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1. SoFi Technologies (SOFI) -- Investor Conference & Deposit Insurance
a) CEO Anthony Noto Interviews with Bank of America
On Liquidity & Access to Capital Markets:
- SoFi has $18 billion in total available liquidity. This includes $8.4 billion in warehouse capacity (with $5 billion of that being undrawn), very sticky direct deposits of $7.3 billion and equity capital of $3 billion. It has excess liquidity.
- It saw 0 material hit to financials or liquidity from its drawn $40 million SVB credit revolver. SoFi keeps its deposits with 30 different banking entities to ensure lack of reliance on any chartered institution.
- Relationships with capital market loan buyers remain “great” with SoFi able to tap into asset back securitization (ABS) markets twice in the last few months at “attractive rates” and improving spreads. This is important, and not the case for most other fintechs. This is why catering to prime borrowers is such a positive -- especially now.
On Loan & Underwriting Quality & if SVB Issues Could Be Experienced by SoFi:
As I mentioned last week, SoFi’s hold-to-maturity bond portfolio is tiny at $200 million. These holdings are entirely in short-duration securities. Furthermore, unrealized losses on its balance sheet equate to just 0.2% of its tangible book value. To make it even more insulated, its average loan coupon continues to rise faster than benchmark rates and its hedging program continues to lock in cash flow and eliminate all rate sensitivity. Finally, it accounts for its loans based on fair market value accounting. This requires it to mark-to-market changes in loan value every single quarter. So there’s no build-up in loan valuation impairments here to surprise investors down the road.
Finally, its underwriting criteria continues to be extremely strict and it continues to refuse to widen credit bands to support origination growth. It will keep sending rejected borrowers to referral partners through products like Lantern. It also has some integrated 3rd party loan originators that can approve and fund loans on SoFi’s platform with their own liquidity. This lets SoFi add the customer as a member for cross-selling without taking unnecessary risk. Win, win.
It expects credit performance to fall back closer to pre-pandemic times while it will maintain “industry-high credit performance.” He has seen no recent deterioration with credit performance despite expecting that it would come.
“Regulators will have to re-think policies around accounting for unrealized losses and available-for-sale and hold-to-maturity accounting.” -- CEO Anthony Noto
SoFi’s personal loan market share ranges from 6% to 8% by month. This compares to 6% market share as of last year and 4.5% share in 2021.
All of this is to say SoFi is completely fine, just like I explained in last week’s article. And while this news is not brand new to consistent readers, it’s still reassuring to hear it from the CEO while he continues to buy more shares.
On Deposit Health & Growth:
“Importantly, growth in deposits remains strong. We expect absolute increase in deposits to be equal to or greater than the last few quarters.” -- CEO Anthony Noto
This informal guidance reflects minimum 32% sequential deposit growth to reach or eclipse $9.6 billion. Growth here remains rapid. The quality of its newest deposits is also in-line to above older direct deposit cohorts. There are 0 issues here. Business as usual with the drama serving as a small accelerant to deposit growth if anything.
On SoFi Bank:
“We’ve been able to achieve strong return on equity (ROE) in the bank after just one year and without being fully leveraged. We have a line of sight to ROE in the high 20s or higher.” -- CEO Anthony Noto
On the Student Loan Moratorium Lawsuit:
As always, I do not care about the politics of this issue. I care about the impact on SoFi’s business. You don’t read this newsletter for me to share my political opinions, so I’ll continue to exclude them. Left wing or right wing? I don’t care. It’s about alpha.
There’s a bit of confusion out there on what SoFi’s student loan moratorium lawsuit is actually about. This is NOT about select student loan forgiveness. SoFi has advocated for $10-$20 thousand in forgiveness for people earning $125,000 or less. It has also supported a cancellation of debt for permanently disabled borrowers.
“Our recommendation to the administration was similar to what was announced.” -- CEO Anthony Noto
So then what’s the issue? It is about the administration executing. SoFi is suing for payments to resume for non-eligible borrowers 60 days after the moratorium ends in June. It was the result of the administration refusing to put this spoken promise into writing, which to SoFi meant they weren’t planning on adhering to it. This was not an easy decision for the company. It carefully weighed pros and cons and decided it was in its best interest to file the suit. It saw competition in the space vacating and thought it was important to lead this charge and to preserve the market.
There has been “no change in student loan refinancing demand since filing the lawsuit… But there’s likely a larger regulatory target on its back after this move.
On the Tech Platform:
- Its largest customers here are “well-funded & continue to invest in their businesses.” This was good to hear considering the tumultuous macro backdrop for fintech and how many players have pulled back on business investments.
- Most of the investments in rounding out the product suite and migrating to the cloud are now “behind SoFi.” It will keep investing in Galileo and Technisys, but at a slower pace. This will drive “meaningful profit improvement” as we’ve already been told to expect tech platform contribution margin to have bottomed.
- The company is in “meaningful conversation” with a “significant number” of big financial institutions. I’m candidly tired of hearing this. Stop talking about the pipeline until that pipeline starts to convert.
On How Noto Feels about the Previously Issued Q1 and 2023 Guide:
He remains “comfortable” with quarterly and annual guidance and all key performance metrics. I was encouraged to hear the reiterated annual guide as it becomes less clear if the moratorium will actually end this summer. SoFi “continues to see the positive trends” implied in the guide. He thinks its new FDIC insurance product (discussed below) could maybe provide some deposit growth and revenue upside. We’ll see.
On Financial Services:
- Reiterated this segment reaching contribution profit positive by the end of the year with a “clear line of sight” to get there.
- More product monetization, a slowing of building credit loss reserves and the proliferation of its higher margin credit card business are all helping mightily. It’s still not ready to go full speed ahead on growing the credit business as it continues to perfect the product.
On SoFi in 5 Years (Take with a grain of salt & remember this is the CEO of the company):
“Sky's the limit. The thing standing between us and being a top 10 financial institution is becoming a household brand name. Within the next 3 to 5 years I endeavor for us to be in the top 10… we’re setting up a series of S curves of growth so we can compound for decades, not just a year or 2.” -- CEO Anthony Noto
Quite ambitious.
A Reminder of SoFi’s 2018 Pivot:
When CEO Anthony Noto took over SoFi 5 years ago, the company didn’t look anything like it does today. It was a largely mono-line student loan vendor with a focus on volume and quantity over variable profit, cash flow and quality. In Noto’s words, “loan vintages were not as quality as needed to endure economic cycles.” So? It drastically tightened its underwriting and credit bands and skewed its focus towards maximizing loan volume ONLY while ensuring strong and durable life of loan loss rates. The effect today is an average loan customer with a 750+ FICO and over $150,000 in annual earnings.
This is why I like Anthony Noto so much. He didn’t wait for credit issues to surface like most other fintechs. He didn’t assume tranquil macro would last in perpetuity. Instead, he positioned the business for resilience through these moves and a rapid diversification of its product suite to offer products that do well in all macro environments. He secured a bank charter for cheaper, more reliable access to loan origination funding and an ability to offer a 4% savings APY to juice top of funnel growth. And finally, he vertically integrated the company's tech stack through M&A to become a lower cost operator and an API vendor for its competition. This lets SoFi fully capitalize on the secular tailwind of digitized financial services.
He was 5 years early, and now it’s paying off.
b) FDIC Insurance
SoFi increased its members’ maximum FDIC deposit insurance from $250,000 to $2 million this past week in a timely, savvy move to raise depositor confidence amid banking sector issues. It actually did something similar a few years ago, but the lack of consumer interest led to it ending the program. My how times have changed.
How is it possible to unilaterally 8x the insurance maximum imposed by a federal regulatory body? Good question, I was wondering the same thing. And the approach to pull this off is creative.
To offer this perk, SoFi created the SoFi FDIC Insurance Network. This network features a large cohort of banks that will allow SoFi to disperse deposit funds across a wide range of chartered institutions. Effectively, members will now just enjoy the $250,000 minimum eight times. Importantly, this will not jeopardize or delay access to full account balances as the front-end (what the consumer sees) will still show the aggregate amount while this works behind the scenes. This is a common practice for major corporations and the ultra-wealthy, but has been unavailable for all consumers…until SoFi.
I’d be shocked if other banks didn’t follow suit as I view this as an easy and effective way to juice deposit confidence during a chaotic time when more of those deposits are up for grabs. I absolutely love this move and think it will help SoFi separate itself from the commoditized pack at an immensely key time.
“By offering access to up to $2 million in FDIC insurance, we are making sure our members have peace of mind about their money at SoFi. We know the last few weeks have been unnerving for many consumers, and we hope this helps.” -- CEO Anthony Noto
The glass half empty view on this news is that SoFi is feeling the pressure to maintain depositors via added incentives like this one. Last week’s news on slashing its checking APY in half paired with Noto’s comments on continued rapid deposit growth put that argument to bed.
2. Shopify (SHOP) -- Alphabet
Shopify and Alphabet have long been tight partners. Shopify merchants can sync and push product catalogs directly into Alphabet’s properties (Google + YouTube + Maps) and update product availability in real-time to maximize search engine optimization (SEO). Shop Pay is also available for checkout for Shopify merchants and non-Shopify merchants through Alphabet. Simply put, this is a key selling channel for Shopify merchants.
The partnership deepened this past week. Shopify and Google Cloud are joining forces to “tackle search abandonment.” This type of issue is quite costly to merchants considering they’ve done the work to procure the search and the sale, yet lose the revenue for some reason. So? Google’s discovery AI tools will be directly integrated into Shopify’s largest merchant stores through Commerce Components by Shopify (CCS).
This partnership will more intelligently display search results based on inquiries by mining all relevant Alphabet data to paint a more accurate picture of what the shopper is actually looking for. Rainbow Shops is among the first merchants to use the product which raised its search volume by 48%.
Shopify continues to work on improving its search functionality – which leadership has often called lacking – through both Alphabet and OpenAI’s/Microsoft’s ChatGPT product.
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3. Meta Platforms (META) -- WhatsApp, Ads & TikTok
a) WhatsApp
Zuckerberg announced new WhatsApp upgrades this week. First, Meta debuted a new WhatsApp function on Microsoft Windows. This is an expansion of its video conferencing service which now allows users to host as many as 8 people via video and 32 over audio. It brings the web version of WhatsApp more up to par with its mobile version for this specific use case. The app will be launched on Apple’s operating system soon and user limits per call will continue to be raised over time.
b) Ads
Analysts continue to come out with bullish views of Meta’s advertising revenue growth for the year. They should have read my newsletter when the company was trading in the 80s, but I digress. This week, Piper Sandler, Edward Jones and KeyBank all published fresh research notes pointing to more effective targeting, reporting and returns. Specifically, Piper Sandler called out the trend of falling ad rates slowing to the lowest level in nearly a year.
Whether it be lengthened attribution windows, the release of Advantage+ or other AI-based investments to sharpen efficacy in a post-IDFA world. Meta is clearly turning a corner – and turning this corner will be astronomically more important to its near-term financials than any developments in the Metaverse. Both firms also praised Meta’s continued cost cuts with Piper Sandler adding that it thinks more cuts are on the way. Based on CFO Susan Li’s conference comments from about 10 days ago, I would agree.
c) TikTok
TikTok CEO Shou Zi Chew spoke to congress this week. The news comes as bipartisan momentum to ban the app builds with the Biden Administration recently being granted banning power by the House Foreign Affairs Committee earlier in the month. Shou Zi took to social media to ask fans of the app to tell congress what they like about it. To me, this reeked of desperation and an awareness that a more formal ban may be becoming more likely. Privacy and security concerns here are not going away and our increasingly fragile ties to the Chinese Government certainly doesn’t help. Last week, the U.S. asked TikTok owners to divest the U.S. assets which the Chinese Government subsequently refused.
4. Block (SQ) -- Short Report
Hindenburg Research released a short report on Block this past week after a 2-year investigation. There were some parts of the report that were quite meaty & potentially concerning with other pieces including cherry-picked data and non-issues that needed more context. Here, I’ll dispassionately walk through the highlights.
On User Metrics:
This was perhaps the most potentially concerning and serious piece of the report. There are two main issues within this bucket: Fake accounts and illegal transactions. Hindenburg surveyed several Block employees that estimated Cash App users are anywhere from 40%-75% fake. All massive platforms deal with duplicate accounts and bots, but this proportion is quite elevated and alarming (if true). Like Twitter, which Dorsey also founded, there are countless fake bot accounts of popular personalities to try to scam people out of funds. Hindenberg even tried ordering a credit card using a fake Donald Trump account and Block’s compliance department issued the card.
Secondly, the report claims that Cash App has intentionally catered directly to illegal and black market activity to support its user growth. Allegedly, when Block catches users breaking drug or sex trafficking laws, they don’t ban the user, they just blacklist that specific account. The issue is that these accounts often have up to hundreds of other logins that remain active and part of Cash App’s user metrics. According to a “leading non-profit organization” and multiple DoJ complaints, Cash App is the top app for U.S. sex trafficking “by far.” Again, all major payments platforms have these bad actors. PayPal has them. Zelle has them. They all have them. It’s invariable. The issue is the sheer frequency and the lack of banning as a result (if true).
- It also argued that rappers using Cash App in lyrics to talk about illegal activity was a damning red flag. I found this silly and irrelevant.
During the pandemic, it took what Hindenburg calls a “Wild West compliance approach” allowing bad actors to mass create accounts of identity fraud and to rapidly extract illegal unemployment claims. It allowed single accounts to accept unemployment for several individuals and didn’t effectively verify addresses. All of this led to hundreds of millions in funds needing to be clawed back and a 16x fraud rate in Ohio for Block vs. competing vendors. It also apparently blatantly ignored Anti-Money Laundering (AML) rules to keep this illegal vector of user growth intact & frictionless. Its rate of fraud was 16x that of its closest complement in the state of Ohio. Not a good look from a legal and regulatory perspective.
Interchange Fee Caps:
Block “quietly fueled profitability” by avoiding regulatory interchange fee caps. For banks with asset bases over $10 billion, there are strict limits. Block has $31 billion in assets yet exceeds these maximums routinely by going through a small bank. These interchange fees are 33% of all cash app revenue.
It called out the current PayPal interchange fee investigation and thinks Block will be added to it. As I mentioned in the PayPal section, I see this as a more pressing concern for Block vs. PayPal considering Block is a chartered bank and PayPal is not. This asset cap specifically applies to banks.
This also is irrelevant to me. There’s nothing illegal about taking advantage of interchange law loopholes. Is it legal? Technically yes. Is it a reason to call for 75% equity downside? Not even close.
More Items:
The note calling out rising delinquencies for AfterPay was unfair. Everyone’s delinquencies have risen from the period in question (June 2021 - March 2022) as the stimulus benefit faded away. This is comparing an artificially low period of delinquencies vs. a putrid macro backdrop that promotes delinquencies. The degree of the rise (1.7% to 4.1%) is sharper than others like PayPal, but the fact that its rising is fully expected and not unique to Block. The other Afterpay note on late fees equating to up to a 289% APR was pretty eye opening. Other vendors have no late fees.
It also called out the company warning that it may never be profitable. Virtually every non-profitable company includes that as a risk in quarterly and annual filings. Nothing burger.
The founders cashing out over $1 billion in stock during the pandemic is not ideal, but does not rise to the level of fraud. Many executives have been selling. But again, $1 billion is a large, large number.
My Take:
There were a few items in this report that could be concerning to shareholders and a few more items that shareholders should (in my innocent bystander view) brush off as irrelevant.
5. PayPal Holdings (PYPL) -- Investor Conference & Interchange Fee Caps
a) Head of Merchants and Payments Frank Keller Interviews with BofA
On Modernizing Checkout:
The sheer number of integrations and use cases that proliferated through PayPal’s platform over the last 2 decades leaves checkout flows today somewhat “fragmented” from a merchant and consumer perspective. This leads to some consumer friction and more difficult merchant site maintenance due to a lack of centralized integration and tools to pull from. PayPal is obsessively focused on removing this friction and assuming more of the maintenance and integration work on behalf of its merchants. These changes will allow it to expand into new verticals like transportation and chains where tech stack fragmentation is a real barrier to convincing large brands like McDonald’s to overhaul systems in place. Keller explicitly mentioned McDonald’s. (Perhaps a new Braintree client?)
All of this work will extend to both web and mobile channels for fully inline, eventually single click checkout to delight consumers. The effect is 6% higher merchant conversion and 3%-10% higher PayPal branded checkout share.
- It’s worth noting that Shopify already has this. PayPal is playing catch-up.
Braintree’s tech stack will be the vehicle in which PayPal adds these latest flows and software kits across its merchant base. It will use natural up-selling opportunities like BNPL and tap to pay through iPhone to motivate the upgrade to this latest checkout tech by requiring it for these popular products. This evolution takes time, but with the larger merchants that are now on the latest integration kit, PayPal’s branded checkout share is stable or rising. It’s stable or falling for all others to show how important this upgrade truly is.
“With the strategy of using Braintree and PayPal Commerce Platform (PPCP which is Braintree for smaller merchants) as our core platforms, these will be the rails that all future integrations are going through. Whatever new capability PayPal offers will be through Braintree and PPCP rails and technology.” -- Frank Keller
To identify more needed changes over time, PayPal is embracing a more “scientific approach” through more extensive variable split (A/B) testing. New Head of Product John Kim has vastly accelerated the cadence of these tests. This is how PayPal can better take advantage and extract differentiating value out of its massive base of data. Within those data sets are key insights into what its stakeholders want. It’s now uncovering those insights in a more data-driven and less educated guessing manner.