European fintech lending startups have racked up over 11B in debt facilities in 2023 to help them lend to consumers and businesses. However, cracks in their credit models and approach are starting to appear. Based on findings from 95 in-depth interviews and due diligence of 27 fintechs, credit fund WinYield has today exposed some serious challenges on the horizon for the industry.
WinYield found that fintech lenders lack the necessary credit experience: less than 10% of the fintechs interviewed had staff with previous relevant credit experience. Common underwriting models were composed of a black box using basic regression analysis with no human overlay to assess the actual viability of loans. WinYield found in many cases that delayed payments were running up to 10% of the entire fintech lenders portfolio, this is four times higher than in bank SME portfolios. While the $12B in debt facilities is largely composed of senior debt, it's the 514m ($550m) venture capital that is at risk of disappearing which has first-loss exposure.
Having analysed the various operating models, the report finds many fintech lenders are running an uneconomical business. It was clear that most will never become profitable. This was largely because marketing and operational costs were significantly underestimated while the market opportunity was dramatically overhyped.
Fabricio Mercier, founder of WinYield, commented: Ecommerce, for example, was a 596bn sales market according to Statista in 2022. It sounds like a huge number. But because theres a 30-day sales cycle, fintech lenders in ecommerce have to lend 12 times a year to keep the same amount of lending on their books. In addition to this, the vast majority of ecommerce companies are either operating abroad, or have very limited trading history. Factoring this in, the opportunity plummets to somewhere between 1.5 to 2.5bn. Thats more than 200x smaller!
Many European fintech lenders are opting for the multi-product approach and aggressive marketing budgets favoured in the US. But this does not work in a fragmented European market where the break-even portfolio size is much too high. The US market is a single market with its own regulation. Europe, on the other hand, has 27 different markets with 27 different combinations of rules, laws and languages. It is therefore incredibly difficult for a single fintech to compete across all 27 jurisdictions of the European market. Europeans also find very limited synergies when adding a second product because doing so would require an entirely new client journey, operations, and funding facilities. Another way to think of this is to look at the number of full-time employees per million of assets under management. Single product, uni jurisdiction fintech can go as low as 2 FTEs per million even in the case of a small portfolio vs 12 for a multi-product/multi jurisdiction. added Fabricio Mercier.
Reaching profitability will be a challenge for most European fintech lenders. Those that do become profitable will likely need to pivot several times and ultimately partner with a bank. Indeed, European banks are getting more competitive, using partners like Thought Machine and others to plug their APIs to fintechs directly.
Based on the numbers WinYield gathered, with a single product and one jurisdiction, the asset under management (AUM) level for which a lending fintech would break even can be as high as 150m for a SaaS lender, 35m for an embedded lender and 160m for a credit card lender. Reaching these levels may be challenging in many European countries.
Fabricio Mercier, CEO of WinYield commented: "The VC funding drought has actually helped clean a lot of the malpractice in fintech lending, bringing European fintechs to their senses with a degree of discipline and rationality returning to their decision making. Now we are entering into the phase of Fintech 3.0, with more experienced founders doing more with less. Although there's still a lot of learning to be done, the fintech sector is reshaping for a better future. By getting serious and institutionalised, fintech will grow again, partnering with credit funds and banks."
Off the back of the report, WinYield offers the following considerations that fintech founders could act on to achieve sustainable growth:
- Start with a small team of no more than 5 people, build a product that works well, and then start looking at scaling the business
- Find a funding partner who understands the intricacies of your operations and the fintech lending ecosystem and seek the highest LTV possible
- Find a niche market where high cost of money solves a problem that is not related to high credit risk.
For investors, WinYield recommends:
- Dont trust black box underwriting you are the credit expert.
- Favour fintechs that are growing steadily by focusing more on their product and risk proposition as opposed to following a VC agenda.
- Partner with small funds or high quality advisors to reduce your workload as transactions tend to be smaller than expected.
Despite the challenges faced by fintech today, the outlook is not all doom and gloom. Fabricio Mercier, CEO of WinYield noted, "Our latest industry report reflects that the ample liquidity provided by VCs fostered bad habits among fintech lenders. Its become clear that the bull market of 2020 was creating an irrational bubble in fintech lending. While there are still many bad apples, we believe that the shortage of venture capital may bring European fintechs to their senses with a degree of discipline and rationality returning to their decision making. However, a lot of education is needed to have a healthy market.
WinYield is a specialised fintech credit fund founded in 2022 with a focus on providing first-loss financing for fintech and investment solutions for early-stage fintech companies. WinYield is tackling the challenge of venture capital funding scarcity for lending fintechs, particularly in segments such as early-stage fintechs. WinYield leverages expertise in identifying risk earlier with real-time, big data analysis and by partnering with the originator in the underwriting. For more information please visit: https://www.winyield.co/
+44 7714 007257
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