It’s difficult to find anyone involved in or knowledgeable about fintech that doesn’t have an opinion on SoFi, a profitable San Francisco fintech giant whose office feels more like a big trading floor than a start-up. In just a handful of years, this company has gone from being a focused fintech in one corner of the financial services market (i.e., student loans) to a leading innovator in several arenas. We sat down with the company’s leadership looking for answers on how SoFi has pulled off its string of accomplishments. While we didn’t find any one magic bullet, we were impressed by a few core attributes of the company’s approach. Those include a deep commitment to its members, a sharp understanding of the capital markets, an aversion to pushing products on its customers and a clear vision on how it wants to grow. Now, on the back of its $500 million capital raise, SoFi has even more firepower to follow through on its objectives. The FR’s Gregg Schoenberg discussed those objectives in a recent conversation with Mike Cagney, SoFI’s Co-Founder, CEO and visionary.
SoFi’s $500mm Financing
The Financial Revolutionist: Mike, it’s good to see you. SoFi has been making big news on a regular basis in recent months. Let’s start with your newly announced $500 million round. Was your goal to raise that much or was that amount a function of the demand you generated?
Mike Cagney: That amount was our goal — we saw significantly more demand than that and could have easily raised more if we had wanted. One of the important things for us in this raise was getting participation from a variety of geographies, and we were able to bring in new investors in Asia and Europe which will prove valuable as we enter markets in those areas.
FR: Your press release states that you will use the funds to accelerate product development and international expansion. Will you also use part of the cash to fortify your balance sheet?
MC: That’s not our plan.
FR: When a highly visible company like SoFi, valued north of $4 billion, chooses to raise a massive new equity round privately, it underscores my view that the IPO market remains problematic for many companies that ought to be public. If the rules were different and if more public shareholders had a longer term perspective, do you think SoFi would have gone public by now?
MC: Our being a private company isn’t a function of anything in the public markets, but really because we want to get some of our more nascent businesses to a more mature place. I’ve always said there’s a lot of virtue in being a public financial services company, and an IPO is a great opportunity to introduce and clearly define your brand to a broader audience.
Becoming a True Bank
FR: Turning to your other recent news, how does the Zenbanx deal play into SoFi’s pathway to becoming a true bank?
MC: I think there are several dimensions to becoming a bank that we have to consider, but they’re all interrelated to the fact that a bank collects deposits. So our not collecting deposits means we have to address our capital markets challenge. But we're out financing every day and I think we've gone a long way towards solving that. What's more relevant to us is not having the product for the customer. The fact that we don't have a deposit product means that we really can't offer a ‘fire your bank’ proposition.
FR: Because of the basics you can’t do?
MC: Yes, because you can’t make that pitch to a customer if they still need to go somewhere else to deposit their paycheck or go to the ATM.
FR: So how would an industrial loan bank charter play into this?
MC: An industrial loan charter is the structure that works well for our long-term vision.
FR: How so?
MC: It allows a non-bank parent to have a captive bank subsidiary. The reason why that’s important for us is around marketing and brand. It also relates to things that are intrinsic to SoFi that you can't do as a bank holding company. So the ILC structure makes a ton of sense, but keep in mind that the FDIC hasn’t given out this charter in over ten years. At one point there was a moratorium on the charter, primarily because it was used by folks like John Deere and Harley Davidson to basically do equipment financing.
FR: So getting back to Zenbanx, how does it play into SoFi’s vision?
MC: It effectively allowed us to get to market much faster with a product that's in the market today, that's got some really cool payment capabilities and other components that would've been 2018, 2019 initiatives for us otherwise. We can bring those capabilities forward into this year now. It also helps our ILC licensing process because now we have the technology stack that's in production and that's been approved by the FDIC. That jump-starts and de-risks the whole application structure.
FR: From a client demographic perspective, was there much synergy between SoFI and Zenbanx?
MC: There was some interesting synergy internationally, given that Zenbanx's done a phenomenal job setting up an infrastructure for cross-border payments and remittances.
FR: How does that fit in?
MC: Because we're thinking about how we can better serve people here in the U.S. who aren’t citizens, like those here on H1-B visas. There's a huge need for that.
FR: Let’s turn to your target market. When I think of the term HENRY, I think of SoFi. Do you have active conversations about whether to expand beyond the HENRYs?
MC: There are 80 million 25-45 year olds in the US. We're just going after a 20% slice of that market and that's 16 million individuals. Today we're at 250,000 or so, and we're adding 20 to 30 thousand members per month. We hope to be at twice that at the end of this year and to keep that kind of growth up over the next few years. So today, our penetration is nascent in terms of our addressable market.
FR: Even those with 750 FICOs and above?
MC: Absolutely. I think one of the things that was surprising to us and that's constantly reinforced is that our market is much larger than anyone anticipated. When we started, we were doing loans for Stanford grads and that's a very defined market. Then it was the top five business schools, then it was the top 20 schools and we continue to expand. We’ve now refinanced student loans for over 2,000 different Title IV schools.
FR: So why the focus on 25-45 year-olds?
MC: Because misperceptions about millennials have led them to being underserved by traditional financial services firms.
FR: Could you elaborate?
MC: People think they're fickle, they're not loyal, they're price sensitive and they don't want to buy homes. But we have found them to be extremely engaged and loyal. Price matters to them, but it's like number four on the list. Ahead of that is speed, transparency and alignment. If you can deliver those things into that customer base, you will have someone for as long as you can deliver value to them.
FR: Do you ever worry about incumbents targeting your core market?
MC: Traditional financial services firms just don’t get that market. When we started SoFi, we had to say, "Okay, are we going to be price leaders or are we going to lead on a different dimension?" Back then, our cost of capital was much higher than a bank’s cost of capital. So we decided to lead on brand and service.
FR: I take it that’s the genesis of your community efforts?
MC: Yes. We decided to build outstanding service levels and make the bet that it would matter to the 30 year-olds in our community. I remember how skeptical the banks were when we did this. They tried to tell me that I would never book a mortgage if I was charging five basis points higher than the rate on Bankrate.com. Today, in student loan refinancing, we’re the number one provider. A large bank is the number two provider and they have lower rates than us, but we do four times as much volume per month. In personal loans, we're the number one prime personal lender. Number two is also a large bank and we do more volume by a mile, but we don't have the lowest rates.
FR: Given your high volumes, hasn’t your cost of capital dropped?
MC: Yes, now it’s in line with a bank’s cost of capital, so there’s no comparative advantage in funding costs. But we still drive brand and services and give products that people want. We created student loan refinancing — it didn't exist before we did it. We recast the personal loan to make it the surrogate for home equity loans as home equity disappeared. We've done interesting stuff in mortgages, especially high LTV prime jumbo mortgages. And our net promoter score runs between 75 and 90 across the product set.
FR: Your community efforts aren’t just around your products. What’s the broader scope of that effort?
MC: I think our concept of community value is the key thing that the financial industry just doesn't understand. We help people with their career. We help them with their resume. They lose their job, we get them re-employed. We’re also going to start showing people how much they get paid within their company on a relative basis because we have more salary data than anybody out there.
FR: How will that work?
MC: We will be in position to say to our members, "You're in the 25th percentile of Google. You need a raise, right? Ok, we're going to help you get a raise and here's the path to do it."
Cross-selling & Cross-buying
FR: Isn’t all of this extra effort indicative of the challenge you face in cross-selling your services? An implicit recognition that what SoFi is trying to do is very hard for an online financial services company?
MC: My experience is that most financial institutions have not been successful in cross-selling. A lot of the cross-sell stats that you see are people opening up multiple checking accounts or other low margin business product lines, sometimes unbeknownst to you that it was open. Most institutions have failed and I'll give you a good example as to why.
I once took the COO and a few other senior executives of a top four bank to my bank, which is also a top four bank. I walked in and said, “I would like a mortgage,” and the teller punched-up my name in the computer and saw that I had a little star next to it. Because I’m a private client, they said "Oh, Mr. Cagney, you get to go sit over there." So, I get taken to a separate area, with this dumb green lampshade overhead, and five dudes in suits behind me. Then a nice lady comes out to greet me and says, "What can I help you with?" I say again, "I would like a mortgage." She then looks me up in the computer again and says, "Mr. Cagney, that's great. Let's get started." She goes into a filing cabinet, pulls out a piece of paper and she gives it to me. The first thing I have to write on this piece of paper is my name. I then say, "This is all I need. Thank you very much.”
FR: Sounds like standard protocol.
MC: Exactly. I took the document back to our office and explained to the executives what was wrong with this process. Just think about how orthogonal that experience was. I had to go to a branch between 9am and 5pm. Plus, there's a clear caste system within the branch, which doesn't resonate to a lot of 30 year-olds. I then had to go through an antiquated process with a private banker. After all that, what is the first thing that this banker does to sell me the highest margin product in the bank? Hand me a blank piece of paper and ask me to write my name on it.
FR: How long have you been a customer?
MC: 19 years. The systems just don't talk to each other, they aren’t integrated, the business lines are different. The banks will try to justify why you have to put up with this experience, but they’re hurting themselves by making the next product as hard to sell as the first one. But it’s not just the banks. It’s the same issue in fintech too.
FR: How do you mean?
MC: A few years ago, there was a lot of hubbub about businesses that were supposedly revolutionizing the lending space. But they went out into a finite market, such as car consolidation, and competed for the same borrower. There was no incremental value proposition and yet they expected the cost of acquisition to go down over time.
FR: Customer acquisition costs have been challenging non-bank lenders ever since.
MC: Right, because the only way you get this model to work is to deliver a value proposition where someone goes from your first product into your second without friction. You can't pay for it and you can't push it. In fact, you can't actually sell another product at all, which is why cross-sell isn't the right term for what we do. Customers have to want to go on their own, which is why I like to call our approach a cross-buy.
FR: Mike, this is a beautiful, frictionless ideal. But doesn’t it only work with a small slice of the population?
MC: Actually, lots of people have great credit. I have great credit, but when I went to the bank, it immediately introduced a paper process into the middle of our interaction, which is nothing more than friction. In order to get the economics to work in our model, you've got to be effective at getting people from one product to the next in a frictionless way. If you look at our mortgage production today, I think in February, over 40% of our mortgages were done for existing members. That's huge because that's a high margin product where we’re making anywhere from $5,000 to $20,000 of margin each time.
FR: On that note, I’d like to discuss wealth management. After doing some searching online, I couldn’t find out much about your effort other than to note that you have some form of nominal presence already. What is the current status of the effort? Because if I were on your management team, I would be pounding the table to ramp-up wealth management.
MC: It makes a ton of sense, but so far, we haven't advertised our wealth management solution. We just put a tab up.
FR: You mean it wasn't my bad googling?
MC: (Laughs) Your natural language skills are intact. Look, wealth management is a complicated and scary space for people. One key takeaway from our research is that the reason people like financial advisors is because they're afraid of making mistakes and they're afraid of doing something outside the scope of their peer set.
FR: You’re saying that peer analysis is central to a future wealth management offer?
MC: Yes. I think one of the single greatest things you can do to empower individuals is to give them peer analysis. Showing them how much they are saving relative to their peers and how aggressive they are is powerful. As for the advisor, it’s not too difficult to design an optimal portfolio for your level of risk. In fact, I would argue that it could be massively simplified from how it’s done today.
FR: Do you envision some kind of performance benchmarking or is it just on the savings side?
MC: Both. I come the hedge fund world where absolute returns are good, but what people really care about is how they’re doing relative to peers. If you did 20% this year and I did zero, that makes me feel really bad. If we both did negative five, I'd actually feel better in that context than if I did zero and you did 20%.
FR: So it sounds like SoFi has been actively exploring how to differentiate its wealth management offer. Is it fair to say that over the next few years, regardless if you’re public or private, SoFi is going to have a very robust wealth management business?
MC: Five years from now, you will see a robust wealth management platform. You'll also see a very robust lending business and full service banking functionality. You will also see an asset management platform that feeds into that wealth management business and you'll see some kind of an insurance initiative, which I haven't figured out yet.
FR: I saw the deal SoFi did with Protective Life, but I assume it’s just a toe in the water. Are you debating between trying to ramp up quickly as a carrier, re-insurer and/or broker or are you inclined to acquire one or more insurance start-ups?
MC: We’re always inclined to grow organically, and from an insurance standpoint, we have a community that has interesting characteristics.
FR: Like what?
MC: For example, on an actuarial basis, we should've had close to 600 of our members die. But I think something like 25 to 30 people have actually died. There's real value there from a life insurance standpoint.
FR: You're talking peer-to-peer insurance akin to Lemonade?
MC: Yes, it's along the same conceptual idea, but I think that if you have a common deductible, you end up creating a really interesting structure. That structure was the old mutual concept, but the key to making it work is the community, and nobody has a better community to address adverse selection and moral hazard pitfalls than us.
Rhetoric & Positioning
FR: Now that you have fresh capital, and a greater ability to pursue your aspirations across financial services verticals, I think about some of the provocative rhetoric you’ve used in the past to describe big banks. But increasingly, one day you’re competing against banks and the next day you’re partnering with them. Do you ever think about softening your rhetoric?
MC: Yes, I think that I have softened my tone in dealing with the banks. People resurrect very old comments of mine, that were often taken out of context, and insert them into current publications. But I believe that there's an enormous market out there and there are roles for banks to play in this market.
FR: It is fair to say then that some of your old comments were trying to convey a broader message?
MC: Yes, I think we're going to drag the financial industry, maybe kicking and screaming, but we're going to drag them into a different kind of delivery model for a new generation of customer.
FR: As you mentioned, you’re a hedge fund guy by background. Are you still involved managing money and does your trader DNA inform how you have built SoFi?
MC: Well my board didn't like the idea of me running a relatively large macro fund and running SoFi, so we rolled it into SoFi. And yes, I see the markets everywhere.
FR: To that point, is SoFi a financial services firm or is it a technology firm?
MC: We consider ourselves a financial services business that exists because of technology. The rooting of that business is in our capital markets, risk, compliance, branding and marketing expertise, which you’re not going to find in any other fintech company.
FR: And your technology?
MC: Technology is necessary, but you have to remember that technology is not a moat. You can copy technology, so while it’s necessary, it’s not a sufficient condition to win. I mean calling us a technology businesses is really a disservice to what we're trying to build.
FR: As you know, the trajectory of the financial services industry changed along with everything else last November. How do you view SoFi and the markets now as compared to prior to the election?
MC: Things changed dramatically in November. For us, we straddle a book business and a non-book business. Because we have one foot in each camp, we lean in the direction where the wind's blowing. Right now, the capital markets are very frothy, so we're gated by capital, not by demand.
FR: What do you mean by that?
MC: We could double the size of our securitizations and we wouldn't lose participation on the transactions.
FR: What happens when the pendulum swings the other way?
MC: We produce enough on a monthly basis that if the market completely shut down, between permanent capital and the balance sheet, we could originate for 12 months.
FR: And If the market falls apart?
MC: The market always falls apart. Sometimes it's the butterfly’s wings in Somalia that causes the crash and sometimes there's a real reason for it. But the market always falls apart and you have to be ready. In fact, one of the good things that came out of the financial crisis is that people now know how to build balance sheets that can withstand financial and market volatility. At SoFi, when that day comes, we’ll be ready.
FR: Spoken like a true former hedge fund guy.
FR: Best of luck to you as you embark on your next chapter.
MC: Thank you so much, Gregg.
This interview has been edited for content, length and clarity.