Technology Executive Council
To join the CNBC Technology Executive Council go to cnbccouncils.com/tec
Technology Executive Council

The newest fintech unicorn is a credit card, and it's betting against big banks

Key Points
  • Two demographics inspired fintech start-up cred.ai to create its Unicorn Card: banking newcomers and millennial/Gen Z Americans with weak credit histories who are distrustful of the financial system.
  • The CFPB says as many as 23 millions Americans have a limited, if any, credit history.
  • Competition is growing and includes Apple's Apple Card, online bank Chime, a CNBC 2020 Disruptor 50 company, and J.P. Morgan Chase, which recently launched a digital credit card with Marqeta, also a 2020 CNBC Disruptor 50 company.
Founders of the fintech start-up cred.ai, which is launching its Unicorn card in both physical and digital versions, believe younger Americans with lack of credit history are ripe for solutions that don't come from big financial institutions.
Cred.ai

Philadelphia-based fintech start-up cred.ai has unveiled a new banking platform for millennials, complete with a solid metal credit card, and a mission to disrupt the banking system.

The platform, backed by high-profile investors including John Legend and former AOL CEO Tim Armstrong, launched its app and Unicorn Visa Card in beta on August 6 and plans to open applications to all consumers in early Fall. While beta participants include some of cred.ai's backers, founders are targeting two demographics that inspired the project: banking newcomers and younger Americans distrustful of the financial system.

For the newcomers — from recent college graduates to individuals previously unable to apply for credit cards — cred.ai is betting that its proprietary Credit Optimizer tool will be a selling point: it has been designed to help users build credit quickly.

Largely in the millennial and Gen Z age bracket, the credit-averse population needs new tools to get past their hesitation and reframe their mindset around credit, according to cred.ai co-founder Ryan Brown.

"While they've been terrified of or hateful towards the concept of credit cards, and rightly so ... the concept of credit is still very necessary. And it's key to success and opportunity," Brown told CNBC via Google Hangouts.

The competition, including Apple

Brown claims the AI-enabled credit optimizer tool is cred.ai's main differentiator when compared to other fintechs breaking into banking, but competition is fierce, well-funded, and growing among both start-ups and some of the largest companies in the world.

Fast-growing online bank Chime, which ranked No. 25 on the 2020 CNBC Disruptor 50, recently launched its Credit Builder Visa Credit Card. By sharing on-time payments with credit bureaus, Chime says it helped users improve credit scores by 30 points during the test period.

Apple released its Path to Apple Card program in June, offering rejected Apple Card applicants steps to improve their creditworthiness. The tech giant, which partnered with Goldman Sachs on the card, endured a PR headache over the card launch and some high-profile application rejections. Both Apple and Goldman have referred to the card as the most-successful new credit card ever.

Cred.ai's optimizer feature relies on an algorithm to impact the user's debt-to-credit ratio, which accounts for up to 30% of a FICO score. The algorithm is adaptive, offering some flexibility on a user's credit limit.

Building credit for millions of Americans

In venture capital firm Andreessen Horowitz's a16z's newsletter, one of the VC's fintech deal partners, Seema Amble, recently highlighted the growing popularity of credit-builder products like Chime and Apple's Path program.

Users can report rent payments to credit bureaus through fintechs like RentTrack and PayYourRent, but "most traditional lenders don't give consumers as much credit for paying rent and utilities as they do for making more discretionary payments to cards and loans. Therefore, rent and utility payments are often not factored into underwriting models," the Andreessen Horowitz partner wrote.

According to the Consumer Financial Protection Bureau, underwriting innovations could help expand credit inclusion to the estimated 23 million Americans with limited, if any, credit history.

Cred.ai has built its own underwriting infrastructure, which has been optimized to manage third-party cards — the fintech start-up plans to offer integrations next year.

Unlike traditional banking players, cred.ai is foregoing fees, interest, and rewards. For revenue, the platform relies on merchant transactions and deposits, as well as its plans to license its underwriting system and compliance infrastructure technology to small banks and other fintechs in the future.

Oppression pays for Chase Sapphire points, basically.
Dylan Brown
cred.ai co-founder

Cred.ai is pitching itself to consumers as an alternative to the credit card industry's traditional percentage-based points programs, a system that the founders argue contributes to millennial and Gen Z distrust of big banks.

"Those points are funded by the lower income people paying massive interest in fees in the subprime portfolio that lifts that entire program," said co-founder Ryan Brown. His brother and co-founder Dylan Brown added, "Oppression pays for Chase Sapphire points, basically."

Past surveys have found that distrust of financial institutions is high among younger Americans. A 2016 Facebook survey of 27,000 Facebook users found that only 8% of millennials trusted financial institutions. Half of Facebook's millennial users in 2016 were affluent, and 68% had at least a college degree. This demographic, the HENRYs, or "high earning, not rich yet" population, is part of cred.ai's target consumer group.

According to co-founder Ryan Brown, cred.ai users won't miss traditional banking rewards because they aren't building credit to accumulate points for vacation. Rather, they're working toward buying a home, or applying for loans. "Rewards are going to be tied to actions," Brown said, adding that users who spend certain places and attain specific goals receive an instant cash award.

But rewards have been a huge-selling point for recent successful cards, and CreditCards.com industry analyst Ted Rossman says rewards programs are key to keeping users coming back. He said the choice not to offer a traditional rewards program is risky to cred.ai's long term sustainability. "That's something that they're going to need to add over time to be competitive."

Rossman said fintech start-ups targeting banks and the credit business, including Tally, Revolut, N26 and cred.ai, face a big hurdle in customer retention.

"I view it as a stepping stone into the traditional banking system," Rossman said.

Millennial use of credit was rising before Covid-19

Use of credit by younger generations of Americans was rising pre-Covid, and so were the rates of these individuals getting into credit trouble. Credit-building is a draw for new customers, but Rossman said after new users build the credit they need with these start-ups there is a risk that spenders move to other financial institutions. "I fear for their sake that that could be kind of self-defeating, in a way. They're going to establish credit and then they're going to move on to something more lucrative," he said.

In the 2016 Facebook study, 45% of millennials said they'd switch credit cards, banks, or brokerage accounts if they found a better option, which was 1.4 times more likely than Gen Xers and baby boomers. Fintechs' ability to amass the early credit data on users could become a problem as traditional banks develop competitive features and the space becomes even more saturated.

The cred.ai platform includes offerings like self-destructing virtual "Stealth Cards" designed for risky transactions, and a "Friend and Foe" system allowing users to directly manage the trust and permissions of merchants in real-time. Users can access those features, as well as tools to budget and pre-approve future expenditures, on the cred.ai mobile app.

Although the solid metal Unicorn Card by Visa is part of the product's appeal to young spenders, users don't need to wait for the sleek package to arrive to start spending. "When you sign up ... you can start spending with it building credit, using the fraud features, within two minutes, because you can take that Stealth Card and put that in your Apple Wallet immediately," Ryan Brown said.

Last month, JPMorgan Chase partnered with fintech startup Marqeta, which ranked No. 33 on the 2020 CNBC Disruptor 50, to launch digital-only credit cards, available immediately for use via Apple Pay or Samsung Pay. Discover and Bank of America used to offer similar virtual card products, but have since discontinued them in favor of other fraud prevention features. Citi and Capital One still offer virtual card numbers.

Cred.ai founders believe that it's not the credit card, but the credit institution that's ripe for the most change. Several members of the cred.ai founding team are veterans of the industry, having helped build ING Direct, which was ultimately acquired by Capital One in 2012.

VIDEO1:1201:12
NY Fed: Household debt down $34 billion dollars in Q2, despite recession

Amid the pandemic, the Federal Reserve reported that household debt declined in the second quarter, the first time since 2014. American credit card balances fell by $76 billion, the biggest drop on a record going back to 1999. Coronavirus stimulus checks and other relief measures have likely helped many Americans pay down debt and manage finances.

Rossman said Covid-19 prompted a decline in discretionary spending, which often falls on credit cards. "Like a New Year's Resolution on steroids," he said.

The winners in this environment may turn out to be debit cards, or even fintechs like cred.ai offering a "supercharged debit card," the credit card industry analyst said, explaining that the Unicorn Card is basically like a debit card that builds credit. Cred.ai does market its card along similar lines, pointing to the platform's real-time automation, and the absence of fees, payments, and interest.

In addition to Legend and Armstrong — who has set up his own investment company to focus on direct-to-consumer start-ups — in the last three years cred.ai has secured seed and Series A funding from NBA star Andre Iguodala and Fanatics executive chairman Michael Rubin. It has raised a total of $17 million and plans to award some Unicord Card beta applicants $10,000 to achieve their financial goals.

Its mobile app is just part of the co-founders' plans for the platform. Lead investor, co-founder, and CEO of Campus Apartments David Adelman, told CNBC, "If people start to trust the cred brand, why can't we go into other verticals?" Adelman envisions opportunities for rent and mortgage applications on the platform as it grows.

Currently, cred.ai partners with WSFS, a longtime Visa partner, and the team is in talks to partner with other banks on licensing the platform's technology and infrastructure.