Why SoFi Will Win the Student Lending Game

Tim Chen
Tim Chen
Feb 29, 2016 · 4 min read

Potential 10x yield on unicorn investing?

So many people and VCs talk about hunting for the next unicorn. But what about the unicorn of unicorns? Uber was once valued in the low billions, and is now worth ~$68bn. Here’s my take on which unicorn could achieve another 10x growth in the next 4–5 years.

SoFi is tackling $2.7T+ lending markets through social platform mechanics:

  • $1.2T Student loan market broken with growing federal default rates
  • SoFi funded $6B loans by targeting high-performing students & creating a social platform
  • Strong borrower base + social platform to gain entry into $1.45T mortgage market

Behavior change and market timing

To cover the high cost of tuition in the US, many students take out loans — in fact, the US student loan market is ~$1.2 trillion as of 3Q2015. But the system is inherently broken — under FDIC insurance regulation, banks lose pricing flexibility on student loans whereas they can calibrate risk for mortgages and auto-loans. A market with varying default rates would adjust for quality of education, e.g. Harvard/Stanford vs. for-profit colleges, but today, high-performing students subsidize loans to below-average school students, which have higher default rates. The delinquency rate in 2015 for federal student loans was ~12% vs. mortgages ~6% and auto loans ~4%.

So as a student borrower, I can’t refinance my loans at a lower rate. And if I want to take out another loan, I have to go through a confusing and time-consuming paper-work heavy process, use antiquated systems (FICO score), and put up with poor customer service just to get above-average rates! So how can I get a student loan commensurate with my education quality, career and lifestyle?

Defensible moat, scalability, and competitor

SoFi (~$4B post $1B series E led by Softbank), an online lending marketplace, launched in 2011 to refinance student loans by focusing on top schools. It connects students with their school alumni, who not only lend (SoFi’s also lends its funds raised), but also offer career mentoring, which ultimately reduces lending rates and delinquencies (~3% as of 2016). Instead of the FICO score and traditional debt-to-income ratios, SoFI uses responsible bill payment, monthly income vs. expenses, and professional experience metrics to better predict a loan’s repayment. And unlike traditional methods requiring filling out endless paperwork taking days, SoFi enables users to get loans real-time via their phone.

Naturally, SoFi’s moat is its commitment towards making the loan process about developing a community of like-minded borrowers and donors. This sets SoFi apart from competitors because it’s building a social platform. For example, to scale, SoFi threw cocktail parties for its members, and of the few borrowers who defaulted, SoFi paused their payments and helped them land interviews with potential employers. Oh, and SoFi also provides 6-mo. breaks for customers who want to start their own companies.

Furthermore, unlike competing P2P & social lenders, SoFi started with the strongest demographic customer base, which drives strong earning power. As of 2016, SoFi registered 120K+ members, funded $6 billionto date, and originated an incredible $1 billion in loans each month vs. $1 billion for all of 2014. SoFi has experienced hockey stick growth and profitability (profitable as of 2014) as a result of it’s ease of use and customer base. Competitors (Roostify, Lending Club, etc.) merely want to unbundle banks or streamline existing processes for consumers and Fannie & Freddie. SoFi wants to kill banks.

Risks and exit analysis

SoFi is a social platform that will transform finance and education. It’s social infrastructure (50% referral rate and 90 net promoter score) help the company scale, market and distribute its “community capital.”

Risks include lowering lending standards to subsidize growth, federal regulations loosening to compete, and bigger banks cutting rates (Wells Fargo has already). There’s also refinancing risk: subscribers lend money to SoFi, against its 5-year fixed rate notes, which originate 5–20 year maturity loans to borrowers.

SoFi is also expanding into the $1.45T mortgage market by leveraging its social platform and strong customer base. SoFi underwrites mortgages based on a person’s free cash flow to broaden customer pool and pull from its student base. Over half of SoFi’s borrowers earn at least $100K and have an average FICO of 774, driving favorable securitization ratings from Moody’s and S&P. Nonbanks grew their US mortgage marketshare to ~38% and PwC estimates nonbank mortgage lending to grow 30% CAGR from $6.5B in 2014 to $150bn by 2025. SoFi’s social model & strong customer base can drive it to at least $50B.

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