Crypto Mining Loan Firesale, Conflicts of Interest, Material Weakness: Provident Bancorp's Delayed 10-Q
Feds Probe Goldman's Consumer Biz, Moonstone Quits Crypto, Nexo's $45 Million Settlement
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Fed Probes Goldman’s Consumer Business
According to reporting late Friday from the Wall Street Journal, the Federal Reserve is investigating Goldman Sachs’ consumer business “to determine whether the bank had appropriate safeguards in place as it ramped up lending, according to people familiar with the matter.”
Per WSJ, the Fed “has concerns that the bank didn’t have proper monitoring and control systems” in its Marcus consumer unit, especially as it quickly scaled the business and expanded into new products. The probe is said to include compliance, audit, and legal functions. The latest news comes after similar reports in September that the Fed was probing the business unit.
It’s not the only regulatory attention Goldman’s consumer efforts have attracted. In its second quarter 10-Q, the firm revealed the CFPB was looking into its credit card practices, saying at the time:
“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.”
With the information that’s been reported to date on both inquiries, it’s difficult to judge how serious they ultimately could be. The reality is, these types of inquiries are par for the course. That the matters have attracted heightened press attention is driven by the subject of the investigations — Goldman Sachs.
Still, the inquiries are a regulatory and PR headache the bank surely would’ve rather avoided — particularly on top of its walk-back of its consumer banking ambitions and its less-than-stellar quarterly earnings.
Moonstone To Exit Crypto, Cannabis After FTX Fallout, Scrutiny
One of the stranger twists of the FTX saga involved tiny Farmington State Bank in Washington state.
Farmington was purchased by a holding company controlled by Jean Chalopin who, in addition to being the co-creator of the 1980s “Inspector Gadget” cartoon, is also the executive chairman of Bahamas-based Deltec Bank.
Chalopin and Deltec in many ways paved the way for the Bahamas to become a haven for crypto companies — encouraging and helping the Bahamian government to draft digital asset legislation. Deltec counts as clients Tether — the largest “stablecoin” by market cap — and FTX.
Chalopin acquired Farmington State Bank in 2020 through a holding company. At the time, it had just three employees, a single branch, and lacked online banking.
Farmington rebranded as Moonstone Bank — denoting its new strategy focused on crypto companies and marijuana businesses.
In January, 2022, FTX’s sister firm Alameda Research made an $11.5 million investment in Moonstone Bank’s holding company at an inflated valuation that seems designed to keep Alameda’s ownership below a key 10% threshold.
Since Moonstone’s acquisition by Chalopin, the bank saw its deposits swell from around $10 million to about $84 million — with the increase driven by just four accounts. FTX held $50 million between two accounts at the bank, according to Bahamian bankruptcy officials — though its not clear what the current status of the funds is.
Unsurprisingly, FTX’s involvement with Moonstone has drawn scrutiny from across the regulatory and legislative establishment.
In December, Senator Elizabeth Warren (D-MA), who sits on the powerful Senate Banking Committee, sent a letter to the Fed requesting additional information about several banks’ involvement in crypto — including Moonstone specifically.
Following volatility, including significant deposit outflows, at crypto-focused banks like Silvergate, Signature, and Customers Bancorp, and amidst increasing regulatory pressure, some banks are re-thinking their crypto strategies. Metropolitan Commercial Bank announced about a week ago it would stop serving crypto customers altogether.
Now, Moonstone is the latest bank to retreat from crypto. The bank said in a press release last week (emphasis added):
“Farmington State Bank, d/b/a Moonstone Bank, announced today that the bank is returning to its original mission as a community bank and is discontinuing its pursuit of an innovation-driven business model to develop banking services for industries such as crypto assets or hemp/cannabis.
The change in strategy reflects the impact of recent events in the crypto assets industry and the resultant changing regulatory environment relating to crypto asset businesses.”
The bank will also drop the Moonstone branding and return to being known as Farmington State Bank.
Provident Bancorp (Finally) Files Q3 10-Q, Reveals “Material Weakness” In Controls, Risk of “Conflicts of Interest” In Now-Shuttered Crypto Lending Unit
Provident Bancorp, parent of BankProv, filed its third quarter 10-Q last week.
The lengthy delay in filing stemmed from losses in its digital asset lending business, which lent money to bitcoin mining companies secured by their “mining rigs” (computers) — which we covered previously here.
Losses for Q3 came in worse than expected.
In the 8-K it filed in mid-November, Provident expected an approximate net loss of $27.5 million for the third quarter. Instead, it posted a net loss of $35.3 million for the quarter — nearly 30% higher than expected and a dramatic swing from the $5 million in net income it posted in the same quarter in 2021.
The large third quarter loss, driven primarily by increases to loan loss reserves to cover potentially bad loans to crypto miners, more than wiped out earnings from the first half of the year, making its year-to-date losses about $24.2 million.
The impetus for Provident’s chaotic 10-Q filing seems to have been a bitcoin mining company that defaulted on loans to the bank. At the end of Q3, Provident reached an agreement to repossess the bitcoin mining rigs in exchange for forgiving the outstanding $27.4 million loan balance.
Provident is now the proud owner of those bitcoin mining rigs, which it has valued on its own balance sheet at about $10.5 million — or about $17 million less than the loans the rigs served as collateral for (emphasis added):
“On September 30, 2022, the Bank repossessed cryptocurrency mining rigs in exchange for the forgiveness of a $27.4 million loan relationship. Upon repossession, the assets were written down through an $11.3 million charge-off through allowance for loan losses on September 30, 2022.
Due to continued volatility in the Bitcoin markets, the Company evaluated subsequent events and took an additional charge-off through the allowance for loan losses in the amount $5.6 million.
The repossessed cryptocurrency mining rigs were reported as other repossessed assets at their fair value less costs to sell, establishing a new cost basis in the amount of $10.5 million on the September 30, 2022 Consolidated Balance Sheets.”
More significantly, in mid-December, Provident decided to offload the risk of its remaining crypto mining loans by selling them to third-parties — at a steep loss.
At the time of sale, the face value of the loans was $50.1 million — but Provident was only able to get $15 million in cash for them (plus a replacement loan backed by mining rigs of $6.2 million). The bank also has ceased writing new loans backed by crypto mining equipment (emphasis added):
“During the quarter ended, September 30, 2022, the recorded investment in impaired commercial loans secured by cryptocurrency mining rigs was $51.0 million, which included outstanding principal and unamortized premium. At that time these loans were allocated $31.7 million in specific reserves.
On December 16, 2022, the Bank entered into an agreement to sell loans at which point the total recorded investment had reduced to $50.1 million due to payments made during the fourth quarter of 2022. The sales price for the loans was $15.0 million in cash in addition to a replacement loan relationship secured by cryptocurrency mining rigs with a principal balance of $6.2 million.
…The sale was recorded during the quarter ended December 31, 2022; however, the Company retroactively adjusted the September 30, 2022 financial statements to reflect the $29.0 million charge-off that ultimately resulted from the sale and exchange of these loans.
In addition, because of the continued volatility in Bitcoin and cryptocurrency mining rigs, the Company has ceased originating new loans secured by cryptocurrency mining rigs.”
Despite the hefty losses incurred to reduce its crypto-related exposure, Provident’s capital levels remain comfortably above regulatory requirements:
Material Weakness, Conflicts of Interest in Digital Lending Practices
In addition to the financial results, Provident Bancorp’s 10-Q discloses “material weakness in internal control over financial reporting,” though the company “believes that the material weakness did not result in any material misstatement of the Company’s financial statements.”
A review of the bank’s controls relating to its digital lending practices by its audit committee, board, and with the assistance of outside legal counsel found “material weakness,” including “risks pertaining to internal conflicts of interest.”
Per its 10-Q (emphasis added):
“This material weakness in the control environment stemmed from ‘tone at the top’ issues that contributed to a control environment that was insufficiently tailored to monitoring of risks as it relates to the digital asset lending program. This material weakness is a result of weaknesses in the following:
The precision of the design and maintenance of effective controls to sufficiently address risks pertaining to internal conflicts of interest related to the digital asset lending program; and,
effective avenues of communication regarding certain relevant information to the Board of Directors of the Company, related to the digital asset lending program.”
Provident’s filing said control problems stemmed from a “tone at the top,” though it didn’t name specific roles or individuals it deemed responsible for that “tone.”
It is worth noting that, per an 8-K filing and its December 23rd press release, the bank reached a “mutual agreement” with then-CEO and advocate of the digital asset strategy David Mansfield to part ways. Mansfield collected a cool $1.5 million lump-sum payment on his way out the door and will have his and his dependents’ medical and dental insurance paid by the bank for 24 months.
While Provident’s Q3 10-Q doesn’t disclose any investigations or legal proceedings against the bank, these types of control failures and conflicts of interest tend to be the kind of issues that concern banking regulators (for a fuller discussion on this topic, see Bank Reg Blog’s recent analysis.)
Nexo Pays $45 Million to Settle SEC, State Cases
Crypto lender Nexo, previously the subject of a cease and desist order, has reached a $45 million settlement with the SEC and the North American Securities Administrator Association.
The settlement stems from Nexo’s “Earn Interest Product” (EIP). The offering was largely similar to those of other crypto lenders that attracted regulatory scrutiny, including BlockFi (now bankrupt), Celsius (bankrupt), and numerous others.
According to the SEC:
“The EIP allowed U.S. investors to tender their crypto assets to Nexo in exchange for Nexo’s promise to pay interest. The order states that Nexo marketed the EIP as a means for investors to earn interest on their crypto assets, and Nexo exercised its discretion to use investors’ crypto assets in various ways to generate income for its own business and to fund interest payments to EIP investors.
The order finds that the EIP is a security and that the offer and sale of the EIP did not qualify for an exemption from SEC registration. Therefore, Nexo was required to register its offer and sale of the EIP, which it failed to do.”
Nexo had already announced in December it would exit the US market, after its petition to narrow the scope of a separate CFPB investigation, the first such investigation into a crypto company, was denied.
Nexo is doing its best to paint the settlement in a positive light, describing it as “a final landmark resolution” that recognizes the company as a “pioneer” that provides “disruptive solutions” —
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Listen: NexGen Banker Podcast
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