WORKWEEK

#1: How Were Your Grades? 

What happened?

Revolut claims that it was profitable in 2021:

Financial technology giant Revolut reported its first-ever annual profit in 2021, according to financial accounts released Wednesday, as subscriptions to its paid packages and overall usage of its app grew sharply.

The company reported revenues of £636.2 million ($767.1 million) for the year, three times what it made the previous year, and swung to a pre-tax profit of £59.1 million. In 2020, Revolut recorded a pre-tax loss of £205 million.

Asked about Revolut’s valuation Wednesday, Salovaara said he couldn’t say how much the firm was worth since it hasn’t raised cash since 2021, but he’d be “hard pressed to believe investors wouldn’t continue to be pleased with our performance.”

So what?

You may recall me writing about this a while back when Revolut was getting in trouble with regulators in various European countries for repeatedly missing deadlines for reporting their 2021 results. The basic issue was that regulators were finding the earlier fillings prepared by Revolut’s auditor (BDO) inadequate.

Well, here we are. We have the results, and they are interesting!

Here are some details:

• The company reported £636.2 million in revenue and a pre-tax profit of £59.1 million in 2021.
• The majority of that revenue came from a category called “foreign exchange & wealth,” which includes a bunch of stuff, but the big one is crypto. Crypto was a major driver of Revolut’s profitability in 2021, which is concerning given that almost all of that revenue could, very conceivably, not be there in 2022 and 2023 (given the broader crash in crypto).
• BDO included a really interesting “qualification” in its audit (which is unusual), basically saying that, because of limitations in Revolut’s control environment, they were unable to verify important details about £477m of revenue. That represents 75% of Revolut’s total revenue in 2021, so this is interesting. The Financial Times had a take on this, which Revolut pushed back on in a quote from an anonymous spokesperson. 
• Revolut continues to push, very strongly, for a U.K. banking license, which it told CNBC it expects to get before the year is out.

What should we make of all of this?

Here’s an imperfect but directionally-useful analogy.

Imagine a high school student whose parents ask her how her grades were for her freshman year. Even though they ask her during the summer after her freshman year, she doesn’t answer until after the first semester of her sophomore year. She says, “Great! I got a 3.1 GPA”. Her parents say, “cool, but how did you do in each class? Particularly in that weird advanced placement class that is graded on a five-point scale and is supposed to be super easy to pass? What was it called? Math for the Morally Flexible? She gives some vague and unsatisfying answer and then says, “remember the deal where I get a car if I get all Bs for the first two years of high school? Should we start shopping for that now?” 

I mean, everyone has a different parenting philosophy, but personally, I don’t think I’d be buying her the car quite yet!  

#2: Fractional Reserve Banking Works … Even for Crypto

What happened?

Elsewhere in crypto-banking news:

Silvergate Capital, one of the crypto market’s top banks, said that recent events leave it at risk of being “less than well-capitalized” and that it is evaluating the effect those events have on its ability to continue as a going concern.

Shares of Silvergate were off 25% in after-hours trading. Its latest statement came as part of a Wednesday afternoon regulatory filing, in which it also said it wouldn’t be able to file audited financial statements to regulators on time.

So what?

The irony of this story is just incredible.

A common thing that I hear from crypto true believers is that we need an alternative, fully decentralized financial system because banks aren’t trustworthy, and fractional reserve banking is a scam. The argument, according to this line of reasoning, is that your money isn’t safe at traditional banks because they’re not actually holding most of it in their vaults. If all of a bank’s customers asked for their money back at the same time, the bank wouldn’t be able to do it!

This is theoretically true, but it never actually happens in practice. I mean, outside of a panic-induced bank run (which we’ve built very effective mechanisms to prevent), in what scenario would every one of a bank’s customers ask for all their money back at the same time?

Shares of Silvergate Capital sank 42.7% on Thursday after the crypto-focused bank released preliminary fourth-quarter results that showed massive customer withdrawals.

Total deposits from digital asset customers declined to $3.8 billion from $11.9 billion at the end of the third quarter, a decline of roughly 68%.

Ohh yeah, right. If you narrowly focus on banking the crypto industry, particularly the crypto exchanges, then yeah, everybody might just ask for their money back at the same time. This is a danger that the Fed, the FDIC, and the OCC recently warned banks about:

Deposits placed by a crypto-asset-related entity that are for the benefit of the crypto-asset-related entity’s customers (end customers). The stability of such deposits may be driven by the behavior of the end customer or crypto-asset sector dynamics, and not solely by the crypto-asset-related entity itself, which is the banking organization’s direct counterparty. The stability of the deposits may be influenced by, for example, periods of stress, market volatility, and related vulnerabilities in the crypto-asset sector, which may or may not be specific to the crypto-asset-related entity. Such deposits can be susceptible to large and rapid inflows as well as outflows, when end customers react to crypto-asset-sector-related market events, media reports, and uncertainty. This uncertainty and resulting deposit volatility can be exacerbated by end customer confusion related to inaccurate or misleading representations of deposit insurance by a crypto-asset-related entity.

This sudden and massive outflow of deposits at Silvergate, which, again, had nothing to do with concerns about Silvergate itself, forced the bank to liquidate a bunch of its assets (which were mostly very boring and safe things like bonds) at a loss in order to cover all of the deposit withdrawals. And now that Silvergate is struggling to maintain sufficient capital ratios, the rest of its crypto customers are also pulling their money:

On Thursday, the crypto firms Coinbase Global Inc., Circle Internet Financial, Paxos Trust Co. and Galaxy Digital Holdings Ltd. all announced plans to stop banking with Silvergate.  

The crypto market crash somehow managed to simultaneously demonstrate that A.) fractional reserve banking works great (Silvergate honored all deposit withdrawals) and B.) one of the only things that can cause a run at a regulated bank these days is a high concentration of crypto-related deposits!   

#3: Amazon Gets the Better Deal

What happened?

Amazon has entered into an interesting partnership:

Amazon employees will soon be able to use their company shares as collateral when buying homes, under an arrangement with online mortgage lender Better.com.

A new Better.com product, Equity Unlocker, will allow employees to pledge stock for loans for down payments, the companies said, rather than having to sell the stock to raise cash.

So what?

The idea of leveraging investment assets as collateral for a loan is always risky. The question is, how is the risk shared?

Better appears to be hedging its bets:

To protect itself from a continued slide in Amazon’s stock price, Better.com will charge a higher rate on the mortgages of employees pledging stock—between 0.25 and 2.5 percentage points above the market rate, depending on how the down payment is structured, the company said.

But so is Amazon:

unlike in stock-based loans that carry the risk of margin calls, requiring borrowers put up more collateral or sell assets to reduce debts, Amazon employees’ loan arrangements would be protected if the stock price slides, Better.com Chief Executive Vishal Garg said in an interview.

Overall, it feels like Amazon came out on top in this deal. Better has some downside protection, but Amazon and its employees appear to have no downside. Given its recent troubles, I guess Better didn’t think it could do any … well, better.  

#4: Definitely, Maybe

What happened?

Goldman Sachs has a plan. It definitely has a plan:

Goldman Sachs Group Inc. set out to reset the narrative and breathe new life into its stock. Investors aren’t buying it just yet.

Chief Executive Officer David Solomon got visibly flustered as analysts pressed him to explain the apparent divergence between promising to scale up operations such as credit cards and installment lending, while signaling parts could also be sold.

“This is an albatross around Goldman’s neck,” Gerard Cassidy, a banking analyst with Royal Bank of Canada said of the consumer business in an interview, adding that it was disheartening to hear that it’s not going to break even until 2025.

“They could have come out and said we made an error, we are putting it all up for sale, and it’s egg on our face,” he said. “They could have said we are committed to this business and turn it profitable through organic means. But having a blended message was a confusing one. Are you going to keep it or are you going to sell it?”

Goldman has already scaled back its consumer ambitions, folding what’s left into a segment called Platform Solutions — a collection of units that the firm has blamed for almost $4 billion in losses over the past three years. 

So what?

I’ve followed Marcus and the associated “platform solutions” business at Goldman Sachs pretty closely since its inception, and I am at a complete loss to explain how it has lost 4$ billion in the last three years and how it won’t break even until 2025. 

How is this possible? How has Goldman not figured out a coherent strategy for generating any type of long-term synergies between its retail banking and investment banking businesses?

And given where things are today, why not just pull the rip cord?   

#5: Helping Merchants Sell More is Always Smart Business

What happened?

Klarna reported big losses in 2022, but optimism for the near future:

Swedish payments group Klarna aims to return to profit by the summer, the “buy-now, pay-later” company said on Tuesday, as it reported wider losses for 2022 but an improving performance in the fourth quarter.

Klarna posted a full-year operating loss of 10.5 billion crowns ($1 billion) against 6.6 billion crowns in 2021. Gross merchandise volume (GMV) – the value of goods purchased through Klarna – was up 22% and revenue growth was 19%.

So what?

Some interesting additional facts about Klarna:

• The U.S. is now Klarna’s biggest market by revenue. The company now has 34 million users in the U.S. and 8 million monthly active users in the U.S.
• The company’s credit losses and non-credit operating expenses both fell on a year-over-year basis in Q4 2022, which suggests progress towards that “profitable by this summer” goal. Specifically interesting – credit losses in the U.S. were down 37%, suggesting, perhaps, that more experience in the market has led to better underwriting results (this has been a pattern in other countries Klarna has expanded into).  
• Klarna’s fastest-growing business line isn’t lending. It’s marketing. The company reported that marketing revenue increased by 131% year-over-year, driving over 600 million clicks to retailers during the year (a 111% YoY increase).

It’s the last bit that most interests me.

A mistake that fintech companies and other non-banks make when trying to change the way that consumers buy stuff is to focus on bribery. Everyone tries some combination of lowering costs for merchants and offering rewards or discounts to consumers. The theory is that merchants hate interchange and consumers love rewards.

It mostly doesn’t work.

Consumers like rewards, but what they really like is buying stuff. A product that helps them buy more stuff is very appealing.

Merchants care a bit about reducing costs (Walmart is obsessed with it), but what they really like is selling stuff. A product that helps them sell more stuff is very appealing.

One macro story that you can tell about BNPL is that it initially evolved as a tool to help consumers buy more stuff (0% financing) and help merchants sell more stuff (0% financing + marketing tools). As interest rates and inflation went up and consumer credit quality started to get concerning, smart BNPL companies put less emphasis on the 0% interest lending part of their business and a lot more emphasis on the marketing part.