months. Advocates and the media considered it a (still do, probably) a rip-off. Investors didn't see the multiples (and they may still not). And the lines became blurred with entrants like American Express' Bluebird (which is sold as a checking account alternative, but not FDIC insured, nor able to receive government benefits), Green Dot's GoBank (which is an actual bank account, but marketed online) and startups Simple, Plastyc's iBankUp and Moven. Still, Green Dot, NetSpend, RushCard, AccountNow and others continue to sign up new customers in droves. And TSYS paying a 30% premium to Tuesday's trading price is but one, but a meaningful indicator that GPR has a life beyond BlueBird and Chase' Liquid. (And for what it's worth, we expect GPR to grow 15% as an industry sector year-over-year). TSYS has been in prepaid for 10 years (since acquiring Anil Aggarwal's Clarity Systems), so isn't a naive buyer.
While the size of the US underbanked consumer segment is generally agreed to be large, most people still believe it's fit for charity and public policy (the missionaries), or predatory companies (the mercenaries), but not legit, mainstream business. TSYS is neither missionary or mercenary. They are a $4B market cap global payments processing business, (quite acquisitive, and this acquisition is the largest they have ever made) that believes this consumer segment represents an "exponential" growth opportunity for them. (I recognize that as a hammer, everything I see looks like a nail, and this observation is entirely self-serving to my business' strategy).
Lest people argue the acquisition simply offers TSYS diversified distribution channels, new products and technology capability, I think the most interesting aspect of this transaction is the fact this is the first major entrée into direct-to-consumer business, not just by TSYS, but by the entire payements processing oligarchy (FIS, Fiserv, First Data, Jack Henry, etc). I believe that this premium (which computes to about $550 per active NetSpend account) is justified by fundamentally diversifying TSYS out of the commodity business of payments and bank processing and into the higher margin retail financial services business.
It's a small step for the underbanked, but a giant leap for payments processing. I wouldn't be surprised if we see FIS, Fiserv and First Data find ways to get closer to direct-to-consumer relationships. I wouldn't be surprised if banks think differently about this consumer segment as a result.
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?
Walmart made Green Dot. Now it's making Blue bird. The low-cost merchant has long offered a full suite of payments products to its customers, at record low prices. From international money transfer to bill-pay to check cashing and prepaid, Walmart has long been a pioneer of financial services for the emerging middle class. In 2010 a venture-backed company originally called NextEstate went public largely due to its exclusive deal with the retailer to distribute its general purpose, reloadable, branded prepaid card. At some point, after the IPO, and after Walmart financial services executive, Jane Thompson, moved on, Green Dot's deal became non-exclusive. Walmart did a deal with American Express, which has made a massive investment to market its nascent prepaid capabilities, and dealt a massive blow to the value of Green Dot.
Unlike everyone else, it appears, I believe Green Dot is undervalued and remains a critical player in prepaid. I also believe that Amex' prepaid effort will benefit the prepaid industry more than it will the company. On the former, insiders are buying the stock, the company is worth half of what it has in cash (and near-cash), and we have yet to see its new product made possible by its purchase of Green Dot Bank. (I also anticipate, by the way, that Green Dot is going to buy Russell Simmon's competing RushCard).
On the latter, American Express' Bluebird appears to be a great product. It is low-cost and does more than the average general purpose (GPR) prepaid card (like sub-accounts, and roadside and purchase protection). It's got a great website, and great promotional materials.
But most importantly, Amex finally finally finally frames prepaid for what it should be, a checking account replacement, instead of a glorified gift-card. I can't stress enough how cool or how important that is. The media, consumer advocates and regulators have had it in for prepaid, believing that the exceptions of Kardashian cards are the norm and that prepaid is basically a sham for low-income users. To be sure there are bad actors (although very small in numbers), and there are quite a few good-but-not-amazing prepaid products (which still beat out a checking account with overdraft on an average use-case). Bluebird is "Your Checking & Debit Alternative." Brilliant.
So, if Bluebird is so great and Walmart so big, why won't it be a success? First, because they will make very little money on it, if not lose money. No fees is awesome for consumers, but there are actually costs associated with running a program like this. I'm guessing that Amex plans to make money on dormant accounts, or cross-sales to traditional products, or better interchange on some Durban slight of hand. Second, because American Express is not "everywhere you want to be." It is accepted at about 4.5million merchants worldwide. That's a lot, but it is only just over half the 8 million merchants where Visa is accepted. And guess what, it's not accepted where the underbanked work, live and shop. And third, because I think that by and large relationships aren't purchased on a J-hook. In other words, it should be no surprise that most prepaid cards purchased from a retailer, hanging next to a pack of gum, will enjoy a short life. I'm betting that will be true for Bluebird as well, unless they start taking online customer acquisition seriously.
So, in short: I wish Green Dot and Amex the best. I think Green Dot's got a second act and I'm excited to see it. I think Amex will ask itself why they left home without their charge card. And I think that the prepaid industry will have gained priceless value in being legitimized by Bluebird.
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 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.
Kermit is not the only LA-based green creature that feels misunderstood. Just over a week ago, Green Dot Corporation (GDOT) lost over 60% of its value on the news that things weren't as rosy as expected. This leader of the next generation of companies serving the unbanked and underbanked appears plagued by a number of colorful hairy villains including dimmer growth prospects, greater competition, and tighter regulation. How bad is it, really, bein' Green Dot? Certainly not 61% worse than before (read, great time to buy), I believe.
So earnings were 1.5% below projections and 2012 expectations diminished meaningfully from jubilant prior earning calls. Bummer. 2013 will likely look like what 2012 should have. Not great. Big players - notably American Express and JP Morgan Chase - are getting serious about general purpose prepaid. Great, not good for Green Dot, but not nearly as bad as people seem to think. Many of the 50,000+ retail locations that offer Green Dot are not bound to exclusivity. For good or bad reasons, most people seemed to think this was the case. A couple ambulance chasers are trying to sue the company over this. Tighter know your customer requirements forced Green Dot to turn down more card applicants. Welcome to being a regulated bank holding company, folks.
I believe the overwhelming issues that made Green Dot so unpopular aren't likely to be its real Achilles heel. Yes, American Express and JP Morgan Chase are big players and recent entrees into prepaid. Amex did offer its card against Green Dots in retail. First, the Amex card is even skinnier in options than Green Dot. Second, while Amex enjoys an aspirational je ne sais quoits, it is also accepted at FAR fewer places, especially those relevant to the underbanked.. As for Chase, I'm not aware their well-named Liquid card is available at retail - only online or at Chase bank branches. I don't think they're going to. The Liquid card serves to give Chase an "account" for low-balance people that it can't make money on in their normal checking accounts.
I believe the Chase Liquid card - and others not acquired off a J-hook in a retail store - will be more successful in the long run. You see, getting a card at a retail location just doesn't lend itself to a l0ng-term relationship. Indeed, many - if not most - cards purchased at retail are loaded once, used and tossed. Their use pattern is closer to that of a gift card than a bank account. Part of it, I believe, is the mindset of the card holder. Part of it is the context: since payroll direct deposit is the single biggest predictor of long-term utilization, getting this done from the check-out line is much harder than from online or your employer, or even your tax-prep site.
So, Green Dot has real pressures to contend with. But in my opinion their real challenge is inherent to their primary distribution channel. That said, Green Dot has almost $200 million in cash and short-term investments, but is valued at only $350 million. Their revenues are on a run rate of $540 million and net income $48 million. All in, while it's clearly not easy bein' Green, I think it's a great buy right now.
NB: I don't own any shares of GDOT as of this writing; nor does my venture fund, Core Innovation Capital.