Record Fintech VC Funding: Banks Getting Amazoned

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Record Fintech VC Funding: Banks Getting Amazoned

Q1 2021 was the largest quarter for venture capital fintech funding on record, according to data from CB Insights (link to full report below). Today we’ll review a few key highlights from their report and offer our thoughts on what this means for the stocks of publicly held financial institutions.

#1: Overall funding: VC-backed fintech companies around the world raised $22.8B across 614 deals in Q1 2021, up 98 pct and 15 pct y/y respectively. That’s impressive, given that it exceeds the prior record set in Q2 2018 which included Ant Group’s $14B funding round. There were a record 57 $100M+ mega-rounds, making up 69 pct of total funding. The average deal size also almost doubled to $37M from $19.3M in Q4 2020.

#2: Funding by region: “Every continent except for Africa saw QoQ growth in deal activity.” Deal growth was global in nature, although North America (264 fintech rounds in Q1) still dominates, followed by Europe (151) and Asia (147).

#3: Funding by category (ranked high to low in terms of new investments):

  • Capital markets (i.e. sales and trading, analysis, infrastructure tools): Funding jumped 250 pct q/q to $8B, even though deal activity dropped 4 pct. Mega-rounds “were over 80 pct of total funding in the quarter”.
  • Payments companies (i.e. payments processing, money transfer platforms): Raised +$6B in Q1 2021, up 188 pct q/q. Deal activity rose 50 pct to 114. 18 mega-rounds represented +75 pct of total funding.
  • Wealth management (i.e. personal finance tools, investment and wealth management platforms): Funding here “rebounded significantly”, up 560 pct q/q to $5.4B amid 8 mega-rounds which accounted for 83 pct of total funding in Q1. Deal activity rose 27 pct. Robinhood raised about 60 pct of total funding in Q1.
  • Digital lending: Funding and deal activity jumped 203 pct and 96 pct q/q to $4B and 102. This included 8 mega-rounds, or the most since Q2 2019.
  • SMB (“companies focused on providing solutions to small and medium sized businesses”): Funding increased 154 pct to $3.4B, while deal activity fell for a third straight quarter, down 21 pct.
  • Banking (i.e. digital-first banks): Digital banking deal activity dropped 12 pct q/q, the first fall since Q4 2019. Funding was up 25 pct to $3.3B, however, and has risen for two straight quarters.
  • Real estate (i.e. mortgage lending, transaction digitization): Real estate companies saw funding rise by 29 pct to $2.4B, although deal activity dropped by 9 pct.

Here are our takeaways from this data:

#1: Consider that if you annualize Q1’s pace of global fintech VC investments you get $91 billion, which is more than the market cap of Bank of New York and State Street combined. It is also about 75 pct of American Express’ market cap, or 60 pct of Citigroup’s valuation. VCs clearly see a very large opportunity in financial services, and they’re moving quickly to disrupt the sector.

Jamie Dimon gets it; in his letter to shareholders last month, he explained how JPMorgan Chase “must get faster and be more creative” as “the competition will be intense.” Here’s why: “Banks already compete against a large and powerful shadow banking system. And they are facing extensive competition from Silicon Valley, both in the form of fintechs and Big Tech companies (Amazon, Apple, Facebook, Google and now Walmart), that is here to stay. As the importance of cloud, AI and digital platforms grows, this competition will become even more formidable. As a result, banks are playing an increasingly smaller role in the financial system.”

One of his solutions: “…acquisitions are in our future, and fintech is an area where some of that cash could be put to work – this could include payments, asset management, data, and relevant products and services.” Incumbent banks have already started responding to digital disruptors. For example, JPMorgan is launching consumer banking services via its mobile app in the UK, while HSBC UK announced a mobile first banking service called HSBC Kinetic.

#2: Q1’s funding data shows payments and digital lending are the hottest areas for disruption. With the pandemic accelerating a more online-enabled world, we expect this to continue.

Dimon called out both areas in his letter as “increasingly… moving out of the banking system.” Dimon said that “the growth in shadow banking has also partially been made possible because rules and regulations imposed upon banks are not necessarily imposed upon these nonbanks.” Incumbent banks therefore typically face a headwind versus newer entrants as they are forced to adopt or acquire disruptive products and services and only if their heavily regulated industry allows.

#3: The high share of fintech mega-rounds says venture capitalists are funding less risky, more established companies that are at the cusp of an IPO/SPAC deal or sale to an industry player. This was especially true in the wealth management and capital markets categories, where mega-rounds accounted for +80 pct of total funding for Q1. A large part of that was due to the positive global equity market backdrop, enabling digital investment platforms (i.e. Stash and Webull) to raise new funding rounds, while a couple of major retail investing platforms went public (i.e. Robinhood and eToro). Additionally, just like after any recession, there was increased interest in automating capital markets processes and data analytics for investment research workflows. And of course, virtual trading companies also attracted funding for their institutional-grade products as that market matures and gets institutionalized.

Bottom line: as much as we like Financials for a cyclical recovery trade, the data here presents a bleak picture for the industry’s investment merits over the medium and long term. It’s not like JPMorgan or Citi or Wells are going away, but rather that investors saw what ecommerce did to department stores and know how this movie ends. Financials already have the lowest valuations of any S&P 500 sector (14.4x), but there’s no saying they can’t go lower still.

Sources:

CB Insights Report: https://www.cbinsights.com/research/report/fintech-trends-q1-2021/

Jamie Dimon Letter: https://www.jpmorganchase.com/content/dam/jpmc/jpmorgan-chase-and-co/investor-relations/documents/ceo-letter-to-shareholders-2020.pdf