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Dave is a fintech company that offers digital financial products to financially challenged Americans. Its main offerings are Extra Cash, an early wage access loan, and a digital checking account designed for people living from check to check. Dave’s stock was submitted as a short on VIC about a month ago. While the short article effectively describes the current regulatory headwind facing the fintech industry, I view Dave as a good investment on the long side despite these obstacles. 

How did we get here? 

Simply put,fintech companies with their banking partners are growing too fast without proper supervision. The collapse of fintech Synapse caused tens of millions dollars’ worth of deposits to be frozen because of the company's poor bookkeeping. This obviously alarmed the regulators. Recently, many banks that provide services to fintechs have received consent orders from the FDIC and other regulators. Evolve, Dave’s banking partner, received 

a comprehensive consent order from its banking regulator. To further understand the situation, WSJ and Bloomberg just published articles related to the regulatory tightening on the fintech industry.

The short article points out that it  is almost impossible for Evolve to fully comply with the items on the order before the 90 day deadline. An untimely compliance could lead to further penalties in the future, and ultimately force Evolve to fully exit certain businesses, including banking as a service which is crucial for Dave. To make things worse, no banks are willing to take on payday lending processing. Therefore, Dave is stuck with Evolve, its worst business partner possible and its future hangs in the balance. 

While fully agreeing with the near term uncertainty surrounding the Evolve partnership, I believe the risk is not severe as the short article portrays. 

Is Dave really stuck with Evolve: 

What does Evolve do exactly for Dave? Per Dave’s 10-K, Evolve performs two functions: 1). loan origination 2). bank account and credit card issuance. Evolve does not process any account or credit card transactions – this function is performed by another company Galileo, a subsidiary of SoFi. 

Dave is not the only fintech company that offers an early wage access product. Searching for Dave on one’s mobile phone will also bring out all of its competitors. I checked Dave’s biggest fintech competitors and found that they all use different banks. Apparently, there are alternatives to Evolve. 

Fintech                Partner

Brigit

Costal Community Bank

Empower 

nbkc

MoneyLion

Pathward

Cleo

Thread Bank

Interestingly, Costal Community Bank and Thread Bank also received consent orders. However, I have yet to find consent orders for nbkc or Pathward. 

MoneyLion, another public fintech company, is a direct competitor to Dave in the cash advance loan market. MoneyLion customers can request up to $500 for cash advance, or to $1000 if they open accounts with MoneyLion. Based on its 10-K,  MoneyLion, with its own lending licenses, originates loans itself and partners with Pathward, another publicly listed bank(12.7% Tier 1 cap ratio, well above 10% guideline to be considered well funded), for bank account opening. All the transactions are, again, handled by Galileo. So in the worst case that Evolve stops working with Dave, one way to move forward for Dave is to acquire lending licenses and switch partner banks. The short article also discussed the possibility of Dave’s going back to the old way of issuing loans on its own but concluded that it is too hard to find a partner to handle Dave’s volume. But it turns out that Evolve is not even involved in handling the financial transactions processing in the first place. 

So how sound is the business Galileo? Galileo, unlike Synapse that recently collapsed, is at much lower risk of going under. Per SoFI’s latest financials, accounts serviced by Galileo have increased 20% YoY to 150 million accounts while the contribution profits have more than doubled. Also strategically, SoFi itself relies on Galileo for account servicing so it is in SoFi’s best interest to manage Galileo well. Compared to Galileo, Synapse was at a much smaller scale with only 50m of venture capital funding. 

2). Evolve will dissolve all BaaS relationships

This is a remote possibility but far from 100% certainty. Going through the list of problematic banks provided by the short article, we have seen that none of the banks that received similarly comprehensive consent orders earlier than Evolve have fully exited the space yet. What the banks are doing instead, by searching through FitTwit on X, is sorting out the fintech partners they want to keep and offloading the ones they don’t want. The short article is right that the timeline on Dave’s product road map could be pushed back but all Dave’s competitors’ innovations will also be hindered due to the industry wide phenomenon. Furthermore, any prospective competitors won’t be able to enter the market during this period of cleanup. Meanwhile, Dave can keep growing its business with its existing product line. As discussed later in this article, Dave’s existing products are already very compelling to consumers compared to the traditional payday loan.

Additionally, from the regulatory standpoint,is shutting down the entire industry and rolling back years of innovation enjoyed by the end customers the most effective approach? Evolve and many other banks with consent orders are serving tens of millions of Americans and SMBs. 

This article tells of a similar development that occurred in the early days of prepaid cards.(https://thefinancialbrand.com/news/fintech-banking/banking-as-a-service-is-finding-its-regulatory-feet-178859/) Banks processing prepaid cards as a new financial innovation were given consent orders due to concerns about violations regarding BSA/AML, marketing disclosures and third-party risk management, almost the exact same violations committed by the BaaS banks. Many thought this was the end of the prepaid card era. However, instead of eliminating prepaid cards altogether, regulators paused their rapid, unregulated growth to gain a better understanding of how to effectively regulate them. Subsequently, regulations for prepaid cards were introduced, consent orders were lifted, and the troubled banks that received the orders became the largest prepaid card issuers in the country. 

3. Serving financially vulnerable people is a bad business

Dave in their 10-K cited a report from the Financial Health Network, a nonprofit organization focused on the underbanked, that approximately 180 million Americans are “financially vulnerable” or “financially coping” based on financial health scores. The FHN study implies that over 70% of Americans fall into these low or volatile income and credit-challenged categories, which is up from 66% in 2021. Legacy financial institutions charge nearly $40 billion in fees annually. The FHN estimates that financially “coping” and “vulnerable” populations pay over $160 billion a year in fees and interest for access to short-term credit.  Similarly, the December 2023 Paycheck to Paycheck Report published by PYMNTS found that, in November 2023, 62%, or approximately 160 million, of all U.S. consumers were living paycheck to paycheck. Nearly 40% unable to afford a one-time $400 emergency expense, according to the Federal Reserve's report on the Economic Well-Being of the U.S. Households

Dave’s core products have very good market fit for this segment. The short-term early wage access loan has 0% interest rate compared to 30-300% APR charged by legacy payday loans. It doesn’t charge late fees either.  The majority of Dave’s revenues come from a non mandatory express fee about 3-5% of the loan size. Instead of waiting for 3-5 days for the money to arrive, borrowers can access the money instantly if they pay the fee . It also offers a basic bank account without any overdraft, minimum deposit, or account closing fees and 4% APY on deposits. In order to use any features on Dave, there’s also a $1 monthly fee users have to pay. Overall, customers get a much better deal and experience using Dave’s service than the predatory payday loans. 

The company’s revenue has been growing nicely in the 20%+ range. On average, it makes $9/loan on a $159 loan, a nice 6% take rate for a short-term loan. Its 28-day past due loan loss is about 2%. So it makes good margins with a very short cash cycle. Dave underwrites these loans by solely utilizing AI to analyze loan applicants’ cash flow from their existing bank accounts. The accuracy of the AI underwriting model is improving nicely evidenced by the rapidly declining loan loss rate in the last 3 years while Enova(the traditional payday loan lender)’s 30 day delinquency rate did not meaningfully improve during the same period. 

Valuation: 

The stock, as the short article pointed out, has run up a lot from 5 to the current price. But it is still a cheap stock. At a market cap of 480m, it is trading at 1.5X 2024 revenue with a 20%+ revenue growth rate net cash. By the ‘24 EBITDA ex SBC metric, it appears expensive at around 40-50x by my estimate. But the company just turned cash flow positive this year and should generate more cash in the future. The incremental EBITDA margin based on management’s current estimate at the midpoint is 80% YOY. So if you believe eventually as the business matures, it can generate a 15% EBITDA margin excluding SBC, then this company is trading at 10x look-through EBITDA multiple, which I argue is still quite cheap given how good the product is for its vast potential user base and its growth ahead of itself. A period of increasing regulation and consolidation happens to any fast growing industry, but the leaders usually emerge stronger as proper regulation boosts consumer confidence in these products and ultimately drives adoption. 

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