Every banker has read the sensational headlines of massive funding rounds at almost unfathomable valuations for almost any company with a fintech moniker. They also know the narrative; bankers are greedy and dumb, credit unions are slow and can’t innovate, and morally superior (here again) fintechs are here to disrupt the trillion-dollar financial services industry, all driven of course by their altruistic motives and missions. After all, where else can you take a traditional subprime financial service, add a boatload of marketing, call it a fintech and get a multi-billion-dollar valuation?
While the amount of each funding and valuation is publicly hyped and celebrated, what has never been clear to the outside observer is the actual financial performance of these companies. With the recent spate of SPAC and bank charter filings, the fog in the valley of the unicorns appears to be lifting and the bright sunlight of public disclosure is shining down, revealing that perhaps some of those unicorns might be more akin to donkeys with a horn taped on.
A Case Study: Varo Bank (Varo Money Inc.)
For fintech-focused venture capital firms, the equation appears simple: growth = good. If a fintech can amass a million customers it is worth a billion-plus—the company can always figure out later how to actually generate a profit. But the equation in banking is more nuanced and complex. It includes capital, assets, management, earnings, liquidity and sensitivity (CAMELS). On top of every banker’s favorite desert companion, add a load of BSA/KYC/AML and IT, then add consumer compliance, a healthy dose of laws, regulations, and finally regulatory oversight and examination. Suddenly, the simple fast-growth formula of keep customer acquisition cost (CAC) to the lifetime value of a customer (LTV) at 1:3 or better and pour on marketing money to acquire customers as quickly as possible doesn’t quite seem up to the demands of a regulated industry in which consumers are broadly protected.
Varo Bank appears to serve as a revealing case study. The bank describes itself as “the first consumer fintech to be granted a national bank charter by the Office of the Comptroller of the Currency,” which it received with much fanfare about a year ago on July 31. But with that charter and the approval of Varo Bank’s holding company, Varo Money Inc., came the obligation of financial public disclosure. The following analysis is based on a review of the public press, SEC, FRB and FDIC regulatory filings.
I’ll caveat this analysis by revealing that I am not a venture capitalist, Wall Street investment banker or technology guru. I’m just a trade association executive trying hard every day to understand how the landscape of banking is changing. So, if I’ve missed something or got something wrong in my analysis, please let me know.
Varo Bank and its parent holding company appear to have raised just shy of half a billion dollars since inception. The investor list is a veritable who’s who of investors and celebrities with vast sums of wealth. Of that ~$500 million dollars, Varo Bank appears to have about $70 million remaining. Here’s where things get a bit dicey and perhaps Varo becomes the pin that pops the fintech valuation bubble.
At first blush, Varo’s narrative fits nicely within the unicorn storyline. Millions of customers and rapid (non-interest) revenue growth—in fact, more than 100 percent growth of $13.8 million from Q4 2020 to Q2 2021 ($11.5 million to $25.3 million) and No. 7 on the 2021 Inc. 5000 list. Unfortunately, the growth narrative also extends to Varo’s non-interest expenses too, which grew at an even faster pace during the same period, increasing $25.4 million from $49.3 million to $74.7 million. Said another way, for every $1 of revenue growth, expenses grew $1.84.
This ratio of revenue to expense has negatively impacted Varo Bank’s bottom line where the bank’s losses in just the first half of 2021 total $103.9 million. That’s more money than Varo Bank has remaining in capital and a cash burn rate of more than $575,000 per day in 2021. What’s more, the losses accelerated from Q1 to Q2, with Varo’s Q2 cash burn rate increasing to more than $645,000 per day. Varo Bank’s call report also shows only $67 million capital remaining in the bank as of June 30, 2021. At its Q2 burn rate, the $67 million would reach $0 in just over 100 days, or by mid-October. Well before Varo Bank’s capital reaches $0, it would cross the threshold of being categorized as “less-than-well-capitalized” and a host of regulatory restrictions would come crashing down on the bank.
Turning our analysis to assets, it appears Varo’s management is aware of this potential impending crisis and has been offloading assets to increase capital protection. Varo Bank might be one of the only banks in America whose assets have shrunk in 2021, decreasing from $515 million at the end of 2020 to just $248 million on June 30, 2021. Assuming Varo Bank continued its Q2 burn rate and holds assets steady at $250 million, it would become less-than-well-capitalized based on its leverage ratio by late September, at which point prompt corrective action provisions would become effective.
The company has issued assurances that everything is fine and Varo Bank is successfully executing its slow-and-steady-wins-the-race strategy to reach profitability, noting that most de novo banks have losses their first two years. But there is one big difference between de novos and Varo Bank. Most de novo banks have sufficient capital to make it through those two years without needing to raise more capital. That does not appear to be the case for Varo as it appears it is reliant on raising new capital, and lots of it, just to survive to the end of the year.
One can likely assume that the leadership of the bank is working feverishly to raise new capital and perhaps just as likely that inside the OCC conversations are occurring at a similar pace about what to do given that Varo’s charter is barely past its first anniversary.
If nothing else, Varo will stand as a cautionary tale. The OCC’s desire to issue fintech charters should be tempered heavily by the Varo experiment. And the losses of Varo should be held as a barometer for capitalization of any future fintech, especially for any that will pose a direct threat to the deposit insurance fund.
Industry experts have decried special regulatory treatment and an uneven playing field for fintechs. It is well within reason to say that Varo has been treated differently than other banks. And we have to ask why that is. Would any community bank with losses so large that it would appear to only have 100 days of capital remaining not be placed under a public FDIC or OCC consent agreement with a capital maintenance provision?
As I wrote before, there may be something that I don’t see, and Varo may be on the verge of great success. I have some thoughts on what might have gone wrong and what community banks can learn from this case study. You’ll have to wait for part 2 of this article for that. I’ll share a deeper dive into Varo Bank’s public financial statements and business strategy in the next week or two.
In the meantime, stay tuned as this story develops with one of two things likely to occur before Halloween: either Varo announces a large capital raise or a federal regulator announces a public enforcement action—or perhaps both.
Christopher L. Williston VI is president and CEO of the Independent Bankers Association of Texas, based in Austin.