Ignore the naysayers, SoFi is the future of banking

2023 has been an eventful year for the banking industry. The collapse of Silicon Valley Bank earlier this year created a domino effect that impacted other weak regional banks. Some investors were worried that the banking crisis would also affect small digital banks like SoFi ($SOFI).

SOFI was not impacted at all by the banking turmoil but actually benefited from it. The company made the right decisions at the right time, boosting customer confidence and attracting new depositors.

While SOFI stock tumbled during the early days of the banking crisis on fears of contagion, it has recovered phenomenally since then. $SOFI has rallied 50% since March and the stock currently trades near 52-week highs.

The stock has pulled back lately after an analyst downgraded the stock to a "sell" and set a price target of just $5. Such short-term pullbacks are likely great buying opportunities as SOFI's underlying fundamentals move in the right direction and the future prospects look too promising to ignore. Here's why.

Attracting Depositors By Offerings High-Quality Products

SOFI started out as a fintech startup with the mission to provide more affordable options for those taking on debt to fund their education. Student loans and student loan refinancing were its first two products. But the startup was not officially a bank so it faced limitations in offering financial products to the general public. The company officially became a bank in early 2022 and that was an important milestone for the business.

As a bank, SOFI is now able to offer more financial products at more attractive terms. For example, the bank's Checking and Savings product now offers one of the highest annual percentage yields (APY) of up to 4.30%. By contrast, the average US interest rate on savings accounts stands at 0.40% APY, which obviously doesn’t compare to SOFI's APY.

Given the high-interest rates environment, savings accounts have become very attractive financial products and SOFI has been one of the biggest winners. While the company is still tiny compared to global banking giants, it is growing very rapidly. Deposits soared 37% in just a single quarter, topping $10 billion in Q1. This highlights SOFI's success in positioning itself as a reliable and trustworthy small bank amid a challenging environment for small banks. The company's decision to boost its insurance coverage to $2 million for checking and savings accounts during the banking crisis compared to the $250K required by the Federal Deposit Insurance Corp. (FDIC) increased depositors' confidence in the digital bank.

The very attractive financial products and the high depositor confidence in the company allowed SOFI to continue its rapid growth in Q1. As you can see below, the digital bank added 433K new members or customers during the quarter, up 46% y/y, and exited the quarter with nearly 5.7 million customers. The most interesting thing is that growth during the quarter remained very strong and didn't slow much compared to the previous quarter. This confirms that there is a large addressable market that SOFI is successfully capturing.

Its Focus On High-Quality Customers Makes It Resilient To Macro Disruptions

SOFI offers several different financial products, making its revenue base highly diversified. However, as a bank, interest income on loans accounts for the bulk of its revenue. For example, in Q1, interest income accounted for 79% of its revenue. The total interest income soared 214% y/y during the quarter to $371.6 million thanks to the rapidly rising interest rates and the increase in loan originations.

SOFI is facing growth headwinds in two of its three loan verticals: student loans and mortgages. Student loan origination volume fell 47% y/y in Q1 as the moratorium on federal student loan payments continues to weigh on the business. And mortgage origination volume plunged 71% due to the high interest rates. However, the total loan origination volume actually increased 7% y/y to $3.5 billion during the quarter because of a 20% increase in personal loan originations. Personal loans are by far the company's largest loan category, accounting for 83% of the total and continue to grow because SOFI primarily targets super prime borrowers or those borrowers with credit scores of at least 720. The average credit score of SOFI's personal loan borrowers is 747 and the average income is $164K, meaning that SOFI primarily attracts high-earners who are able to secure loans regardless of the macro environment.  

Total revenue, which includes non-interest income from other products such as loan sales and tech solutions increased 43% y/y to $460 million and exceeded analyst forecasts by $23 million. The company is now able to grow rapidly and efficiently as it cross-sells its different products to its millions of existing users. For example, in Q1 the company added 433K new members and 660K new products. Each product is a product or service a member uses such as a savings account, brokerage account, a loan, or something else. The faster increase in new products shows that each member uses more than one product, allowing SOFI to grow more efficiently as the cost to cross-sell to an existing member is minimal. This is why sales and marketing expenses increased by only 27% y/y in Q1 and helped the company achieve operating leverage. In Q1, the net loss margin improved significantly to -7.3% from -33.4% in the year-ago quarter. And excluding the stock-based compensation of $64.2 million in Q1 that fell 16.6% y/y, SOFI delivered an adjusted profit of $75.8 million during the quarter, up 770% y/y.

What About Valuation

Bank stocks typically trade at low multiples because their financials are volatile and are directly affected by the interest rates that constantly change. This is the case with SOFI, so even though the company grows rapidly it can't trade at software-like multiples. At current prices of $8.4 per share, $SOFI trades at 4.8x sales, and the stocks could rise up to 6x sales, if the outperformance continues.

What Else

SOFI has successfully become one of the top fintech companies in the US and investors can thank the visionary CEO Anthony Noto for this. The company has bright future prospects as it offers a comprehensive and fully digital banking experience that high-earner millennials love. On top of that, it seems that the recent banking crisis has made the company stronger as deposits have soared in a clear sign that the digital bank has only strengthened its relationship with new and existing members.

I've no positions in the stocks mentioned.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.