Fintech – Major Failures Since 2008/9

Current failures will be much bigger but with similar factors

Fintech only started in 2008/9 and in the fourteen years has seen notable failures.

However, Fintech risk has dramatically increased in the ‘Covid’ stay at home era aided by excessive valuations, ‘free’ central bank money, government stimulus, exuberant VC’s and private equity and run away share markets.

All of this is looking very shaky as ‘free’ money is withdrawn and interest rates must rise to curb runaway inflation.

Early in 2021 stock markets starting warning that risk would not be rewarded, and Fintech’s needing to make profits, not fancy charts of ‘future growth’ and massive cash burn.

Declines gathered pace in 2022 in Tech stocks – most recent Snap being smashed and social media stocks losing US$165 billion.?

The Fintech 'collapse risks' are elevated to all-time highs making the previous ‘leaders’ Wirecard and Ezubao look like small fry.

Major bubbles have developed across key Fintech segments – BNPL, Crypto, Neo Banks, Saas payments, Alt Fi, P2P cash and lending, POS and online payments.

Current Risks are Extremely Elevated

The huge run up in shares and private valuation risk a new group of Fintech failures – many are fighting for survival right now.

Examples of risky areas:

Cryptos great vanishing act in 2022 will create a number of failures - already South Korea's TerraLabs stable coin has lost US$40 billion ( it may be as high as US$60bn).

BNPL – Affirm has lost US$40 billion in market cap, Australia’s BNPL stocks have lost US$28.5 billion, Klarna looks like losing US$15.5 billion with its new valuation. The sectors could end losing US$100 billion, which is ironic given global sales in 2021 were US$145 billion and revenues US$8.85 billion!

Neo Banks – public float of NuBank in December 2021shares closed at US$9 with market cap of US$43 billion – that’s not supposed to happen, US$2 billion below VC pre-IPO valuation of US$45 billion. Today NuBank is worth $3.53 and market cap $6.6 billion despite Warren Buffet owning shares. Dave another similar stock is $2.29 down from its high $15.35.

Successful Korean Neo Bank Kakao Bank has seen its shares decline to US$31 or $15 billion in market cap from its post IPO peak a 57% decline for this profitable bank.

Block/Square has felt the impact of its disastrous US$29 billion purchase of unprofitable Afterpay. Blocks market cap is US$45 billion down from it peak of US$127 billion. ?

This put all this in perspective Big Tech losses so far are 2022 -

?VC Investments are at All-time Highs

Total Fintech Investments 2008-18 were US$63.9 Billion which includes Venture Capital (VCs) and other investors including private equity and crowd funding, representing 6.7% of total start-up funding.

Since 2018 Fintech investments jumped to average $50 billion a year until 2021 which totalled a whopping US$131 billion. This is now set to decline as first quarter 2022 showed with early indications Q2 is declining further - this has real consequences.

The VC challenge now is turning around all the start-ups, changing their mindsets and ‘runways’ to fit the new circumstances – some gig!

Major listed Fintech collapses since 2008

Important to remember the list below are losses from public companies. The vast majority of Fintechs are not public and 9 out of 10 start-ups fail - so actual sector losses would be 4-5 times higher. These losses are hidden from public view as VCs do not report on them - yet another example of the 'wild west' of investing.

Wirecard fraud lost US$12.5 billion

Ezubao fraud lost US$9.9 billion

Lending Club stock collapse lost US$9.8 billion

Greensill lost US$4.6 billion*

Greensky Inc stock collapse lost US$4.2 billion

On Deck Capital stock collapse lost US$ 1.8 billion

Funding Circle stock collapse lost US$1.5 billion

Finablr stock collapsed losing US$1.4 billion

Other ‘smaller’ collapses have lost US$28.7 billion

Giving US$74.4 billion in losses!!

*Australian owned Greensill was a private company but planed a 2021 IPO worth US$22 billion.

History Can Tell Us Plenty!!

The US$12.5 billion collapse of Wirecard in June 2020 at the time the largest Fintech collapse. The collapse also rubbished German’s regulators and Fintech’s reputation while severely denting auditors EY.

WIRECARD

Glamour Fintech Wirecard collapsed in June 2020, costing investors US$12.5 billion dollars over fraud and audit issues.

It emerged since the collapse German regulators didn’t act soon enough – despite repeated calls over a seven-year period.

Did this collapse display a significant blind spot for regulators of the world's financial system: how do you regulate a firm that acts like bank, but isn't really a bank?

For years, Germany's supposed fintech star escaped strict scrutiny because financial watchdog BaFin was focused only on its small German banking unit rather than Wirecard as a whole.

Wirecard wasn't classified as a finance company in previous assessments by BaFin and other institutions.

While its German bank and its UK unit were supervised by local regulators, oversight of the group company was essentially limited to whether it met the disclosure obligations to the German stock exchange – since when do share-brokers and stock markets become regulators?

The Wirecard scandal has undermining Germany's reputation (and auditor EY) as a place to do business; the broader question is raised who regulates the fintech industry?

TOTAL LACK REGULATION

The European Banking Authority (EBA) estimates 31% of European Fintechs are unregulated including: BNPL, cryptocurrencies, ‘white labelling’ of loans and credit cards, Saas banking models and pre-paid cards.

A Fintech company should cross the line into finance and all the regulatory scrutiny that entails when more than 50 per cent of its business is associated with financial activities like lending, payments and taking deposits, according to the EBA.

To get a payment licence, companies like Wirecard only needed to provide documentation on governance to national regulators and are required to keep their customer funds separate from their own revenues. Management should have been screened by regulators and the banking arms need to maintain a certain level of financial strength.

For some, the debate about changing or increasing regulation is a distraction from the failure by authorities like BaFin to enforce existing rules much earlier.

EZUBAO COLLAPSE

Ezubao collapse in 2017 seemed like a pure Ponzi scheme, but it trashed China’s regulators reputations and has still a recurring issue today, reflecting the way Jack Ma’s Alipay/Ant Group and all other Tech companies were treated is seen in stock prices.

Ezubao was P2P (peer to peer) lending?scheme-based Anhui eastern China. It was set up online in July 2014, attracting US$7.6 billion in deposit funds at its peak.

On 1 February 2016, the scheme was closed and 21 people were arrested.

It was billed as a successful ‘lending’ company. Instead, Chinese police said the online lender used fake business listings to acquire US$7.6 billion from nearly 1 million people expecting a 14 percent return.

Ezubao is the largest fraud ever reported in China. The U.S equivalent is Bernie Madoff who stole $17 billion in investments and Robert Stanford’s US$7.2 billion fraud.

Chinese P2P lending works by matching up an investor with someone looking to borrow, often promising double-digit returns on short-term investments.

P2P found fertile ground in China which lacks a unified credit ratings system, making it difficult for rural residents and smaller entrepreneurs to access consumer credit. While China’s middle class is flush with cash but distrustful of investing in China’s stock market or property.

China’s 2290 P2P lenders peaked at US$445 billion in receivables in 2017 with the industry rife with fraud and accounting issues. Regulators were reluctant to intervene (sound familiar?). The major concerns were that heavy regulation could cause financial chaos among P2P companies into which millions of people have poured their savings.

In 2017 several P2P platforms in Hangzhou, 170km from Shanghai, collapsed. Angry investors, unable to retrieve their money, engulfed the Shanghai public security bureau, demanding government action.

Balancing civic order and financial prudence is a major concern in China and the lack of response from regulators resulted in a change in approach.

It has taken China’s regulators four years to clean up the mess and has clearly impacted and resulted in different approach to other Fintech/Big Tech sectors

China has the world largest big tech lending reaching US$516 billion in 2019 and can be seen in the manor of regulation since.

It should be no surprise that China acted across the Fintech/Big Tech sectors after the P2P crisis and Ezubao. The lack of awareness among western commentators and media is also no surprise.

Major Risk Factors at Company Level

What the key risk factors to look for within a start-up?

A great list as complied by Neil Campling of Mirabaud Securities.

The equity research house stood out for being the only person to?put a price target of zero?on Wirecard the German payments processor which collapsed in June 2020.

Mirabaud have a list of 20 warning signs that they are looking out for in trying to determine the next “Big Fintech Disaster”. They are:

?1. Massively promotional CEO who actively looks for publicity and spends a lot of time courting Wall Street/investors etc and is very media savvy

?2. Huge CEO/Senior Management compensation package NOT tied to cash flow or Earnings but just to Sales and/or the stock price, creating the possibility of egregious wealth creation if the stock goes up a lot.?Huge pledging of collateral by the CEO in return for margin loans to fund a billionaire lifestyle

?3. Management?compensation generally way out of line with peers despite notably less profitability

4. Glossy future projections that have a habit over a long period of being proven to be too optimistic

5. Questionable product?quality, ie defects (boon??) or debatable technological leads over similar products

?6. Some evidence of self certifying, whether it be through strange international subsidiaries or not having an Auditor or experiencing unusual and slightly sudden end of quarter surges in revenues, up to and including the last day.

7. Unusual or unverified and large?Receivables in a business where the product is exchanged for cash up front

?8. Evidence that the company is?existing on a shoestring, not paying Suppliers, Employees, Landlords etc

9. Unusual margin progression, with?SG +A?going down over time despite a rising global footprint, or?GM's staying flat despite much lower ASP's over time, for instance.?

10. High levels of?Gross Debt. Cash balances not matched by notable Interest?Income thereby suggesting they are fraudulent

11. High employee turnover, especially in the LEGAL and FINANCE areas. Co-founders or Board members leaving.

12. Aggressive pursuit via paid third parties and/or “heavies” of any?critics or people who have too many questions, which in any case are “boring”

13. Dislike of Hedge Funds

14. Possible Narcissistic Personality Disorder on the part of the CEO. Additional points if he/she uses Twitter a lot

15. Large cabal of outcasts/weirdos/bloggers/Twitter groups who have been saying for years that everything is amiss but just get a lot of criticism because the stock keeps going up ergo they must be idiots

16.?Slowing top line growth?rate despite all the hoopla and supposed “growth stock” status. Evidence of competitors rapidly eroding unsustainably high market share.?

17. Loss making. Ideally never made a profit but likes to pretend it did or failing that, that it will for sure in 2-3 years due to highly questionable new products.?But the 2-3 years gets pushed out constantly

18. Extensive use/exclusive use of NON-GAAP Accounting and occasional bridging to get from a Net Loss to a (small) Net Profit via poorly explained one-offs/Other Items/unusually large Credits of some kind in a desperate attempt to get into an Index by illicit means

19. Weak Board, preferably also small and ideally?in hock in some way to?the CEO, who therefore do his/her bidding. Helps if some of them are related physically to the CEO.

20. Gullible media, gullible analysts and dozens of?paid bloggers who produce Price Targets out of nowhere based on “Option Value” or put another way products that are at least 5 years away from having any material impact.?

Note - Mirabaud Securities list published in FT Alphaville by:?Jemima Kelly June 27th 2020