We spoke with Mizuho FinTech and payments analyst Thomas McCrohan, who initiated coverage of eleven stocks in June, including companies such as Visa, MasterCard, PayPal and Square. He shares his insight into the lingering security issues and opportunities for payments, why consumers should keep their debit card information close to the vest and what the bank upgrade cycle will mean for investors.
Question: What are some major themes that you’re currently seeing in the FinTech and payments space?
Answer: Mobile person to person (P2P) payments are going to be a big theme this year in our view, specifically as U.S. banks try to take on Venmo, which is owned by PayPal. Another key theme is integrated payments, as merchant acquirers create partnerships with software companies as a new distribution channel. Some players, like Square, are interesting, given that they are the integrated solution and don’t rely on third party distribution.
Alternative lending remains another consideration - players like Square and PayPal are providing working capital loans to small businesses who otherwise would have difficulty getting a loan, or need the capital sooner than what a bank can provide.These loans are tied to credit card receipts and lenders are getting repaid through a percentage of the daily credit card sales, which reduces repayment risk. Unlike traditional loans, Square and PayPal have the luxury of analyzing historical credit card sales to determine who to extend credit to. That’s been an area of great interest.
Q: Is that something you see as a growing part of the industry?
A: Yes. Small businesses have always struggled to get loans, in part because they are not significant enough to get the attention of traditional banks. In addition, investors have been frightened because of what happened to LendingClub last year, but these loans are different from LendingClub’s so-called market place model.
Q: Is security still a primary concern for online payments processing?
A: The chip card introduction in the U.S. only addressed counterfeit fraud; it did not address card-not-present fraud (eCommerce) or mobile-based fraud. Regardless, magnetic striped technology is very old and the U.S. was the last developed country to still rely on this dated technology. This new chip security protocol has helped reduce “counterfeit” fraud given fraudsters can’t produce a chip card in their garage – it’s much more sophisticated. The retail industry was upset that Visa didn’t package this security upgrade with fraud-reduction solutions for eCommerce fraud, where the majority of future growth is.
When a market like the U.S. goes chip and pin, the fraudsters migrate to the most vulnerable areas. Now we’re going to see e-commerce fraud spike similarly to what we have seen in other markets that have migrated to chip. Visa and MasterCard’s solution to reduce online fraud is something called tokenization, which replaces our sensitive payment credentials with a useless “token” that is of no value to the fraudsters.
As it currently stands, our credit card numbers can be populated across an abundance of ecommerce merchants. Wherever you’ve made an online purchase, your card is on file. Tokenization replaces all those payment credentials with an innocuous number that a fraudster can’t make sense of – it makes the data invaluable.
For example, if you hacked Nordstrom, all you’d get is a bunch of numbers that don’t make any sense. They’re working on this, but it’s going to take some time.
So yes, security is still a major concern. The growing popularity of P2P mobile transfers could pose a real risk to consumers who link their wallet to their debit card. For hackers, getting credit card information is one thing, as it’s easy to call the credit card company and ask to reverse the charge. When someone gets a hold of your debit card number, that’s a big problem. We all know someone whose identity has been compromised.
I think the banks will focus on their security advantage as they roll out their new P2P service called Zelle. Venmo is under investigation by the OCC due to security concerns. The banks have the opportunity to demonstrate their competitive advantage on security.
Q: With all the talk of disruption in the FinTech and payments space, is there going to be a point where banks become less relevant?
A: The truth of the matter is, working with a bank is difficult, but replacing them is even more difficult. The consumer experience needs to improve dramatically and FinTech firms are showing them how this can be done. The goal is to create a consumer experience similar to buying something on Amazon
Two years ago, the key word in this space was disruption. You’d go to a conference like Money 20/20 and every cool startup would say ‘here’s our business plan, we’re going to disrupt the banks – banks are going away.’
Then, all of a sudden, these same disruptors began to talk about partnering with the banks. The narrative shifted to – ‘we’re not going to disrupt them, we’re going to collaborate with them.’ There was a realization that they just can’t displace the banks because the banks have the regulatory know-how, the scale, and the customer reach. Getting to scale is very difficult for FinTech players without the cooperation of a bank partner.
Disruption is cooler to talk about, but it isn’t going to happen to the degree many had originally thought. However, what you will see are a lot more partnerships and collaborations, a lot more M&A.
Case in point: JP Morgan’s recent annual shareholder letter highlighted the $600 million dollars they are spending on FinTech, out of a total technology budget of $9 billion. The FinTech spend is directed towards internal development, partnerships and M&A. We think that most, if not all, of the banks are going to be redirecting a portion of their annual technology budgets to partnering with the FinTech firms, or simply buying them.