BaaS Is No Silver Bullet for Community Banks, De Novos, Analysis Shows
Affirm Hit By Rising Cost of Funds, Loan Loss Provisions; TAB Gets "Needs to Improve" on CRA
Hey all, Jason here.
It’s just 10 days until the Banking Renaissance 2023 event here in Amsterdam. I’m looking forward to joining industry stalwarts like Brett King, Jim Marous, Paolo Sironi, Chris Skinner, and numerous others for several days of discussion and networking. If you plan on attending, give me a shout so we can make sure to catch up that week!
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Announcing Fintech Business Weekly’s First Research Report: 2023 Market Analysis of Banking-as-a-Service, Partner Banks
Anyone who has been in the fintech ecosystem for any length of time has likely read the widely-cited a16z blog post, “The Partner Bank Boom.” I myself have pointed to it numerous times when explaining partner banking/banking-as-a-service.
In particular, a graph in the post plotting partner banks’ return on equity (ROE) and return on assets (ROA) tends to pop up frequently, usually in the context of explaining the potentially outsized returns banks can generate from the business model.
But a lot has changed since that post was published back in 2020 (and, indeed, the ROE/ROA analysis was based on data from 2017-2019). It barely even mentions the role BaaS platforms play — a role which has grown substantially since 2020.
An Update for 2023
That’s why I decided to undertake a comprehensive look at what we’re now calling banking-as-a-service — focusing primarily on how the partner bank space has evolved but also profiling the rise and growing role of “middleware” BaaS platforms.
One key takeaway? Spinning up a BaaS business model is no a silver bullet.
While the strategy can help banks generate incremental fee income and source deposits and originate loans beyond their geographic constraints, building out capabilities to operate these partnerships carries real costs — and risks.
Analysis shows that while many banks do generate outsize returns as measured by ROE and ROA, new entrants to the space — both de novos focused on BaaS and community banks new to the market — can incur significant losses:
What’s in the Report
In this 30+ page research report, you’ll learn:
the origins of the banking-as-a-service business model (spoiler: the name may be new, but the business models aren’t)
what drove the explosion of BaaS in the late 2010s
BaaS’ “killer use case” — embedded finance
explanation of the rise of BaaS “middleware” platforms
key metrics for 30+ partner banks, including Bancorp, Blue Ridge, Evolve, Sutton, Coastal Community, WebBank, and more: assets, deposits, interest income/expense, non-interest income/expense, net income, ROE and ROA
profiles of six BaaS platforms: Bond, Solid, Synapse, Synctera, Treasury Prime, Unit — including bank partners and key clients
the evolving regulatory environment and thoughts on what’s next for BaaS
Affirm Earnings: Cost of Funds, Provision for Loan Losses Bite
The fintech reckoning continued last week as Affirm posted fairly dismal earnings and announced it was laying off 19% of its staff and shuttering its nascent crypto effort.
While bucketed under the “buy now, pay later” label, it’s worth remembering that Affirm started out focused on longer-term, (usually) interest-bearing loans originated at point-of-sale.
In its early days, it partnered to offer installment loan financing for popular direct-to-consumer ecomm brands like Casper and Burrow. It only more recently expanded into the pay-in-four formulation used to finance smaller purchases over shorter duration. (For background on pay-in-four vs. POS lending, see this classic Fintech Business Weekly explainer on the topic.)
Affirm’s partnership with once-hot home fitness brand Peloton — in particular the offer of 0% financing for as long as 36+ months (and pandemic-era demand) — was, in many ways, the “killer use case” for Affirm.
But a business model and economics that might have worked in a zero interest rate environment look quite different with rising interest rates that look set to stay higher for longer.
Revenue Grows, But Costs Balloon
Affirm has managed to continue growing its gross merchandise volume (GMV) — the total value of transactions it finances.
And while the average order value (AOV) has dropped significantly since 2021, that is presumably being driven by Affirm’s move into the pay-in-four space, which is used primarily for smaller consumer purchases:
Nearly a quarter (23%) of Affirm’s volume is now in pay-in-four vs. 77% longer-term loans, which is comprised of 10% at 0% APR and 67% that is interest-bearing:
Affirm, like virtually every other BNPL provider, is trying to diversify away from relying on merchants to drive transaction volume by become a shopping destination and offering other avenues for consumer usage, like browser extensions and its Affirm+ debit card.
Still, fully 4/5ths of Affirm’s volume comes from merchant point of sale, which makes it worrisome that growth in its number of active merchants seems to have stalled out:
The big problem for Affirm is rising transaction costs — and, unfortunately for Affirm, those scale with transaction volume. You can’t grow your way out of them.
Affirm saw its transaction costs balloon, driven primarily by rising cost of funds, increasing provision for loan losses, and “processing and servicing” costs:
The result? Even though total revenue was up about 10% to just shy of $400 million, revenue less transaction costs dropped over 20% to $144 million:
The upshot? GAAP losses rising to $360 million — though that number includes significant share-based compensation expenses.
Still, even on an adjusted basis, Affirm’s operating loss more than tripled from $19 million in FY Q1’23 to $62 million in last week’s earnings report:
Fintech Lending Partner TAB Bank Gets CRA Downgrade After Iowa Dust Up
Transportation Alliance Bank, popularly known as TAB Bank, is a Utah-based industrial bank and one of relatively few banks that partners with fintechs to originate high APR consumer credit. (TAB is one of 30+ partner banks profiled in Fintech Business Weekly’s just-released 2023 analysis of the banking-as-a-service sector, which you can get here.)
Currently, the bank partners with six non-bank lenders that largely target subprime consumers with installment loans, credit cards, and BNPL:
One of the bank’s fintech partners, EasyPay, recently caught the attention of Iowa’s attorney general for the 160% APR loans it offered residents of the state.
While banks like TAB generally enjoy the privilege of exporting the interest rates of their home states, a quirk in Iowa law means that state-chartered out-of-state banks do not enjoy such protection (we covered this case in greater detail previously here.)
Now, it seems TAB has gotten dinged on its Community Reinvestment Act rating because of the case.
While the bank has previously received “Outstanding” ratings on its assessments in 2015, 2017, and 2019, it was downgraded several rungs to “Needs to Improve” on its assessment published earlier this month.
The CRA assessment doesn’t specifically name the EasyPay case, but it’s quite clear that is the reason for the downgrade.
The assessment states that a discriminatory or other illegal credit practice at a single “strategic partner” led to the downgrade:
“DISCRIMINATORY OR OTHER ILLEGAL CREDIT PRACTICES REVIEW
The FDIC lowered the CRA rating from “Satisfactory” to “Needs to Improve” due to an illegal credit practice present during the review period for this CRA evaluation. Examiners identified a violation of Section 5 of the Federal Trade Commission Act, Unfair or Deceptive Acts or Practices. The violation was limited to a single strategic partner; however, it impacted a large number of consumers over an extended period of time.”
While the Iowa case is the result of relatively esoteric state banking law, TAB’s CRA downgrade illustrates risks to underlying banks from the activities of their fintech lending partners.
California DFPI Asks Court to Block OppFi’s High-APR Loans
In other fintech lender news, California’s banking regulator, the DFPI, has asked a court to block OppFi from facilitating loans to California borrowers at rates that exceed the state’s interest rate cap for such loans — generally, 36% + the federal funds rate.
OppFi partners with Utah-chartered FinWise to originate loans at rates up to 160% APR. (FinWise is one of 30+ partner banks profiled in Fintech Business Weekly’s just-released 2023 analysis of the banking-as-a-service sector, which you can get here.)
The filing is the latest in the back-and-forth legal battle between OppFi and the state regulator, which we’ve covered previously here, here, and here.
The California case is quite distinct from the TAB/Iowa case. In Iowa, the AG’s argument hinged on TAB’s right (or lack thereof) to preempt Iowa state law.
In the FinWise/California case, the California DFPI is arguing that OppFi, rather than its bank partner, holds the predominant economic interest in the loans and is thus the “true lender” and should not enjoy the preemption rights that FinWise presumably would.
Per law firm Ballard Spahr’s excellent summary and analysis of the filing (emphasis added and spacing adjusted):
“[T]he DFPI generally repeats arguments set forth in its earlier cross-complaint against OppFi, including allegations that a substance-over-form / totality of the circumstances analysis to be performed under California law results in a determination that OppFi, not FinWise Bank, is the ‘true lender’ and therefore the loans in question are subject to California’s usury law;
that OppFi’s ‘predominant economic interest’ in these loans indicates it is the ‘true lender’;
and that California’s usury law reflects a public policy that the CFL interest rate limits should apply to these loans: ‘the legislature has already determined that such usurious transactions are contrary to the public interest and will result in significant public harm.’”
Like the TAB/Iowa case, OppFi/California illustrates potential risks to bank-fintech partnership lending models, particularly for APRs in excess of state usury caps.
Other Good Reads
The Unusual Crew Behind Tether, Crypto’s Pre-Eminent Stablecoin (WSJ)
The Bizarre and Brutal Final Hours of FTX (FT)
Merge or Perish: 25 Struggling Fintech Startups (Forbes)
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