It has been an interesting few weeks for FinTech.  Coming off recent years where both public and private FinTech markets were trending positively, the tail end of 2015 and the start to 2016 have been unique as performance has started to diverge.  The performance of public FinTech companies has been relatively flat through the first quarter of 2016 (see Public Market Indicators on page 3 of the First Quarter 2016 FinTech newsletter), and signs of weakness have been observed in alternative/marketplace lending, as well as some of the more high profile FinTech companies that have gone public recently.  The median return of the FinTech companies that IPO’d in 2015 was a decline of 16% since IPO (through 3/31/16). For perspective, Square, OnDeck, and Lending Club are each down significantly in 2016 (down 28%, 53%, and 64%, respectively from 1/1/2016 to 5/18/2016).  Also, the broader technology IPO slowdown in late 2015 has continued into 2016 and no FinTech IPOs have occurred thus far in 2016.

However, optimism for FinTech still abounds, and the private markets continue to reflect that with robust investor interest and funding levels.  In 2016, 334 FinTech companies raised a total of $6.7 billion in funding in the first quarter (compared to 171 companies raising $3.2 billion in the first quarter of 2015), and Ant Financial (Alibaba’s finance affiliate) completed an eye-popping $4.5 billion capital raise in April.

While the factors driving this divergence in performance between public and private markets are debatable, the divergence is unlikely to continue indefinitely.  A less favorable public market and less attractive IPO market creates a more challenging exit environment for those “unicorns” and other private companies.  Headwinds for the private markets could develop from more technology companies seeking IPOs and less cash flow from successful exits to fund the next round of private companies.

Consequently, other strategic and exit options beyond an IPO should be considered such as partnering with, acquiring, or selling to traditional incumbents (banks, insurers, and money managers).  The potential for M&A and partnerships is even more likely in FinTech, particularly here in the US, due to the unique dynamics of the financial services industry including the resiliency of traditional incumbents and the regulatory landscape.  For example, consider a few of the inherent advantages that traditional banks have over non-bank FinTech lenders:

  • Better Access to Funding. Prior to 2016, the interest rate/funding environment was very favorable and limited the funding advantage that financial institutions have historically  had relative to less regulated non-financial companies.  However, the winds appear to be shifting somewhat as rates rose in late 2015, and funding availability for certain FinTech companies has tightened. For example, alternative lenders are dependent, to some extent, on institutional investors to provide funding and/or purchase loans generated on their platform, and a number have cited some decline in institutional investor interest.
  • Banks Still Have Strong Customer Relationships. While certain niches of FinTech are enhanced by demand from consumers and businesses for new and innovative products and technology, presently, the traditional institutions still maintain the majority of customer relationships.  As an example, the 2015 Small Business Credit Survey from the Federal Reserve noted that traditional banks are still the primary source for small business loans with only 20% of employer firms applying at an online lender.  The satisfaction rate for online lenders was low (15% compared to 75% for small banks and 51% for large banks).  The main reasons reported for dissatisfaction with online lenders was high interest rates and unfavorable repayment terms.
  • Regulatory Scrutiny and Uncertainty related to FinTech.  Both the Federal Reserve and the OCC have made recent announcements and comments about ways to regulate financial technology.  In the online lending area specifically, regulatory scrutiny appears to be on the rise with the Treasury releasing a white paper discussing the potential oversight of marketplace lending and the CFPB signaling the potential to increase scrutiny in the area.  The lack of a banking charter has also been cited as a potential weakness and has exposed certain alternative lenders to lawsuits in different states.

At the same time that FinTech companies are increasingly considering, or being forced to consider, strategic options beyond an IPO, traditional incumbents are starting to realize that they must develop a strategic plan that considers how to evolve, survive, and thrive as technology and financial services increasingly intersect.  For example, a number of banks are looking to engage in discussions with FinTech companies.  A recent survey from BankDirector noted that boards are focusing more on technology with 75% of respondents wanting to understand how technology can make the bank more efficient and 72% wanting to know how technology can improve the customer experience.

FinTech presents traditional financial institutions with a number of strategic options, but the most notable options include focusing on one or some combination of the following: building their own technology solutions, acquiring a FinTech company, or partnering with a FinTech company.  One area where we have started to see more FinTech partnerships and M&A already start to play out is wealth management and the industry’s response to robo-advisory.  Robo-advisers were noted by the CFA Institute as the FinTech innovation most likely to have the greatest impact on the financial services industry in the short-term (one year) and medium-term (five years).  Consider the following announcements in this area over the last few years; on the acquisition front, BlackRock’s acquisition of FutureAdvisor in August 2015, Invesco’s acquisition of Jemstep, and Ally Financial’s acquisition of TradeKing in April 2016.  On the partnering front, Motif and J.P. Morgan announced a partnership in October 2015, UBS announced a major partnership with SigFig in May 2016, and Betterment and Fidelity announced a partnership in October 2014. Community banks will also have an opportunity to enter the robo-advisory fray as Personal Capital announced a partnership with Alliance Partners that will allow over 200 community banks offer digital wealth advisory tools.

While we do not yet know which strategy will be most successful, discussions of whether to build, partner, or buy will increasingly be on the agenda of boards and executives of both financial institutions and FinTech companies for the next few years.  The right combination of technology and financial services through either partnerships or M&A has significant potential to create value for both FinTech companies and traditional financial institutions.  Any partnership or merger should be examined thoroughly to ensure that the right metrics are utilized to examine value creation and returns on investment.

Transactions and significant partnerships also have significant risks and potential issues will need to be discussed.  For example, significant issues with M&A and potential partnerships can include: execution and cultural issues, shareholder dilution, whether the partnership is significant enough to create shareholder value and provide a return on investment, contingent liabilities, and regulatory pressures/issues.  These issues must be balanced with the potential rewards, such as customer satisfaction/retention, shareholder value creation, and return on investment.

If you are interested in considering strategic options and potential partnerships for your financial institution or FinTech company, contact Mercer Capital. Financial institutions represent our largest industry focus for over thirty years. We have a deep bench with experience with both FinTech companies and traditional financial institutions (banks, asset managers, and insurance companies).  This uniquely suits us to assist both as they explore partnerships and potential transactions.

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