SoFi Technologies (SOFI) & Discovery Financial (DFS) – New Product & Discover Financial Read Through – January 20, 2024
New Product
SoFi continues to dip its toes into new financial services. Whether it’s rewards partnerships, home lending or now small business lending, it truly wants to be the one-stop-shop for everything.
This week, SoFi debuted an expected small business lending product. SoFi will not be issuing these loans, but instead connecting applicants to its network of originating partners. It’s similar to the personal loan marketplace product (called Lantern) in that SoFi isn’t the actual source of funding. Conversely, this will be the only business product that it offers for now while Lantern is where SoFi sends rejected personal loan applicants. I see this as the commencement of its expansion into additional small business use cases. Whether that’s working capital management or bill pay next, I think this is just the tip of the iceberg.
For now, SoFi will likely use all of this business lending data to season potential algorithms for a future credit product (where it actually is the originator). I’m speculating, but somewhat confidently so. Personally speaking, SoFi offering business accounts would lead me to move my account over immediately. Give the people what they want. In its journey to meet ALL needs of its customers, some of those needs will naturally entail entrepreneurship. This is part of being that one-stop-shop.
Discover Financial
Discover Financial delivered a bad quarter this past week. Charge-off rates and overall credit quality deteriorated more quickly than expected. Some are assuming this means SoFi and other issuers will struggle with the exact same issue (despite Ally & AmEx looking pretty good this week). That’s always possible. Credit quality maintenance gets more difficult as macro worsens. SoFi needs to maintain high quality credit metrics and that will be difficult in 2024.
Credit quality worsening is the main risk to the SoFi bull case. I thought the risk was more pressing in 2022 and 2023, but it won’t vanish in 2024. Poor performance here would lead to balance sheet bottlenecks, slowing revenue growth, challenging profit generation and more challenges. This risk must be respected, but it is not overly alarming in my view. Here are the reasons why:
First and foremost, SoFi reiterated its plans for consistent profitability and tangible book value growth earlier this month. That cannot happen if its credit quality falls off a cliff. The former and the latter in this case are mutually exclusive. Furthermore, SoFi’s fair value credit assumptions include 2.5% GDP contraction and 5% unemployment. Neither of these items have come remotely close to playing out. Its guidance includes the type of origination and fair value environment that coincide with that conservative outlook. That’s a large part of its comfortable loss rate outperformance. SoFi’s guidance includes expectations of more loss rate deterioration. With macro developing in a more favorable manner than its overly prudent expectations, it should be well positioned to keep outperforming.
But wait, there’s more. Discover handles the lowest credit quality network in the business. This is not Visa, Mastercard or American Express. They cater to a larger cohort of fragile borrowers. That’s why they’ve struggled with credit quality for the last few quarters while the others mentioned (and SoFi) have seen continued consumer resilience. To me, Discover Financial is to gauging credit quality as Snapchat is to a social advertising. Additionally, SoFi’s credit and capital market access have comfortably outperformed expectations across the board into 2024. It’s not like late 2022 and 2023 were easy environments for lenders… quite the opposite. That’s the luxury of responsible underwriting, immense selectivity and an average borrower FICO well over 750. And finally, most of SoFi’s credit card debt held on its balance sheet is just refinanced unsecured personal credit. Its highly strict approval process and existing repayment data on the specific loans are a lot different than letting consumers go buy a couch with a plastic card.
Source: YCharts
