Brett Shafer (3:59)

All right, Ryan, how did we get here? SoFi Today has, and I think you have the Number below here, 11.7 million members today. So one of the largest banks by total customers already in the United States. How do we get here? Take us through the relevant history for the listeners.

Ryan Henderson (4:19)

Sofi in the early days didn't really look anything like what it is today. So I'm not going to spend a ton of time on the history, but there are some important kind of thumbnails throughout the company's history that I'll mention today. Though SoFi can be, can be the primary banking app for its members, it's not the primary banking app for all of its members. We'll talk about that in a second. But they offer credit cards, they offer savings accounts, home loans, student loans, personal loans, a whole bunch of other products, insurance, directory, you name it. They really have become a holistic bank for their customers. But in its early days, SoFi was essentially just a peer to peer lending network. So. So the company was founded in 2011 by four co founders who met at Stanford Business School. None of these guys are involved in the company anymore, nor are they significant shareholders. Maybe they have some, but I wasn't really able to find them on the significant shareholders list. But the genesis for the idea was simply to provide more affordable lending options for the student loan refinancing market. The way they did this initially was with a $2 million loan pilot program. So they got, they probably reached out to a ton of Stanford alumni and they were able to get 40 of them to put up a combined amount of $2 million for this program. And then they use that 2 million to give student loan refinances to 100 students. So roughly $20,000 each. In the early days they were also, the goal was to kind of sort of reinvent the student loan refinancing market. They would even host events where alumni would meet students so that they wouldn't feel like this was a faceless transaction. Obviously this wasn't, this isn't that scalable having these events. Maybe they still have them, I don't know. But it was a nice way to kind of get the business off the ground in 2012. So a year after their founding, SoFi raised $77 million in a series A, which is currently kind of astounding to think about, like raising 77 million in your basically first funding round a year into the company. So huge growth from the start, or at least a huge funding round and that really helped them grow their student loan refinancing operations. So over the next few years they pulled in a lot of different forms of funding. So they got away from just sort of the peer to peer funding market and they also got debt, they got credit lines, There were some, as I mentioned, VC funding and it really helped them expand their operations. By 2015, SoFi had financed $2 billion in student loans. However, it was getting notoriety in maybe some negative ways. It was getting some of that success in by using questionable tactics. Their marketing was misleading according to the ftc and management did not really seem to be running the company very professionally. So the CEO was accused of sexual harassment. In September of 2017, he was forced to step down. This also, as I mentioned, coincided with an FTC investigation around misleading marketing practices at the time and around this period, late 2017, Sofi was being deemed a troubled fintech like they were, you know, CEO turnover, the founders leaving FTC investigation, A lot of things looked rough for them at this time. However, In January of 2018 they hired Anthony Noto, which I think is probably the most transformative moment in the company's history. Noto has a, honestly a remarkable resume. COO at Twitter, head of Global TMT investment banking at Goldman Sachs, CFO of the NFL. I think he went to West Point for university really just impressive background across the board. But really what really stands out to me beyond obviously now since Noto has come in, we can see the growth but, but it feels like he's brought in sort of a, a sense of professionalism for Sofi. And Sofi. When I think about a lot of the neo banks today, a lot of the online only banks that are kind of trying to disrupt traditional banking, Sofi feels like one of the most credible and maybe the least scammy, I guess. So I honestly think a lot of that has to do with Noto and the way he's run the company. But I on he deserves a lot of credit for basically making them into the full blown bank that they are today. And we'll get into what they, what all they do and the businesses that they're in. But basically Sofi today looks nothing like what it was in 2011. Two more milestones worth mentioning though. They went public in June 2021 through a SPAC which was nearly perfect timing, almost coincided exactly with the 2021 bubble. They raised roughly $2 billion in the transaction. And in 2022 they bought Golden Pacific Bank. The bank itself was sort of trivial. Like the acquisition was $22 million, but it allowed Sofi to apply to become a bank holding company which they were approved for. And this gave them the ability to hold the loans themselves and also fund the loans with direct deposits. And those deposits have grown rapidly. Looking at their deposits over the last three years, I guess three and a quarter, it has gone from basically $1 billion in deposits in March of 2022 to $29 billion in as of last quarter. So literally a 10x over the last three years. 90% of their interest bearing deposits are from consumer direct deposits. So this really has been a super fast growing online bank that offers a whole host of products that gives most consumers everything they need out of a banking app. And that pretty much takes us to today. So I mentioned it. They're trying to be the all in one financial app. They often talk about their mission, which is basically help people get their money right. It's broad, but I think that's because they do a lot. And the truth is with Sofi you can save money, you can spend money, you can borrow, you can invest, you can get connected with insurance products and much more. So they really have become a holistic financial app.

Brett Shafer (11:14)

First question, what do you think of the tagline? I feel like it's pretty good, but I don't know. What do you think? Is it good? Is it Better than some of the other banks out there. What are your thoughts?

Ryan Henderson (11:31)

Yeah, I mean it's fine. I guess every company needs to have some sort of tagline and I think for a banking app that does a lot, it's probably hard to come up with like a succinct tagline. So get your money right. Seems, seems decent.

Brett Shafer (11:50)

They have some commercials that are still stuck in my head and I think they're, they're running into right now from, from all the sports commercials they run. As we'll get into, they have the scale not to spend a lot on marketing. But the other question I have is we look at this interest bearing deposits chart from our friends at fiscal AI1 billion in March 2022 up to pushing probably $30 billion today. If we go after the Q2 figure which was $29.4 billion. I know Ally Financial is someone that over that exact same time period has had struggles to grow their deposits. Do you think some of that is because they're switching over to SoFi?

Ryan Henderson (12:27)

Maybe? Yeah, some of that might be some of the deposit growth might be sort of the yield chasers as we're going to talk about in a sec. They offer pretty compelling savings rates. So among probably the highest in the U.S. they end up being ranking pretty highly on some of the highest APY charts that are out there. So they could be eating some of Ally's lunch, but it's kind of hard to say where the depositors are coming from. All we know is that deposits are coming in.

Brett Shafer (13:04)

Okay, that segues right to our next question. Our next section is they have 11.7 million members as the chart you'll have in the newsletter here shows. Back In June of 2020 it was only 1.2 million. So that's about a 10x give or take from just five years ago. How did we get here?

Ryan Henderson (13:27)

Yeah. Before diving into sort of the how or the why, any sort of competitive advantages, I want to talk about what this number actually means. The 11.7 million members. So a member in SoFi's definition is basically anyone who has interacted with SOFI in some way. So whether that means they borrowed money, whether that means they just opened an account, they maybe they linked an external account or they even signed up for SoFi's credit score monitoring service. If you've done any of those things, you are considered a SOFI member. That does not mean SOFI is the primary bank of all its members. So a very important distinction. And when people are like, oh, you know, that doesn't. It's you know, it's still 11.7 million members is so good. Yes, it is. But I think if you are a SOFI shareholder, you don't want them to be at 11.7 million members because. Or you don't want. I. It shows that there's more of a ceiling to go out and get deposits. If you imagined that all this was the primary bank for all their members, the they would have an average account deposit balance of $2,000 per member, which would mean they're going after extremely low or poor members, which that just isn't the case. It's basically just saying that this is not the primary bank for all of its members. It is for some, but if you think about like Ally Financial, they have an average consumer deposit value of $43,000. So 20 times SoFi if you use that member figure. I guess what I'm saying here is the member growth is important and it's nice because there's cross selling that can be done. Like if you can get someone to borrow money with you, it's actually pretty. It's sort of an attractive proposition for them to bank with you as well because they get a discounted loan rate or interest rate if they're banking with SoFi. So there's some value in the member figure. But the number to pay attention to is deposits more so than members. So just kind of keep them both in mind as you're going through it. Nonetheless, they are adding members and most importantly deposits at a rapid rate. Today they have, as you mentioned, 11.7 million members. And here is how many new members they've added each of the last four quarters. So Q3 of last year they added 598,000. Q4 of last year they added 755,000 new members. Q1, 788,000, Q2 the most recent quarter, 830,000. So it's gone up. They have set record quarterly net additions for the last three quarters in a row. So they have added nearly 3 million members in the last year alone. That is about how many retail depositors Ally bank has in total. So Even if just 10% of those customers are using SoFi as their primary banking app, that is still really, really solid growth. And they are stealing market share across the banking landscape overall. So really good growth. What is driving it? I've basically boiled it down to three things and Brett, maybe you can chime in here if you think there's anything I'm missing. But the first one is counter positioning. So as an online only bank, they save a Lot of money compared to traditional banks by not having to support branches. You don't have to have those people on payroll. They don't have to have physical locations, pay rent or own those facilities. This means that they are able to return those cost savings to customer in the form of higher savings rates. This is a huge attraction and draws people away from their legacy banks. Right now, for example, SoFi offers 3.8% APY on their savings accounts. It's actually 4 1/2% for SoFi plus members, which is kind of their subscription offering. For comparison, Chase bank offers a whopping 0.01% on their savings account.

Brett Shafer (17:39)

Still have any sizable deposits? I've, we talked about this with our interview. Oh man, I'm forgetting his name, the fintech guy. Ryan, you. Maybe you can jog my memory here.

Ryan Henderson (17:50)

Yevgeny.

Brett Shafer (17:51)

Yeah, he, he fantastic interview. Everyone should go listen to that. But he said why do people have deposits at these banks anymore? And I, I'll say I still have a relationship with bank of America, but I keep the minimal amount of deposits there and I think over time more and more of the population is going to do that. Probably transition to ones that actually can offer these high yields accounts. I mean you said in your notes here, I mean the one that I use has like a 3.8% right now. But I saw that SoFi +1. I just looked up what the membership fee is. I can't figure it out yet but I, I would want to, I don't know, transition to there. If you can get four and a half percent now that's four of the SoFi plus members. I'm seeing three and a half point eight percent but maybe I'm looking at it wrong.

Ryan Henderson (18:40)

Might have been a special offer. But I saw one page that had a four and a half percent whatever okay listing on it. It can't change.

Brett Shafer (18:49)

It's a limited time APY boost to get people to switch over. Could be worth it. That's pretty juicy.

Ryan Henderson (18:56)

Yeah. And part of it is that helps them rank really well on all those articles where when you look up what's the highest savings account AP APY I can get, SOFI is going to be up there. Even if it's that one time promotional offer or even their 3.8% recurring APY they're going to be up there. If you compare this to your regional bank, chances are SOFI is far more attractive. So they rank really well. I imagine this is probably one of the biggest draws to SoFi for new members. And the other thing is I mentioned this earlier, but when you look at these lists, I'm sure a lot of people have done this, like highest savings account rate online, whatever. And you find this list full of companies that have a high savings rate. A lot of these banking apps are something you've never heard of. It's a little bit questionable how they even offer these rates. It feels like there isn't a lot of trust for it. When I look through this list, SOFI kind of seems like the most credible and they probably have the most name notoriety and brand recognition.

Brett Shafer (20:13)

The only other one I knew is Betterment. I mean, that's a solid brand too. But I would look at these and I would see Bread Savings, Western Alliance, New Tech bank and I would go, can I really trust these guys now? So far, maybe they're building that trust over time. But I agree this is a notarized, a notable name and it's one that through all their marketing over the last 10 years, you go, okay, I understand SoFi. High yield savings, easy to use. Apple, if you are serious about investing, you need to consider Interactive Brokers. I've said this before and I'll say it again, the number one reason I use Interactive Brokers is because they do not cut corners. IBKR gives investors powerful capabilities that make a difference in the long run. For example, they offer margin rates up to 53% lower than the industry. They provide up to 3.83% interest on instantly available cash. They allow you to easily make extra income on your fully paid shares of stock held in your account through their stock Yield Enhancement program. Plus much more. We considered a number of different brokerage platforms when we were deciding who to trade through here at Chit Chat stocks and all. In all, Interactive Brokers was the clear choice. Head on over to ibkr.com restrictions apply. Interactive Brokers is a member of SIPC.

Ryan Henderson (21:33)

Yeah, and I think I'm going to talk about it. Second, competitive advantage is marketing. But they've been able to really drive that credibility. The other thing I'll mention here in terms of counter positioning and this doesn't necessarily show up in any of the numbers, but most legacy or traditional banks have so much technical debt that it's no wonder that SOFI is able to launch products and features. It's a much faster pace. So some of these banks have systems that were built decades ago on premise by people that probably no longer work at the company. And now they're having to revamp their apps, their websites, their internal systems and they spend so much time. I imagine if you it's got to be a nightmare to work on the dev team at some of these companies because you're probably debugging so much old crap that wastes so much time. And it's why a company like SoFi, which was built a decade ago natively on the cloud, can ship products and features at a much faster rate. So those are the kind of things that are a little harder to measure, but they are a massive advantage relative to incumbents. Second big competitive advantage in my opinion is marketing. Obviously that's not a huge advantage relative to the big incumbents. I think Chase bank or JP Morgan spends a little bit more on marketing than SoFi does, but it is a big differentiator versus other neobanks. They timed their SPAC really well and they raised nearly $2 billion from the transaction. So this allowed them to basically double their marketing budget in less than a year. They now spend just under a billion dollars on sales and marketing each year and that is among the largest budget for all Neo banks. Chime, for example, which is another one of the largest, spends about half of that, which thankfully they recently went public so we can kind of comp some of the figures. So if I it's not only do they have a much bigger budget, which is a nice advantage to have, but I'd argue that they've done an excellent job with their marketing efforts as well. You can kind of see that in the membership growth too. But one example is the stadium. I don't typically like stadium sponsorships, but if there's any company that's going to do a stadium sponsorship, I think consumer fintech app makes a lot of sense. They spend about $30 million per year on I think they locked into a 20 year deal for SoFi Stadium. And even though it's a little tough to measure, this has obviously brought them a ton of name recognition and like we said, some sense of credibility. Part of it is when you see a company and this, this shouldn't be a signal but it is when you see a company sponsor a stadium, SoFi Stadium, you think oh okay, they must be a big credible company if they, they can spend that much money. And so maybe that might be part of the reason why when you look at those lists they are one of the top ones that you actually recognize. The the other part here is with a stadium they're stadium and a consumer fintech app they're able to offer some like other ways to do things so they can have stuff in the stadium that's like I think they have SoFi specific ATMs they could probably do like checkout discounts with SoFi app or SoFi credit cards. There's all this different kind of stuff that they can actually do in the stadium beyond just being the name. Thoughts on the stadium sponsorship overall?

Brett Shafer (25:14)

I specifically this one, it makes sense. It's one of the premier stadiums in the world now. It's one of the top ones in the NFL. It's going to get regular super bowl appearances and over the next few years you got the World Cup I think playing there and the Summer Olympics. So 30 million a year, it's going to get inflated away. Some of those costs there. And versus what they're spending on customer acquisition costs, they're probably spending what, $400 million with Google every year. This isn't really going to crush them. And it's probably some solid brand marketing versus the cost. I like it. It's better than someone such as FTX or crypto.com that seem to be doing it without a sustainable business model. And for SoFi, again, like I just said, it is one of the most notable stadiums in the world. You're going to have it on the most watched TV events in the world. Sunday Night Football, Monday Night Football or not in the world, sorry, in the United States, which is their only market, they're going to have Sunday Night Football, Monday Night Football. It's, it's going to be there. Bunch of people are going to see it.

Ryan Henderson (26:17)

Yeah, it's like I said, one of those things that's hard to measure, but I think it had to be a good deal for them. And if you look online, there's a bunch of things that say it was a really good deal for them. But obviously a lot of that is subjective.

Brett Shafer (26:33)

The what we can quantify here though, and maybe you're going to talk about it, is as their marketing spend has accelerated in recent quarters, their member acquisition has accelerated. So what's nice is that they're able to invest more and get more members, get more people to join the platform.

Ryan Henderson (26:48)

Yeah, it kind of goes back almost to like we talk about that advantage for remitly, which is they're in that sweet spot of being able to invest more than the other Neo banks in customer acquisition, which gives them more customers, which actually lowers customer acquisition costs also. So I don't know, it's. I think it goes back to, I think booking holdings is one of the clearest examples of that like 20 years ago where they had that early marketing advantage and it carried them for decades. But the other thing here is the numbers do speak for themselves. Over the last five years, members have grown tenfold. Meanwhile the sales and marketing budget has grown fourfold. So they are getting a lot of member acquisitions from, from that sales and marketing budget increases. The last thing I'll talk about because we're maybe going a little bit long on this segment. The third competitive advantage for me, and this one sounds a little weird, is being competitive across the board. So this might sound a little vague, but it's important. Banking is in a lot of ways a commodity. You want to open a savings account, there are probably thousands to choose from. So how does a bank stand out? Oftentimes what I have noticed is you'll see a bank do one or two things really, really well. Maybe you'll have a high savings rate. Maybe you can have like great credit card rewards program. Maybe there's a great lending rate. You're known as like a very good lender, maybe a best in class customer service. First Republic was known for that, which is kind of ironic because they were struggling in some other areas.

Brett Shafer (28:29)

They had to focus a little bit more on the balance sheet per se, which is why they went bankrupt.

Ryan Henderson (28:33)

Yeah, but then you will lack in other areas and often that's intentionally so. The big banks are a great example of this. Maybe they are good at customer service. I'm thinking about my regional bank here. You can go into a branch, it's nice. You've got some good mobile app offerings and there's some good customer service.

Brett Shafer (28:55)

You talk to a person, you talk to a real person. Right.

Ryan Henderson (28:59)

But there's, you get next to nothing on your savings account. So they're able to get a really low cost of funds and that's where they kind of make their money. And they're somehow still able to retain customers and deposits, but that we'll see how long that lasts. In the case of SoFi, they are competitive across the board. Student loan refinancing, very competitive savings rates, they're very competitive. Personal loans, they're very competitive on rates. Especially if you bank with SoFi. Credit card there seems reasonable 2% unlimited cash back. I mean it's not, there's no annual fee. It's not a crazy credit card rewards program, but it's competitive. There's stock trading, which it's not like we've seen apps that are like, oh, you can also do stock trading. But then the trading service sucks and there's commissions, there's no commissions on SoFi. They even are trying to get into like the pre IPO stock stuff. Which I think is whatever. I wouldn't personally invest in it, but there's no harm in offering it. So a lot of the different areas that they're in, they actually have a credible, formidable, they have feature parity. So the list really goes on and on. But it's clear that when they enter a new market they are trying to be as competitive as possible. And I think this helps attract more members because they rank well when in so many different categories. So when you look up best spot to get a personal loan, SoFi's there. When you look up best spot to get a high savings rate, SOFI is there. Student loan refinancing, SOFI is there. It they are, they rank well across many different categories. It kind of is one of those things where maybe it doesn't stand out at first, but them not cutting corners, like for example a regional bank cutting corners on their savings rates it over time it shows up. And I think that that leads to more deposit growth over time as well. So what is the competitive advantage? Because I had, we had a listener ask that basically like all these neobanks do the same thing. What are the competitive advantages? One, they have a lower cost structure which allows them to offer more attractive rates and terms relative to incumbents. Two, they've reached a level of scale that other neo banks aren't at, which allows them to invest more into new customer acquisition. Three, they are a legitimate bank. That's actually a huge deal, especially as you look at it relative to like Chime and some of these other financial institutions because their cost of funding relative to other neobanks is lower and they can also earn interest income. And I actually think they're in this perfect sort of sweet spot for growth where they are not only the innovator but they can. Where they're, they're on the right side of the innovator's dilemma. But they're also big enough that they have credibility in the eyes of the consumer. So I do. It's kind of a lot of different reasons that they've succeeded. But the long story short is they're in a good spot versus incumbents and they're in a good spot versus neobanks. I think that's probably why they've 10x members over the last five years.

Brett Shafer (32:04)

And I did test out your Google search best app for personal loan. There was a sponsor listing. First one was upstart says loans with no paperwork. That sounds legit. No, sorry, upstarts recovered a bit. The second one was a nerd wallet list. So I clicked on that 2025 best personal loan lenders of September. That's a nice SEO there, guys. First one on the list, SoFi. So I think you're right. Now, Ryan, I'm going to pull up my phone and I'm going to show you what might not show you, but I'm going to read off my personal finance applications. One, our sponsor, Interactive Brokers, of course, but that's kind of different. American Express, bank of America, Venmo Wise, Chase. Now Chase, I only have for the Prime Amazon Prime Visa card, which everyone should have as a, as a little note, 5% back on Amazon purchases and no annual fee. What is going to convince me to become a SOFI member? And does that matter? Because I feel like they're at this personal loan spot and you're going to get into it. Their revenue is really coming from these personal loans. But one convinces me to switch over from bank of America and American Express.

Ryan Henderson (33:16)

Do you have the high yield with American Express?

Brett Shafer (33:19)

Yeah, let's. I believe I actually, I remember looking today because of this recording. It's 3.75%. So maybe they can go higher. Yeah, yeah.

Ryan Henderson (33:29)

If you're a yield chaser, you could get a slightly higher rate with SoFi. If you were a borrower from SoFi. So say you had a medical expense that you couldn't pay for and you wanted to take out a personal loan and SoFi looked like they were giving you a competitive rate and they said, you know, if you also bank with us and we have access to your banking data and we can just have an automatic withdrawal for repayment, we can lower your interest rate as well, then you'd probably feel inclined to become a SOFI member as well. There's a lot of different reasons, but I would guess being a borrower first or chasing a high yield is probably two of the primary reasons people end up moving over.

Brett Shafer (34:11)

Yeah, I see this credit card to 2% unlimited cash back, no animal fee. I feel like for some people that just want that regular cash back card, that is a pretty attractive rate as well. But either way, I kind of like, you know, bring in some of the anecdotal evidence there. Are you a SOFI customer, Ryan?

Ryan Henderson (34:28)

I'm not and there's honestly no reason that I shouldn't be. I think I could get a higher yield with them than where I'm currently at. But I would probably, for us, for me, I would guess that the first thing that would actually draw me in to being a customer with SoFi would either be borrowing from them or maybe the credit card if I wanted just that pure cash back card. But I'm not necessarily as much of a yield chaser because I don't keep a lot just in my savings accounts. I usually move into bonds or whatever.

Brett Shafer (35:04)

But optimizing the brokerage, huh?

Ryan Henderson (35:07)

Some, some people might.

Brett Shafer (35:09)

Yeah, no, that is, I think what this illustrates is that there is lethargy is probably the right word of people staying with their existing financial services app, at least most people. And then it's going to take a long time to convince people to switch to these optimal solutions. And that gives someone like Sofi a steady but long term reinvestment Runway to keep up this marketing and acquire new users. But let's get to how they make money. And as you mentioned, we're not going to talk that technology side of things because I think we discussed it beforehand. It's a small part of their contribution profit. It's going to be a smaller part over time. If you really want a detail on that, you can find some other research reports. But we're going to be talking lending. What do they offer people and how do they make money and account for all of this interest income as a bank?

Ryan Henderson (36:01)

All right folks, if you are a regular listener to Chitchat stocks, then you know that we use Fiscal AI formerly known as FinChat daily. Fiscal AI is our complete stock research terminal. It's where we have our investment dashboards, it's where we create financial charts, it's where I read all the transcripts for conference calls, sell side events, shareholder meetings, and it has Morningstar's high quality reports on more than 1700 companies. It really is the complete research platform for stock focused investors. If you use our link Fiscal AI Chitchat, you will automatically get two weeks of Fiscal Pro for free. And if you find that it's worth upgrading, which I think you will, you'll get 15% off any paid plans with our link. Again, that is fiscal AI chitchat. The link will be in the show notes. Yeah, and maybe I can just hit this the technology side really quickly because some people might say, oh, you're neglecting this hidden asset in Galileo, which is basically B2B software White labeling your financial services app type technology. It seems fine, it seems like a mid sized B2B SaaS company that's growing. But if you believe that so far is going to do really well, it's going to be a small, small piece of the puzzle. Right now I believe it accounts for like 13% roughly revenue and 10% of contribution profit, roughly so it's, it's already a small piece and as lending continues to grow, it's going to become a smaller and smaller piece. That's nothing against Galileo, but it's just hopefully you're getting better growth out of the banking side if you're a shareholder. But let's talk loans. So as I mentioned earlier, SoFi offers a number of different loan types to its customers. These each fit into pretty much one of three categories. Personal loans, student loans, or home loans. They also, as we mentioned, have credit cards, but that's not really big for them at the moment in terms of their credit portfolio. So I'm going to focus on the other three categories before we get into the loan characteristics, default rates, stuff like that. Let's talk about some of the particulars because the accounting can be a little tricky for Sofi and we actually had a question on this and I'll get to that in a second. When Sofi writes a loan, they can do one of a few things with it. Either A, they can hold it on their own balance sheet, which they're able to do now because they are a bank. B, they can sell the entire loan to an asset buyer, this is also known as a whole loan sale. Or C, they can securitize it and sell it to an asset buyer. And securitizing just means basically packaging up a bunch of these loans to sort of spread out the risk characteristics so that institutions can buy them as securities based on however much capital they want to allot to it. Holding the loans themselves is a pretty straightforward process. You just collect the interest over time.

Brett Shafer (39:05)

But.

Ryan Henderson (39:06)

But the selling of the loans presents some funky accounting, so I'll try to walk through it. It's going to get a little nitty gritty here in the details, so bear with me.

Brett Shafer (39:16)

But first off, this is why for the complicated stuff, it's a lot easier to read it on the newsletter. So if any of this is confusing, talk to us, DM us on Twitter, send us an email, message us on substack or read the newsletter. Should hopefully help clear some of this stuff up. Yeah.

Ryan Henderson (39:34)

So first off, right when so far originates a loan, they tend to hold that loan on their balance sheet for a little before they sell it. While it's on their balance sheet, they are collecting interest on it then based on whatever risk appetite investors are seeking. So if I will pool, they will sell a pool of loans into what is called a securitization trust investors. And when you're thinking like who's buying these loans, it's pretty much big institutions like asset managers like BlackRock or stuff like that, or pension fund managers or insurance companies, basically any one of those huge asset managers that's looking for steady interest, steady growth of their portfolio. But they're not chasing like the highest possible return. They will buy bonds backed by those loans. If the loans are valued by the market at a premium to what SOFI holds them out on their own balance sheet, SOFI will then record a gain on sale. So there's basically four ways that SoFi makes money on its lending operations. One, origination fees. So sometimes on a loan, this is paid up front by the borrower. It's often waived, especially for personal loans. SOFI doesn't make you pay any origination fees. Two, Interest income. This is straightforward. They collect interest while they hold the loans. Three, gain on sale. So this shows up under non interest income when the securitization is executed and then for servicing fees as well as occasional residuals. So the two things here, they, they have a servicing arm, which is kind of a hidden benefit by being able to basically pay off your loan with the same provider that actually originated it. It's kind of nice to just consolidate those two. And even when they sell the loans, they'll still usually service the loans as well after the sale. And then sometimes they also retain partial ownership of the loan. So that's going to be maybe the residual income beyond it. But the big, the two big ones are non interest income, which is primarily the sale of the loan, and then interest income itself. I know that's all sort of convoluted, but it's important because all those income sources, especially the interest income and the non interest, which is the gain on sale, Those account for 85 to 90% of SoFi's revenue. Also, it helps provide some additional context for a listener question that was asked in preparation for this episode. So a listener asked us, what are the pros and cons of using fair value accounting? Specifically, how vulnerable is SOFI when delinquencies rise, since that would trigger negative fair value adjustments leading to lower or even negative net income. And this would also reduce the value of assets on the balance sheet. If that happens, what impact would that have on their CET ratio? So very technical question. Thank you for asking. To whoever asked that SOFI uses fair value accounting for pretty much all of its loans. And typically banks will use this form of accounting for loans that are being quote, the term is held for sale versus held to maturity. So if it's held for sale, they'll typically Use fair value accounting because people are buying these so they want like sort of a mark to market. But SoFi also uses fair value accounting for most of the loans it holds for investment. So what is the difference? I've got a little part from the 10Q that you can look at in terms of the total loan value and how much is measured. A fair value versus cost. So fair value accounting marks the loan to the current market value. So whatever the loan could be sold for or what SoFi believes the loan could be sold for today, that requires some assumptions on default rates, but that means the loans change quicker in value as rates move. This affects SoFi's reported net income on a quarter to quarter basis. Quarter to quarter basis, especially when there's sort of a rapid increase or decrease in rates. So back to the question, what happens if delinquencies or rates rise? Well, anytime you hold a long duration asset, specifically a loan, whether they're held to maturity or held for sale, a rise in delinquencies or a spike in interest rates is bad news. However, with fair value accounting, that is reflected in the earnings sooner. So on the other hand, when you think about you like if you used amortized cost accounting, which is sort of the alternative here, the losses aren't actually accounted for until they're actually recognized. We saw this, I'm trying to think of a good example here. Charles Schwab basically had this happen a few years ago when they had all these held to maturity assets that were underwater. So they weren't marking them down right away because they were holding them to maturity, but they had reached for yield at a time when rates were historically low. And then rates rose and those all of a sudden investors were seeking a much higher yield and the value of those was significantly lower. Basically a rise in delinquencies doesn't benefit either of them, but you'll see it sooner with fair value accounting. The difficulty can be that if SOFI does want to sell these loans and rates have risen, investors would be looking for higher yields. So they might be sort of tough to get rid of in that situation. Now they could just continue to hold them instead if they wanted to hold them as an investment. But like I said, they're basically underwater if the rates are significantly below what people can get elsewhere. My most of their personal loans have a coupon rate of like 13%. So the likelihood that you're going to be underwater on any of those is. It's really unlikely, frankly, because the fed funds rate there, it could rise. But I have a hard Time imagining for pure US economic purposes, it rising.

Brett Shafer (45:56)

Too far as you say here, the length is about, I wonder if they have an average length. They probably do somewhere. But I guess it's not necessary to have the exact number. But you said two to seven years here. This isn't a 30 year mortgage that people are getting stuck with like a Charles Schwab should work itself out over time. And what matters really at the end of the day, no matter what type of accounting you're using as a bank is are the loans, are they fine? That's, that's the big question. Now previously people said, well sofi, they have no experience in this. And if you look at the chart here, their volumes in personal loans are growing rapidly. They kind of came out of nowhere over the last five years. What stats do they have, Ryan, to show that these loans are doing fine or how are they performing?

Ryan Henderson (46:44)

Yeah, so they do have actually a good amount of history. But let's, let's look at the actual loan portfolio. So I'm going to primarily focus on the personal loan side of things because that is it accounts for Two thirds of SoFi's current loan portfolio and then it's 80% of new origination volume. So at this point, to simplify things, you can honestly just think of Sofi as a personal lender. That is the current majority of the business and it's going to increase as a percentage as well. Not to mention student loans tend to have extremely low default rates. So any sort of uncertainty would be, I think on the personal loan side, these are unsecured personal loans, meaning no collateral required. These, that means things like debt consolidation loans, home improvement loans, say you wanted to, whatever, but do a new kitchen or whatever, don't have the money at first, you're going to take a personal loan, you'll pay it back over whatever two years. Medical expenses, travel events like a wedding, for example, you name it. These loans typically range in value from $5,000 all the way up to 100,000 and have durations ranging from 2 years to 7 years, they have really high prepayment rates. So if you're pay and the average coupon rate on these loans like I said, is 13%. So you know, if you paid for a brand new deck in your backyard and you're paying 13%, you're probably going to want to prepay that as quick as you can. There's no prepayment penalties either. So yeah, the duration isn't as big of a concern as say primarily a mortgage portfolio. But in terms of Performance. These loans are performing really well at the moment. Their net charge off rate last quarter was 4.5% which has continued to come down over the last 12 months. And, and their average coupon rate as I mentioned, is 13%. So a very good spread at the moment on this personal loan portfolio, which continues to make up a greater and greater percentage of SoFi's business. My general belief here and with, with any bank, there is just a level of trust in underwriting. Like you have to believe that they're. Because you don't have full visibility into these loans as a investor. You just don't.

Brett Shafer (49:06)

They could just double. They like, there's no, you don't know what is going to change.

Ryan Henderson (49:13)

Yeah, it's really hard to forecast, to.

Brett Shafer (49:15)

Go to not trying to use a swear word for the kids in the car. The economy could go to heck in a hand basket and that is killing. It's going to kill their net income margin, is going to kill their net charge of rates. But no bank is immune to that. That's just the business they're in.

Ryan Henderson (49:34)

Yeah. And so my general belief here is that as deposits grow the, or as long as deposits grow, the loan portfolio portfolio should work itself out over time. This is not some newfound risky lending operation. They have been writing personal loans for more than a decade now. They've gone through some pretty challenging economic environments in that time, through Covid and 2022. And they were able to endure. And from what I can tell, they follow very standard underwriting procedures. It's not like they're coming up with their own credit scoring model and trying to compete with the FICO score. They use the FICO score. They use debt to income ratios, they use employment history, education history. And if you want to bank with them, they also have access to your banking data that helps as well. So it's. They have a pretty good history of underwriting here. They haven't done it quite at this size that they are now. But I wouldn't be too discouraged by them growing this personal loan portfolio and thinking, oh, this is some massive risk that they're taking. They have been doing this for quite a while now.

Brett Shafer (50:47)

Okay. We've talked about the growth, we talked about how they acquire customers, we talked about how they make money. Now, after researching this company and doing some financial analysis, fundamental analysis, how are you valuing the stock and what are your thoughts about adding it to your portfolio?

Ryan Henderson (51:04)

Yeah, valuing SOFI is challenging. I think that maybe actually scares off some investors. I guess all banks are a little challenging to Value, for that matter, because you are for SOFI now because technology, the technology side of things, has become such a small piece of it. You're basically having to forecast out net interest margins. And the reality is nobody, and I mean nobody knows what net interest margins for a bank are going to be five years from now, especially one that uses fair value accounting because it's entirely dependent on prevailing interest rates. So what can we do? Well, we can try estimating earnings based on various net interest margins, which I'll do here in a second. But the real value here and what's going to determine the outcome for Sofi as an investment, in my opinion, is going to be the deposit growth. As I mentioned earlier, I think SOFI is in a sweet spot for growth. They've reached scale plus. They're on the right side of the innovator's dilemma. And they're willing to be aggressive with their offerings too. So I suspect they will be able to grow deposits at an impressive rate over the next five to 10 years. I ballparked it in some of my assumptions at a 20% deposit annual growth rate over after this year because they've actually grown. They accelerated recently. But from 2025 to 2030, I forecast 20% annual growth in deposits. I'm doing some, I'll link to maybe my crappy spreadsheet here for anyone that wants to really read it. But I'm doing some kind of gross math here on this model, though not even a model on these assumptions that I put together. The two things I'm sort of assuming are 20% deposit growth from 2025 to 2030. And I test out basically three different scenarios of 5% net interest margins, 5.8%, which is what they've been at the last two years on average, and 6% if you wanted to expand that range. It's very easy to do. So obviously, if net interest margins contract to like 2%, they could be losing money. Their CET ratio is going to look a lot worse. Yada, yada, yada. It kind of goes on and on. But I don't know, you can kind of make the net interest margins as aggressive or as conservative as you want. I think 5 to 6%'s a fair range. If I use that middle ground of 5.8%, which is, like I said, about where their average has been over the last two years, they would, they would be earning a about $6 billion before any operating expenses. So just from their loan portfolio, they'd be earning about $6 billion in 2030. Now operating expenses obviously matter and they will grow for so far, I suspect. But the pace of growth has slowed and I think it should continue to slow over time. So let's assume operating expenses grew at 10% annually, which I think is the rate they've grown at over the last two years. They would have just over $4 billion in operating expenses. That means total earnings of about 2 billion doll. Using that first assumption, I had.

Brett Shafer (54:18)

That.

Ryan Henderson (54:18)

Today they traded a market cap of 28.9 billion. So that's roughly 13 times 2030 earnings. Now, keep in mind.

Brett Shafer (54:27)

Not good.

Ryan Henderson (54:28)

Brett's. Brett's shaking his head. Keep in mind that math I did was not good. It just wasn't like it. Very imprecise. But that does give me some.

Brett Shafer (54:38)

There's no way you can be precise. Well, you can be precise. Sorry, we're getting that definition wrong. You can be precise. You just. The accuracy is in question because Nim could be five and a half. Five, four and a half, depending on the economic environment.

Ryan Henderson (54:54)

Yeah. The good thing is they are flexible and the durations are not so long that they're able to recycle these like the. The loan portfolio, probably quicker than some other banks. So if they did have a spike in delinquencies or whatever, they can make the appropriate adjustments. It might be a rough year or two, but it shouldn't be this. They don't get caught in this terrible situation where they're screwed for a decade. But anyway, the. The math or the numbers I put on that spreadsheet should give me some rough numbers to work with. 13 times 2030 earnings for a bank that I do. I do think the bank is really well positioned to grow. It feels fine to me, but it's not screaming attractive like it's.

Brett Shafer (55:43)

Yeah, it could be dead money over the next five years. That's possible. Even though I've over the last three.

Ryan Henderson (55:51)

When anytime I'm modeling earnings out five years, I want to be looking at a. Personally, I want to be looking at a single digit earnings like 2030 earnings multiple. So. Or five years out earnings multiple. That's kind of what I personally feel comfortable with. So I was hoping it'd be a bit cheaper. I might be willing to take a starter position because I do like SoFi and I like where they're at and I think they have a real competitive advantage. But unless this drops by probably 30% or more, I'm going to be holding off on making this a big position. Ultimately. The thing that is kind of in question here is the deposit growth rate. So they could grow faster than 20% annually. I actually would not be surprised if they did. They're currently on pace to do that this year, but by quite a bit. But we've also seen banks go the other way. Like I, I thought that for Ally for a while. I thought, wow, they've got a real advantage here as an online only bank. They're going to grow deposits really quickly and they've seen consumer deposits just kind of grind to a halt. So I think Sofi is probably in a better position than Ally bank was. But it's just so competitive. So I want to be buying this at a single digit 5 years out earnings multiple. It's not quite there yet. I do think this is an impressive business. Anthony Noto has done a very good job building this into the company that it is today, but probably holding off on taking a huge position here.

Brett Shafer (57:24)

I think to sum it up, it's a bank at four times book value. Either you have to have an insane return on equity or be pricing in a lot of growth. And it looks like they're pricing in a lot of growth right now. I think another question to ask in regards to the entire Neobank sector and we'll probably talk about when we give go through your personal portfolio update in an upcoming episode is how this makes you feel about Ally Financial and your position in that company. Which do you, you still own, I think, right?

Ryan Henderson (57:52)

Correct me if I'm wrong, I technically still own it because the limit order for a sale that I put in didn't go through and I just got lazy. But I tried to sell it. This, this does concern me. Like I think looking at Ally versus Sofi, I might rather own Sofi. Honestly, they seem like a much better value.

Brett Shafer (58:15)

I'd rather a new bank is. New bank.

Ryan Henderson (58:16)

Yeah, probably.

Brett Shafer (58:18)

Honestly so far, I mean good business, it's doing well right now. But four times book roe is not proven to be that good and you're pricing a lot of growth. All right, we're going to close things out. Any closing thoughts Ryan, for the listeners? Regarding so far?

Ryan Henderson (58:35)

No, I'd say go read the reports yourself. Read other people's work as well. I might have missed some stuff. I didn't spend a lot of time on Galileo just because I think if Sofi works out it won't be a huge part of the business business. But there is a lot to like and I would not be surprised if this is a much bigger business in five years. It's just, you know, you're, there's always some risk when you're paying, like you said, four times book for a bank and and it is such a competitive industry. But I like the business. If you enjoyed this, please give us a review. We always appreciate the support.

Brett Shafer (59:12)

Yep. And congrats to the shareholders that bought at like $5 and wrote it up to 25 today. That's been a great call. As a disclosure, we are not financial advisors. Anything to say on the show is not formal advice or recommendation. Ryan I or any podcast guests may hold securities discussed in this podcast, may have held them in the past and may buy, sell, or hold them in the future. Thank you everyone for tuning in once again. If you have anything that you want more with this episode, remember to read the newsletter that'll be coming out this week and we'll see you guys next time.