I recently took an informal poll, asking some of my friends and family about the last time they had been to an actual, physical bank branch. Out of 10 people, nine had to scratch their head and think about it. Most said maybe they had gone a few months ago and generally go around two times per year. Those responses seemed to be consistent with my personal experience but at odds with the number of branches within just a few miles of my house.
However, there does seem to be some acknowledgment from the traditional incumbent banks that we are overbanked. TD Bank, for instance, has started to shrink its footprint, citing reduced in-person transaction volume. U.S. Bank just closed about 400 branches in the fourth quarter of 2020. These banks are not alone. Over 3,000 bank branches were closed across the country last year, according to S&P Global Market Intelligence. Part of this can certainly be attributed to COVID-19, but the trend had largely begun pre-pandemic.
A related development has been the exponential rise in neobanks. These are digitally native banks that offer many of the same products and services as local branches but in a mobile-only format, resulting in significantly less overhead expense compared to traditional banks. Neobanks often focus on the unbanked or underbanked populations as well as more tech-centric millennial populations, typically generating revenues from interchange fees rather than overdraft and other direct fees paid by consumers.
According to the FDIC's "National Survey of Unbanked and Underbanked Households" published in October 2018, 25.2% of U.S. households either did not bank or were underbanked. Neobank users are often younger and have fewer ties to traditional banks. Once neobanks reach sufficient scale, they can roll out more products and services to generate additional value from these relationships. They can also leverage cutting-edge technology more easily — often offering personalized experiences through budgeting, money-tracking tools and real-time balances. Through a cloud-only presence, neobanks can add different services over time and leverage the vast amount of transaction data they collect.
Additionally, the opportunity in emerging markets is significantly larger than in the developed world, because these countries have broad mobile phone penetration, younger demographics and much larger unbanked populations. They also have less brand loyalty to incumbent banks compared with what you would find in the United States and Europe.
Top digital banks are doubling their customer bases within two to three years. But it is difficult to find a pure-play on this trend in the public markets, as almost all of these neobanks are currently in private markets. Venture capital and growth equity investors have funded several companies in this space, recognizing the significant total addressable market (TAM) and rapid pace of growth. Looking at the chart above, the global neobank market was valued at $18.6 billion at the end of 2018. It is expected to reach $63 billion by the end of 2024, expanding at a 22.5% compound annual growth rate during that period.
Some of the largest digital banks include Chime, Nubank and Revolut. Chime was ranked No. 25 on the CNBC 2020 Disruptor 50 list and raised a financing round in September 2020 that valued the company at $14.5 billion. Chime focuses mostly on Americans who earn between $30,000 and $75,000 per year, generating its revenue through interchange fees versus more traditional loans and penalties.
Brazil-based Nubank is now valued at $25 billion following a financing round in January of this year, after growing its customer base from 12 million in 2019 to 34 million by 2021 just on word of mouth. It started as a credit card company and has morphed into a full-service mobile bank.
In February 2020, Revolut raised $500 million in capital at a $5.5 billion valuation. Revolut started as a way to spend money overseas without paying hefty fees and has added new features to its app, including cryptocurrency, stock trading and, more recently, savings products. It now has over 10 million users, with customer growth climbing over 150% in 2019.
Based on the user growth of neobanks, as well as their success in raising private capital, it is pretty clear that these businesses are to be taken seriously. Traditional incumbent banks are taking notice and trying to add their own digital offerings. Although it remains to be seen how profitable these newcomers can be, the opportunity set and markets are large and growing. Looking in the private markets, it is still possible to find companies in traditional financial services that are growing by orders of magnitude faster than gross domestic product.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
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