Fintech Results Season Special

Alex Johnson, Jason Mikula and Simon Taylor take a look at Fintech results season.

Fintech is Macro

Hey Fintech Nerds 👋,

Alex, Jason, and Simon here. We’re collaborating on results season as an experiment because we thought it might be fun. Results season is upon us, and we see the outcomes for Fintech companies and bank stocks are not always positive. But what does this mean?

  1. Alex is going to break down Regional Banks …

  2. Jason looks at how SoFi’s acquisitions are paying off… 

  3. And Simon can’t help himself but talk about payments …

We hope you enjoy. Hit reply and send us your comments :)

For more you can find Alex Johnson’s Fintech Takes here and Jason’s Fintech Business Weekly here.

Let’s dive in 🏊‍♀️

  1. Regional banks aren’t having any fun - By 💰 Alex Johnson

    1. Big banks are doing great, but regional banks are getting crushed.

    2. Deposit costs are going up and lending volumes are going down.

    3. Cost cutting and M&A are the classic solutions, but they may not be enough this time.

  2. SoFi’s decision to buy a bank pays off - By 🏦 Jason Mikula 

    1. Still focusing on adjusted EBITDA? You’re a bank now!

    2. For first time, all business segments have positive contribution profit 

    3. Deposits, deposits, deposits

    4. Galileo/Technisys goodwill impairment charge

  3. Are payments dead? By 🧠 Simon Taylor

    1. The 2010s created a boom in new digital companies and payments companies to serve them

    2. The legacy players used M&A to keep up while debt was cheap

    3. Fintech feels shifts in consumer spends first

    4. M&A driven roll ups hit worst by this as their cost of credit starts to inch higher with rates

    5. Digital-first payments companies are in a different league

Regional Banks Aren’t Having Any Fun – by 💰 Alex

I have an unhealthy fascination with regional banks. 

They’re big enough to be able to dabble in all the same lines of business and technology innovations as the megabanks, but they’re not so big as to be insulated from the effects of the macro environment (JPMC isn’t interesting at all … its balance sheet is an impenetrable fortress).

Regional banks are the canary in the coal mine that is the U.S. economy.

And based on regional banks’ Q3 2023 earnings, it appears that the canary is a bit listless at the moment.

While profits surged at the megabanks (JPMorgan Chase, Wells Fargo, and Citi reported a combined $22 billion in profits in Q3, up by more than a third from Q3 of 2022), the large regional banks faired significantly worse. Q3 profits at KeyBank were down 44% from the previous year. Citizens Bank saw a 32% year-over-year decrease, while Truist saw a 28% decrease. PNC’s Q3 profitability came in just under what it was in Q3 of 2022, making it a relative winner for the quarter among its peers.

What’s driving this degradation in performance for the large regional banks? And what are they doing about it?

Let’s review 👇

1. Deposit Costs Are Up

This is true for all banks, obviously, but the megabanks have been more successful at keeping their deposit betas (the % of rate increases that they pass on to their customers) down. The big four have a lot of sleepy retail money, which has been a boon for them.

Not so for large regional banks, which saw their average deposit rates rise to 2% (or higher) in Q3, which is roughly 2% higher than they were a year ago. Indeed, PNC, Truist, and KeyBank all saw their interest expenses (i.e., what they pay depositors) jump roughly 300% between 2022 and 2023.

That has been a big drag on profitability and, in some cases, a threat to regional banks’ liquidity. 

2. Auto and Mortgage Lending Continue to Cool Off

At the same time that deposit costs are going up, the categories of consumer lending that regional banks rely on – large secured installment loans for cars and houses – continue to slow down.

At the beginning of the year, the Mortgage Bankers Association forecasted that lenders would originate $855 billion in mortgages in the first two quarters of 2023. It turns out that that very conservative estimate wasn’t conservative enough, as lenders originated less than $800 billion in mortgages during that timeframe. The MBA and other mortgage industry groups are now banking on a rebound in 2024, which they admit will only happen if the economy goes into a recession and the Fed is forced to cut interest rates. Not a great thing to root for, but here we are.

Auto lending is being similarly affected by rising rates. According to the New York Federal Reserve, 14% of applicants for auto loans were rejected over the past year, which was the highest such proportion since the New York Fed began tracking the figure in 2013. It has gotten so bad that multiple regional banks, including Citizens Bank, most recently, have gotten out of the auto lending business entirely.

3. Regional Banks Don’t Have Credit Cards to Fall Back On

The megabanks are seeing similar challenges in auto and mortgage lending (mortgage originations, for example, slid 9% from a year earlier at JPMorgan and 17% at Citi), but they are less reliant on those lines of business because they have massive consumer credit card franchises.

And whew boy! Those franchises have been driving a lot of value lately!

Credit-card spending was sharply up at JPMorgan Chase, Citi, and Wells Fargo in Q3. At JPMorgan and Citi, credit card balances jumped by more than spending, indicating that consumers are increasingly revolving rather than paying off their balances. That’s cause for mild concern as consumers burn through whatever savings/stimulus they have leftover from the pandemic (Citi said that its net charge-off rates in credit cards would hit prepandemic levels by the end of the year), but in the short term, it’s a significant revenue driver.

Credit cards are also a nice product to have when rates are rising because credit cards charge a variable interest rate tied to the prime rate, which means that interest income from credit cards can keep pace with (or exceed) rising deposit costs, unlike most installment loan products. 

Regional banks, which control less than 5% of the consumer credit card market in the U.S., don’t have these same luxuries.  

4. But They Do Have Commercial Real Estate Weighing Them Down

You know what they do have a lot of?

Commercial real estate loans!

You know what’s not a fun business to be in while interest rates are rising rapidly and companies are, for the first time in the history of capitalism, allowing a majority of their employees to work remotely?

Commercial real estate lending!

Not great!

At M&T Bank, for instance, net charge-offs rose by more than 50% to $96 million in the third quarter, driven by three large office buildings in Washington, D.C., Boston, and Connecticut and a healthcare provider with multiple properties in New York state and Pennsylvania. The bank said it could charge off more from that portfolio in the fourth quarter.

5. So Regional Banks Are Cutting Costs

So what are regional banks doing about these challenges?

Well, the big one is … drumroll … cutting costs.

PNC is cutting its workforce by 4%, which will help it reduce its 2024 expenses by approximately $325 million. KeyBank has shed roughly 900 employees in the last year and is aggressively cutting back spending on consultants and unused office space in an attempt to become “a smaller, simpler, more profitable company.” Truist sold its student lending portfolio off earlier this year and is considering existing or downsizing any lines of business that aren’t “strategic assets.”

I read through the earnings call transcripts for all the big regional banks in the U.S. There wasn’t one that didn’t talk about cost-cutting.

6. And Bank M&A is Picking Up

For regional banks that aren’t able to batten the hatches down tightly enough to weather this storm, an acquisition may be the only viable path forward.

2022 was one of the slowest years, in terms of bank M&A, that we’ve seen in quite a while. A lot of that had to do with the temporary accounting challenges posed by banks’ underwater bond portfolios.

However, there are recent signs that the M&A freeze is thawing. According to S&P Global Market Intelligence, there were 34 bank deals announced in the third quarter with a combined value of nearly $3 billion. The value of bank deals announced in the first and second quarters was about $630 million total.

My Take?

Regional banks can’t stay still.

I don’t even think cutting costs will be enough. The financial services industry has changed. The old playbook won’t suffice anymore.

If regional banks want to survive they’ll need to find lines of business and customer segments where they have a unique right to win and they will need to invest significantly in those opportunities.

As a wise bank investor once advised, “be greedy while others are fearful.” 

2. SoFi’s Decision To Buy A Bank Pays Off – By Jason 🏦

I have a primacy bias, where I still think of SoFi primarily as an unsecured consumer lender – student loan consolidation and personal loans. This bias of mine is also driven, in part, by focusing on SoFi as the closest competitor in personal lending during my time helping to build Marcus at Goldman, which offered a competitive personal loan product.

But, as its quarterly earnings demonstrate, SoFi has moved far beyond its student loan refi roots. And, unlike many fintechs that focus on consumer segments often ignored by big banks – lower income and lower credit score or thin/no file – SoFi has historically focused on the opposite end of the spectrum: prime/super-prime and upwardly mobile.

While these consumers are arguably over-banked, in their early adulthood, despite being upwardly mobile, the level of service and CX and major establishment FIs may not meet their needs (or desires.)

SoFi’s strategy has been to capture “HENRYs,” high earners, not rich yet, and retain them as they advance in their careers and their income and assets grow – and cross-sell them into other products, of course.

Since its student loan refi days, SoFi has grown its offerings considerably, both through building, acquisitions, and partnerships. It now offers in-study private student loans, mortgages, credit cards, a checking/spending account, investments, insurance, and a PFM tool, along with issuer-processor Galileo and core banking platform Technisys. The company also became a nationally chartered bank through its acquisition of Golden Pacific Bancorp, completed in early 2022.

Looking through SoFi’s recently announced Q3 earnings, four things stood out to me:

  • A bank focusing on adjusted EBITDA? Sigh.

  • Diversification by acquiring Galileo, Technisys

  • It’s all about the deposits (and SoFi has them)

  • Goodwill impairment charge

1. Still Focusing On Adjusted EBITDA? 😂

This may be more of a pet peeve than anything else, so let’s get it out of the way upfront. Banks, a group SoFi joined when it acquired Golden Pacific, tend to report out, be measured on, and be valued by different sets of KPIs and financial metrics than non-banks.

The desire to emphasize metrics like adjusted EBITDA is understandable, as it paints performance in a better light, but it also can exclude material cash expenses, including corporate borrowing interest expense in SoFi’s case (though a non-cash goodwill impairment is the largest driver of the difference in adj EBITDA vs. GAAP earnings):

While SoFi has business units that look less bank-like, it would be nice to see the company report out ROE, ROTE, and book value per share data, as they are standard metrics for evaluating banks’ financial performance.

2. For First Time, Each Reporting Segment Has Positive Contribution Profit

Unlike mono-line fintechs that rely on a single revenue driver, SoFi has developed a number of diversified lines of business: lending (primarily personal loans), its “technology platform” (primarily Galileo), and its financial services segment (checking/savings, credit card, investments.)

And, for the first time, all three segments reported positive contribution profit in Q3:

3. Deposits, Deposits, Deposits

For a company whose brand positioning was originally “anti-bank,” SoFi was well-positioned to benefit by becoming one. With lending still being its primary business, holding a charter has allowed SoFi to capitalize on deposits as a cheaper and more reliable source of funding vs. relying on capital markets.

And, while many banks have seen deposits run off, owing both to the spring banking crisis and high rates on offer for short-term Treasuries and money market funds, SoFi has actually been able to grow deposits. The bank added $2.9 billion (+23%) in deposits in Q3, reaching a total of $15.7 billion at the end of Q3.

And those deposits are from sticky users – over 90% of those deposits are from SoFi members who’ve set up direct deposit. They’re also creditworthy; for new deposit accounts opened in Q3, the median FICO score was 743.

Given the challenge most “neobanks” have had in attracting customers who hold meaningful balances and have good credit scores, SoFi’s performance here is notable. Some 98% of SoFi’s deposits are insured, thanks to its use of reciprocal deposits to offer up to $2 million in FDIC coverage. And despite offering a competitive 4.60% APY on savings (though a lower 0.50% on checking), SoFi achieved an enviable 5.99% net interest margin for the quarter.

4. Goodwill Impairment: Write Down Related to Galileo, Technisys Valuations

I take it back, I have another pet peeve. Why do companies make it so difficult to ascertain the underlying reason for recording goodwill impairments – especially in cases where it is the single biggest line item (even if it is non-cash.)

In SoFi’s case, it recorded a $247 million impairment charge in Q3, the largest single driver of the difference between adjusted EBITDA of $98 million and its GAAP net loss of $266 million.

For those who are less deep in the weeds of accounting statements, companies carry “goodwill” value on the balance sheet when they pay more than book value for the acquisition of an asset. Each year, they must assess if the fair value is in line with the carrying amount.

In SoFi’s case, in its Technology Platform segment, it was carrying $1.59 billion of goodwill related to its acquisition of Galileo, for $1.2 billion, and Technisys, for about $1.1 billion. Given that SoFi acquired Galileo in 2020 and Technisys in early 2022, it’s not entirely surprising their fair value declined vs. what SoFi was carrying them at. 

My Take

While SoFi is still overwhelmingly a student and personal lending business, its expansion into other banking products and “platform” acquisitions are beginning to bear fruit. The decision to become a bank through its acquisition of Golden Pacific – announced at a time when interest rates were basically 0% – is also paying off, as SoFi is less dependent on volatile capital markets or securitization to power its lending business. At a time when other banks have seen deposits shrink, SoFi has continued growing deposits, while maintaining a respectable NIM of 5.99%.

In a market where most fintechs compete in segments where banks and traditional FIs have poorly served consumers, SoFi is competing in a far more challenging space: upper-income, prime/super-prime. And while SoFi’s business may not exactly be “expanding access and inclusion” or seeking to “democratize” financial services, it does seem to have a viable path to profitability – something that, in 2023, finally seems to matter again.

3. Are payments dead? by 🧠 Simon

It looks bad.

Adyen stock dropped by 50% last results season, now, Worldline is down 70%. Even the mighty Visa hasn’t had a great year.

The S&P 500 has lost 3.6% over 12 months, in that time

  • Visa is down 1.1% 

  • PayPal is down 21.1% 

  • Adyen is down 59.7%

  • Worldline is down 68%

If Fintech was the darling of the 2010s, Payments companies were the darling of Fintech. 

But looking at these share prices, is it the dog of the 2020s? Overvalued, overhyped, and too correlated to weakened consumer spending.

I think this is a case of the market being unable to tell Apples from Oranges. 

  1. Low interest rates in the 2010s created M&A-driven “roll-ups” whose debts are returning to bite them in multiple ways.

  2. The 2010s also created 1000s of growth companies that all needed online payments infrastructure. 

  3. Fintech is Macro and when the consumer is down, Payments volumes follow

  4. Oranges: M&A-driven roll-ups are being exposed (WorldPay, WorldLine).

  5. Apples: Digital-first payments companies like Adyen, Block, and PayPal have one tech stack and regulatory infrastructure.

1. The 2010s and low interest rates created an explosion of new companies and payments companies to serve them

Stripe and Square exemplified a new era of e-commerce-driven growth and small merchants. With simple pricing structures, they appeal to entrepreneurs and company builders. 

And there were a lot of new company builders.

VC funding ballooned. Software as a service became a category, and online e-commerce rocketed from 5% of all commerce to 18% over the decade. 

It was never easier to create a company, and every new company wanted to get paid.

In 2015 at its IPO, Square became one of the first wave of payment companies to hit public markets, that year, PayPal also separated from eBay and got its own stock price. Then in 2018, Adyen joined them as part of the new wave of payments companies taking on older companies.

These challengers had a fantastic run, growing the market share of payments to 5% and delivering double-digit revenue and earnings growth consistently.

2. M&A made sense in the 2010s.

Older payments companies had to react and deliver growth. If the core payment volume of their clients isn’t growing, the fastest way to grow is to acquire new companies. Payments companies had historically been mid-sized and served regions or market segments. M&A created an opportunity to build global brands.

Debt was cheap.  Like buying a mortgage when rates are low, these new companies were “affordable” and would add revenue. 

As an example Worldline made 16 acquisitions or mergers from 2015 to 2023, building up €10 billion of debt on its balance sheet. On the surface, it worked; Worldline revenue grew from €1.1bn in 2014, to €4.4bn in 2022 with only 2.5x the headcount. 

3. Fintech is Macro; if the consumer is down Payments companies feel it first

Adyen dropped 50% after its Q3 earnings missed investor expectations, and Worldline dropped 80% after a significant miss in Q4. 

What has spooked the market about Worldline and Adyen is that these “Fintech companies” (AKA, acquirer processors) are leading indications for a consumer who is spending less. If the consumer is spending less, that’s less volume for the payments companies, and therefore, anyone in payments would be exposed.

The reality is that is not what is happening.

Consumer spending is changing from discretionary to staples. But companies like Visa and Mastercard, who win no matter what the consumer buys, are reporting record quarters. 

The tale of Adyen and Worldline is a much more complex and nuanced story about two ways to build a payments business.

4. M&A driven Roll-ups are being exposed

M&A creates Frankenstein companies that appear coherent on a spreadsheet but are clumsy in execution. They have two primary issues.

  1. The tech and regulatory infrastructure creates duplication. If you acquire 16 companies you now have 16 technology stacks and compliance processes. If one of those goes wrong, it can impact the whole business.

  2. A regulatory issue with one legacy brand can damage the whole group. The case study of Wordline is an example. They had to unwind several clients in Germany due to KYC/AML findings from the regulator.

When you add to this a staff who’s seen rounds of layoffs after their company was acquired, you’re looking at a company that often lacks the motivation to win new market share. 

M&A keeps working so long as debt is cheap.

But debt is getting expensive and those bills will need to be paid.

Unlike mortgages, corporate bonds term out after 5 to 10 years. Some of the early acquisitions will need re-financing and could be at a significantly higher 

5. Digital-first payments companies are in a different league

Adyen is a single tech platform gets banking licenses in each jurisdiction and then creates efficiency by adding scale to that platform over time. The aim is to give a durable cost advantage and, therefore, have the best unit economics in the business.

This strategy has worked in Europe, so why did the share price drop?

As it enters the US, Adyen has fierce pricing competition (notably from PayPal) while it has a surge of cost building a new set of platform and regulatory processes and winning licensing. This upfront cost is an alternative to doing M&A but comes at a time when the market had seen Adyen as the darling that could do no wrong.

An earnings miss was a narrative violation.

This pattern doesn’t apply equally to PayPal or the when-will-they-IPO Stripe. But the broad approach of being tech-first is qualitatively different from M&A roll-ups, and I believe that will show up as enterprise value over time.

My take?

When it is contrarian to believe in Fintech.

Maybe Fintech is finally cheap.

PS. Stripe will IPO when the world realizes Fintech isn’t dead. It’s just sleepin’.


Ps. If you enjoyed this, hit reply and say why.

(Not investment advice. None of us are registered broker-dealers or registered advisors. Please do your own research before investing, and never spend what you can’t afford to lose! We are enthusiasts. These are personal opinions, and I’m sure the same goes for Alex and Jason!).