Banks vs Fintech: A Coronastory

Plus: Managing the Downside, Consumer Lending Trends, Call Me By Your Name

This is the first edition of Net Interest, my newsletter focused on financial sector themes. Each week I will dwell on one theme and highlight a few others of interest. It’s still a work in progress so all feedback welcome. If you like it, please share.

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Banks vs Fintech: A Coronastory

Fintechs should be crushing it right now.

In industry after industry, digital is gobbling up market share. In wine for example, US online sales gained over 20 points of share within two weeks of lockdown. What it took grocery in the UK 20 years to achieve, US wine did in 21 days. And fintechs offer many of the same benefits – speed, innovation and digital distribution.

Yet it’s not happening.

Downloads of challenger bank apps have declined from their pre-Covid levels. Granted, opening a new bank account is less enticing than drinking wine, but existing customers don’t seem to be engaging either. The number of monthly average users of challenger banks has dropped by around 16% compared with pre-Covid levels, according to data from Apptopia.

In some cases, consumers have been left with little choice – many online banks were forced to shut their virtual doors. As the virus took hold Kabbage suspended credit lines to SMEs, and Lending Club and Zopa stopped making new loans to their more risky borrowers. Zopa said that its origination activity would be down 75-80% in April compared with the start of the year.

The credit underwriting algorithms that these companies built to price loans efficiently simply stopped working in the face of an unprecedented pandemic.

Some of this is beginning to be reflected in valuations. Monzo raised new capital in May at a 40% discount to its previous valuation. That’s the same slide in value as publicly traded banks saw, even though Monzo doubled its customer base to 4 million over the period.

Meanwhile, when it comes to digital distribution, incumbent banks are catching up. BBVA announced that between January and March nearly two-thirds of its sales were completed digitally, up from prior periods. Citigroup tripled the number of accounts it opened digitally in March compared with same month last year. Svenska Handelsbanken said the number of online meetings it conducted was up fivefold between February and March. Overall, monthly average user numbers of banks apps are down post Covid, but less than challenger bank apps.

Sitting at the intersection of this divergence between fintechs and incumbent banks are policymakers. For years they promoted fintech in an effort to bolster competition in banking. They set up regulatory ‘sandboxes’, offered tax breaks and in some regimes introduced initiatives to drain industry moats (e.g. Open Banking in the UK). Yet in a time of crisis, it was incumbent banks to whom they turned as their primary conduit for aid.

When government guaranteed loans were launched in the UK in March, 40 banks were eligible to offer them straight away. It took weeks before the first fintech was formally approved and even now some are still waiting. Same in the US. Although Secretary Mnuchin announced on 29 March that “Any FDIC bank, any credit union, any fintech lender will be authorised to make these loans” such authorisation was not forthcoming for fintechs. It took two weeks for the first cohort to get on the list. And the first round of government funds was exhausted before they could even approve any loans.

Policymakers have given banks leeway in other areas, too. They’ve relaxed money laundering and know your customer guidelines given how hard it is for customers to get into branches. And they’ve provided access to cheap funding through central bank liquidity initiatives like the ECB’s TLTRO3, which offers funding at up to -1% for Eurozone banks. Fintechs in the UK have complained that lack of access to such funding threatens to render unprofitable any ‘bounce back’ loans they originate at their regulated rate of 2.5%.

What fintechs are learning is that when it comes to regulators, watch what they do, not what they say.

So they have been gifted a competitive edge in the current environment. But it’s not like banks are capturing any value. European bank share prices are below their financial crisis lows in absolute terms – down 40% since March 2009; and US bank share prices are below theirs in relative terms after 32 percentage points of underperformance versus the broader market.

A lot of this is due to the uncertainty that permeates their earnings outlook. US banks have been reluctant to provide guidance for credit losses. Jamie Dimon came closest in his shareholder letter, suggesting an extreme case of 4.2% of losses over a two-year period. Company-run regulatory stress tests put losses at closer to 4.0%. But history throws up a wide range of outcomes. Prior recessions led to losses anywhere between 2.4% (2000/2001) and 9.2% (the Great Depression).

Right now, forbearance is taking over. The latest securitisation data shows that Barclays’ credit card delinquencies were up only marginally in April, to 2.1%. But a further 3% of the loan book is on payment holiday. If it all remains there, delinquencies will exceed 5% which is broadly where they peaked in 2009. Whether they will stay there or not, nobody knows. The Bank of England estimates that UK banks could see £80 billion of loan losses as a result of the Covid economic shock; that compares to £100 billion of losses a shock may have wreaked without any government response.

Perhaps more critically, some of the underperformance may also stem from a creeping realisation that banks have lost their independence. This was happening anyway, which is one of the reasons banks failed to recover their pre-financial crisis valuations. Regulators inserted themselves in banks’ capital stacks in some cases explicitly, in all cases implicitly. They controlled management appointments, management remuneration, dividend policy, buyback policy, and, in some markets, they steered lending policy. But just when banks thought they were getting out from under this, Covid emerged and the option on control they’d written became fully exercised.

There is an argument that unlike in the last crisis, banks are part of the solution this time rather than the problem. It’s a view that has been expressed by many, including the general manager of the Italian Banking Association, the CEO of Brazil’s Banco Itaú and the editorial board of the FT.

But the economics of being part of the solution look fuzzy. Zoom is part of the solution and it’s clear what that means for its profits. For banks, it may come with a cost – particularly if they are coerced into raising equity capital.

Andy Haldane, chief economist of the Bank of England, had already raised questions about whether banking was ‘socially-purposed’ and whether it should act as a utility service as part of a shift towards more ‘community capitalism’. The Covid crisis could accelerate that trend.

One feature of the trend is the transfer of lending from the private sector to the public sector. More and more lending is being undertaken by government. The Federal Reserve is currently putting the finishing touches to its US$600 billion Main Street Lending Programme to lend directly to middle-market companies. Of course, none of these programmes are meant to be permanent, but weaning the market off government-sponsored programmes has proven hard in the past. The mortgage market is a case in point. Last year private-label securities made up only US$46 billion of the US$2.38 trillion in mortgages issued in the US – less than 2%. That compares to the 40% share the private sector issued before the financial crisis in 2006.

Banks may not yet have been nationalised, but many of their markets have been.

If banks and fintech lending models have been poleaxed by the coronavirus what does that mean for the future of finance? Well, that's a big question that will be explored in future editions of Net Interest. But one trend is the infiltration of models not aligned either to banks or to traditional fintech. This week Shopify announced that it will be rolling out bank account services and point-of-sale credit tools for its merchant customers. That’s more financial services earnings for a company that already makes half its revenue in payments. This tweet says it all.

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Elsewhere

Managing the Downside

The full Haldane piece mentioned above is worth a read. In a 2018 speech he outlined a new theory of economic growth. He cited research by Steve Broadberry and John Wallis which showed that growth never really picked up after the Industrial Revolution the way we think it did. Since 1750 growth has averaged 3.2% a year in expansionary phases; that’s actually a bit less than growth during expansionary phases before the Industrial Revolution. What changed is the dramatic fall in both the propensity and cost of economic contractions.

“Put differently, the real revolution in living standards after 1750 came about not exclusively, or perhaps even mainly, from the surge in ideas and technologies. Rather, it resulted from societies having found some means of avoiding the subsequent recessionary bullets.”

It’s a powerful idea. As Sun Tzu said, ‘He wins his battles by making no mistakes.’ John Bogle, founder of Vanguard, applied the idea to markets. Rather than looking to maximise returns by beating the market, he sought to minimise losses to fees and poor manager selection. As most investors know, minimising drawdowns can be more sustainable than maximising gains.

As a framework for understanding economic growth, though, it demands another question: Why did economies become less recession-prone? Haldane argues it’s because institutions emerged post the Industrial Revolution which served to dampen the effects of recessions. He highlights several categories of institutions and in his latest speech he reprises them. They are: public limited companies, limited liability banking, measurement systems, public education, public infrastructure and civil society. The role of measurement systems is a particularly interesting one. The number of accountants plying their trade in the UK grew from 587 in the late 19th Century, to over 350,000 today.

The problem now is that there are signs of erosion in each of these pillars. He flags for example the ‘death of the public company’. And in banking he points out that beyond a certain point higher financial intermediation does not lead to higher per capita growth.

Consumer Lending Trends

One of the surprising features at the outset of the last recession was how resilient some pockets of consumer lending behaved relative to mortgage lending. The presumption going into the crisis was that mortgages would be the last loans to fall – that borrowers would default on auto loans and credit card loans and personal loans before ever defaulting on their mortgage and losing access to their home. Yet that’s not what happened. The interpretation at the time was: ‘you can live in your car, but you can’t drive your house’.

With unemployment ratcheting up to record levels, how is the waterfall of debt repayment shaping up this time around? The early evidence is that, thanks to policy responses, most consumers are staying current. April securitisation data shows that the delinquency rates on prime auto loans in the US are stable. In credit cards, the dollar amount of delinquent loans actually went down in April. It was only in subprime auto – the most credit sensitive segment of consumer lending – where a material pick-up in delinquencies could be discerned and the rate there had been increasing steadily for over five years.  

Even more recent data from online lenders shows an improvement in May, where delinquency rates are below historical levels. Of course, as with Barclays (see above) a lot of that is due to many loans being in forbearance. But whatever their cause, impairments stopped increasing near the end of April and have decreased so far in May. Whether this is sustained depends on the continuation of government benefits and critically in the US any drag on consumer finances from non-insured medical expenses.

Call Me By Your Name

All too regularly you come across academic papers which answer questions you never thought you had.

As a former sell-side analyst I used to publish earnings estimates on companies. Sometimes I was on target, other times I was off. One question I never thought to ask though was whether my accuracy was better on companies whose CEO shared the same first name as me or companies whose CEO didn’t.

In my case the sample size was pretty small. I don’t recall a single company under my coverage having a CEO whose first name was Marc-with-a-c. A few had CEOs with first name Mark-with-a-k. Mark Wilson, for example, of Aviva and Mark Tucker of Prudential and AIA. And as a buysider I covered Carlyle, whose founder is David Rubenstein – but it’s spelled different and surnames don’t count.

I may have been a better analyst had I covered the tech sector which has a longer list of companies founded by Marcs-with-a-c. Companies like Netscape, Salesforce and Netflix. The reason is that, according to new research out of Berkeley and UCLA, the earnings forecasts of analysts who share a first name with the CEO of a covered firm are more accurate than those of analysts who do not share a first name.

The authors conjecture that “the CEO is more likely to share private information with a matched analyst”. Which suggests that Axe Capital should hire a bunch of analysts called Peter, Bob and Jack because these are the most common names of CEOs.