Cal. Regulator Cites BNPL Firm for "Illegal Loans"

Goldman Faces CFPB Scrutiny, Varo's Q2 Call Report, Ford's ILC Charter, Neobank Bnext Quits Mexico

Aug 07, 2022

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California DFPI Cites BNPL Firm for “Illegal Loans”

California’s banking regulator, the DFPI, entered into a consent order with BNPL firm Four over what it described as the company’s “illegal loans” in the state.

While that language sounds serious, the order stems from the apparently minor infraction of Four operating in the state without a California Financing Law (CFL) license.

Per the consent order, Four will refund $13,065 in fees illegally charged to California consumers and pay a $2,500 administrative penalty to the DFPI.

Concurrent with the consent order, the DFPI granted Four’s application for a CFL license.

Four isn’t the first BNPL company to run into this issue in California. In 2020, the DFPI reached settlements with Quadpay, Sezzle, Afterpay, and Klarna over the same issue.

What is surprising is that Four either wasn’t aware of or didn’t act after those cases to secure its own CFL license, instead waiting to be cited by the DFPI for operating without it.

Varo’s Q2 Call Report: Narrowing Losses, But Deteriorating Account Quality & High Charge Offs

Varo’s second quarter call report was posted last week. While the filing did contain some bright spots, the firm still posted an approximately $77 million loss for the quarter.

Growing Revenue and Accounts

Net interest income was up considerably vs. the prior quarter, reflecting the impact of a rising interest rate environment and the fact that Varo is a licensed bank. Still, while net interest income may be up, it totaled just $453,000 for the quarter, reflecting Varo’s customers’ low average balances.

Non-interest income grew modestly from the quarter prior, edging up about 6% to $23,341,000.

Varo grew its headline number of accounts by about 720,000 vs. the quarter prior to a new total of 4,751,329.

A statement from the company claimed the cost of acquiring new accounts in June had dropped by 64% vs. Q1 on the back of reduced marketing spend — likely signaling a substantial slowing in account growth from June onwards.

It’s unclear how many of Varo’s 4.7 million accounts are active or use Varo as their “primary” account. The company declined to answer questions about what proportion of its accounts are active.

Ultimately, the company narrowed its net loss to $77 million for the quarter — still a whopping number vs. its $222 million in equity capital at the end of Q2. At its current burn rate, that would give Varo about 8.5 months of runway — though its burn rate should come down further as reduced marketing spend and layoffs show up in the data.

The call report reflected 777 full-time employees, which is actually a slight increase from the company’s Q1 filing.

Varo announced it had laid off 75 employees in July, which would bring that number down to about 700. The layoffs will save Varo about $10 million per year (excluding restructuring costs), which certainly helps, but doesn’t get the company anywhere near profitability.

Average Balance and Revenue Per Account Shrink; High Charge Offs

Despite growing its total number of accounts, the average balance per account shrunk to just $65 — an all-time low since Varo began filing call reports.

This could reflect that not all the accounts in the headline number are actually active, that Varo’s customer base is getting squeezed as stimulus funds are long gone and inflation surges, or both.

Varo’s average revenue per account also continued to slide, hitting a low of $5.16 per account in the quarter, or $20.64 on an annualized basis.

Despite growing the number of accounts, Varo’s total deposits actually fell about 7% to $311,758,000 at the end of Q2. Total assets also fell about 11% to $593,178,000.

Varo’s credit losses are also worrisome. The company saw a 2.8% charge off rate (annualized, net of recoveries) on its Varo Believe card, a credit-building credit card.

That’s despite structuring the product such that users pre-fund an account, which then determines their credit limit, and are encouraged, though not required, to opt in to use that escrowed money to automatically pay in full each month.

For frame of reference, the banking industry’s overall charge off rate on unsecured cards was 1.71% (annualized, net of recoveries) in the first quarter.

Meanwhile, charge offs on its Varo Advance small dollar loan product were a whopping 27.3% on an annualized basis, though that was actually a significant improvement from the first quarter.

Varo’s high charge off rates make it understandable why the bank hasn’t been eager to expand further into lending (and, perhaps, also provides context on why competitor Chime has been slow to launch a lending product.)

A representative for Varo declined to answer questions about the products’ high charge off rates.

Varo Bank Entity Tops Up Equity Capital

Although Varo posted a net loss of $77 million for the quarter ($161,521,000 year to date), the bank ended the second quarter with about $222 million in equity capital.

That’s because $28 million was brought into the bank through a transaction with stockholders, most likely Varo’s bank holding company, Varo Money. Presumably this is capital Varo raised in previous venture financing rounds. It’s unclear from the call report where the additional $15.6 million of direct capital came from.

What to Watch

Varo’s cost cutting is almost certainly not over. The biggest levers it has are marketing spend and headcount.

It’s already begun trimming both, but only reduced losses by 9% in Q2 (though headcount reduction won’t begin showing until the Q3 report.) Expect further cuts to both marketing and headcount as Varo seeks to extend its runway. Such cuts, however, are likely to slow the company’s growth — which won’t particularly help as it tries to figure out a route to profitability.

Spanish Neobank Bnext Exits Mexico After Losing BaaS Provider

Spanish neobank Bnext is exiting the Mexican market after it’s banking-as-a-service provider, Cacao Paycard, failed to win authorization from the Mexican banking regulator, the CNBV.

As covered in Fintech Business Weekly this January, although Mexico passed a “Fintech Law,” it hasn’t been smooth sailing for startups.

Numerous companies that had been operating under the “8th transitory” provision of the law while they sought licensure ultimately were not granted licenses. This included companies operating BaaS-style models, where they powered other companies’ consumer-facing banking products.

Cacao Paycard, which powered popular fintechs like Oyster, Kapital, and Bnext, had its application for authorization declined in October 2021. The setback led to Bnext pausing the onboarding of any new customer accounts in the country.

And as of July 24th, all of Bnext’s customer accounts were disabled — as many as 230,000 users, according to El Economista.

As a result of the regulatory setbacks, Bnext has decided to exit the Mexican market altogether.

CFPB Investigating Goldman Over Credit Card Practices

Goldman Sachs is under scrutiny from the consumer protection agency, the firm’s most recent 10-Q shows (emphasis added):

“Consumer Investigation and Review
The firm is cooperating with the Consumer Financial Protection Bureau in connection with an investigation of GS Bank USA’s credit card account management practices, including with respect to the application of refunds, crediting of nonconforming payments, billing error resolution, advertisements, and reporting to credit bureaus.”

While the brief statement obliquely refers to the bank’s “credit card account management practices,” currently, Goldman only manages two card programs: a GM co-brand card and the Apple Card.

The Apple Card was Goldman’s first effort in the credit card space and was developed in-house, in coordination with Apple; the GM co-brand card was acquired from Capital One.

While specific numbers are unavailable, Apple Card balances likely account for the lion’s share of Goldman’s $12 billion credit card portfolio.

Now, these kinds of inquiries into a bank’s practices are hardly unusual. The matter is garnering headlines because it involves Goldman Sachs and Apple, which handles much of the marketing for the card and controls the UX.

Further, CFPB Director Chopra has made no secret of his dislike for Big Tech, including Apple. The agency has made frequent statements arguing Big Tech’s entrance into financial services markets poses a threat to competition, and has an ongoing inquiry to gather data about Big Tech companies’ payment platforms, including Apple’s.

With limited authority to supervise Apple directly, opening an inquiry into Goldman’s credit card practices could be a backdoor to scrutinize Apple’s financial services business.

Ford Is a Test For New ILC Charters

At the end of July, Ford Credit Bank filed its application for FDIC insurance.

Ford’s pursuit of a bank charter is resurfacing the debate about Industrial Loan Company (ILC) charters — which continue to be a hot-button issue.

ILCs, a type of bank charter only offered in a handful of states, are the most common way for a non-financial company to own or control a bank. ILCs aren’t new, and, indeed other automakers, like BMW and Toyota, operate this type of bank.

Recent companies that won approval for FDIC insurance tied to an ILC charter include student loan servicer Nelnet and Block (known as Square at the time).

But the composition of the FDIC board, which decides such applications, has changed since those applications were approved.

Trump-appointed Chair Jelena McWilliams resigned earlier this year. Current board members who will weigh in on the application include FDIC Chair Martin Gruenberg, acting Comptroller Michael Hsu, and CFPB Director Rohit Chopra.

Gruenberg opposed Square’s ILC application, and no such applications were approved during his previous tenure as Chair of the FDIC from 2011 to 2018.

Appointees of the current administration are highly skeptical of anything that appears to mix commercial activity and banking. If Ford’s application were approved, what about an ILC application from Walmart? Or Apple?

Industry expert Todd Baker, Senior fellow at the Richman Center for Business, Law and Public Policy at Columbia University, told American Banker, “This would be the most likely thing to get an approval, but I just don't see any likelihood of action on this front in the near future. It just doesn't seem to be the priority of the FDIC.”

FT Partners Report: Funding Volume, Deal Count March Lower

The dollar volume of funding continues to decline, as appetite for fintech deals, particularly in later stage growth rounds, continues to cool. The count of deals announced in July also dropped significantly vs. June (maybe it’s just summer?)

There’s no sign of this trend abating; the funding environment is extremely unlikely to return to what it has looked like for the past year.

As fintechs adapt to VC’s tightened purse strings, expect M&A activity — and layoffs — to accelerate.

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