Why I like Financial Services in 2013, and in 2014, 2015…

When I look at financial services, I see opportunity. Period.

Industries that Need to Change
Companies that literally handle the money, and most haven’t changed much in 30-40 years. Do you know how many major financial services companies are still running programs on mainframes from the 70’s? You should be frightened. I have worked in multiple financial services firms, and seen a lot of dysfunction– my years at Ditech were most illustrative of why I see so much opportunity; they were the most frustrating, stagnant years of my life. (Others high on the frustration meter include my stints in investment management, banking, consumer lending and insurance). And Ditech was considered the most “innovative and leading” in the mortgage industry.

Ditech was ahead of the curve– 70% of our applications originated online, and it is one of the few companies that was solid through the crash. All that said, I felt like I was in the stone age. We had just figured out how to build simple tools. When I joined, we had over 200 software applications in production, some that did almost nothing, but were integrated into a spiderweb so ugly, it was almost impossible to sort. We had critical systems built in Delphi (look it up :-)). A huge accomplishment for us was moving to Java, and retiring well over 100 applications, getting down to only a handful of critical systems. But candidly, we didn’t innovate; we didn’t change the way we did business. We made one giant effort to adapt our business as other mortgage companies were swimming in subprime profits. We tried hard to launch subprime lending back in 2004-5 from our historical base of doing A paper mortgages. The customers were different, the processes needed to change, and our agents needed to change to address the different section of the market. We couldn’t. We failed miserably, and did only a handful of subprime mortgages, which was a blessing we didn’t realize at the time. Bottom line is we performed our normal operations well, but we couldn’t change. And we didn’t really have any pressure to change.

In the mortgage industry, the biggest innovations in the past 30 years have been DU (Desktop Underwriter – note the name) from Fannie Mae, and mortgage-backed securities. Not bad ideas, but missed a few details on the implementation (see 2008). This is just one industry under the financial services umbrella, and there is plenty of room for change.

My Fin Serv Investments
From banking and asset management to consumer lending and insurance, my career has led me through several financial services industries, and this is a key area of expertise and focus for me at Blumberg Capital. We are very active investing in financial services. I closed 9 investments in the past 18 months, and all of them have one thing in common: they are trying to change their industries and attacking outdated systems and capabilities:

– Addepar – next generation wealth management
– Credorax – acquiring bank built as a technology platform
– Lenddo – emerging market lending using social media
– Coverhound – car insurance 2.0
– ZipZap – global cash payment network (pay cash for online purchases)
– PaidPiper – payment messaging system
– Zanbato – infrastructure investment software platform
– Kreditech – advanced short-term loans using big data
– Paymill – simplest payment solution for merchants globally

And there may be one or two more coming :-).

Just Getting Started
This is just the beginning, and I’m not the only one thinking this way. When I speak with the big incumbents, they know. These are huge markets, and financial services is by definition in the flow of money– very attractive targets for entrepreneurs. As I said above, there isn’t much innovation from incumbents. Turning an aircraft carrier is not easy, especially if the steering is old. The most forward-looking financial services firms are spending a lot of time with entrepreneurs, seeking new opportunities for their businesses. If you think for a minute that financial services will look the same in 2020 as it does today, you are mistaken.

Opportunities for Entrepreneurs
Financial Services is a complex arena, full of regulatory pitfalls, difficult customer patterns, and structural roadblocks. These complexities make it difficult for new companies to succeed, and there are more than a few failures that burned through inordinate amounts of capital without success, plus a few public companies that are now roadkill.

However, the structural, regulatory, and inertial challenges make financial services a very attractive market. Sure, you have to run through a few brick walls, but mortar loosens with hammering. And, the same challenges make it very difficult for competitors (it’s like the walls reappear). The incumbents don’t innovate much, and the markets are huge, so if you have the guts to take on the establishment, there are some massive opportunities.

In each industry I’ve mentioned, the potential for game-changing innovation is off-the-charts. Underwriting needs to change. Lending and access to capital needs to change, both for businesses and individuals. Emerging markets are completely under-served. Insurance has plenty of room to improve, and asset management, for all of the complexity it has at some levels, is still using Excel in many areas.

If I am an entrepreneur looking to build a very big business and change the world, financial services is a great place to look. These markets are measured in trillions of dollars globally, and there are myriad places to find people who are under-served. You don’t need to displace a huge incumbent or take huge market share to build a great business. That said, if you can really disrupt the industry, you will be a huge company. HUGE.

The opportunities are flat out immense, and a few of us are looking carefully for people who want to take these challenges and build the next generation of financial services companies.

In future posts, I will talk more about some specifics, but suffice it to say that as an investor, I love financial services!