The cloud-based banking software provider nCino (NCNO 0.03%) is in the business of selling technology to financial institutions. Banks use nCino to automate many parts of the loan origination process in order to originate more volume and better leverage data. The market has sold off bank stocks this year due to concerns over an economic slowdown and potential recession, which banks can struggle with due to the cyclicality of their business. What could this mean for nCino's business?
While the jury is still out on whether we'll see a recession over the next six to 18 months, investors should be thinking about how every stock in their portfolio might perform if the economy takes a turn for the worst. Let's take a look at nCino and see how its business might hold up if there is a recession and its target customers begin to struggle.
Image source: Getty Images.
NCino is not a bank
Understanding bank technology is no easy task, but the first big thing to understand is that while nCino may serve banks, it is by no means a bank. It doesn't gather deposits or make loans, and therefore isn't as reliant on consumers or small businesses as an actual bank.
nCino's goal is to make the loan origination process more efficient and smoother for both loan officers and borrowers. nCino's platform links the front-, middle-, and back-office employees of a bank with clients and third parties in order to cut down on manual labor. For instance, nCino can largely eliminate manual data entry with its automated spreading technology, which can extract pertinent data from financial documents, minimize errors, streamline the underwriting process, and reduce the time it takes to analyze and spread financials by over 75%, according to the company. The platform also allows bankers to get into their loan system remotely and securely, which obviously was huge during the pandemic. nCino also provides lots of analytical tools bankers can use for loan pricing discovery, identifying credit trends, and finding new lending opportunities.
nCino also has a very different operating model from a bank. Banks make a large portion of their revenue by gathering deposits and lending them out in order to make money on the spread. Banks also make fee income from other businesses such as wealth management and investment banking. nCino makes the bulk of its revenue through a recurring subscription revenue model that it charges per bank employee using the software. Contracts with financial institutions can be for five years, and grow in value.
Image source: nCino.
Sales during an economic downturn
The banking industry as a whole doesn't have the best reputation for being at the forefront of technology, although few realize how big of a project it can be for banks to implement new core banking technology. But I think the industry is definitely at an inflection point -- banks realize that to keep pace with all of the competition and simply provide the services and experiences that consumers and businesses expect these days, they are going to have to make the move.
"Look, we see lots of eyes on the market and looking at the macroeconomic situation. But I don't hear a lot of banks questioning whether they need to digitize and whether they need to digitally transform. We just believe that's where the industry is going," Josh Glover, president and chief revenue officer of nCino, said on the company's recent earnings call.
He added: "Whether interest rates are up or down, our banks are not going to want to lend money slower to their customers, right? They're not going to want to offer a less competitive experience."
The other thing to consider is that with the Federal Reserve rapidly increasing interest rates, banks are expecting to make more money because the yields on many of their assets such as loans will go up. Many banks also realize they need to get more efficient and increase revenue while holding expenses flat or decreasing expenses. While implementing a new system like nCino can be a bit of an investment and disruption for daily business, there is definitely a payoff. On average, nCino says its clients see a 40% decrease in loan closing time, a 92% reduction in data reentry rates, a 13% decrease in loan delinquencies, a 25% increase in efficiency, and a 127% increase in account opening.
The business should be resilient
Based on the long contracts that generate recurring revenue, and the fact that the banking industry seems to understand the need to digitize and automate their operations, I think nCino can still perform solidly in a modest recession. The company already counts 12 of the world's top 25 banks as clients, so those that don't have similar technology or build their own systems are likely going to be at a disadvantage regardless of the macro environment -- which is why I think nCino's business should be somewhat resilient during a recession.
