Update: Flying Fintechs & Zombie Banks

November 29, 2023 | Premium Service | Since the end of the third quarter of 2023, all manner of equity securities have soared on the promise of lower interest rates. Meanwhile, the latest US Treasury auctions are a decidedly mixed bag, with shorter duration securities flying off the virtual shelves but longer dated maturities drifting higher in yield. Everything from 7s on out the yield curve is slipping as short-dates rally. Like we said last week, a normal yield curve beckons. Below we catch up on some of the latest action in banks and fintech firms.

By far the best performer among our three areas of focus is Coinbase Global, Inc. (COIN), one of the survivors in a sector that has seen excessive hype overtaken by enforcement actions and prosecution for firms like FTX. COIN provides "financial infrastructure and technology for the cryptoeconomy in the United States and internationally."

The company’s equity market capitalization has doubled to $28 billion over the past year. COIN has a beta of 2.66 and trades under 5x book or 10x sales, hardly an astronomical valuation. Yet fact is that COIN is up over 260% LTM, according to the Bloomberg. Coinbase CEO Brian Armstrong says the industry can finally close the chapter of bad actors after the recent settlement between Binance and the U.S. Department of Justice.

COIN has been helped by a groundswell of positive comment about crypto in 2023, due to some losses in court for the SEC and a general desire to try one more time. We point out to clients, however, the federal bank regulators, FINRA, the SEC, IRS and most state agencies are treating crypto as a problem.

We just got done with CE for our FINRA principal tickets and annual disclosure. “Informal assets” are basically becoming a legal and compliance ghetto for anyone working in regulated finance. Also, just to add to the fun, crypto kicks in a presumption of enhanced compliance monitoring for anti-money laundering (AML) and know-your-customer issues up the wazoo. Our fintech surveillance group is shown below.

Source: Bloomberg (11/28/23)

Next we move to Affirm Holdings (AFRM), which is up over 200% in the past year.  This is a volatile stock with a market cap below $10 billion or 1/4 of COIN, where insiders and special channel partners like Amazon (AMZN) carry off huge chunks of equity. There is just enough filling and crust left for the daring investor to take a wild flier on this 3 beta stock (which means AFRM is 3x more volatile than the S&P 500).  The chart below shows AFRM over the past year. 

Source: Google Finance

Like many of the names in our fintech group, however, AFRM is slowing down a great deal, especially when you look at the equity over the past five years. This is a natural maturation process whereby the Buy Side managers fall into and then, sadly, out of love with certain names. Block (SQ), PayPal (PYPL) and other higher flyers litter the animal graveyard of tech stocks. Look at the chart for AFRM going back five years.

Source: Google Finance

Whenever you do analysis of a new stock, the first thing to do is go back as far as the data goes. Are we still climbing the value mountain, or are we done? When you look at that long-term chart for AFRM, it shows the coming of age of yet another fintech, point-of-sale play in the world of consumer finance. Will firms like AFRM survive the eventual correction in consumer credit?

We love the whole buy now, pay maybe phenomenon, mostly as a sign of the times, but in a real recession all of these subprime consumer plays will be vaporized by credit and operations risk. We note that number of retailers facing lower income consumers such as Dollar General (DG) are reporting a pullback in discretionary spending.

Also significant is the still torrid pace of cash-out refinance transactions by low-FICO, high LTV FHA borrowers reported by several Ginnie Mae issuers. Are consumers who are willing to refinance out of a 3% loan coupon into a 7% loan in order to take out cash in trouble? Yeah, probably. You could also call these consumers smart for taking cash out before the residential housing market corrects in a couple of years.

Enjoy the fun while it lasts. If the gloom & doomers are right about an impending consumer seize up in credit, then we’d expect most of our fintech universe to lose significant value in 2024. But not quite yet, as we keep reminding clients. Yes, the bottom 20% of FICO scores in cards, autos and mortgages are seeing higher net default rates, but the rest of the credit stack not so much. Is this a tale of two credit markets?

We’d be remiss not to mention that Kingdom Holdings, the investment company of Prince Alwaleed Bin Talal, has raised its stake in Citigroup (C) to 2.2% after buying a $450 million stake from the Saudi billionaire. This gives the Saudi government one of the largest stakes in the bank and also a control position since most of the other large equity holders are passive custodians. 

Citigroup is still trading at less than half of book value, but the stock is now in the middle of our bank group after rising in the high teens percent over the past month.  We attribute the rise in Citi’s equity market value to news of cost cutting and layoffs at the bank, which is only just starting to address the poor operating leverage. Citi’s researchers are predicting strong growth in earnings for S&P 500 companies, but we cannot say that yet for the bank.

Source: Google Finance

And in recent news, Citigroup is reported to be among several global banks that provided credit to a now-insolvent unit of Rene Benko’s Signa group of companies, Bloomberg reports, “making the Wall Street firm the latest in a long list of banks with exposure to the Austrian real estate tycoon.”  Amazing. The term "adequate systems and controls" comes to mind.

Finally, we also note that Apple (AAPL) has ended its credit card relationship with Goldman Sachs (GS), putting another exclamation point underneath the Wall Street bank’s retreat from traditional commercial banking. Apple gave Goldman Sachs “a proposal to end its credit-card and savings account partnership within the next 12 to 15 months,” CNBC reported yesterday.  

AAPL also announced an end to its quest to manufacture smart phone modems, another sign of good decision making at the electronics giant.  Suffice to say that GS has had about as much reason to get into white label credit cards as AAPL did getting into the manufacture of low-margin generic parts like modems. Only monumental hubris made Goldman Sachs think that they could compete profitably with the large bank issuers of credit cards in terms of funding costs or operational proficiency.

What now David Solomon? 

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