How Can Legacy Banks Keep Up With Open Banking?

Investment Thesis

First National Bank of Omaha (“FNBO”), a subsidiary of First National of Nebraska, Inc. (OTCPK:FINN), has always taken an innovative approach when offering its customers new financial services. FNBO was amongst the first banks to issue credit cards and was one of the original members of the Visa organization, BankAmericard. FNBO now works with fintech disruptors to further enable its business to remain competitive in today‘s day of digitized financial services. FNBO ultimately intends to offer consumers better access to financial services based on more accrued models that approve more qualified borrowers while denying more of the bad ones.

Improvements in technology, specifically cloud computing and the widespread adoption of smartphones, enable widespread access to data, even for legacy financial institutions like FNBO, to run a better business that is more inclusive, and overall better for their communities.

Introduction

Upstart Holdings’ (UPST) Leaders and Lending podcast series is a show for lenders who want to improve their go-to-market approach and improve their consumer lending programs. Last week, Upstart published an episode titled “Fostering Innovation in Credit Cards, BNPL, & Credit Management”, which featured Jerry O‘Flanagan, Executive Vice President of FNBO. O‘Flanagan‘s been in the consumer lending and credit card business for the past 35 years, with experience at Citibank and JPMorgan Chase in addition to 16 years at FNBO. O‘Flanagan has an abundance of experience when it comes to credit cards and consumer lending, and I greatly valued his perspective on fintech and to hear about FNBO‘s opportunity to improve learning based on alternative and transactional data.

• Leaders in Lending by Upstart: Fostering Innovation in Credit Cards, BNPL, & Credit Management

I always thought credit card was its own management science, to begin with in banking, and you know, it’s always been on the forefront when it comes to technology, marketing, and credit.” – O‘Flanagan

FNBO is a private company with $25B in assets while its technology stack is more than 40+ years old. FBNO partners with fintechs to remain competitive and “incubate” innovation within their financial products. These tools enable FNBO to innovate their operations by featuring the latest tools and technology which allow them to use AI and machines to analyze vast amounts of data.

For a bank like ours, you know, to really effectively compete we have to be willing to disrupt ourselves. We have to take inspiration from the fintechs and really build a business within a business and deal link the couple from the technology, existing technology stack and create a new technology stack. And you have to be willing culturally to do that. It’s not easy to do, but you know, we are pursuing credit cards as a service and you know, we will be standing up later this year, our own national direct-to-consumer digital bank. All of this has been achieved through a recognition that we couldn’t do it in the existing technology stack…” O‘Flanagan

Opportunity For BNPL

When O‘Flanagan described his initial experience hearing about the BNPL (“Buy Now, Pay Later”) phenomenon, he didn‘t take the opportunity seriously because he didn‘t see any difference in this form of credit compared to a traditional credit card. As I‘ve explained in previous notes highlighting BNPL and more specifically Affirm, companies are now able to underwrite loans on a transaction-by-transaction basis versus providing one lump sum per month based on their FICO score.

Fintechs today enable the flow of data between multiple parties within a transaction, from the end-consumer, the merchants, and the product manufacturer.

Affirm is a “software-defined, data preserving, vertically integrated network” that serves merchants and consumers by preserving transactional data at the point of sale. Affirm uses this data to understand the flow of funds between merchants and consumers. Affirm has access to SKU level data, which means it can underwrite transactions at its partnered merchants to the item-specific merchandise being purchased. This approach to credit is significantly better than just giving somebody a monthly balance based on their FICO score because each transaction is underwritten on the transaction level, something the incumbent payment networks are not capable of (I explored this topic in a BNPL note).” – Author‘s latest Affirm Note

O‘Flanagan doesn‘t see BNPL as a threat to credit cards, but rather as a “conduit” or tool that enables banks to provide better services for their customers, especially as its recent partnership with Marqeta (MQ) will enable them to offer a modern credit product. FNBO partners with companies like Upstart and Marqeta so that they ensure their technology stack is compatible with the underlying data that‘s now enabled by the widespread adoption of cloud-compute and smartphones.

I see [BNPL], you know, if we do this correctly, as a conduit for the credit card. These are often customers that we have traditionally not underwritten and I think could be great credit card customers. They can be graduated in short order to a credit card and then maybe get a customer for life…

It’s as an older banker I missed it, I admit it. I totally missed it. I just didn’t – I remember telling my boss – I think this is my number one fail how did I miss this? But I do think that the two can work in tandem with each other very well. It doesn’t have to be a zero or some game. I think this is actually a good thing for consumers and financial institutions.” – O‘Flanagan

BNPL has the potential to transform the way that people access credit because the issuer, the merchant, or now the product manufacturer has a method to subsidize a transaction. For example, the issuer can offer a 0% installment loan for a consumer at the point of sale and the merchant will be charged a higher fee (in the form of the merchant discount rate) from the issuer because non-interest-bearing loans are more appealing to consumers.

Another example of innovation taking place is within the product manufacturer. As mentioned in Alex Rampell‘s Tweets above, an Affirm co-founder and partner at Andreessen Horowitz, the product manufacturers now have the ability to subsidize custom items at specific merchants because they can now subsidize specific transactions linked to a specific SKU, while the consumers are more likely to make a transaction with 0% interest on loans or a cashback reward for instant purchases. This enables product manufacturers to sell more goods by using BNPL, demonstrating that it‘s not only just a tool for merchants to sell more stuff.

Better Experiences For Customers, Driven By Partnerships

• FNBO partnered with Upstart in 2019 for a pilot program which was a success, as approval and loss rates met or exceeded expectations, while consumers were extremely satisfied. FNBO had an 83 Net Promoter Score for the pilot program and announced that it expanded its partnership with Upstart last December so that more people can get access to the loans they need with higher approval rates.

FNBO is focused on delivering modern capabilities to our consumers that make capital more accessible and help them with their credit needs. We are expanding our program with Upstart so that more people nationwide can get personal loans they need with higher approval rates through a modern all-digital experience enabled by AI.” – Marc Butterfield, Senior Vice President of Innovation and Disruption at First National Bank of Omaha

• Last December, FNBO also partnered with Marqeta, Inc., which I wrote about here, to enable its customers to issue credit card programs using Marqeta‘s modern card issuing platforms which enables issuers to leverage transactional and alternative data at the POS to underwrite an individual transaction. Marqeta‘s customers now have access to FNBO‘s deep expertise when it comes to issuing credit cards, while FNBO customers have better insights into the data present within a transaction and more spending controls. Moving forward, it will be notable how FNBO leverages its technology partners together as it‘s not unforeseen that Upstart or one of FNBO‘s other partners could leverage their APIs with Marqeta‘s platform.

This partnership with Marqeta will allow us to continue to modernize our credit offering and meet demand for a more flexible, digitally native experience. We‘re proud to be on the leading edge of banking-as-a-service and look forward to expanding our offerings with Marqeta.” – Jerry O‘Flanagan

• In addition to these two partnerships, FNBO also announced last September a collaboration with Skeps, a POS loan origination platform and EXL (EXLS), an operations management and data and analytics company. This allowed FNBO to launch a BNPL product and build a seamless integration with partnered merchants online and at brick-and-mortar locations.

FNBO realizes that it must innovate and disrupt itself to remain competitive with the nimble fintechs that capitalize on the latest technological innovations. FNBO is well-positioned to remain a leader when it comes to integrating these new tools and remain competitive with the large financial institutions as well as up-and-coming fintechs.

The Consortium

To end the Leaders for Lending Podcast, O‘Flanagan was asked if he had any future bold predictions for the world of lending.

I would say I would look for a consortium over the next twenty-four months to be developed from buy-now, pay-laters. I think that the fintech infrastructure folks will get around to forming a new network. You know, they’re going to want a piece of that economic pie.”

BNPL is a global phenomenon and as O‘Flanagan mentioned in the podcast, there‘s a significant opportunity to make for a more inclusive, fair economy because BNPL considers so many unique data points. It is crucial that the BNPLs develop a consortium so that the data generated from each of these transactions is included in someone‘s credit history. If BNPL enables more tailored financial services and consumers prove that they are worthy borrowers, it is important for them to be recognized for paying off their loans on time or not, while this is not currently the case. The CFPB concluded its probe into BNPL the week of March 25th and the ruling will be important for fintechs in establishing defined reporting standards.

Conclusion

FNBO has been at the forefront of payment technology for the past 60 years dating back to when it initially issued credit cards. The actual technology behind credit cards themselves haven‘t changed much over the past 50 years, but now new payment tools enable payment networks to include other parties in processing and underwriting each transaction. This is only enabled by the new open banking paradigm, which builds on cloud computing, artificial intelligence, and the widespread adoption of smartphones, to make it possible for merchants and product manufacturers to be included in this new paradigm of payment networks.

I can think of no way to fully realize the concept by including merchants and cardholders as owners/members. The slightest hint in that direction raised a storm of opposition. We should have included them. Perhaps with more time, tenacity, and ingenuity, we could have. But that can never be known… “I could devise no way to include cardholders and merchants as owner/members of the system. They should have been, for they are certainly relevant and affected parties.” – Dee Hock, One From Many: VISA and the Rise of Chaordic Organization

I explored these topics in greater depth in my Affirm note, Reorienting The Payments Rails, explaining the company through the quotes of two of its founders, Max Levchin and Alex Rampell, as well the founder of Visa, Dee Hock.

I don‘t blame O‘Flanagan for missing BNPL because it is truly a watershed moment for mankind, but FNBO is positioning itself to be way ahead of its competitors through partnering with disruptors like Upstart and Marqeta.

Marqeta powers financial institutions like Citibank, JPMorgan, and Goldman Sachs and it is a system of record that enables fintechs like Affirm, or tech companies like DoorDash, to issue any type of payment whether through the card networks, ACH, or blockchain protocols. Upstart on the other hand is an AI platform that partners with 42 banks today to improve access to affordable credit. There are $6T in annual loan originations between consumers and businesses while there were $6.7T in card-based payments in the U.S. in 2021. Upstart still has thousands of banks to capture as customers while Marqeta processed $100B in volume for the first time in a single year in 2021, there‘s still massive room for growth given there was ~$74T in global money movement last year.

I am bullish on Marqeta and Upstart and view the two as generational buys while these two fintech stocks remain depressed.

Thanks for reading and happy investing!