Unicorns – SoFi
5 Ways That SoFi Threatens Bank Of America
As an investor in Social Finance (SoFi), a San Francisco-based fintech startup, and customer of Bank of America BAC +0.25%, it’s clear that the upstart is winning the consumer finance battle.
Ever since the financial crisis, I have been hoping that a new form of financial institution — one that’s free of the moral hazard of relying on government-guaranteed consumer deposits to finance risky lending that enriches unaccountable bankers — might replace the traditional banking industry.
SoFi and many of its fintech peers are beginning a journey that will siphon depositors and borrowers away from traditional banks like Bank of America.
Before getting into that, let’s look at what I thought over four years ago would help. As I wrote, “The idea — to create Deposit Only Banks (DOBs) which would offer consumers an ATM network where they could deposit funds in safe money market funds that would be financed with fees or advertising to depositors — is not new. I wrote about it in June 2009 and again in April 2010.”
SoFi’s idea is much better. It offers below-market-rate student loan refinancing, mortgages, and other consumer loans using funds obtained from institutional investors and wealthy individuals to whom it pays as much as 6.5% annual interest — depending on the borrower’s rate of loan repayment.
But SoFi — which has been profitable since 2014 and raised $1 billion last month valuing it at an estimated $3.8 billion, according to the Financial Times — has bigger ambitions. As CEO Mike Cagney told CNBC, “We actually are trying to change a fundamentally broken [banking] system.”
And with the new capital, Cagney plans to expand through “initiatives in wealth management, banking account alternatives — things that allow us to give a holistic solution [that will lead] people to leave their existing banking relationship and just work with SoFi,” Cagney said.
Here are five reasons that SoFi could take business from Bank of America.
1. Market segmentation
Traditional banks are highly regulated and they can’t get away with cherry-picking the best borrowers and ignoring the rest. SoFi — which does not take deposits and is regulated at the state level by the Consumer Financial Protection Bureau — has more strategic flexibility.
SoFi prospers by targeting students at relatively selective schools–such as Stanford and Harvard– whose alumni tend to get high-paying jobs and to be financially responsible.
Moreover, SoFi’s original concept matched up wealthy alumni of those schools who in addition to providing the money to refinance those loans helped borrowers seeking career advice.
2. Lower loan rates
SoFi estimates that it can save the typical student loan refinancing borrower about $14,000 and that its rates “start at 3.50% fixed and variable rates start as low as 1.90% [annual percentage rate] APR (with AutoPay).”
My efforts to find the interest rate that Bank of America charges for a student loan refinancing came up empty.
But rival, Citizens Bank charges what sounds like more — from 4.74% APR to 8.90% APR (with autopay) for fixed rate and 2.33% APR to 6.97% APR (with autopay) for a variable rate loan.
3. Higher deposit rates
Like most traditional banks, Bank of America pays a barely detectible 0.03% interest rate to depositors — but it can go up as high as 0.08% for those with an account at its Merrill Lynch unit.
SoFi does not take consumer deposits. However, individuals who qualify to provide cash to borrowers can earn much higher yields — up to 6.5% depending on the rate at which borrowers repay.
To be sure, the people who provide capital to SoFi are taking a much bigger risk than a depositor at Bank of America. But with deposit rates near zero for the last eight years, SoFi offers a substantial reward to those willing to take that risk.
4. Better customer experience
Bank of America is the second-largest U.S. lender but the leader when it comes to customer dissatisfaction.
According to an April 2015 J.D. Power survey of 80,000 bank customers on problem resolution, products and fees, Bank of America ranked “last in four of 11 regions in 2015 including the Northwest and Southeast, compared with two in 2014.”
I could not find such a survey for SoFi, however, a comparison of SoFi’s loan application process to Bank of America’s reveals one reason why consumers might like SoFi more.
SoFi offers to give a potential borrower a rate on their loan within two minutes based on the borrower’s response to questions asked on its website.
Bank of America’s website lets a potential borrower fill in an application but does not guarantee the time it will take to deliver the rate quote.
5. More rapid response to change
Since I first wrote about SoFi in 2011, its business strategy has evolved in response to market feedback, changing technology, and upstart competitors.
It started off in student loan refinancing.
SoFi broadened its sources of capital from wealthy alumni to others — such as securitizing and selling the loans to institutional investors — it has completed over $2 billion worth of student loan securitizations so far.
Then it expanded into mortgages. 60% of SoFi’s current loans are for student loan refinancing now, but by the end of the year, new origination in mortgages and consumer loans [will] top student debt refinancing, Cagney told Fortune.
SoFi plans to continue to adapt. As Cagney said, achieving his vision is “going to require us [to take] some chances. And those are things that are difficult to do as a public company, when you’re on a quarterly reporting calendar.”
Perhaps that concern with quarterly results helps to explain why the adequate — but not great — products and services I have received from Bank of America have not improved notably over the last four years.
Bank Of America is hardly the only bank that could lose business to fintech upstarts. It will be interesting to see how SoFi evolves as it grows and whether incumbents can adapt.