Yannis Zurmpanos
Summary:
- SoFi grew from a student loan provider to a major fintech company, growing its member base from 1 million to nearly 7 million in three years.
- The company has diversified its offerings, including investment products and credit cards, with a focus on "financial services performance cycle."
- SoFi's adoption of a bank charter led to a more intensive approach to the balance sheet, which grew to $28 billion in assets and a strategic shift toward more lending.
- The company is on track to achieve GAAP profitability by improving profitability and marketing efficiency, as well as effectively managing risk across its growing loan portfolio.
If you are SoFi Technologies Inc. (SOFI, Financial), you may recognize it as the epitome of a disruptive fintech company's extraordinary trajectory.
Originally founded as a convenient student loan provider, SoFi has evolved into an integrated financial solutions provider. Targeting a young, tech-savvy customer base, the company aims to offer affordable and convenient financial services at the touch of a button.
FinTech revolution
Over the past five quarters, the company has grown adjusted net income by an average of 43.1% (annualized) each quarter. The platform's membership (yes, they passionately call their customers members) grew from 1 million in early 2020 to nearly 7 million in Q3 2023.
The reason they nominate their customers as investors is their strategy to seamlessly engage and solve their immediate financial problems through a combination of data-driven insights and technology innovation, which SoFi calls the "customer performance cycle." Financial services.
After providing customers with security through savings or loan products, the company gradually expanded its offerings to include investment products, credit cards and features such as SoFi Relay, which allows customers to consolidate their bank account information and financial services in one convenient one-stop shop. platform. In September, SoFi's financial services products were 5.6 times its credit products.
With its comprehensive financial services platform, SoFi has grown its membership at a compound annual growth rate of 66.7% over the past three years. Membership will have a high growth trajectory in the coming years due to network effects and multi-layered added value for customers.
Additionally, SoFi has reached new heights using a traditional asset-based fintech model that typically grows without significantly expanding its asset portfolio, achieving a revenue-to-asset ratio of 7%. In comparison, similar fintech companies such as Affirm ( AFRM , Financial ), Block ( SQ , Financial ) and Paypal ( PYPL , Financial ) maintain revenue-to-asset ratios between 21% and 64%.
In contrast, institutions like Coinbase ( COIN , Financial ), Robinhood ( HOOD , Financial ) and SoFi have lower income-to-asset ratios, ranging from 2% to 7%. Therefore, SoFi positions itself in the group of fintech companies with large balance sheets.
Source: author's collection
Growth from a fintech pioneer to a true banking powerhouse
SoFi has evolved into a global bank, adopting a bank charter and asserting its identity as a financial institution with fintech DNA. This transition has strained the company's balance sheet, as evidenced by a significant 3.5-fold increase in its asset portfolio to $28 billion over the past two years.
As a full-fledged bank, SoFi is now subject to regulatory requirements that require strong capital to support its expansion. Striking a balance between the size and growth typical of fintech companies and the significant capital base required for banking operations, the company has deftly maneuvered it in search of a strategic balance.
CEO Anthony Noto noted in his latest 10Q10 earnings report that the company's credit side will drive growth and that the technology platform and financial services segments are growth drivers because they are capital-constrained businesses.
This statement shows that management's preference for growth is through low-cap companies, but current business drivers are largely skewed towards high-cap companies, especially in the credit sector. This business, which is still in its early stages of development, faces potential changes as it evolves.
SoFi's profit mix changed as net interest income became the dominant factor in its profit mix, reflecting the company's strategic shift to making more loans than selling them. Sales of loan originations fell to 6.80% in the third quarter from 57% in the first quarter of 2022, so there could be two reasons for holding on to loans rather than selling them.
The first reason is that management can embrace the idea that they can act like a bank and not just be a platform to make loans and sell them to others. On the other hand, management is delaying the sale of these loans to avoid losses due to rising interest rates, which may have peaked. When interest rates fall, there will be a good opportunity to profit.
Source: author's collection.
The company's original lending business model was a distribution model from the start, in which SoFi acquires loans and then sells them for profit or transfers them through securitization. The effectiveness of this model is currently limited, as there was a significant decline in sales during the reporting period.
These assets are now mainly funded by deposits, as SoFi can attract deposits with attractive offers. Interest-bearing deposits protected 61.3% of interest-bearing assets in September, up sharply from 5.1% in March 2022. It is worth noting that this funding is more stable and is mainly received by the participants. This change has the dual purpose of reducing the cost of funds and giving SoFi more control in seeking funds to expand its assets.
Finally, SoFi's path to becoming a full-fledged bank is to increase its capital base, but at the same time, the need for large capital banks is also increasing.
On the road to profitability
In its latest 10Q10 earnings report, management outlined the path to GAAP profitability in the final quarter of 2023 and over the next few years. The company recorded an increase in profits, and perhaps this is the direction that the management continues to follow.
Currently, the dominant income structure is net interest income. Net interest margin may increase due to lower financing costs and increased investment in high-yield consumer loans. In the third quarter of 2023, the net interest margin was 5.99 percent, compared to 5.86 percent last year.
The company also achieved marketing efficiency. Last quarter, marketing spend per new member fell 17% quarter-on-quarter and 32% year-on-year. As a result, SoFi increased its Ebitda margin year-over-year by 700 basis points to 18%.
Master the art of smart risk-taking in expanding master markets.
Around 1980, a reporter asked Howard Marks (trader, portfolio) who could find great investment opportunities in distressed assets. Marx replied, "How can life insurance companies insure a person's life if they know they are all going to die?"
The teacher used the phrase "smart risk taking for profit" to indicate that an investor is not wrong to take risks when the risks are measurable, manageable and profitable.
Many may look at SoFi's aggressive expansion of its loan portfolio as risky. Risk becomes a problem when a company fails to manage it well. SoFi has effectively managed its credit risk, and bank loans consist of student loans, personal loans and home equity loans. Similarly, consumer loans stand out as a key catalyst for loans, representing a highly profitable segment of the loan portfolio.
Surprisingly, FICO scores remained high across all segments. As of September 2023, the weighted average FICO scores for personal, student, and home loans were 744, 781, and 755. Meanwhile, SoFi Relay's growing user base (the source of all users' financial data) gives the company a significant data advantage. for processing. effective credit classification and risk management.
SoFi maintains a strong Tier 1 capital position. Although the capital adequacy ratio has a downward trend, it remains above the minimum requirement. A typical challenge for bad banks is the potential for capital constraints to support long-term loan portfolio growth.
Finally, since the company is on a path to profitability and loan sales are likely to increase when interest rate conditions are favorable, this ratio should improve in the coming quarters.
Source: author's collection
Final thoughts
SoFi's evolution from a specialty student loan provider to a dynamic financial and banking leader demonstrates innovative growth, strategic risk management and strong capitalization.
Finally, by adopting a balance sheet-intensive approach, SoFi is poised to achieve future scale and profitability by combining the agility of fintech with the power of traditional banking, thereby transforming the financial services landscape.
Disclosure of information
I/we currently hold positions in these stocks and do NOT plan to sell any or all positions in these stocks within the next 72 hours.
