EVs Wane, Fintech Sputters & COF Dumps Commercial Mortgages

January 29, 2024 | Premium Service | In this issue of The Institutional Risk Analyst, we revisit some of our earlier comments to benchmark our prognostications with the actuals. Banks, China, fintech and crypto – you know the list. All share a common thread in that the collective investment mania of the 2020-2022 period has now ebbed.

Let’s start with China, a country we have studied for decades and is now sinking into an economic crisis engineered by the Chinese Community Party and paramount leader Xi Jinping. In China, only politics matters. When the father-leader totally screws up the economy, nobody says a word. Sad to say, command economics as practiced by the CCP under Xi or the Biden Administration in the US does not seem to deliver positive results.

A Hong Kong Court has ordered the wind-up of what remains of isolvent China Evergrande, one of the largest real estate developers with over $330 billion in debt. The Chinese government has announced a rescue of the financial markets, but it is unlikely to be sufficient. We wrote last August (“China's Debt Crisis Accelerates”):

The collapse of China's property sector coincides with mounting debt and falling population, both part of a narrative of accelerating deflation. It is notable that China has just prohibited securities lending for short-selling of domestic securities. Meanwhile, some bold foreign investors are deploying long positions in China to take advantage of an eventual rebound. Charlie McElligott at Nomura writes:

The property sector is not the only source of deflation in China. The implosion of the market for electric vehicles is going to add big losses to the ledger for Chinese companies. China’s cities are littered with thousands of unwanted EVs, as Bloomberg reported last year.  But the biggest story is the turn away from EVs in many western economies.

In 2021, President Joe Biden heralded the arrival of the EVs as the start of a new era. Now Ford Motor (F) is cutting production of its loss-leading F-150 Lightning pickup. Ford lost $36,000 for every F-150 EV sold in Q4. Was Toyota Motor Corp (TM) leadership right about EVs? Yes they are. The green progressives in the Biden Administration are wrong. Shame on Ford for allowing themselves to be bullied into wasting billions in shareholder funds on EV mania. 

The political push for electric vehicles (EVs) is collapsing as subsidies for these lithium battery-powered toys ebbs. Most of the G-20 nations are up to their ears in public debt. There's no spare cash around to subsidize the infrastructure needed to support widespread adoption of EVs. Yet none of the nations that pushed for private production of EVs ever asked if doing so was possible.

In our 2010 book “Ford Men: From Inspiration to Enterprise,” we noted that Henry Ford, Thomas Edison and many other 19th Century inventors wanted to build electric electric cars. Such were the obstacles to using batteries, however, that Edison ultimately advised Ford to use gasoline as an energy source. The rest of the industry followed.

Not much has changed in the intervening 120 years since that conversation except greater efficiency of devices. Of note, the giants of electrification a century ago were working in Detroit years before Henry Ford built his first car. Edison created the Edison Electric Company in 1889.  And all shared a vision of a fully electric world. Yet the technology remains lacking.

TM Chairman Akio Toyoda, speaking at the Tokyo Auto Salon, noted that people are “finally seeing reality” on EVs. No surprise to readers of The Institutional Risk Analyst, the auto executive repeated his bearish forecast for EVs, predicting that just three in 10 cars on the road will be powered by a battery. And Dr. Toyoda is probably being kind. 

We own TM and have followed Japan’s premier automaker for decades. TM moves very slowly and with deliberation and purpose, two qualities that are alien to many American business leaders. Dr. Toyoda knows that EVs never made sense commercially.

EVs are not particularly practical (a/k/a safe & reliable) for consumers, they are very expensive to manufacture to minimum safety standards (forget China EVs), and EVs are not particularly green. Notice in the chart below that the explosion of Tesla Motors (TSLA) coincides with the manic market volatility in 2020. Yet the company went public in 2010.

Source: Google Finance (1/26/24)

Watch the migration of TSLA from techology novelty to automotive manufacturer as the stock sinks below 50% of its all-time high. Part of the challenge facing TSLA and Elon Musk is that all of the makers of EVs are becoming familiar. TSLA was once highly differentiated and desirable, to borrow the branding measure of Young & Rubicam, but today it is increasingly valued by investors for being a car maker.

Leaving aside the vicious economics of the global auto business, the legacy environmental cost of mitigating the pollution from electric vehicles and lithium batteries makes EV manufacture even less attractive. In fairness, we must add this cost to the larger electronics waste heap of solar panels, PCs, displays and smartphones, and other complex silicon devices.

As described in the 2017 Denis Villeneuve film Blade Runner 2049, the remediation of human waste is the growth industry of the future. Recycling one solar panel costs $15 to $45—significantly more than the $1 to $5 per-panel cost of just sending it to a landfill, according to a US Department of Energy. Many states are considering stiff taxes on electronic manufacturers to compensate for the cost of remediating the waste from their products.

Now let’s take a look at how some members of the banking and fintech sector are doing in the first month of 2024. Just as nouvelle firms like TSLA are migrating from technology plays to mere automotive manufacturers, the tech stocks of yesterday are now becoming, well, commonplace.

Affirm Holdings, Inc. (AFRM) lost more than 20% of its value since the start of the year, a reaction to the shift in narrative from recession to economic expansion.  We’ve written critically about AFRM and some of its peers because we see little value in the stock for shareholders. Insiders and corporate partners have taken huge amounts of value out of AFRM.

At the close last week of $180 per share, AFRM is less than half of the $440 all time high reached in 2021. AFRM reported a $1.2 billion operating loss in its fiscal year ended June 30, 2023. That operating loss includes $130 million in D&A, $452 million in stock-based compensation for employees and $499 million in enterprise warrants and other share-based expenses for partners such as Amazon (AMZN). 

The close companion of AFRM, Upstart Network (UPST), is likewise down sharply since the New Year. Like AFRM, UPST is still up double digits over the past 12 months, but institutional investors and analysts are fleeing both names since the Fed pivoted to a rate-cutting narrative.

Like most fintech stocks, neither AFRM nor UPST will report Q4 2023 earnings until the last two weeks of the reporting period. Keep in mind that the market momentum of equity managers, not financial results, governs the movement of these two stocks. Our fintech group is shown below. Notice that Latin payments platform NU Holdings (NU) is now #2 in terms of total return after AFRM.

Fintech Surveillance Group

Source: Bloomberg (1/26/24)

In the world of commercial banks, the heady optimism of December 2023 has been replaced by a more somber mood. Consumer-facing names such as CapitalOne Financial (COF) and Ally Financial (ALLY) have been giving ground slowly.

COF actually delivered an up quarter in terms of net interest income in Q4 2023, a considerable achievement given the down trend in most earnings releases. Higher credit provisions and other expenses cut operating income by 60%. Higher losses on auto and credit card loans drove the reserve build and current losses.

COF’s non-interest expense was increased by the FDIC special assessment of almost $300 million in Q4 2023. Of note, COF reclassified $888 million in commercial office real estate loans from loans held for investment to loans held for sale as of June 30, 2023. 

Like many other lenders, COF is cleaning house and will likely be taking a loss on some of the asset dispositions later in 2024. COF is joining a crowd of banks looking to dispose of commercial property loans in NYC. The key point to emphasize is that the unfolding of the commercial property crisis will take years to work through the earnings of banks.

Bank Surveillance Group

Source: Bloomberg (1/26/24)

The good news on COF is that credit expenses are rising slowly and the $440 billion asset bank reported a 61% efficiency ratio in Q4 2023, ten points better than some of its larger peers. Headcount was down, but operating expenses rose single digits. The gross yield on COF's loan book was nearly 10% in Q3 2023 for a net interest margin of 6.75%.

Bad news is that COF has $90 billion in commercial loans and mortgages on its book. If there is a future problem at COF, the commercial loan book is likely going to be the source. Commercial and multifamily charge-offs were up sharply in 2023. COF's loss rate on commercial real estate loans jumped into the 99th percentile of Peer Group 1 in Q3 2023 at 195bp.

COF has historically managed its consumer loan book with great skill, but the bank has had problems when it wanders away from this area of core competency in terms of credit underwriting and risk management. We don't think that the $880 million in commercial loans targeted for disposal by COF will be the last. We are also concerned about the high loss rates reported by COF on commercial exposures at the end of 2023.

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