SoFi Is Digging A Wider Moat

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SoFi Is Digging A Wider Moat

Seeking Alpha2023-09-01

SoFi's moat is expanding as they execute their all-in-one financial app strategy and differentiate themselves from competitors.SoFi is experiencing strong deposit and member growth at decreasing ...

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Hungry4More
·2023-09-01
Great potential
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NealRiggers
·2023-09-01
Sofi is an undervalued stock. Clear winner in Fintec space for 2023.
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differentiate themselves from competitors.SoFi is experiencing strong deposit and member growth at decreasing ...</p>\n\n<a href=\"https://seekingalpha.com/article/4632387-sofi-digging-wider-moat\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"BK4549","symbol_name":"软银资本持仓","start_time":0,"source_url":"https://seekingalpha.com/article/4632387-sofi-digging-wider-moat","article_id":"2364173542","we_media_id":null,"thumbnails":[],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2364173542","pubTimestamp":1693534437,"sourceInfo":{"source_id":"seekingalpha","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"Are they carving out a defensible niche and creating differentiated products that lead to better outcomes?Is there an inherent network effect being created or a superior brand being 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sustainable growth.tamara_kulikovaA common refrain I still hear from people who do not think SoFi (NASDAQ:SOFI) is a good investment is that there is significant competition and that SoFi does not have a moat. If a business doesn't have a moat, it means there are low barriers to entry, anybody can just copy the business, and it is impossible to build a business that outperforms competitors. I previously discussed both SoFi's consumer-facing moat as well as their technology moat. After their strong 2Q23 results, it is an excellent time to revisit this discussion.With the rare exception of heavy patent protection, a moat takes time to dig and fill with water. Moats aren't just bestowed by the investing gods, they are built through exceptional execution. What determines whether SoFi will be \"just a bank\" or the \"winner take most in the fintech space\" is their execution.This leads to one of the core tenants of my examination of a company's moat. While the size of the moat is very important, sometimes what is more important is whether the moat is expanding or contracting. Is the business executing in such a way that their competitive advantages are expanding relative to their peers? Are they carving out a defensible niche and creating differentiated products that lead to better outcomes? Is there an inherent network effect being created or a superior brand being built? Those are hard questions to answer directly, but the results invariably show up in the numbers.SoFi CEO Anthony Noto is fond of saying that when he joined in 2018 that everyone was talking about being an all-in-one financial app, but that SoFi is the only company who has actually done it. However, up to this point, SoFi's moat has been mostly theoretical. They say a one-stop shop should allow for a better experience and cross selling. They argue that it will increase user engagement and drive greater lifetime value from their members. Essentially, it should make SoFi's results differentiated from their competitors. The data are showing that to be the case. The moat is expanding.Financial Services OutperformanceDepositsSoFi has a focus on getting new members to move their direct deposit to SoFi. That is because the bank where you send your direct deposit is almost always your primary bank, and your primary bank is where you keep most of your money. Here is what was said on the earnings call about deposit growth:From a balance sheet perspective, our unique value proposition in SoFi continues to fuel high-quality deposits, that increased by $2.7 billion sequentially and we ended the quarter with nearly $12.7 billion in deposits. Importantly, more than 90% of our consumer deposits are from sticky direct deposit members, and nearly 98% of our deposits are insured.Big deal, SoFi is getting a lot of deposits because it's offering a high APY on their savings account (4.5% at the time of writing), right? Ally (ALLY) currently gives 4.25%, LendingClub (LC) clocks in at 4.5%, Discover (DFS) is at 4.3%. SoFi and LendingClub are equal now, but LendingClub actually had higher APY than SoFi for the entirety of 2Q23. If it all came down to APY, LendingClub should have been the biggest winner, and all the others should have also seen significant deposit growth. Credit to Vadim Kotlarov for this graphic.Quarterly deposit growth of large neobanks (Vadim Kotlarov)Every neobank has seen deposit growth over the past year as they've been taking customers away from incumbent banks by offering higher APYs than the likes of JPMorgan (JPM), Wells Fargo (WFC), and Citigroup (C). However, peak deposit growth for most neobanks was 4Q22 and they've all seen a steep drop in growth thereafter. There is one exception. SoFi's deposit growth has continued to accelerate. LendingClub even saw deposits shrink in the last quarter despite offering higher rates that SoFi the entire quarter.When I see a definitive trend reversal like that across an entire industry with one outlier who bucks that trend, I take note. Especially when on the face of it there is no reason for it. It isn't like SoFi gave higher APY or even higher signup bonuses during these last two quarters than before. They didn't increase marketing spend, as we'll see in a second, they just outperformed the competition because of something innate about the product. This is a testament to the fact that their product is differentiating itself in other, less obvious ways. This is what a moat looks like.Member growth at low customer acquisition costSoFi is paying less in customer acquisition costs (CAC) than they have in well over a year while simultaneously adding more members than they ever have before. As CEO Anthony Noto's described it in the earnings call:And I think this quarter is the first quarter that I can say, I feel really confident the flywheel is working. And what I mean by that is, we're seeing efficiencies in our customer acquisition cost. And those efficiencies are really more correlated with the unaided brand awareness being increased in addition to the fact that our marketing and product teams are iterating every day through technology and content information analytics to drive those efficiencies. […] It's the holistic approach that we've taken over the last 5.5 years that is really starting to pay off in the quarter and as we look into Q3 as well.I love that he said that this trend is continuing into Q3 as well. One quarter of lower CAC and high member adds is not definitive proof that they truly have turned a corner. However, the increase in brand awareness they highlighted in the earnings call also provides data that supports this trend. If CAC can stay low as quarterly new members climb, it would be another piece of evidence that the moat is growing.SoFi quarterly customer acquisition cost (Author)SoFi quarterly new member growth (Author)Lending OutperformanceLast November I wrote that SoFi was pulling away from LendingClub and Upstart (UPST), the two other fintech companies who operate primarily in the fintech lending space. All three of them, at the moment, rely on personal loans as their main source of revenue and income. They all compete for borrowers and selling loans to the same debt investors. I'll provide a little more nuance into the different business models below, but I think the performance of these three companies since that article proves my analysis at the time was prescient. The differentiation of SoFi from its competitors is only getting more obvious over time.Quarterly revenue of SoFi, LendingClub, and Upstart (Author)Macro BackdropAll three of these fintech businesses have to deal with a supply and demand issues on two fronts. On one front, they are offering to lend money to those who want a personal loan. These potential customers may be trying to refinance high variable rate credit card debt into lower fixed rate personal loans, renovating their house, financing solar panels, or any other reason. I'll refer to this as borrower demand, and it is extremely strong right now. People are looking at their credit card statements, feeling the pain, and seeking to refinance that variable rate debt into a lower fixed rate.How borrower demand and investor demand affect lenders (Author)On the other side of the equation are debt investors. These are banks and asset managers such as hedge funds, sovereign wealth funds, pension funds, etc. These are the entities that buy loans from companies like SoFi, LendingClub, and Upstart. All three of these companies sell loans to these debt investors, and depend on them for liquidity and, to an extent, their revenue and profits. I'll refer to this as investor demand, and right now it is weak. As a result of the banking crisis, most banks are actively looking to offload assets like personal loans to decrease their risk profiles and increase liquidity. Bank demand for personal loans is very low and in fact they are selling loans. This results in excess supply of assets at the moment. Asset managers are happy to step in, but the increase in supply means that they can be very picky about the pricing and the quality of the loans they are purchasing. The result is that investor demand is very weak right now.Business Model DifferencesI like to give context for my analysis, so let's briefly review the similarities and differences between SoFi, LendingClub, and UpstartUpstartUpstart's target market is near prime and subprime candidates whom Upstart believes are higher quality borrowers than their FICO score would indicate. They do not disclose the average FICO score of the loans they fund or refer to their partners. Upstart, for the most part, tries not to hold loans on the balance sheet. They use their machine learning algorithm to determine credit worthiness and approve or deny the loan at a given APR. The majority of their revenue comes from fees they charge up front for finding and approving the loan. They let someone else hold the loan, collect interest, and take the default risk.Upstart has two cohorts of buyers of their loans, partner banks and the asset managers mentioned above. Partner banks can use Upstart as the de facto credit check service for their own customers and also can house loans that Upstart approves through its platform. They grew originations like crazy during the zero interest rate policy (ZIRP) days. However, Upstart immediately ran into issues as soon as rates started to increase. Origination growth was only positive 1Q22 because Upstart stepped in and used their balance sheet to fund loans. While they have continued to use their balance sheet, it hasn't been enough and demand to buy their loans has completely collapsed. Originations plummeted for 4 straight quarters before seeing a slight uptick in 2Q23.Upstart Quarterly Originations (Author)LendingClubLendingClub targets near-prime, prime, and prime plus customers who are serial users of credit. For loans they hold on their own balance sheet, as of 4Q22, the average FICO score was 729 and the average income was $116,000. The entire servicing portfolio, which includes loans they've sold to others, had an average FICO of 717 and average income of $113,000 at that same time. They stopped disclosing those numbers in 2023.LendingClub also has two cohorts for the loans they originate. The first is themselves. LendingClub is a bank and takes a portion of their loans and puts them in their \"Loans Held for Investment\" (HFI) portfolio. These are loans that LendingClub intends to hold on their books through maturity. The remaining loans are sold on what they refer to as their marketplace, which is comprised of the same type of debt investors referred to above. So they have a pretty steady rate at which they add loans to their own HFI portfolio as the existing loans are paid off, and then a variable amount of loans they sell on top of that. The amount of variable loans they sell fluctuates, but right now it is limited by investor demand from their marketplace.In their 2Q22 earnings call, LendingClub warned that the marketplace demand might soften as rates rise. CEO Scott Sanborn explained, \"For certain investors, their funding costs will move based on the forward curve, meaning where the fed is expected to go. These investors are seeking more yield to cover their increased costs.\" Investor costs move with where people expect rates to go, so their costs went up faster than the actual funds rates. LendingClub's loan pricing, by their own admission, lags the Fed Funds rate hikes by at least a few months. Investors were getting squeezed with higher costs now but the loans they were buying did not yet have higher interest rates to offset those costs.LendingClub Quarterly Originations (Author)This is exactly what happened. During 3Q22, marketplace originations dropped 15% from $2.82B to $2.39B, correspondingly dropping their revenue from those loans from $213.8M to $181.2M. This drop in marketplace originations has continued every quarter for the past year. Part of the reason for the marketplace drop is because they keep the highest quality prime and prime plus loans their HFI portfolio and sell the lower quality prime and near prime loans to investors.SoFiNow let's move on to SoFi. SoFi employs a slightly different model to Upstart and LendingClub. Rather than have two separate cohorts for their loans, SoFi holds all originated loans on their own balance sheet for a period of time before selling them on to debt investors. They previously guided for 6-7 months holding period, but right now they've been holding them much longer because of the weakness in investor demand. In this way, SoFi's balance sheet acts more like a shock absorber, giving them liquidity and optionality. SoFi can absorb or release loans as needed. As CEO Anthony Noto put it previously:We run to where the opportunity is. And in some quarters, that opportunity may be driven by being able to raise WACC. In some quarters, the opportunity would be driven by a really strong securitization market. And some quarters are going to be driven by a really strong wholesale market.Right now, the opportunity lies in gobbling up market share of their core target demographic - high-earning, high-quality customers not well served by the current banking system. As Upstart and LendingClub are slowing originations, SoFi has continued to increase them. In 1Q22, SoFi was only originating less than 2/3 the volume of personal loans as LendingClub and less than half the volume of Upstart. Now they are originating a little under double LendingClub and more than triple Upstart.SoFi Quarterly Originations (Author)SoFi's borrowers are also the most affluent and highest quality of the three companies. Their personal loan borrowers have an average FICO of 745 and an average income of $164,000. Furthermore, SoFi has actually been front-running the fed's interest rate hikes. They raised the APR they charge their borrowers faster than the Fed hiked rates and faster than their competitors. They could do this because of the the strong demand caused by their network effects. Raising rates faster than competitors and simultaneously increasing originations is a differentiated result. Their key underwriting variable is cash flow, because they want to make sure that borrowers have excess monthly cash flow to cover their loan payment.Why SoFi is WinningAll three of these companies have a ton of borrower demand at the moment, so that does not explain the discrepancy in originations. SoFi is proving their lending moat is expanding in three ways: superior availability of funding, choosing resilient customers, and better underwriting.Availability of FundingLC underwent origination growth in 2021 and 2022 after receiving their bank charter in December 2020. However, their marketplace originations have tanked in 2022 and 2023 because of rising rates and tightening credit as described above. They do not leave room on the balance sheet to absorb any fluctuations in investor demand, so marketplace originations boom and bust in real time with fluctuations in investor demand.Upstart has virtually no control over their funding sources, so they are almost completely dependent on the whims of the economic environment. LC has been able to maintain some stability in originations because they hold a portion in the bank to maturity and can replace those as they hit their term. When demand from banks and asset managers for new loans dries up, Upstart gets hit the hardest. They have had to give preferential pricing and take on extra risk to supplement volumes in hard times. It is not a durable business through a full market cycle. Upstart the most cyclical of the three businesses.SoFi got their bank charter in 1Q22. They have had significantly more flexibility to add loans to their balance sheet throughout 2022 and 2023 because they are the funding source. It's part of the plan to be vertically integrated across the entire business and own the whole process.SoFi's business model to hold loans on the balance sheet for a variable amount of time and then selling them when the economics make sense appears to have given them the most flexibility to combat the economic turmoil caused by the rapidly rising rate environment. It even compares favorably to LC's business model even though both have bank charters. The timing of the bank charter was also fortuitous, no doubt about it, and has allowed them to continue scaling because they had plenty of room on the balance sheet to hold their own loans. However, I would argue that the business model is still superior because of the extra flexibility it gives them. Business model and execution are part of SoFi's expanding moat.SoFi, LC, and UPST quarterly originations (Author)Resilient BorrowersSoFi's decision to only loan to affluent and high quality borrowers is a part of the business model that makes them resilient. SoFi could easily have loosened credit standards in the easy money ZIRP days. They did not. Instead, they deliberately built a robust business model that can grow through an entire cycle. LC and Upstart leaned into lending to lower quality borrowers during the ZIRP days to boost growth, but as investor demand pulled back, they have been forced to move up the value chain to higher quality borrowers.SoFi was already focused on a higher quality pool of borrowers and has not seen their potential clientele shrink in the same way. In fact, SoFi's all-in-one platform has attracted record members. This has allowed them to grow originations more than 6x from $614M in 4Q20 to $3.7B in the most recent quarter without compromising on credit quality.SoFi total members by quarter (Author)SoFi chose an antifragile business model and it has resulted in consistent and sustainable growth through the significant headwinds that all three businesses have faced in the last year and a half. That means they are now far and away the market share leader in the fintech personal lending space, and even more so in their credit box. This gives them an advantage to maintain that position moving forward. When the credit cycle turns and demand returns, they will be in position to ramp originations to maintain their place as the leader, selling loans as required at a profit to facilitate the increasing volumes.Better UnderwritingSoFi's credit outcomes are demonstrably better. The first reason for this dovetails with their resilient clientele. Higher quality borrowers hold up better in adverse economic conditions. Deliberately targeting that cohort of borrowers was a choice that is now paying dividends for the business.Upstart publishes what they refer to as their Upstart Macro Index or UMI. It gives a value that predicts how many of their borrowers will default on their loans relative to historical norms. If default rates are normal, UMI is 1. If loans are overperforming because of the macro environment (e.g. the government gave out a bunch of stimulus checks), UMI is less than 1. If loans are underperforming (e.g. stimulus stops and inflation is at 40 year highs), the UMI is above 1. UMI has literally never been higher than it is today. Upstart's borrowers are defaulting 70% more often than normal.Upstart Macro Index (Upstart)SoFi outperforming Upstart is to be expected as affluent customers are more resilient. That does not explain how SoFi is seeing lower defaults than before the pandemic. LC's borrowers are ostensibly in the same credit box at SoFi, yet LC borrowers defaults crossed over prepandemic levels in 1Q23. SoFi just reiterated again in their 2Q23 earnings call that their credit outcomes are still better than they were before the pandemic. Not only that but their default rates actually decreased between 1Q23 and 2Q23.SoFi Personal Loan Default Rate (Author)I do not know of a single lender of any type - bank, fintech, or otherwise - who can make that same claim. SoFi's underwriting is best in class and leads to better credit outcomes. This is what a moat looks like. When SoFi's balance sheet does eventually fill, it stands to reason that their superior credit outcomes and higher rates charged on their loans should allow them to find buyers for their loans easier than competitors. This is a claim that cannot yet be proven with data, but we can track in the coming quarters. LC did mention in their earnings call that the one bright spot for investor demand is for their seasoned prime personal loans. That just so happens to be exactly the type of loans SoFi has in abundance.The moat is expandingExceptional companies differentiate themselves in the hard times. The data supports the argument that SoFi really is building a business that is better than its peers. SoFi has a robust business model built on a more resilient client base. They utilize superior underwriting. They are continuing to accelerate deposit growth. Essentially, they offer an all-in-one platform that is taking market share for banking and lending. That has led to better outcomes in hard times. I think the evidence makes those statements undeniably true. When the headwinds slow, differentiated results will continue to separate them from competitors. The moat is getting deeper and wider every quarter.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[{"id":215173088198784,"gmtCreate":1693539717153,"gmtModify":1693539722593,"author":{"id":"4101205765268450","authorId":"4101205765268450","name":"Hungry4More","avatar":"https://community-static.tradeup.com/news/53a5e00cb2716b667bdd9b03ea411c3f","vip":1,"crmLevel":2,"crmLevelSwitch":1,"authorIdStr":"4101205765268450","idStr":"4101205765268450"},"htmlText":"Great potential","listText":"Great potential","text":"Great potential","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":0,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/215173088198784","repostId":2364173542,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"},{"id":215031844274336,"gmtCreate":1693535029112,"gmtModify":1693536409501,"author":{"id":"4152496098951332","authorId":"4152496098951332","name":"NealRiggers","avatar":"https://community-static.tradeup.com/news/default-avatar.jpg","vip":1,"crmLevel":1,"crmLevelSwitch":0,"authorIdStr":"4152496098951332","idStr":"4152496098951332"},"htmlText":"Sofi is an undervalued stock. Clear winner in Fintec space for 2023.","listText":"Sofi is an undervalued stock. Clear winner in Fintec space for 2023.","text":"Sofi is an undervalued stock. Clear winner in Fintec space for 2023.","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":1,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/215031844274336","repostId":2364173542,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"}],"hasMoreComments":true,"newsSizeData":{"likeSize":9,"commentSize":2,"repostSize":2,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false}}