Blue Ridge's Brokered Deposits Soar 1,000% As It Offboards Fintechs
Varo Spent $20m On Ads But Lost 1m Accounts In 2023, City National Hit With $65m Penalty for Unsafe & Unsound Practices
Hey all, Jason here.
It’s a special day in our household — our dog, Lito, is turning four years old today! Yes, there will be a (dog-safe) birthday cake 🎂 to celebrate.
Otherwise, it’s been a dreary and busy time in the Netherlands. I’ve mostly been heads-down working on a number of projects, particularly as the spring is shaping up to be a busy conference-and-travel season. Looking forward to catching up with folks at Fintech Meetup, Finnovista Connect, and NY Fintech Week in the coming months!
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Varo Spent $20m On Ads But Lost 1m Accounts In 2023
One of the drawbacks (or benefits, depending on where you sit) of being a bank is that you must file quarterly reports of condition and income — giving anyone who wants to take the time a decent level of insight into how a bank’s business is performing.
While it depends on how you define “neobank,” Varo arguably remains the only US neobank with a charter. Yes, SoFi and LendingClub became banks, but they both remain predominantly lending businesses that acquired banks, at least in part, as a capital diversification strategy.
Varo provides insight on the question, can you make a bank that caters primarily to lower-income and lower-credit quality customers work?
The answer still appears to be “no.”
That isn’t to say Varo hasn’t made any progress.
The company has progressively grown its loan book — though classifying its Varo Believe product as a “loan” is a bit misleading, as the product is secured and does not charge interest or fees.
It is fair to assume the balances on Varo Believe represent funds that otherwise would have been spent on Varo’s regular debit product — meaning the incremental revenue is the difference between the interchange on a charge card transaction vs. a Durbin-exempt debit transaction.
On the flip side, operating the charge card product comes with incremental cost, namely fraud/credit losses, and complexity, specifically in complying with relevant regulations like the CARD Act and FCRA. Developing and implementing policies and procedures for furnishing credit data is not a zero cost endeavor.
Varo has continued to grow its Advance small-dollar loan product, including by increasing the maximum loan amount to $500, though it’s unclear how many Varo customers actually qualify for larger amounts.
Varo Advance is structured as a line of credit that the company markets as “0% APR,” though it carries a fixed-fee up to $40 for advances of $500 — equivalent to an APR of 208% if repaid in two weeks.
While Varo has scaled the balances of both Advance and Believe, it has made no meaningful progress on improving loss rates for either product.
Because the revenue of both Advance and Believe is treated as fee income rather than interest income, it appears in Varo’s filings as non-interest income.
Varo’s year end call report provides additional granularity on the company’s sources of revenue, including that nearly 60% of its revenue for the year was derived from interchange.
Varo remains predominantly an interchange-driven business. The bank’s interest income declined by about 12% quarter over quarter, as its deposit and asset base continues to shrink.
Varo’s per account metrics remain stagnant, with the average balance per account down slightly and average revenue per account up slightly.
Perhaps most alarming is that Varo’s number of accounts continues to decline.
In 2023, Varo spent $20.8 million on advertising and marketing, yet saw its number of deposit accounts drop by over 1 million.
The company has said previously it is closing inactive accounts. But if that were all that was happening here, and the marketing spend was attracting new, active users, you would expect the average deposit and average revenue per account to improve — which is not the case.
Rather, it appears Varo is spending millions on marketing and is not even able to replace the number of users it’s losing.
Without continuing VC subsidies, Varo seems likely to continue shrinking — which is a problem, because, despite shrinking its expenses, mostly by cutting staff and marketing, the company’s progress on shrinking its losses has mostly stalled out.
To be sure, Varo remains well capitalized. With $109.5 million in tier 1 capital held against average total consolidated assets of $474 million, it has a leverage ratio of over 23%.
But with no plausible pathway to profitability (despite management’s protestations to the contrary), Varo is the very definition of a “zombie fintech” and should serve as a cautionary tale.
Yes, users like “free” accounts, but with the negative selection bias of the segments of users attracted to such products and the limited avenues to monetize them, it is increasingly clear that the business model is not sustainable.
Varo might be good for users now, but what happens when those that have come to depend on it as their no-fee bank account find they can no longer do so?
Blue Ridge's Brokered Deposits Soar 1,000% As It Offboards Fintechs
Blue Ridge Bank, which publicly disclosed its second BaaS-related enforcement action about a week ago, has another problem to tackle: as it offboards fintech programs, it needs to backfill the lost deposits.
And it has to lean on expensive brokered deposits to fill the gap.
At the end of 2022, Blue Ridge held about $690 million in deposits related to fintech programs. Fintech deposits actually increased during 2023, reaching $720.8 million at the end of Q3, before declining to $465.9 million at the end of 2023.
Per Blue Ridge’s earnings release, fintech-related deposits at the end of 2023 comprised 18.2% of total deposits.
As Blue Ridge has offboarded fintech programs, it has leaned heavily on brokered deposits to make up the difference. Year over year, the absolute amount and relative share of deposits considered brokered increased by over 1,000%.
As of the end of 2023, just over 20% of Blue Ridge’s deposits are now classified as brokered.
The result of the shifting composition of Blue Ridge’s deposit base is a rising cost of funds that has outpaced its peer group (blue line below), helping to drive a sharper contraction in net interest margin than peers (yellow line below).
Given that Blue Ridge still has $465.9 million in fintech-related deposits on its balance sheet, it suggests the bank’s cost of funds is likely to rise further, to the extent it continues to exit the BaaS space and backfill with more expensive brokered deposits.
The situation is worth paying attention to, as it is likely to repeat at other banks that decide — or are forced — to wind down BaaS business models.
It should also serve as a warning to banks operating or considering launching BaaS programs: they could regret developing a high concentration of these deposits, as replacing them in a hurry is likely to come with a steep price tag.
OCC Fines City National Bank $65m For Unsafe & Unsound Practices
If City National sounds familiar, it may be because around this time last year, the bank reached a $31 million settlement with the Department of Justice for violating fair lending laws with its illegal redlining practices.
Now, the bank is in trouble again — this time, with its primary federal regulator, the OCC.
The OCC found City National to be “engaging in unsafe or unsound practices, including systemic deficiencies related to the Bank’s operational, compliance, investment management, and strategic risk management and internal controls, as well as (1) noncompliance with 12 C.F.R. 30 – Appendix D, OCC Guidelines Establishing Heightened Standards for Certain Large Insured National Banks, Insured Federal Savings Associations, and Insured Federal Branches, and (2) violations of the Bank Secrecy Act (BSA) and 12 C.F.R. 9 – Fiduciary Activities of National Banks;”
The OCC cited deficiencies in operational risk management, including internal controls; compliance risk management, including BSA/AML and fair lending; strategic risk management; and investment management practices.
Per the consent order, City National must:
appoint a compliance committee of at least three members, of which the majority must not be employees or officers of the bank
develop an acceptable written action plan with specific corrective actions necessary to achieve compliance with the order
adopt policies and procedures that will result in an effective operational risk and internal control environment
revise and adopt policies and standards that will result in effective identification and control of risks related to money laundering and terrorist financing and achieve and maintain compliance with the Bank Secrecy Act — including independent validation of models and filtering thresholds and policies and procedures to ensure the timely filing of suspicious activity reports (SARs) and currency transaction reports (CTRs)
adopt a written, institution-wide BSA/AML and OFAC risk assessment
revise and adopt a know your customer (KYC) standard as the basis for a customer due diligence (CDD) program, including clear definition of low-, medium-, and high-risk customers
develop and adopt a fair lending risk management program, which shall address known deficiencies
receive OCC non-objection to its risk governance framework
implement an investment management governance program
strengthen its staffing analysis and plan, compensation and performance management, and succession planning, particularly as it relates to front line units and independent risk management staff
strengthen its internal audit program
submit a strategic plan covering at least a three-year period for OCC non-objection
City National was also ordered to pay a $65 million civil money penalty.
FT Partners: More Smaller, Early-Stage Rounds
As always, FT Partners’ industry analysis is worth a read. The specialty investment bank released its report, The Fintech Journey Continues: What to Expect in 2024, last week.
In addition to funding stats, the report takes a look at some key trends expected to shape 2024, including real-time payments, financial APIs and payroll data for SMBs, restaurant tech, digital identity, and more.
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Other Good Reads
Why Two Cores Can Be Better Than One (Bank Director)
Does FinTech Increase Bank Risk Taking? (IMF Working Paper)
A Blueprint for Implementing a Risk Governance Program (Eric Bonnell)
Can Anyone Win BaaS? (Fintech Takes)
Listen: Is 2024 The Year BaaS Goes Boom? (Breaking Banks)
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