Sioux Falls, S.D.-based Pathward Financial Inc. sees venture capital and private equity investments in neobanks declining, and as a result, the banking-as-a-service provider currently drives more growth from legacy partners than from financial technology companies.
President Anthony Sharett noted that the macroeconomic environment is drying up the venture investments used to fuel the growth of neobanks, which are users of banking-as-a-service, or BaaS, offerings. Fintechs' ability to raise capital matters to Pathward because sufficient and reliable funding sources are key to a startup's viability in the longer term, Sharett said.
"We certainly do our due diligence around their financial viability; what type of capital they are raising; what commitments that they receive for wherever the capital is coming from," Sharett said in an interview.
Pathward was the 16th-largest financial institution by payment origination volume via the Automated Clearing House network in 2021, according to the National Automated Clearing House Association, an industry group that governs the ACH payment network. Transactions processed through BaaS make up a large chunk of its payment volume.
For the three months ended June 30, Pathward generated $24.7 million from payment card and deposit fees related to BaaS, accounting for 45.7% of its total noninterest income during the quarter, according to its latest 10-Q filed in August.
Amid the recent pullbacks from investors, the bank is now slowing down the pace at which it adds fintechs to its mix of BaaS customers. In September, global venture capital investment plummeted by 62.9% year over year to $21.82 billion from $58.76 billion, as investors navigate high inflation and the risk of a recession, according to S&P Global Market Intelligence data.
"But as we've told everybody, 80% to 90% of our revenue comes from the larger, longstanding and continuing-to-grow participants in program management in the industry," Pathward CEO Brett Pharr told investors during an earnings call Oct. 27. "We feel good about the pipeline. I wouldn't say that it is over the top, because it has less fintechs in it," he added.
An example of such larger partners is tax preparation company H&R Block Inc., which is in an agreement with Pathward through June 2025. Pathward issues prepaid cards, processes tax refund transfers, and provides lines of credit to H&R Block's users. Pathward's BaaS revenue tended to spike during tax season over the past few years.
Due to the shift in its customer mix, income from card fees is projected to grow by 15% year over year for fiscal year 2022 that ended Sept. 30, wrote analysts Steve Moss and Gates Schwarzmann at B. Riley Securities Inc. The year-over-year growth in card fees was 22% in fiscal year 2021, elevated, in part, by government stimulus programs.
Neobanks in a dynamic market
Since startups may find it more challenging to raise capital, those that have not figured out a clear path to profitability could seek to be acquired or merge with a peer.
"We're seeing some consolidation among the fintechs and neobanks. I think we're going to see more of that, particularly where the unique capabilities that they're trying to bring to bear are similar," Sharett said.
Still, Pathward is actively working with the fintechs that it has already onboarded. For instance, it will soon launch new products for neobank Clair Inc., Sharett noted. Pathward will use Clair's API to connect it with large wage and compensation systems so that Clair can provide early wage access to its consumers.
Founded in 2019, Clair announced the partnership with Pathward in May 2021, and a month later, Clair announced a Series A funding of $15 million led by Thrive Capital Management LLC.
As a chartered bank supervised by the Office of the Comptroller of the Currency, Pathward views its ability to manage third-party risks as a competitive advantage, and it is dedicated to helping the younger companies understand regulatory compliance, Sharett said.
In addition to BaaS, Pathward also interacts with fintech startups by making equity investments, with some being its BaaS customers. During the fourth quarter of its fiscal year 2022 that ended Sept. 30, it recorded a pretax $1.9 million loss on the sale of an undisclosed venture capital investment.
Faster payments a new growth area
While the current neobank marketplace may present fewer opportunities to BaaS providers, Pathward continues to explore other growth areas.
It is investing in technology and product teams to make faster or real-time payments an option available to its fintech customers, Sharett said. In July, it signed a partnership with Moov Financial Inc., enabling Moov to connect directly with Visa's network to provide real-time and other payment methods for merchants, the executive added.
Pathward's real-time payment strategy is currently anchored on partnerships with external technology vendors and fintech companies, Sharett said. Pathward is not on the list of participant banks of the RTP network, the major real-time payment rail in the U.S. for banks operated by The Clearing House.
In comparison, some other BaaS providers, including BankProv, Coastal Community Bank, and Cross River Bank, work directly with The Clearing House to deploy RTP. Cross River also participates in the pilot program of the FedNow Service, another real-time payment rail that the Federal Reserve plans to roll out in 2023.
"For us, we would have to utilize and leverage a partnership model for real-time payments because we don't have 24-hour customer services through branches like perhaps a superregional bank or another institution," Sharett said.
As part of Pathward's shift to BaaS, it completed the sale of its community bank division in February 2020, which included branches in Iowa and South Dakota.
"I think the banking-as-a-service industry, along with folks like Visa Inc. and Mastercard Inc., are still trying to figure out the use cases and then where does everybody fit in," Sharett said.