2023-11-26 21:52:49 ET
Summary
- SoFi's Net Interest Margins are expanding due to increased lending rates and a higher share of low-cost deposits.
- The company is benefiting from a surge in student loan refinancing following the resumption of student loan payments.
- Despite rising economy-wide delinquency rates, SoFi's improved loan book quality mitigates some risk, leading to a Hold rating for the company.
Thesis
SoFi Technologies, Inc. (SOFI) is a personal finance company and online bank based in San Francisco that provides lending products such as student loans, mortgages, personal loans, and credit cards. It also provides banking and investing services. The company is disrupting the banking and financial services space and has won market share over its competitors. It is also benefitting from tailwinds such as an expansion in Net Interest Margin and a surge in student loan refinancing.
Catalysts
Net Interest Margins Expansion
One of the largest tailwinds for SoFi has been the expansion in Net Interest Margins. NIM grew by 13 basis points year-over-year and 25 basis points sequentially. The most obvious explanation is an increase in lending rates across the board - Student Loans, Home Loans, and Personal Loans. While this explanation is true, it does not fully explain the expansion in NIM for SoFi. A big reason for the expansion in NIM during this quarter was the increasing share of lower-cost deposits (lower cost compared to debt/borrowings) on the company's balance sheet.
Q3 2023 Earnings Presentation
The above graph shows SoFi’s Quarterly Average Balances of interest-earning Assets and interest-bearing Liabilities. A rising trend is a healthy sign for the company.
SoFi Q3 2023 Earnings Presentation
The above graph shows Quarterly Average Interest Rates on SoFi’s interest-earning Assets and interest-bearing Liabilities. The upward trend in both and the rising gap between the rates on assets and liabilities has contributed to expansion in NIM for SoFi.
While the average rate on interest-bearing assets (advanced loans) grew by 53 basis points from the previous quarter, it was partially offset by an increase in the average cost of interest-bearing deposits and debt, which grew by 18 basis points compared to the previous quarter. Other factors also contributed to the change in NIM having an effect of 10 bps.
I expect that over the coming months, as the personal savings rate in the economy (image below) bottoms out and rises again, people will increase deposits/ decrease withdrawals at the bank, and so, in my opinion, the company will be able to raise further funds at the deposit rate which is cheaper than raising funds through external debt, as the above image from the Q3 2023 earnings presentation shows.
FRED
The above graph shows how the personal savings rate is close to the lowest level in 10 years, with the average being closer to 5%. If we see a recession in the economy or simply a reversion to the mean level closer to 5%, people will increase the balance of deposits at banks allowing the banks (including SoFi) to raise funds from a source cheaper than external debt, and then further advancing loans to customers at existing interest rates. This will fuel growth in the loan book as well as expansion in the Net Interest Margins for SoFi. This is a macroeconomic tailwind that will benefit all banks including SoFi.
Student Loan Payments resume
In June 2023 , The Supreme Court of the United States ruled to strike down a plan of Joe Biden’s Department of Education that would have wiped out $400 billion of student debt for over 40 million Americans.
Starting September 1st, borrowers can anticipate the resumption of interest on their student loans. The commencement of payments is scheduled for October, as the debt ceiling agreement enacted on June 3 prohibits the Biden Administration from unilaterally extending the moratorium on student loan debt without obtaining approval from Congress.
This is a major tailwind for the company as student loan originations doubled in Q3 2023 over the past year, largely due to refinancing.
I expect this tailwind to continue for the coming quarters as the company offers an opportunity to refinance at a slightly lower interest rate or monthly payments at higher interest rates. As fewer and fewer banks report demand for auto loans and home loans , student loan refinancing remains a good source of opportunity for SoFi. Additionally, the probability of default in a high-interest rate environment remains relatively lower compared to auto loans and home loans. The company’s management has repeatedly hinted that in an environment of interest rates being higher for longer, student loans could be a great way to mitigate some risk and offer a more balanced approach to underwriting loans. In adding $919 million worth of student loans, which was 130% higher than the previous quarter, SoFi has maintained and improved the quality of its student loan book. In Q2 2023 , the weighted average income of student loan borrowers was $163,000, with the weighted average FICO of 768. In Q3 2023 , these metrics improved to a weighted average income of $180,000 with an average FICO of 781. There was also a decline in the annualized charge-off rate from 42 basis points in Q2 2023 to 38 basis points in Q3 2023.
Financials
SoFi has grown 50% this year, but now it’s time to look at the company's financials. Over the past year, Interest Income has just under tripled. Meanwhile, Interest Expenses have quintupled as interest rates on deposits are catching up to the Fed’s rate hikes. Increased loan originations drive the increase in interest income at interest rates higher than last year. As a result, Net Interest Income has also quintupled.
This may lead some to believe that Net Interest Margins have declined, but that is not the case, as the Asset Base has only doubled, allowing Net Interest Margins to expand by 13 basis points from 5.86% to 5.99%.
SoFi Quarterly Results
SoFi Quarterly Results
Net Revenue for the bank includes Net Interest Income plus non-interest revenue, such as revenue from loan origination and sales, securitizations, servicing, and technology and product solutions. Net Loss is calculated by subtracting non-interest expenses from net revenues. Net Losses have steadily decreased over the past seven quarters. Q3 2023 has been marked with an asterisk because goodwill impairment was roughly a quarter billion dollars, making a significant dent in profits, so the graph reports profits without deducting the goodwill impairment expense.
SoFi Quarterly Results
The above graph shows the trend of quarterly decline in Net Loss before Taxes for SoFi. This is a positive sign and while it may not be a catalyst, it reaffirms my belief in the company’s upward trajectory.
Risks
Rising delinquency rates across the economy
The US Economy has generally seen an uptick in delinquency rates since late 2021 and is now above pre-COVID levels. Credit Card delinquency rates currently (Q2 2023) stand at 2.77% compared to 2.66% in Q1 2020. Consumer loan delinquency rates are at 2.36% in Q2 2023 compared to 2.47% in Q1 2020.
Although the delinquency and charge-off rates on SoFi’s loan book have remained lower than the industry average for commercial banks, the uptrend in delinquency rates is surely a major cause of concern for existing/ prospective SoFi investors.
The below graph shows the weighted average FICO scores and the weighted average incomes for personal loan and student loan borrowers for Q3 2022, Q2 2023, and Q3 2023. The graph shows a strict improvement across both weighted average measures (credit score and income) for SoFi’s student loan borrowers. For personal loan borrowers, the weighted average income has improved compared to both the last quarter and the quarter a year ago; however, the weighted average FICO score has declined slightly but it is not concerning at all.
SoFi Quarterly Earnings Call Transcripts
One thing that does mitigate the risk or console SoFi investors is that the quality of the loan book has improved for student loan borrowers and that, for personal loan borrowers, has remained very stable. The below image shows how key metrics, namely weighted average FICO score and weighted average personal income (expressed in thousands of dollars), were at the end of Q3 2023 compared to the previous quarter and the same quarter a year ago.
Additionally, the company has reiterated that it is going to be very balanced and cautious in how it manages its lending mix as well as the quality of borrowers. The company has also said that it is going to increase focus on its non-lending business such as Technology and Financial Services, which it expects to be the driver for profitability growth.
I believe these factors partially mitigate the risk from economy-wide rising delinquencies.
Conclusion
To conclude, I believe that the catalysts/ tailwinds arising from NIM expansion, resumption of Student Loan payments, and the observed positive profit contribution margin from all three segments and high likelihood of achieving GAAP profitability starting Q4 2023 do mitigate and to a fair extent outweigh the risk arising from rising delinquencies. For that reason, I would like to place a Hold rating on SoFi. Investors are also recommended to continuously keep track of news and announcements surrounding the company, in addition to looking at financial metrics such as revenue growth, NIM, GAAP profitability, and delinquency rates during the quarterly earnings report.
For further details see:
Holding Steady: Evaluating SoFi Technologies Amidst Financial Shifts And Market Dynamics