Many traditional banks lack the broad suite of services (and the velocity) that people demand in a digitally connected world. As a result, the financial services industry is becoming more fragmented, allowing new players to emerge and win market-share from incumbent financial institutions. Until now, I think that SoFi (SOFI +0.25%) has been overlooked as a potential disruptor. The company's recent Q3 earnings report illustrates that it is on a mission to revolutionize the banking industry.
Leading up to Q3 earnings, SoFi was given three "buy" or buy-equivalent ratings from equity research analysts. As a result, SoFi's stock price increased nearly 60% from when the research reports were issued in September to Q3 earnings in early November. Was the run-up validated? Let's dig into the results and find out.
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Financial performance
SoFi set a new quarterly revenue record in Q3 2021 with $277 million in net revenue, representing 28% year-over-year growth. Although the company was originally a lending business, SoFi has invested heavily in product development in an effort to build a mobile-first super-app. On this app, members can access a multitude of financial services and products, such as trading cryptocurrencies and IPO investing.
As of Q3 2021, SoFi's member base was 2.9 million users. A total of 4.3 million products were being used by these individuals, implying that, on average, each member uses more than one product. Total products used on SoFi's platform increased from 3.7 million in Q2 2021 to 4.3 million in Q3 2021, whereas new members increased from 2.6 million in Q2 2021 to 2.9 million by the end of Q3.
That fact that SoFi's product growth exceeded its member growth in absolute terms in the third quarter could indicate high product satisfaction and a greater willingness to adopt additional products. This also reinforces the value of the company's flywheel business strategy. In fact, SoFi is recognizing higher adoption in financial services and technology products and becoming less reliant on its legacy lending business. SoFi's lending business accounted for over 80% of its total revenue in 2020, while financial services and technology products accounted for less than 20%. However, through Q3 2021, lending now comprises roughly 75% of total revenue, while financial services and technology have increased to nearly one-quarter of year-to-date revenue.
SoFi also achieved record volume in both personal and home loans, which were up 166% and 26%, respectively, year over year. However, student loan volume remains depressed by the extension of the CARES Act moratorium on federal student loan payments.
Given the economic headwinds the company faces in its lending unit, the growth in additional product offerings is particularly encouraging. In Q3 2021, SoFi recorded a $30 million GAAP net loss, an improvement of nearly $13 million from its Q3 2020 net loss of $42.9 million. SoFi's ability to trim its losses may illustrate that its flywheel strategy is paying off. As members use more SoFi products and become more ingrained into its ecosystem, the company generates more revenue per member without incurring additional acquisition costs.
What's on the horizon?
Morgan Stanley was one of three investment banks that issued a buy or buy-equivalent rating on SoFi. A big part of the thesis is the prospective approval of SoFi's bank charter, which Morgan Stanley expects in early 2022. A bank charter would make it easier for SoFi to partner with other companies and offer sweep accounts, as well as win access to FDIC insurance warehouse facilities, among other financial services. Morgan Stanley noted that SoFi's approval of its bank charter could boost total revenues by 10% within its first year, solely based on the benefits of gaining access to the same low interest rates as other banks.
A bank charter could be such a transformative event for SoFi that the prospect of the charter itself has led to a run-up in the stock over the last month. It is important to keep in mind that SoFi has other strategic opportunities that are not yet contributing to its revenue growth. For example, SoFi partnered with Pagaya in late October. Pagaya offers an artificial intelligence infrastructure that enables financial technology companies, banks, and other loan providers to offer increased access to financial products outside of traditional credit models. Pagaya's machine learning models aim to reduce risk for lenders and help better inform credit risk. To date, Pagaya's partnership with SoFi is the largest deployment of its technology in the financial technology marketplace. This partnership is meaningful because it will allow SoFi to offer its services to a broader audience without taking on additional credit risk.
Now what?
SoFi is worth keeping on your radar if you are looking for exposure to disruptive financial technology investments. While I will monitor SoFi's ability to build a moat in the long-term, its strong financials lead me to think that SoFi is well on its way to establishing itself as an industry leader. Despite short-term headwinds in its loan business, it is important to note that SoFi is investing heavily to continue increasing its product suite, which can help shift its revenue mix from primarily lending to other financial services products as it scales its business.
