FTT+ April 19th: Consumer Lending During the Economic Crisis - Some Thoughts on Last Week's Outages
Hi all, Julie here.
First off, we wanted to announce a new product for FTT+ subscribers that’s launching this Wednesday: FTT Jobs, a new newsletter focused on helping people find jobs and advance their careers in the fintech space. We’re working with onejob, one of our favorite newsletters in the careers space, and will be launching a member-only job board and weekly content around finding new roles, career development, and how you can get a step ahead. This newsletter will be free for FTT+ subscribers, so if you’re interested, sign up at the link here.
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In case you missed it, big banks reported earnings this week, and they went roughly how you’d expect them to, with substantial declines in profits as they set aside billions of dollars to cover expected losses on loans. To quote the Financial Times:
“Big US banks made one thing clear this week: they are battening down the hatches to deal with an expected surge in loan losses as the pandemic casts serious doubts over the capacity of consumers and companies to pay their debt…Loan loss charges at six big American banks reached a total of $25.4 billion in the first quarter. This marks a 350% surge in collective provisions across Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs and Morgan Stanley versus a year earlier, as charges soared to levels not seen since the financial crisis. The provisions are additions to reserves so banks have enough in their rainy day fund to cover future losses.”
This leads us to our topic of the week: consumer credit. The idea came from a VC friend of mine (and a subscriber, thank you), who said “unsecured consumer lending is the tip of the spear in any downturn.” So while things might not get really bad for a while, it’s this market that might give us the first sign of just how bad it can get. “These companies all need to react immediately by tightening credit approvals, perhaps even pushing away less profitable merchants and dealing with their balance sheet partners. All doable but it has all of the moving pieces,” they added.
One segment of the market is installment lending. While there are several private companies in this space, there aren’t as many public ones. However, we lucked out with Afterpay, which released a quarterly update early last week. Shares fell all the way to $5 from a 52-week high of $28 at one point, with several analysts downgrading the company and warning that precautions for Covid-19 might not be enough for how bad things could get. As of March 31, Afterpay says it had $541.1 million of cash and $719.2 million of total liquidity on hand.
Another installment lender is Affirm, founded by PayPal mafia member and really good cyclist Max Levchin. I had a few questions for the firm, and was able to talk to Silvija Martincevic, its Chief Commercial Officer directly overseeing the commercial side of the business. She said that there have been several obvious trends in spending pattern shifts. For instance, travel related purchases took a huge hit, but office supplies are up 200%, at-home fitness like Peloton, Mirror and Tonal are up 163%, and people really are baking more banana bread like they’re posting on Instagram, with kitchen supplies up 67%.
Affirm’s terms of service say that while they can report you to the credit bureaus if you stop paying, they can’t come after you for the money. Affirm has certainly taken increased risk into their credit modeling, and Martincevic says that they will continue to only make loans that consumers can afford on a payment schedule that works for them. The issue they will have to account for here is that the consumer knows about a change in income before the lender does. Sometimes quite a bit before. In order to help consumers that have been impacted, Martincevic says that Affirm is offering payment flexibility options to consumers experiencing hardship. They could look for additional ways to get data on consumers to make credit decisions as well, as long as they stay within regulatory guidelines which can get tricky.
While Afterpay and Affirm aren’t subprime, I reached out to a friend that works in that space to get their thoughts on the consumer market right now. They said that any lender across the credit spectrum is tightening right now, and that portfolios could have huge risks.
“Repayment actually isn’t bad (yet), especially short-term delinquencies. A few theories: 1) unemployment is high but spending is also way down 2) it’s tax season so people could be putting tax returns in debt repayment 3) younger workers get hit the most and they are not in the credit markets anyway 4) stimulus check is being used for debt payments.
Something that I’d love to dive into even more in the future would be how anyone is pricing these types of assets anymore. Any sort of models you had before Covid are likely worthless. So what have the last few weeks been like trying to figure that out, and how much risk should be taken into account? Which assets would be riskiest, and which borrowers would be riskiest (without violating any regulations in evaluating the borrower).
Hi, Ian here.
Last week, as I’m sure a number of you are aware of, was stimulus week for many Americans. Part of the CARES Act included a one time disbursement of $1,200 to American’s who made less than $75,000 (after that, it would be a sliding figure for people, capped at folks who made $99,000.)
It led to an interesting phenomenon; mid-week, most of the websites and apps for big banks and fintech companies alike were down for a period of time. As I wrote in FTT on Friday, banks like Chase, Citi, PNC and fintech apps like PayPal and Cash App were all down. Most of the outages were around the website and online banking products, and a smaller percentage seemed to affect mobile apps from these institutions.
It’s also affected non-consumer companies in the fintech ecosystem. According to Plaid’s status page, the company has been suffering from issues since the 15th, namely “elevated institutions errors.” The status page says “certain institutions are experiencing high item add error rates and slower transaction updates.” (high item add error rates roughly means that Plaid’s having trouble connecting to bank accounts at institutions.) But by Friday, we hear that most of the issues have been solved, and by today, most of the top 30 institutions are fully back online.
If one thing I’ve learned in my time building products in fintech, when it comes to people’s money, the average user isn’t forgiving, especially in certain situations where stress levels are already elevated.
I had a couple of observations over the past few days that I wanted to highlight for y’all:
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Just based on the sheer amount of volume, and the circumstances surrounding COVID-19, digital banking is becoming more popular in the US whether we like it or not. People can’t go to bank branches because of shelter-in-place and quarantine rules related to COVID, so they’re resorted to online and mobile banking. How long until these behaviors become more common?
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Another thing a friend, who worked at banks and fintech companies, and I were discussing this week: is COVID the beginning of the end of massive branch networks for consumer banks? For years, banks have thought about shuttering branches, but those decisions are always met with contempt from local communities. With consumer behavior shifting and no real end in sight for the quarantine, my friend hypothesized whether banks can capitalize on this to shutter some of their costly branches that aren’t bringing in business and move more towards digital products. Chase, Wells Fargo, and Capital One have all temporarily closed branches. Wonder how long it’ll be before these closures are permanent.
I’m curious if they’ll start affecting the corporate suite too. Morgan Stanley’s CEO said something to that effect to Bloomberg TV after the company’s earnings call. “We’ve proven we can operate with no footprint,” Gorman, the firm’s chief executive officer, said in an interview Thursday with Bloomberg Television. “Can I see a future where part of every week, certainly part of every month, a lot of our employees will be at home? Absolutely.”
- The most interesting observation to me was that both banks and fintech companies suffered outages. Almost no one seemed to be fully prepared for the volume we saw this week. Some, however, like Chime and Current, didn’t because they were able to advance their users’ stimulus payments by tracking ACH payments. As Julie noted last week, it was really surprising banks didn’t seem to try to do anything similar.
But the reason both startups and banks had the same issue is, at a high level, they use the same infrastructure. Banks are leveraging core banking processors from companies like FIS, Fiserve, and others, while companies like Cash App have bank partners like Sutton Bank that use the same technology too. Based on a lot of my discussions over the past week, those technology stacks are incredibly outdated compared to modern systems and just simply can’t handle the scale.
Not only that, but these systems aren’t used to these volumes either, and might be misinterpreting them. One theory I’ve heard was that these volume spikes look similar to DDoS attacks, where hackers attempt to take a website down by overloading it with traffic. A failsafe mechanism might just be to shut the whole system down.
In any case, it was an interesting case study on the backend operations of the financial system in the US. A few things are clear—banking is becoming digital, and our systems need to improve in order to handle that and better serve our customers.