When Sofi Technologies' (SOFI -0.42%) stock first came public in June 2021, investors were very impressed by this disruptive fintech company. That view helped push the company's stock as high as $24.65 a share. As concerns about excess inflation grow, however, SoFi's stock has taken a tumble and now trades at $6.25 a share.
Is that steep stock price decline a sign that investors should bail from SoFi's stock? Or is it an opportunity to buy stock in this revolutionary lender at a discount? I think it's the latter and I have at least two reasons why SoFi Technologies stock can outperform the lending industry going forward.
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1. SoFi Technologies is now a bank
Before February 2022, Sofi operated as a non-bank lender. As a result, it funded its loans by borrowing money from other financial institutions -- a significant cost disadvantage as SoFi paid relatively high interest rates on those borrowed funds. In February, SoFi's bank charter went into effect and SoFi benefits by being able to fund loans internally from money deposited by its customers into checking and savings accounts. This is a much cheaper source of funding loans -- especially since interest paid on the average checking and savings accounts generally falls under 1%.
Relatedly, Instead of pushing off loans it created to partner banks so that they could collect the interest on payments, SoFi can now hold loans on its books and keep that interest in-house. Recently, SoFi CFO Chris Lapointe said that investors should start seeing the benefits of the company being able to hold loans for longer in the back half of 2022.
Finally, being its own bank helps SoFi differentiate itself and gained a competitive advantage over other fintech companies. Competitors like Rocket Companies and even PayPal Holdings can't use lower-cost deposits to fund loans because they are not banks. Because getting a banking license is difficult, it increases Sofi's competitive moat. Other fintechs are unlikely to travel down the difficult road of obtaining a banking license.
2. SoFi's risk management differentiates it from traditional banks
SoFi's risk-management framework helps it grow loan originations at a brisk rate while limiting losses, which can be seen in SoFi's first-quarter results. For example, SoFi's largest loan category, personal loans, improved its 90-day personal loan delinquencies as a percentage of loans on the balance sheet by 14 basis points in the first quarter (the annualized personal loan charge-off rate is 1%). In addition, personal loan originations grew 151% year over year in Q1, and totaled about $2 billion. This origination number is more than double SoFi's average quarterly rate of $933 million in 2019.
The prime way SoFi manages its credit risk is by targeting high-end customers (high-net-wealth individuals who have a great credit profile and high income). In Q1, the weighted average income of personal loan borrowers was $160,000 and the weighted average FICO score was 746. For student loan borrowers' the weighted average income was $170,000 with a weighted average FICO score of 775.
Second, SoFi develops and iterates its proprietary credit underwriting models using data that goes well beyond the traditional industry-specific underwriting data that most banks use. SoFi uses a similar approach as Upstart by using artificial intelligence to develop risk models that are theoretically better than the FICO score that most traditional banks use to gauge risk. If SoFi's risk models prove to be better than the FICO score over the long term, then it could gain an edge over traditional banks by better pricing loans and managing loan risk.
Dangers in a faltering economy
While SoFi is diversifying its business into other financial services, about 77% of its revenue is currently generated through its loan business. SoFi today has three loan business lines: home, student, and personal loans. And only one of those business lines, personal loans, is growing. Student loan growth has been negatively impacted by a pandemic-related loan moratorium. And home loans have deteriorated as interest rates have risen. The big danger for SoFi is that the personal loan business may also partially collapse should economic conditions worsen.
People that invest in SoFi at current prices are banking on both its risk management policies seeing it through difficult times, and the return of growth to home loans and student loans as the economy normalizes over the long term.
SoFi stock is currently trading at a price-to-book ratio of only 1.18, which is near historical lows for SoFi and low for any banking institution. Considering that SoFi grew revenue at 69% in the first quarter on the back of its superior loan business in a difficult environment, risk-tolerant growth investors might want to consider putting SoFi on their buy list.
