Brian Hamilton has his fair share of experience in the world of financial technology. He has worked for some of the largest banks in the world, including Capital One, where he ran merchant acquisition and small-business digital banking. Hamilton also has extensive experience building fintech companies and challenger banks -- smaller banks that focus on competing with larger, more established banks, typically by leveraging technology. Hamilton helped launch a company called Clear2Pay that later got acquired by Fidelity National Information Services. He also founded and led a fintech called Azlo, a challenger bank for freelancers and small business owners that had been owned by BBVA (Azlo and another challenger bank, Simple, are being shuttered as BBVA sells its U.S. operations to PNC Financial Services Group).
A few years ago, Hamilton left Azlo to found his current venture, One, a challenger bank that focuses on financial well being and simplicity for its users. Accounts offered by One comes with no fees and no minimums, free bank transfers, and a no-fee approved credit line, among other features. The account also allows users to create "pockets" for savings categories, some of which offer very attractive annual percentage yields.
The Motley Fool caught up with Hamilton to discuss the latest happenings in fintech, as well as how to value and examine fintech and challenger banks coming onto the public markets.
Q: Lots of fintech companies have hit the public markets with big valuations, and investors are paying up. Do you think these valuations are justified? What should investors keep in mind?
Hamilton: People are paying for growth and innovation in the multiples that tech companies are receiving in the public markets. Relative to traditional banks, which often trade at two times or three times book value, these fintechs are trading at 10 times for that reason. It is similar to thinking of them as tech stocks relative to manufacturing or traditional consumer staples in other categories of the market. They are essentially different animals. Some of the super lofty private valuations will ultimately not hold up for too long once floated on the public markets and put under the same scrutiny as their other public competitors, but the fundamentals of being a technology company that happens to do some banking can be very different than the fundamentals of actually being a bank.
Q: Recently, SoFi announced it would go public through a special purpose acquisition vehicle. Do you view SoFi as a good investment? Are there any other challenger banks that you think might eventually go public, and that investors should keep an eye out for?
Hamilton: I think so, in large part due to their acquisition of Galileo, which diversifies their revenue stream into recurring payments and B2B financial services as opposed to relying primarily on directly lending. Investors may remember LendingClub or OnDeck as pure-play lenders that went public and had a tough time in the public markets thereafter. Chime is looking like it will be the first neobank to go public based on their comments and general market sentiment.
They have done a great job on the customer acquisition front, essentially paving the way for a next generation of challengers to do even more across the financial product spectrum for their customers, which is what we will do at One. Some that have already gone public like Square will be important to watch as they put together their consumer ecosystem like Square Cash with the merchant side of the equity business, and create on-us networks that avoid paying freight to the card processing networks.
Q: What advantages do challenger banks and fintechs have over traditional bank stocks? Do traditional banks still hold advantages over fintechs, or are there still major barriers to entry?
Hamilton: They are tech companies, who are more nimble and able to innovate and pivot more quickly. This bodes well in a fast-changing market where consumer preferences ranging from digital UX to the ability to hold crypto take banks years to get their head around, while fintechs quickly get the picture and begin to address the customer need. On the flip side, banks do have structural advantages, namely their ability to use customer funds on deposits to fund their lending activities. This cost of funds advantage is material, especially at scale, and is one reason you see companies like LendingClub purchasing Radius Bank, or fintechs like Varo seeking bank charters even at the expense of falling behind competitors in customer growth.
Q: Traditional bank investors often use several metrics for evaluating bank stocks, including but not limited to return on equity, return on assets, efficiency ratio, net interest margin, net charge-offs, non-performing assets, and cost of deposits/funds. Should investors use these same metrics to evaluate fintech companies, specifically challenger banks? Or are there more important things that you look for?
Hamilton: In short, yes, but they sometimes have a different presentation or vernacular given they are not true banks. The same metrics matter, but the economics of the deal between the fintech and their back-end banking partners are important to understand and are not always disclosed. The net interest margin, for example, could be a combination of the cost of capital the fintech is paying in the private markets, which could be through securitization or other wholesale facilities, and their sponsoring bank fees that are providing lending licenses or other services. Evaluate fintechs like tech companies unless or until they are banks themselves.