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As the tide goes out - which fintechs will be left?

“You only find out who is swimming naked when the tide goes out,” Warren Buffet famously said in reference to financial institutions during the 2008 financial crisis.

Since then the number of fintechs has swelled to 20,000 globally, powered by $275B in investment in 2018 and 2019 alone.

Although venture capitalists seem poised to continue deal-making in the months ahead, this will be the first dip in the economic cycle for most fintechs. Sequoia Capital issued a dire warning to start-ups on March 6th indicating rough times ahead.

In light of coronavirus and an impending recession, what does the change in tides mean for the fintech industry? Expect quick changes in credit risk, sales cycles, and payment volumes.

1. Rising credit risk in small business lending, likely subprime lending as well

Disruption has hit multiple business sectors, including travel, food, and retail, that compose a large proportion of US small businesses and employment:

Disruption to supply chain industries like transportation and wholesale, construction, and to arts, entertainment, and recreation further endangers an additional 17% of small businesses (bringing the total to 40% of all small businesses).

With demand falling as people bunker down at home and international supply chains disrupted, small businesses and the fintechs that serve them are particularly exposed.

These fintechs will have to contend with two forces: declining credit quality of existing small business loans, while facing skyrocketing demand for new loans from small businesses as they seek liquidity and cash. These fintechs will need to adjust their credit models fast and accurately enough to weed out good credit risks from bad.

Wall Street is betting this will prove difficult - small business lenders like OnDeck Capital have seen the largest drops within the industry (down nearly 75% over the last month).

A similar dynamic may be in play with consumers: employers cut hours and incomes unexpectedly decline leaving people without the ability to pay back existing debt and in need of additional credit to act as a bridge to brighter economic times.

Nearly 1-in-2 Americans couldn’t come up with $400 in an emergency. Now that many may face one, what will they do? Ultimately, the level of impact to consumers will depend on the government’s economic response.

2. Longer sales cycles for B2B fintech businesses

Consensus-driven sales already face long sales cycles. The only certainty in a time of uncertainty is these sales timelines will lengthen, prices will be haggled lower, and the risk of deals not signing rises.

This leaves B2B fintech businesses reliant on large deals exposed, including the likes of Amount (by Avant), Upstart, ZestAI (previously ZestFinance), among others.

B2B businesses with more usage-based business models, like Plaid (data aggregation), GreenDot (banking-as-a-service), and Zumigo (fraud protection), are likely to weather the storm easier than others with financial institutions able to adjust to the uncertainty of demand.

3. Declining transaction volume, revenue for payment fintechs

With consumer spending representing roughly 70% of the US economy, declines in consumer activity will suppress payment transaction volume. This will affect payment fintechs like Square and Stripe.

Not all fintechs will be affected equally, however. The decline of international tourism and lower economic activity typically results in lower cross-border transfers, effecting fintechs like TransferWise, WorldRemit, and Azimo more strongly.

The coronavirus crisis is rapidly evolving, alongside its impacts. Expect more updates and developments to come.

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