Banking Infrastructure Re-Imagined

A recent tweet from Charlie Bilello highlighted the top 30 performing stocks in the S&P 500 over the last 30 years from 1990–2020. Coming in at #1 topping AMZN, NFLX , AAPL, MSFT, NVDA, SBUX, etc… was Jack Henry & Associates, “JKHY” compounding at ~29.8%/year for 30 years with a total return of 238,379% over that time period.

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Jack Henry is part of the original “FinTech” club before it was referred to as such, founded in 1976 as a provider of core information processing solution for community banks. Today it generates ~$1.5 billion / year in revenue with ~$425.4mn in EBITDA & ~$272mn in net income across three primary business brands:

· Jack Henry Banking- a provider of integrated data processing systems to nearly 1,030 banks ranging from community banks to multi-billion-dollar institutions with assets of up to $50 billion. Their banking solutions support both in-house and outsourced operating environments with three functionally distinct core processing platforms and more than 140 integrated complementary solutions.

o Enables information and transaction processing platforms that provide enterprise-wide automation. They have three functionally distinct core bank processing systems and more than 140 fully-integrated complementary solutions, including business intelligence and bank management, retail and business banking, digital and mobile internet banking and electronic payment solutions, risk management and protection, and item and document imaging solutions. Their banking solutions can be delivered in-house or through outsourced delivery model in their private cloud.

· Symitar- a provider of core data processing solutions for credit unions, with over 830 credit union customers. Symitar markets two functionally distinct core processing platforms and more than 100 integrated complementary solutions that support both in-house and outsourced operating environments.

o Solutions include two functionally distinct core processing systems and more than 100 fully-integrated complementary solutions, including business intelligence and credit union management, member and member business services, digital and mobile internet banking and electronic payment solutions, risk management and protection, and item and document imaging solutions.

· ProfitStars- a provider of highly specialized core agnostic products and services to financial institutions that are primarily not core customers of the Company. ProfitStars offers specialized financial performance, imaging and payments processing, information security and risk management, retail delivery, and online and mobile solutions. ProfitStars’ products and services enhance the performance of traditional financial services organizations of all asset sizes and charters, and non-traditional diverse corporate entities with over 9,000 customers, including over 7,200 non-core customers.

o Solutions for generating additional revenue and growth, increasing security and mitigating operational risks, and/or controlling operating costs. ProfitStars’ products and services enhance the performance of financial services organizations of all asset sizes and charters, and diverse corporate entities. ProfitStars has over 9,000 customers, including over 7,200 non-core customers. These distinct products and services can be implemented individually or as solution suites to address specific business problems or needs and enable effective responses to dynamic industry trends.

JKHY isn’t alone in serving this market, in fact they are the smallest of the banking core providers which also includes their two main competitors Fiserv “FISV,” and Fidelity National Information Services “FIS.” According to the FDIC at the end of 1Q20 there were ~5,116 FDIC insured institutions, and according to the Credit Union National Association (CUNA) there were ~5,369 credit unions in the country, with 123.5mn members. JKHY serves ~1,030 of those FDIC insured institutions (~20.1%), and 830 of those credit unions (15.5%).

There was a good WSJ article on the “Big 3” banking core providers in April of 2019 entitled Frustrated by the Tech Industry, Small Banks Start to Rebel. According to research firm Celent, the three biggest core providers today do business with 90% of U.S. banks with less than $1 billion in assets.

Rob Nichols CEO of the ABA said, “I’ve met with over 3,000 bank CEOs, and this came up time and again: the challenges and constraints they face with their core provider. The ABA actually made an investment in a startup called Finxact which was founded in 2016, in an attempt to ensure that “member banks have the technology and tools they need to make the transition to banking’s digital future.” In addition to the oligopoly nature of the market the firms lock clients into long-term contracts with significant break-fees. One example found that Millington Bank, a NJ community lender discovered it would owe FIS more than $4.0mn if it sold itself, which was nearly an entire year of profits for the bank.

The Big 3 core providers have become dominant through decades of M&A which broadened their capabilities beyond basic banking to payments and other services. These three companies are on average ~44 years old, with Fiserv the youngest of the group, founded in 1984. Given the fact that growth has been a mixture of both organic and M&A not only are they viewed at times as the only choice but their solutions are often sub-par compared to more modern peers. According to consulting firm A.T. Kearney, midsize & local banks hold 13% of primary banking relationships but capture only 7% of the customers who switch banks; largely due to the lack of having competitive technology offerings.

The Big 3 are part of a handful of other “legacy” financial technology companies that hold dominant positions as infrastructure service providers to the financial service industry. These firms have significant market share and often operate as “Systematically Important Financial Institutions” whether explicitly, or implicitly providing them pricing power. As we look across a range of services including Asset Management / Capital Markets, Banking & Payments, Custodians, Clearing / Settlement, Data, Exchanges, and Mortgages there are 18 firms we highlight as dominant firms in their respective categories. Notably these firms combined for $1.2 trillion of market cap, $152 billion of revenue, $67 billion of EBITDA and $38 billion of net income with a median age of 51.5 years. The average 3 / 5 year total returns are 60.8% / 124.3% (median of 65.3% / 127.9%) which compares to the S&P at 41.1% / 72.9% and NASDAQ at 92.2% / 152.49% respectively (with NASDAQ outperformance coming YTD).

All but the custodians are supposed to be technology solutions which shows the opportunity that lies ahead for challenges to not only sell to the existing pie of financial services but the growing pie of non-financial institutions becoming financial service companies via embedded finance.

As a result of growth through M&A + the age of the incumbent providers technology stacks, this is the multi hundred billion-trillion dollar + opportunity for infrastructure companies to target.

Financial Infrastructure Provider

Embedded Finance

The concept of “Embedded Finance” is something that those in the FinTech industry have been working on for years; however a number of recent posts have brought the concept into “Main Street” (aka VC Twitter) including Bain’s Matt Harris, A16z, Google’s Nik Milanovic, Anthemis, FinTech Today, Ron Shevlin, and countless others.

In order for financial services to be embedded & ubiquitous there is a significant amount of infrastructure that has to be built from the license holder bank, through the various functions required by a variety of providers, ultimately integrating into the “Non-Finance” Brand; which is the opportunity for B2B API Enabled infrastructure companies. The below chart looks to outline some of the key products and therefore opportunities for providers that non-Finance companies are looking to have built out from a license holder bank.

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We highlighted that Varo Money was granted a national bank charter by the OCC & secured requisite approvals from the FDIC & Federal reserve to open Varo Bank, N.A. Acting Comptroller Brian Books said, “Granting a national bank charter to Varo marks an evolution in banking and a new generation of banks, born from innovation and built on technology intended to empower consumers and businesses.” Varo started down this path in 2017 so it took ~3 years to see the vision through fruition. Companies like Square & SoFi have begun down the path of applying for their own national charter & should be beneficiaries of the work that Varo did + Brooks stance.

It’s not just FinTech companies that are looking to obtain bank licenses to use the Charter in an attempt to aggregate low cost deposits by partnering with infrastructure providers to build out the balance of the Banking as a Service stack. Just this week Google signed up 6 more banks to offer digital checking & savings accounts to Google Pay users in the U.S., including Bank Mobile, BBVA USA, BMO Harris, Coastal Community Bank, First Independence Bank and SEFCU. They join Citi & SFCU as earlier partners for the project. While most FinTech companies refer to their banking partner in the fine print only, Google is giving the banks a co-branded experience. This is a continuation of a theme we’ve witnessed over the past couple of years where FinTech firms partner with smaller banks to launch debit cards as illustrated by CBInsights:

CBInsights: Fintechs are partnering with small banks to launch debit cards

Opportunity from Here:

Earlier this year we saw Visa’s $5.3bn acquisition of Plaid, SoFi’s $1.21bn acquisition of Galileo, and Mastercard’s ~$1.0bn acquisition of Finicty all highlighting the importance of API enabled infrastructure for financial services. Post the Plaid deal we wrote a piece entitled The Plaid for X: What’s Next For FinTech Infrastructure? In it we highlighted a few different core verticals that we are focused on which includes:

· AML / KYC

· Banking Core Technology

· Card Issuance

· Custody / Clearing

· Data Aggregation

· Distribution

· Exchanges

· Middleware

· Payments

There’s significant opportunity to create best in class products across each of the aforementioned products / services, those listed below & countless more.

Financial Products

· Cards

o Debit Card

o Credit Card

§ FICO optimization

· Deposits

o Checking Account

o Savings Account

· Insurance

· Lending

o Consumer

§ Auto

§ Personal

§ Student Loans

o Commercial / SMB

o Mortgages

· Payments

o Domestic Payments

o International Payments

o Intra Company Payments

o Payment Processing

· Wealth Management

o Self-Directed

o Managed

Operations

· Account Aggregation / Authentication

· Account Switching

· Accounting / Invoicing

· AML / Transaction Monitoring

· Banking as a Service

· Bill Pay

· Card Functionality

· Chatbot

· Collaboration

· Compliance

· Credit Scoring

· Crypto

· Customer Service

· Document Management

· Digital Banking

· KYC

· Personal Financial Management

· POS Lending

· Receipt Management

· Risk Management

· Sales & Marketing

· Treasury

Capabilities / Workflows:

· Account Opening

· Debt Consolidation

· Personal Financial Management

· Refinancing

· Underwriting

If founders are building in any of the areas don’t hesitate to reach out.

Interested in all things Venture, FinTech, Public Markets, Personal Finance, and Sports

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