Where SoFi-Zenbanx merger falls short

The announcement that Social Finance is buying Zenbanx marks an important milestone in SoFi's ongoing evolution from a one-product company exploiting a pricing anomaly in the government student loan market to the preferred private bank for millennial achievers.

But as positive as this partnership is, it won’t solve all of the challenges facing an alternative lender like SoFi, which still needs a more direct banking capability to deliver sustainable funding for its loan portfolio.

For the last couple of years, SoFi's quest to become the central financial services hub for its approximately 230,000 Henry (High Earner Not Rich Yet) customers has had mixed success. While 230,000 is a large number of customers for a fintech startup, it pales into comparison to a money-center bank like Wells Fargo, which has more than 300 times as many customers and is much fewer than the customer count at private-bank competitors like First Republic. More important, the vast majority of SoFi’s customers have only a single-serve (and not very profitable) student loan relationship because SoFi lacked the transaction banking and deposits capabilities needed to make it the center of its customers’ financial lives.

To move that critically important “share of wallet” needle, the company explored many avenues, including expanding its loan and investment offerings and looking hard at opening or buying a bank itself. The need to grow share of wallet is particularly important to SoFi, since the student lending space is now crowded with companies reproducing SoFi’s products and compressing margins.

Zenbanx has developed a niche as a virtual banking and foreign exchange service for internationally minded customers. The pairing appears to move SoFi closer to its goal of offering core banking capabilities to its customers. While Zenbanx is a fintech company, it contracts with a regulated bank, Delaware-based WSFS, which will do the heavy (and regulated) lifting.

Under the deal, SoFi customers who agree to use SoFi-Zenbanx as their "banking" relationship will get much, if not all, of the traditional bank functionality they need for day-to-day personal needs. SoFi hopes that customers will begin to think of SoFi as “their bank” and buy more personal loans, mortgages, wealth management services and life insurance. Meanwhile, the foreign exchange strengths of Zenbanx may be particularly appealing for SoFi’s tech-employee customer base.

While the ongoing relationship will not be cost-free — WSFS is well compensated for helping to provide banking functionality — the deal on balance looks like a win-win for both sides, and is another example of the growing fintech-bank convergence. “We’re moving one step closer to becoming the center of our members’ financial lives,” SoFi CEO Mike Cagney said in the announcement of the deal.

And yet, even though the Zenbanx acquisition goes a long way toward expanding SoFi’s bank deposit offerings, it does not address SoFi’s other and in some ways more pressing issue related to deposits — specifically the lack of deposits funding its alternative lending model.

The Zenbanx deposits and their funding benefits will stay with the banking partner WSFS, not SoFi. SoFi will still rely on its own equity (thank you, Softbank) and institutional lenders both to hold and pool loans on its balance sheet and to facilitate securitization. That type of institutional funding base works fine (although it is costly) so long as SoFi's portfolio continues to perform well and markets are calm. But at the first sign of credit problems or market dislocations, institutional and bank funding will become scarce and even more costly. SoFi, like any finance company, would be much better off with a stable, self-sustaining, inexpensive funding base derived from its core customers — i.e., bank deposits.

To get those critical deposit funding benefits, SoFi will eventually need to take the final step into banking, which it has so far avoided. SoFi management has been adamant that it doesn’t believe deposit access is worth taking on the regulatory burdens associated with becoming a bank. Cagney flatly said last month that SoFi’s plan to introduce deposit accounts is “not to fund our loans.” And last July, Cagney also noted that it was “not a viable solution for us to be a bank,” saying that the company’s growth rate would trouble bank regulators.

While SoFi’s view that it can fund its business perpetually in the capital markets seems like wishful thinking (just ask all the finance companies that failed in the last crisis), SoFi is justified in its cautious approach because of the still-tough bank regulatory atmosphere. While the Office of the Comptroller of the Currency is making inroads with its proposed fintech charter, the bank regulatory world has yet to find a solution to include fintech-focused banks in a manner that protects the public interest but does not strangle innovation and growth. Let us hope that the logjam will break soon. Perhaps only then will fintech leaders like SoFi be able to access the stable balance sheet deposit funding they will need in a downturn.