This first appeared in the monthly a16z fintech newsletter. Subscribe to stay on top of the latest fintech news.

Consumer Fintech: Back to the Trend Line

When the U.S. government first pursued its massive Covid stimulus package in the spring of 2020, they likely had little idea their actions would have such a big impact on the trajectory of consumer fintech. 

The government allowed digital banking to become a key consumer access point for their money-printing and benefits disbursement. Consumers were already seeking out digitally native solutions following the closing of thousands of retail bank branches, and word of mouth and referral awareness for “get your government payouts faster” created a flood of consumer demand for fintech apps in particular. As a proxy for fintech account openings, app downloads averaged nearly 50% year-over-year growth in the months from April 2020 to July 2021, compared to average declines for incumbent banks during the same time period. And once activated, these new digital users largely spent and invested their newfound liquidity. This in turn translated into higher revenue for consumer fintech businesses, whether in the form of interchange, ATM fees, trading fees, payment for order flow, or otherwise. It’s an understatement that consumer fintech was a Covid beneficiary.

Given this higher revenue and more organic distribution, consumer fintech customer acquisition economics appeared exceedingly attractive in the moment. Accordingly, venture capital poured in, with 2021 fintech funding reaching $138 billion, growing 180% year over year. And then, fintech companies spent more aggressively on marketing; in their Q3 2021 earnings, Twitter reported fintech companies grew their spend 200% year over year with them. However, these unit economics soon changed. Free money from the government to consumers had inflated revenue and eased acquisition. Looking to maintain growth, these same companies pushed more into traditional paid marketing channels, notably Facebook, Instagram, and Google, and we saw customer acquisition costs rise as high as 4-6x, as revenue per user moderated.

Recognizing unit economics were inflated and worried about a possible recession, consumer fintech companies have since cut back marketing spend. As such, downloads and new accounts have declined year over year during recent months. Certain companies may be struggling, but as we look beyond the idiosyncrasies of the last two years, the longer-term sector trend remains favorable. Download growth on a three-year CAGR basis (compounded growth since before the pandemic) remains between 15-20% and appears to have returned to the pre-Covid trend line. 

Ultimately, attractive unit economics are foundational for building long-term businesses, and while growth has slowed, it seems we are headed into a much healthier and more sustainable era. What’s more, the boost from Covid has not been lost. Millions of consumers tried fintech platforms for the first time in the last two years, and as the average primary banking relationship lasts roughly 16 years, we expect they will remain loyal over their future lifetimes. Although the trends have been painful in recent months, we continue to believe that the ~$2 trillion U.S. bank market cap will dramatically shift to digitally native players — a trend accelerated by Covid.

– Alex Immerman, a16z growth partner, Justin Kahl, a16z growth partner, Jamie Sullivan, a16z growth partner

The Rise of Durbin 2.0?

In July, U.S. Senators Dick Durbin and Roger Marshall introduced the Bipartisan Credit Card Competition Act. The legislation, if enacted, would require large credit card-issuing banks with over $100B in assets to offer merchants the ability to route transactions to a second card network, aside from Visa and Mastercard. Merchants have been fighting the card networks to cap card fees for decades, and Sen. Durbin is well known in fintech circles for his 2010 Durbin Amendment, which capped debit interchange fees for banks with over $10B of assets. The intent of this new legislation is to create competition for Visa and Mastercard, who account for roughly 75% of the market, and thereby lower credit card fees for merchants. However, while the idea of fostering more competition and driving down fees sounds good for the merchant, it’s unclear how much of an impact this act would have in doing so.

Mechanically, if this legislation were to pass, the merchant would be able to choose the card network through which to route each of their transactions. Unlike the current system, where merchants are required to accept the single credit network presented by the card issuer, they, post-legislation, would now be able to choose (presumably) the cheaper of the two network options associated with the card. Debit cards have theoretically mandated this routing (e.g., PIN and sign) since the Durbin amendment in 2010 (although iitt hasn’t always been available in ecommerce contexts). Credit has not had such a mandate, so merchants have had to accept whatever fee structure is set by the network and associated with the consumer’s card (provided they accept that network).

In reality, however, unlike debit, credit has few alternative network options to route to. Debit has a number of smaller networks like Maestro and Interlink — some of which are actually owned by Visa and Mastercard. But for credit, aside from Visa and Mastercard, Amex and Discover are the primary options. Both are combined issuers and networks, meaning they have different sets of infrastructure and operations (e.g., around fraud, customer support), and they typically set higher interchange rates, which is one of the reasons fewer merchants accept them. And then FirstData and Chase have ChaseNet and FirstData Net. It’s possible that one of the minor debit networks, who often have lower interchange rates, invests in building out a network for credit, but they have no one not no one has yet.

So why not just cap fees directly? After all, the EU, Australia, and many others have moved to regulate and cap credit interchange fees. Interchange essentially funds the rewards that issuers provide back to the consumer. Lower interchange means fewer rewards to the consumers. Since the Durbin amendment limiting debit interchange went into effect, debit rewards have almost entirely disappeared. The U.S. is more rewards oriented than other countries, and cutting into them is likely politically unpopular. Moreover, some research has pointed to the increase in other fees, most often borne by the lowest-income consumers. Here, issuers could tack on additional fees for consumers. 

We will gain more clarity on the legislation and its intent over the coming weeks, as well as the alternative network possibilities. As the credit landscape stands now, however, it seems like in the near term at least, such legislation would have a more limited impact on bringing down merchant fees.

– Seema Amble, a16z fintech partner 

The Charge-Off Waterfall and What It Means for Consumer Credit

As banks announced second-quarter earnings last month, the health of the consumer balance sheet frequently came up as a topic of discussion. While many institutions reported they were shoring up reserves for potential losses — citing economic uncertainty as a growing risk — bank executives across the board also said consumers were financially healthy, as evidenced by strong spending and credit quality.

Given these mixed signals, how should one judge the current state of consumer financial health? 

If a consumer loses their job or is otherwise unable to pay their existing loan balances, they may have some hard choices to make. How will they choose which debts to service, and in what order? To assess consumer health, we typically start by examining the current rate of personal loan delinquencies, as we believe that to be amongst the best leading indicators for how consumer credit will perform in the coming months. 

Consumer repayment behavior tends to follow a fairly predictable logic, anchored around two key considerations: utility and brand. On utility, consumers are least likely to stop paying down debt on the things they need every day: namely their homes, cars, and credit cards. They would rather miss a payment on a personal loan and accept a hit to their credit, than, say, risk losing access to basic necessities like transportation and shelter. This makes sense — in many cases, personal loans are taken out after a big purchase or decision has already been made, such as a home improvement project or consolidation of existing credit card debt. Personal loans are rarely (if ever) the mechanism by which consumers transact in their day-to-day lives, and as such, feel comparatively lowest on the utility totem pole. On brand, consumers usually choose to pay back the big-name lenders with whom they think they might do business again — a dynamic that disadvantages startups (even those that offer lower APRs). For example, if a consumer thinks that they are more likely to take out new products or services from Chase over the course of their lifetime than they are with a relatively young and unknown startup, they’ll often elect to stay current on their Chase loan at the expense of their startup loan if and when forced to prioritize.

Now that we’ve established personal loan delinquencies as one of the best leading indicators for consumer financial health, we must examine the current data — and what the data tells us on the surface is that the consumer balance sheet is fine… for now. As the chart shows below, these delinquencies have seen a substantial uptick recently but are still at the low end of the historical norm, indicating that the consumer balance sheet is still in relatively good shape at the moment. However, if we look beneath the surface and contextualize how we’ve arrived at these low levels in the first place, the recent increase in delinquencies itself is enough to suggest that consumer credit is about to get squeezed.

The data shows a sharp drop in delinquencies between Q1 2020 and Q2 2021, which is largely attributable to free-flowing government stimulus payments plus the loan forbearance programs included in the CARES Act. While loan forbearance in the legislation only directly covered federally backed mortgages, many lenders ultimately offered forbearance programs on other loan types (e.g., auto, personal, etc.) of their own volition. In addition, for consumers whose financial institutions did not extend them such generous terms, it’s entirely possible that under these very unique circumstances of government stimulus, mortgage loan forbearance programs allowed them to use the resultant freed-up cash to pay off other types of borrowings, artificially depressing delinquency rates. 

Now that stimulus is over and we’re observing a significant rise in delinquencies, we must also consider several additional macro conditions that could spell trouble for indebted borrowers. With inflation way up (CPI +>9% YoY), and the Fed hiking its base interest rate to 2.25 – 2.50% (making any floating rate debt more burdensome to cover), the consumer now has a smaller share of wallet to pay for higher debt servicing costs. Layer in the fact that fewer and fewer of our eligible consumers are choosing to seek employment (the labor participation rate is near the lowest it’s been since the 2000s) or are setting aside savings (the personal savings rate is the lowest it’s been since 2009), and you can imagine a perfect storm brewing for credit. 

We’ll be watching each of these factors closely over the coming months, paying particularly close attention to where the dominoes first start to fall: personal loans.

– Anish Acharya, a16z fintech general partner, Marc Andrusko, a16z fintech partner, Corey Waller, a16z fintech go-to-market partner

Read More

***

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. In addition, this content may include third-party advertisements; a16z has not reviewed such advertisements and does not endorse any advertising content contained therein.

 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.