Fintech firms are battling banks—and the banks are winning

Fintech was supposed to disrupt the financial old guard, but the market hasn’t been impressed with their performance so far

Man with briefcase wearing a cape, but his shadow is a downward arrow

(Illustration by Iker Ayestaran)

Mogo Finance Technology Inc. happily bills itself as the Uber of banking. The Vancouver-based company’s online platform instantly assesses a borrower’s creditworthiness and issues short- and long-term loans. Mogo (TSX: GO) is part of a wave of so-called fintech companies that see themselves as disrupters of the stodgy old banks. Armed with a better understanding of mobile technology, free from costly branch networks and focused intensely on the user experience, these online firms are muscling in on the lucrative business of providing loans, mortgages and portfolio management services to the public. If fintech is indeed supposed to grab market share from the incumbents, it should represent a good investment opportunity.

So far, however, public markets have been less than impressed, particularly with online lenders such as Mogo. Lenders comprise just one corner of the fintech universe, and only a small number are publicly traded, but their track record to date has been dreadful. Mogo’s stock has fallen 70% since the company went public in June 2015. Lending Club Corp. (NYSE: LC), a marketplace lender in the U.S. that matches investors with borrowers, is suffering too. Its shares are down 68% from its initial public offering in 2014. OnDeck Capital (NYSE: ONDK), a company that issues loans to small businesses, has plummeted 65% in the past year. The phenomenon isn’t confined to North America, either. Chinese marketplace lender Yirendai (NYSE: YRD) listed on the New York exchange in December and promptly posted double-digit declines over the ensuing months. (It rallied past its offering price in March, however.)

A number of factors explain the skepticism around digital lenders, but one overriding theme is these companies might not be as disruptive or innovative as first billed, according to analysts who follow the stocks. As the fintech space grows and more companies prepare for IPOs, investors need to look past the hype.

Mogo CEO and co-founder David Feller blames market conditions for his firm’s share price decline. “What happened was the broader market sell-off in technology,” he says. “The fintech stocks are in that technology category.” (Investors have indeed become more cautious around tech stocks, owing to concerns about overvaluation.) What’s more, Feller says, not everybody comprehends the potential of fintech. “Before we went public, we had done a few private raises. We were definitely educating investors on even the word ‘fintech,’” he says. “The view from some of them was there’s no chance to really disrupt the banks.”

Greater understanding doesn’t necessarily lead to higher valuations, however. Just look south of the border, where the fintech space is more advanced than in Canada. Julianna Balicka, an analyst at Keefe, Bruyette & Woods in San Francisco, says that when Lending Club and OnDeck went public in 2014, they were both marketed to investors as technology companies. Tech-focused underwriters brought the offerings forward, tech analysts picked up coverage, and the businesses were awarded the higher multiples usually bestowed on tech firms. But the market ultimately decided the companies were really more like finance firms than flashy tech plays, and valuations fell. “At the end of the day, they’re still providing loans. And that’s a financial product,” Balicka says. She prefers to think of them as “tech-enabled finance firms.”

The same might be said of Mogo. For example, one of the issues dragging down the stock is fairly prosaic: concern about exposure to the hard-hit Alberta economy. Consumers in the province accounted for 17% of the company’s loans as of the last quarter, according to Scott Chan, an analyst with Canaccord Genuity. “They’re underwriting less in that region now, but just like other lenders, weakness hasn’t shown up in the books yet,” Chan says. “There’s a perception it will show up in future quarters.” Indeed, no matter how simple the loan process or how intuitive the user interface, investors are still going to focus on the quality of the loan book.

Uncertainty around fintechs’ financial strength is actually another reason investors are sitting on the sidelines. Digital lenders haven’t yet been through a credit cycle or dealt with a changing interest rate environment. “These companies are on the edges of lending,” Balicka says. Their clients tend to be higher credit risks, some of them previously rejected by mainstream institutions. “So there are question marks around how they will perform,” she says.

The language surrounding fintech lenders has shifted too, Balicka observes. In the U.S., the boasting about disruption is now subdued. The focus is instead on partnering with existing financial institutions. One reason for the tactic is that the online lending space has low barriers to entry, so there’s a lot of competition, and acquiring new customers is expensive. Partnering with a bank allows fintech lenders access to a larger pool of potential clients. That’s why OnDeck teamed up with JPMorgan Chase & Co. (NYSE: JPM) in December; the financial giant will use OnDeck’s online platform to provide loans for its four million small-business customers. “By figuring out how to work with banks, fintechs have effectively become third-party service providers,” Balicka says. Mogo relies on existing finance players too. Later this year, the company will launch what it calls the MogoCard—a prepaid reloadable Visa card.

From that perspective, it hardly seems like this new breed of lender is on the cusp of tearing down the financial world order. That’s not to say there’s no upside for the stocks, however. Balicka has OnDeck pegged as an Outperform, owing partly to the JPMorgan deal. Chan has a Speculative Buy on Mogo, despite the fact he doesn’t see the company as a disrupter. (“I just think they’re way, way too small,” he says.)

Mogo signed a deal with Postmedia Network Canada (TSX: PNC-B) in January that will see the media company provide $50 million in advertising space in its newspapers and digital properties over three years in exchange for a cut of Mogo’s revenue. Chan approves of the arrangement and says it can help increase consumer awareness. Lack of knowledge is the biggest hinderance to adoption of these services, according to a recent survey from EY Canada. Even among digitally savvy Canadians, nearly 60% of were unaware of fintech offerings.

Feller, for one, remains optimistic about not only his own company but fintech in general. He points to a McKinsey & Co. study released last fall (download PDF) that estimates banks could lose up to 60% of their retail profits to fintech firms in the next decade. “A lot of people don’t understand how massive the finance market is in Canada,” Feller says. “It’s one of the few markets where you can truly create a multibillion-dollar business. We’re still in the early days.”

The performance of fintech stocks is a testament to that.