SoFi or LendingClub: which is the best stock to buy? (NYSE:LC)
Sofia (NASDAQ: SOFI) and LendingClub (NYSE:LC) are similar because both are FinTechs that recently became banks. I’ve been an investor in LendingClub since 2020 and have followed its progress very closely and now it’s a important position in my portfolio. I also recently initiated a position at SoFi.
In this article, I will compare and contrast the two companies. There are many similarities (personal loans) but also marked differences in strategy, business operations and financial aspects. Ultimately, I hope this helps investors make a more informed decision on the best stock to own right now.
LC is a digital marketplace bank. It became a nationally licensed bank through the acquisition of Radius Bank completed in early 2021. The engine of its business is providing personal loans through its marketplace. The primary use case for LC personal loans is credit card refinancing and debt consolidation. The benefits for customers are lower interest rates and a better credit score. LC typically retains around 25% of the assets it generates in the market and the rest is sold to investors (banks, asset managers, hedge funds, etc.). LC holds other loan assets such as mortgages, auto loans as well as some commercial loans (inherited as part of the Radius Bank acquisition) but overall these loan assets are somewhat intangible , LC is really a personal lender and marketplace. Currently, around 60% of income is generated by the market and the remaining 40% is interest income from loans held on the balance sheet.
SoFi’s origins are as student loan refinancers. Currently has three business segments loan, technology platform and financial services. It is a much more diversified FinTech/digital bank than LC.
On the lending side, SoFi has expanded its lending strategy to offer home loans, personal loans, and credit cards. On the non-lending financial product side, it offers products such as money management and investment product offerings.
In the technology division, SoFi operates as a platform as a service for a variety of financial service providers, providing the infrastructure to facilitate core customer-facing and backend capabilities, such as account setup, account funding, direct deposit, authorizations and processing, payment functionality and checking account balance functionality through the acquisition of Galileo. Most recently, SoFi expanded its platform to include a cloud-native digital and core banking platform with customers in Latin America through its acquisition of Technisys SA, enabling the company to expand its platform services. technological form to a wider international market.
Significantly in 2022, the company became a bank holding company and began operating as SoFi Bank through its acquisition of Golden Pacific Bancorp, Inc.
SoFi vs. LendingClub
At first glance, the similarities and differences are obvious. Both companies are digitally driven and create, maintain and distribute loan assets. Both companies are also nationally regulated depository institutions and banks.
The differences are also obvious. LC is much more narrowly focused on the full spectrum of personal loan market opportunities. Whereas SoFi’s scope is much more of a multi-product or “super-app” approach. It also operates as a banking as a service for other financial companies, which is already a large and growing part of its business.
But to make an informed decision about the best investment, we need to dig into the details.
Selected key indicators
The table below provides a comparative summary of key metrics for SoFi and LC:
I’ll draw a few key observations for now:
- Both companies have similar quarterly earnings and members; however, LC is profitable on a GAAP basis while SoFi is loss-making.
- SoFi’s market cap is around 3.5x LC, but it’s also proportional to the relative equity base.
- LC’s capital ratios are significantly lower and close to its 11% minimum requirement for Tier 1 leverage, meaning capital is much more constrained compared to SoFi.
What drives profitability?
Let’s start with SoFi with Q2’2022 results.
As can be seen above, the majority of revenue and Adjusted EBITDA comes from its lending segment. Financial Services EBITDA contributes about $54 million in losses and the Technology segment contributes about $22 million.
The lending segment is also directly comparable to LC’s core business, so I will focus on that segment and compare it to LC. Note that the numbers above are Adjusted EBITDA and currently generate an overall net loss of $93 million in Q2 2022 (primarily due to stock-based compensation and amortization costs) .
Comparison of SoFi and LC Lending Segments
Digital creations are the lifeblood of both companies.
I’ve summarized some of the key metrics for SoFi and LC below:
I will make several observations on the table above:
- LC originations are higher than SoFi but the latter retains more assets on the balance sheet. This is not surprising given that SoFi has plenty of excess capital to deploy for asset generation. LC is limited in capital.
- Note that LC arrangements are almost all personal loans. While for SoFi, the figure is around 2.5 billion out of 3.2 billion.
- SoFi originations are impacted by the suspension of student loan repayments. It is likely to increase significantly in 2023 when the moratorium expires.
- LC’s gross yield on personal loans is significantly higher than SoFi’s. Although the average FICO score for SoFi is slightly higher. This suggests that the risk-adjusted returns of LC loans are significantly higher than those of SoFi.
- SoFi’s average gross student loan yield is currently a modest 4.08%. Nowhere is the student loan business as profitable as the personal loan space.
A qualitative assessment of the relative investment case in SoFi and LC
Basically, LC and SoFi pursue different strategic paths even though the end destination may be similar.
LC currently focuses almost solely on the unsecured loan product. There are two main reasons for this. This product generates exceptional financial returns for LC, as evidenced by its increased profitability under GAAP. The highest returns are generated by keeping the loan assets on LC’s balance sheet (up to 3 times the returns from selling to investors). However, LC is also limited by its relatively low capital buffer. As such, LC’s management team has chosen to prioritize the growth of the unsecured loan portfolio currently. In order to grow the book, LC must increase its profits and redeploy capital into the business. This forces the management team to be very financially disciplined as well as slow the pace of investments in a multi-product roadmap. I believe this was a conscious decision that the LC management team made. However, in the medium term, it is clear that LC’s strategy is a multi-product strategy comprising credit, deposit, insurance and savings/wealth management products. The anchor product, however, will remain the unsecured loan product.
SoFi, on the other hand, has taken the super-app route with substantial investments in multi-product development and inorganic acquisitions. GAAP profitability is not currently a focus, instead focusing on contribution margins and adjusted EBITDA metrics pointing in the right direction. SoFi’s true earning potential is somewhat masked by a number of aspects. First, it only recently became a bank, which would allow it to keep more assets on the balance sheet and improve its cost of funding. Currently it uses expensive warehouse lines which should be replaced with cheaper depots.
Second, somewhat handicapped by the student loan moratorium, student loan originations are expected to rebound strongly in 2023 and beyond. That said, SoFi continues to invest heavily as well as a very high rate of equity compensation. While I expect it to improve its GAAP financial statements over time, the trajectory is not yet clear. Yet it has substantial excess capital to deploy to keep on the balance sheet, which should enable it to drive scale and profitability in the medium term.
Clearly, however, the most profitable line of business for both companies is the personal loan segment. In my opinion, LC has a clear advantage in this area. It comes from higher volumes, which leads to marketing effectiveness and a much better gross return while FICO scores are only slightly lower. LC has also proven during the recent pandemic that its credit risk models are super efficient, generating 30% higher loan losses than the industry. I suspect LC’s risk-adjusted returns are industry-leading and it continues to push its edge.
I recently initiated a position at SoFi. The valuation is undemanding and there is a purchase option (virtually free) in its Technology division (banking as a BaaS service). SoFi is growing rapidly and this should allow it to reach profitability in a reasonable timeframe, especially as some of the headwinds subside and it capitalizes on its status as a bank. That said, I am aware of the apparent lack of financial discipline and especially the high dilutive cost of equity compensation.
My biggest position is in LendingClub and I’ve written several articles about it. The key attraction is the exceptional returns it generates from its market and the loans it keeps on the balance sheet. There are pros and cons to the almost singular focus on the unsecured loan product. Returns are exceptionally high, but because they are limited by a thin capital pool, they delay further monetization of the customer lifecycle. The risk is that the likes of SoFi will cement a first-mover advantage as a convenient, user-friendly financial super-app. I believe this is a conscious decision by the LC management team. At present, they are determined to prioritize balance sheet and earnings growth and thereby create capacity for additional investments.
In my view, both stocks are exceptionally good value at current prices. I have a preference for LC given the clear trajectory of GAAP profitability and its competitive advantage in the lucrative personal loan industry.