Could a banking charter really limit SoFi’s valuation?

After years of research, Sofi Technologies (NASDAQ: SOFI) finally has a banking charter. The all-in-one financial services company’s move into banking became official recently when it obtained regulatory approval and then completed its acquisition of Golden Pacific Bancorp.

There’s a lot to like about SoFi’s new look – but investors may want to consider the impact of becoming a bank on the company’s valuation, as the market traditionally expects very different things from banks and corporates. technology, and the bank-fintech combo is still a bit new to the market. We’ll take a look.

What does becoming a bank mean?

There is obviously a reason why SoFi chose to become a bank. First, the banking charter allows SoFi to bring all deposits it has collected through its SoFi Money cash management account into the business, as unlicensed banks cannot hold Federal Deposit Insurance insured deposits. Corporation (FDIC). Then SoFi can use those deposits to fund a portion of its loans, which will save it money as SoFi relies on more expensive funding sources.

Image source: Getty Images.

Having a bank charter will also give SoFi greater regulatory clarity and establish a better framework for keeping loans on balance and collecting recurring monthly interest payments. At the very beginning of 2021, SoFi showed that having a bank charter would increase earnings before interest, taxes, depreciation and amortization (EBITDA) by almost $200 million this year and up to $300 million in 2025. Things may have changed since then, but clearly SoFi sees this as a win.

On the other hand, becoming a bank means that SoFi enters one of the most regulated industries. Banks in the United States generally fall under three different regulatory bodies: the Office of the Comptroller of the Currency (OCC), the Federal Reserve, and the FDIC. Banks must hold regulatory capital, which allows them to cover unexpected loan losses and continue to lend to individuals, families and businesses during an economic downturn.

Now, we don’t yet know exactly what SoFi’s regulatory capital requirements are. But the OCC said in its approval of SoFi’s banking charter that the company “must have at least $750 million in initial capital contributed in cash.” SoFi Bank is expected to have $5.3 billion in assets upon completion. This would equate to a Tier 1 leverage ratio (Tier 1 capital as a percentage of assets, one of several regulatory capital ratios that banks must track) of over 14%. That would be high for a bank, but it wouldn’t be too surprising, given loan club — another fintech that became a bank last year — has an 11% leverage ratio requirement.

Regulatory capital thresholds must be maintained. Profits help build capital, but we know that SoFi is not yet profitable. If companies are growing rapidly and wish to maintain their capital ratios, they must increase their capital, which can dilute shareholders and hamper returns.

How SoFi will be rated

At recent prices, SoFi is considered a high-growth tech company, with investors attributing it a market capitalization of nearly $10 billion with no profitability yet. The idea is that SoFi is building a large, high-income member base that it can monetize heavily down the line, so forgoing profits for now makes sense. But in addition to earnings, banks also tend to trade based on their tangible book value (TBV), which is what a bank would be worth if it went into liquidation. Let’s take a look at SoFi’s valuation against some of the most highly regarded and advanced banks in the industry.

Bank Price at tangible book value Prizes at winnings Return on equity (2021)
American Express (NYSE:AXP) 630% 6:44 p.m. 33.75%
Bancorp Triumph (NASDAQ:TBK) 407% 19.95 15.11%
Live Oak Bancshares (NASDAQ:LOB) 362% 16 25.93%
Sofi Technologies 339% N / A N / A
Discover financial services (NYSE: SDF) 257% 6.6 46.45%
Signature Bank (NASDAQ: SBNY) 249% 22.68 12.81%
loan club 234% 138.5 2.4%
Silvergate Capital (NYSE:IF) 206% 36.29 8.61%

Source: Y Charts.

As you’ll notice, SoFi is already trading at more than three times its TBV, which sits in the middle of this group of top banking stocks. You might say, well, that makes sense because SoFi is much more innovative than a traditional bank. But if you research most of these other banks, I think you’ll find plenty of disruptors with growth potential, powered by technology at least as impressive as SoFi’s.

SoFi offers much more than banking products. Its growing Galileo technology platform, which helps fintech companies perform front-end and back-end operations, is diversifying the company’s revenue streams. But the bulk of income at present still comes from the bank’s lending operations.

Regulatory capital requirements can limit a lender’s growth, as a fast-growing bank may need to raise more capital to maintain its regulatory requirements, which in turn hurts measures such as bond yields. equity. Additionally, if SoFi holds more loans on the balance sheet, certain credit costs and wonky accounting policies come into play.

LendingClub is an interesting example of the struggle as it is a lending fintech that was granted a banking charter last year. The charter has done wonders for the business in terms of profitability. But that has led the bank to increase its capital over the past year to support future growth, and investors appear to be wrestling with how to value it. After LendingClub’s management implied less growth than expected in recent full-year forecasts, the stock crashed as investors apparently valued it more as a bank. Yet if you look at day-to-day business activity, LendingClub continues to evolve with fintech companies like SoFi, Reachedand To assert.

wild west

I still think we’re kind of in the wild west of fintech banks when it comes to valuations. The addition of the bank should greatly help SoFi improve its profitability, but it’s important to look at how these older tech companies manage their regulatory capital. Unlike LendingClub, SoFi has Galileo, but it also already has a high valuation relative to tangible book value. If growth slows from the crazy pace tech investors are used to, investors may see SoFi as more of a bank than some would like. It’s not the worst. Banks are very profitable and strong banks can certainly trade at 15 or 20 times their earnings which can produce very good results over the years.

Ultimately, the valuation of these new models of fintech banks is still filled with uncertainties at this time. I see SoFi as a good test in experience. Maybe nothing changes, but reflecting on this dynamic is good exercise for SoFi investors.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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