SoFi Technologies: The Bank Charter Will Change Everything

Summary

• The bank charter is SoFi's biggest catalyst and will have measurable effects on its margins, membership, and marketing.
• Analysis of the timeline of previous fintechs who have received bank charters suggests that the bank charter approval should be in the near future (within ~6 months).
• Other fintechs' valuations have exploded after receiving a national bank charter and SoFi will follow suit.

georgeclerk/E+ via Getty Images

SoFi Technologies (NASDAQ:SOFI) is finally seeing a return to a reasonable value after its unwarranted price drop following Q2 earnings. At the time, I highlighted that the price drop gave investors a tremendous opportunity to open a position or average down. Since the publication of that article, the stock price has increased more than 40%. That is an excellent return, but there is still huge upside to investing in this major growth fintech. SoFi’s growth story is only getting started. SoFi’s biggest catalyst is obtaining a national bank charter, and this article will explain why a bank charter will accelerate their already impressive growth.

Introduction to the Bank Charter

SoFi investors cannot seem to stop talking about the bank charter or trying to decipher when it will be approved. Despite the excitement surrounding this catalyst, I do not think that everyone understands the whole picture of what the bank charter can and will do for SoFi. As a chemical engineer, I am a numbers guy at heart. I’m the type of person that gets excited about putting together spreadsheets and numerical analysis and breakdowns. I will cover how I think the stock price will react to bank charter news and of what we know surrounding the timeline for approval below. However, one of the things that I most enjoy about investing is that it is a blend of analytical analysis and human emotion. The narrative of a stock often has a significant effect on its share price because there is a large human element involved and humans are not emotionless automatons. I want to start with that narrative, breaking down charter’s effects on three different parts of their business: Margins, Marketing, and Members.

Bank Charter's Effects

Margins

The effect on SoFi’s margins is the easiest to quantify. Owning a bank charter allows SoFi to use their deposits to finance their own loans. Lending is SoFi’s biggest source of revenue and profits. Right now, they have to borrow money from third-party banks to finance the majority of their loans. These third-party banks charge somewhere around 2-2.5% interest (200-250 basis points) to use their money. As soon as SoFi obtains a bank charter, they can use the deposits from their members to finance those loans. That means their cost of capital goes from 2% to what they pay their SoFi Money members in interest (currently 0.25%, but more on that later). This improves their margins. Additionally, answering to and being regulated by a single entity (the OCC) is easier than being independently regulated by 50 individual states (which is what SoFi currently has to do). This cuts down on administrative costs. Most people are familiar with the following slide from their investor slide deck, but it is worth putting here again.

Source: SoFi Investor Presentation

EBITDA is a measure of earnings. The dark blue bars are their earnings without the bank charter, and the light blue bars are incremental earnings they get because of their expanded margins. So in simple terms, between now and 2025, the bank charter is worth about $1B in profit margin between now and 2025 with current revenue. Profitability, free cash flow, cash on hand, and a whole host of important financial parameters will get a big boost with the bank charter.

Marketing

The second key aspect about the bank charter is that it allows SoFi to have more effective marketing. A national bank charter gives them legitimacy. SoFi Money deposits are already FDIC insured, but that is through partner banks. As one of the first Fintech companies with a bank charter, SoFi will have a cachet and credibility that will help them stand out from their peers. That credibility and legitimacy is all well and good, but when people are making a financial decision, the most important factor is usually how it affects their wallets.

Personal Loans

When you type “personal loan” into Google, the first website that pops up (after the paid advertisements) is Bankrate's website and it looks like this:

Source: Bankrate

You’ll notice that SoFi is among the top results. Their product offering ties for the lowest APR, most flexible terms, and max loan amount. What would happen if they could drop their APR by 0.25% or 0.5%? Anthony Noto gave an interview about the effects of the bank charter. Speaking specifically about loans, he said “my cost goes from two percent to fifteen [basis points]. I could give that all back to you in a lower interest rate on that loan, or I can give you a higher interest rate on your deposits, or I could drop it to the bottom line. So we’ll do a combination of those things.” In other words, there are three things ways that SoFi can use their lower cost of capital. They can use it to lower the APR on the loans they offer, they can give a higher interest rate to SoFi Money accounts, or they can use it to improve their margins,. According to Noto, they plan to do all three. SoFi already has such low costs that they are tied for being the lowest cost provider with their current cost of capital. After the bank charter, SoFi can simultaneously drop their APR to attract more customers while expanding their margins. If you are looking for a personal loan and you find that bankrate page, but now SoFi’s APR is 4.75% or 4.5%, that is almost certainly going to be the first link you click. SoFi will have gained another member into their sticky system

Student Loan Refinancing

Let’s try the same exercise with the phrase “student loan refinance”. Again, after scrolling past the paid advertisement results, the first result is a NerdWallet page where you will find the following graphic:

Source: NerdWallet

Again, SoFi’s offering is tied for the lowest rate available. If they use a portion of their lowered cost basis to offer even better rates, they will hoover up an even greater portion of the student loan refinance market.

SoFi Money

The second option that Anthony Noto mentioned was that SoFi can give you a higher interest rate on your deposits. This is in reference to a SoFi Money account, which is similar to a checking account. Currently, SoFi offers 0.25% interest on the balance in the SoFi Money account. Because SoFi is not a nationally chartered bank, they have to send your deposit to a third-party FDIC-insured bank. Once SoFi has their bank charter, they are free to give their members whatever interest rate they choose. The best high-yield savings accounts on the market right now give 0.5-0.6% APY:

Source: NerdWallet

SoFi can easily disrupt this market by offering a better product and a better interest rate. As I mentioned before, SoFi Money is akin to a checking account. It is liquid and you can spend the money in the account with a debit card or withdraw funds from an ATM. These high-yield savings accounts do not have that same liquidity. To access the money, you first have to initialize a transfer to a checking account, which typically takes 3-5 days. Banks do this on purpose to increase friction between you and your money in these higher yield accounts so that you move it less frequently. Anthony Noto is on the record as saying that this practice is not necessary in the modern banking world. SoFi will be able to offer an account that gives you the flexibility of a checking account with an interest rate that surpasses high-yield savings accounts. I believe they will do so to incentivize their members to move all their money into a SoFi Money account. Remember, the greater the total value of their deposits, the better their lending margins will be.

A bank charter allows SoFi to offer best-in-class products for student loans, personal loans, checking accounts, and savings accounts. Their home mortgage loans and home refinancing products will also become even more competitive. Marketing becomes much easier when your product sells itself. Additionally, each new member and each existing member will be adding more to the bottom line than ever before.

Members

The bank charter also makes things better for existing and new members. This will make their product offerings even stickier than they already are. Right now, SoFi has to sweep the deposits from SoFi Money, SoFi Invest, and their other financial products into partner bank accounts. It is frustrating, for example, that moving cash from your Money account to your Invest account takes 2-3 days. This is because they have to move it from an outside bank’s brokerage account to a different bank’s deposit account. A lot of internal friction between their account, investment, credit card, and other products will be removed when they can hold their own deposits, making for a seamless and better user experience.

Additionally, existing members will also get the benefits discussed in the marketing section above. This means better rates on personal loans, student loan refinancing, mortgages, and more interest for their deposits. If you are already a member and you see that SoFi has best-in-class loan offerings, it makes it much easier to stay in the SoFi ecosystem for that loan. Cross-selling is a key feature of their long-term strategy, and having more competitive products makes it easier and more attractive for members to stay with SoFi for all their financial needs. I, for example, have my emergency fund in a high-yield savings account but would gladly move it all to SoFi Money if they had slightly higher interest rates.

Bank Charter Timeline

I am not Nostrodomos nor do I claim to know the inner workings of the Office of the Comptroller of the Currency (OCC). I have no idea when the bank charter will be approved. However, there are some definitive dates that we do know and that we can compare with previous fintechs who have been granted a bank charter. Also, there are some fun breadcrumbs that SoFi seems to be leaving that indicate that the process is moving forward.

Previous Fintech Timelines

Varo, Square (SQ), and LendingClub (LC) are the three fintech companies that have received bank charters. There are two type of charter applications. The first is a de novo application, which is the creation of a new bank. The second is a change of control application, which is where one bank acquires another bank that already has a national bank charter and takes over their charter. Varo and Square went through the de novo process whereas Lending Club went through the change of control process through their acquisition of Radius Bank. The timelines were as follows:

Varo – Received preliminary approval on September 4, 2018 and final approval on July 31, 2020, a period of almost 23 months. Varo was the first fintech to receive a bank charter.

Square – Received preliminary approval on March 18, 2020 and final approval on March 1, 2021, a period of about 11 months.

LendingClub – Announced the acquisition of Radius bank on February 18, 2020, filed for the change of control on April 27, 2020, and received final approval on December 30, 2020, a period of about 10 months.

SoFi Bank Charter Timeline

SoFi’s application started as a de novo application and they received conditional approval of their bank charter application on October 27, 2020. However, on March 9, 2021, SoFi announced an agreement to acquire Golden Pacific Bancorp and changed their de novo application to a change of control application. The linked press release states that “The proposed acquisition is a key strategic step in SoFi’s path to obtaining a national bank charter”, so we can reasonably assume that SoFi believed that the acquisition would expedite the bank charter process. The same press release also states that the completion of the transaction is “anticipated before the end of 2021”. SoFi also submitted a CRA strategic plan as part of their bank charter application. That document states that the “The Bank elects to have its CRA performance evaluated under the Strategic Plan option, with a proposed period of November 1, 2021 (or upon consummation of the Bank) to December 31, 2024.” This also indicates that SoFi is prepared to begin banking operations starting in 2021. Based on the Square and LendingClub timelines, and SoFi’s own press release and CRA plan, it is probably safe to assume that the bank charter approval could come any time between now and spring of 2022.

Breadcrumb Trail to Bank Charter Approval

Now we get into the fun speculation stuff. Please note again that there is still a chance this all falls apart and that the OCC does not grant a bank charter. In that case, SoFi stock still has an analyst target of $25. This section is mostly just for fun, so take everything here with a grain of salt. However, if you like to play connect the dots, here are some interesting tidbits you probably want to be aware of. If this is a little too speculative for you, please just skip to the next section.

Convertible Note Offering Bears a Suspicious Resemblance

If you go back to that GPB acquisition press release, you find this statement: “If successfully granted a national bank charter by the OCC and Federal Reserve pursuant to its change of control application, SoFi plans to contribute $750 million in capital and pursue its national, digital business plan while maintaining GPB’s community bank business and footprint, including GPB’s current three physical branches.” SoFi planned to raise $750 M in capital to expand banking if they are granted the bank charter. On September 29, 2020, SoFi offered convertible senior notes to raise exactly $750M. The offering was later expanded to $1.1B. It is an interesting coincidence that the senior note offering raised the exact amount that SoFi said they would raise if granted a bank charter.

Banking Hires and Positions

SoFi is made a very auspicious hire that showed up on LinkedIn sometime in mid-September. Meet Chad Borton, Harvard grad, former Bank President of USAA and currently employed as the President of “SoFi Bank at SoFi”.

Source: LinkedIn

He was included on the SoFi website Management Team page on October 5, although there has been a fairly conspicuous lack of fanfare surrounding his hire as there was no corresponding press release or other announcement. There has not even been mention of it on SoFi’s official twitter account. Besides hiring a new President of SoFi Bank, there have been numerous hires and job listings for roles that would only be necessary if they become a national bank, such as a Angela Smedley, a Senior Compliance Officer, CRA Officer. Only a nationally chartered bank is regulated by the Community Reinvestment Act (CRA), so this position would be superfluous otherwise. Or this current listing for a Bank FP&A Senior Associate. That job listing says outright in the job description that “SoFi Bank is currently in formation and will establish a nationwide fully digital bank with a member-centric approach that provides relevant, fairly priced products throughout life stages and events.”

Is the Bank Charter Priced In?

After the recent price movements in the SoFi stock, I am more convinced than ever that the bank charter is not priced in. Here is the SOFI daily chart from the last 3 months:

Source: TradingView with my own annotations

You’ll notice that on September 22 and October 11, the stock had jumps of 11% and 13.5%, respectively. Those were each caused by an analyst initiating coverage of SoFi stock with a "Buy" rating. Absolutely nothing at all changed about the underlying fundamentals of the SoFi business, but simply because a Jeffries analyst and a Morgan Stanley analyst recommended the stock as a “buy”. This stock has run up close to 40% in a month on the back of two analyst ratings. If analyst ratings can move the stock this much, think of how much something that materially improves everything about the company can move it.

What Happened to LendingClub’s stock price after obtaining their bank charter?

We can also compare what happened to LendingClub’s stock price. As mentioned previously, LendingClub received their charter approval on December 30, 2020 and their share price closed that day at $8.37. The share price jumped 26% the next day and was up 37% total a week later. What has truly been astounding however, has been their incredible growth since then spurred by record earnings due to their increased margins. Although they received bank charter approval on December 30, they started operations as a fully bank on February 1, 2021. That makes Q2 2021 their first earnings after receiving charter approval. LC announced blowout earnings driven by greater margins in their lending business and raised future guidance and the stock price blew up 48% overnight. At time of writing, Q3 2021 earnings were just announced yesterday and again the stock skyrocketed going up 33% overnight. In all, since the bank charter was announced, the stock is now up 403% since the approval announcement, as you can see in the one year chart below.

Source: TradingView with my own annotations

How about Varo Bank’s Valuation with a charter?

Another data point is Varo Bank. Varo is not a publicly traded company. However, their various funding rounds do give them a valuation. This headline pretty much says it all:

Source: CNBC

Revenue has tripled and the valuation has gone up 3.6x since they acquired their charter (I know the headline says it tripled, but 700M to 2.5B is actually 3.6x).

Square is the Odd Fintech Out

Square is the odd company out here, but that is for good reason. Both LendingClub and Varo operate as consumer banks and lending is a large segment of their business. Their business models make full use of the bank charter. Square, on the other hand, does not have any consumer lending products at all. They do offer business loans, but it is a very small part of their company. In fact, when you read their press release about obtaining their charter, it kind of makes you wonder why they went to the trouble of getting it in the first place. According to their press release, “We do not expect the bank to have a material impact on Square’s consolidated balance sheet, total net revenue, gross profit, or Adjusted EBITDA in 2021.”

What is Wall Street’s Opinion on the Bank Charter Being Priced In?

Wall Street analysts agree that the bank charter is not priced in. John Hecht of Jeffries specifically said that his $25 price target did not include the bank charter and that the charter would add about 30% in incremental adjusted EBITDA relative to his current base case estimates. Betsy Grasec of Morgan Stanley, who also initiated coverage with a $25 price target, has a bull case price target of $34. The difference between the two cases is that SoFi obtains its bank charter by early 2022.

SoFi Future Expectations

So LendingClub’s market cap had increased 4.8x in 10 months and Varo Bank’s evaluation went up 3.6x in 13 months after receiving charters. It’s also worth noting that LendingClub had already run up from about $5 at the beginning of November to over $8 at the end of December prior to the charter approval. Wall Street also believes there is significant upside with the bank charter.

I think it is reasonable to assume that SoFi gets a good short-term bump when the approval goes through. SoFi has had a good run recently, but I think it is clear that there is a lot of upside left to capture. If buy ratings can result in double-digit gains, I think a 10-20% jump on the news can be expected. However, I think the bigger gains will be realized over the next two to three earnings reports that occur after the bank charter approval. I expect SoFi to crush analyst estimates and consistently raise future guidance over those quarters as the true impact of the bank charter hits membership growth numbers, revenue, and earnings. If the bank charter comes through this year, I think a conservative and achievable price target for the end of 2022 is $40-$45.

The most important thing to me that people do not always seem to discuss about the charter is that it fundamentally improves the underlying business long term. This isn’t a catalyst that results in a one-time bump in revenue. This will positively affect every core product SoFi offers, make the ecosystem even stickier, and accelerate member growth (it even positively affects Galileo, although I did not have time to cover that in this article). This change will still be felt 5 and 10 years down the road as SoFi moves from a growth story to a successful fintech bank. SoFi is my highest conviction stock and I believe it will widely outperform the market over the coming years.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SOFI, LC, SQ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The information contained in this article is for informational purposes only. You should not construe any such information as legal, tax, investment, financial, or other advice. None of the information in this article constitutes a solicitation, recommendation, endorsement, or offer by the author, its affiliates or any related third party provider to buy or sell any securities or other financial instruments in any jurisdiction in which such solicitation, recommendation, endorsement, or offer would be unlawful under the securities laws of such jurisdiction.