[Continued from Tuesday]
3. The hype around FinTech
Last year the rise of Financial Technology (‘FinTech’) software and apps led some experts to predict the ‘disruption of traditional banking‘. The new providers of financial services would maximise the agility and cost efficiency provided by technology and as a result would kick the incumbents plagued by legacy systems and excessive layers of staff.
LendingClub, founded in 2006, was perceived as one of the standard-bearers of that shift. As a P2P lending company it offered to put individuals or small businesses directly in touch with lenders through an online platform – a mix of Uber and Match.com. LendingClub was claiming that it would enable small businesses to get easier access to funding while providing lenders with an investment offering a (relatively) decent return. LendingClub was just taking a percentage of the loan as a one-off fee and therefore was not taking any risk.
In 2016 the picture is somewhat different, as Patrick Jenkins points out. Hedge funds and banks have replaced individuals and small businesses and have started securitising the loans – rings a bell? Poor credit risk assessment processes led to the first defaults, the departure of the CEO and a 25% share price drop. Compliance started to take its toll as the company grew. To command a technology startup valuation multiple, revenue growth requires LendingClub to accept an ever increasing volume of loans (new loans account for 90% of revenues), including riskier ones. And the company proved sensitive to credit cycles. As a solution, LendingClub started taking retail deposits to channel them towards its lending platform – basically what a traditional bank does, with a tiny bit of software on top. No quite disruptive any more.
In the meantime, regulators across the world are running behind and have not proposed a robust framework to monitor this new array of services yet – raising the risk to “systemic stability”.
4. Banks desperately looking for yield
Banks are by far the biggest losers of the negative interest rates policy implemented by Central Banks across the world. Their deposits do not generate any revenues any more. Worse, they are a source of cost. Given that very few banks have dared passing the cost through to the customer yet (i.e. charging current accounts), banks are now looking for more profitable investment to make up for the difference – notwithstanding the fact that banks have been massively streamlining their teams over the last 12 months. This implies taking more risks.
O&G companies for instance were granted higher quantums of debt at the time oil was getting close (or above) $150 a barrel – especially those involved in shale gas production. Those quantums backfired when the barrel dropped by more than 80% – shale gas then became almost unprofitable to produce. Despite the recent correction, the O&G industry has been suffering a series of bankruptcies as a result – 42 last year alone. In the US, car loans, student loans and credit cards balances and delinquency rates are also reaching abnormally high levels according to Le Figaro. By willing to invest at all cost, banks are becoming less and less concerned about the quality of their customers.
5. Housing market engineering is back in the game
I thought the 2008 mortgage subprime crisis would repel investors from the housing market for a while. I was wrong.
According to TechCrunch, Opendoor, a company founded in 2014, “currently buys homes sight unseen when a home seller visits its site, asks for a quote, and accepts Opendoor’s bid, which the company comes up with based on public market information about historical home sales and its own proprietary data about market conditions”. Fortunately, the company selects its investments, not purchasing “any home built before 1960 [or] homes outside a $100k-$600k price range” – according to TechCrunch this still means that 90% of homes are eligible, so the criteria are not that drastic after all…
The startup’s balance sheet is currently worth “hundreds of millions of dollars”. Talking about profitability, its CEO “Opendoor isn’t focused on [profitability] just now”. Let us hope for them that the housing market does not decide to spiral down again.
Some hope: Investors seem to have learnt (part of) the lesson
After a euphoric 2015, investors seem to wake up (some of them hungover) and are becoming more realistic about the true potential of ‘disruptive’ investments.
First, raising equity has also proven increasingly difficult for startups since the beginning of the year, especially for those seeking very large cheques (greater than $100m). In Q1 2016 $25.5bn got invested in startups globally, an amount down 8% yoy. When they manage to do so, the financing package comes with increasing strings attached, even for well-established brand names. The bond Spotify issued in March contains an ‘bomb-ticking’ interest rate which strongly incentivises shareholders to look for an IPO in the short to medium-term – in substance, creditors are asking the company to become palatable for the stock market as a whole and not just a series of cherry-picked investors.
Second, the ‘real’ value of existing investments is being re-assessed. BlackRock, for instance, decided to cut its valuation of DropBox by 20% last October. Rocket Internet, the controversial startup studio, lost 18.5% of its equity value in two days in April after it revised the valuation of some of its investments downwards. On a side note, Carl Icahn, the famous activist investor, recently revealed that his fund Icahn Enterprises had a net short position of 149%.
Politics is also joining the party. In the US, the Presidential Election held later this year represents a clear source of uncertainty. Candidate Trump has already declared that “we [were] in a bubble right now” and has been criticising the role of the Fed in the construction of that bubble. The kind of mitigating action that Mr. Trump would implement to negate the bubble still remains unclear at this stage.
What’s next? Because of the excessive amount of liquidity in our economy, value destruction has reached a scale never witnessed before. This is clearly not sustainable. When the liquidity tap will stop flowing, there will be boats left stranded on the shore. But to which extent? Will we ever come back to a pre-crisis environment? I do not believe so either. As I mentioned in an earlier post, I think the answer is in-between: we need to give birth to a ‘new normal’. I fear, however, that the delivery will not be painless.