The one-stop-shop financial services company and digital bank SoFi Technologies (SOFI 1.32%) saw its stock rise by more than 15% after its recent earnings report, which on its face looked pretty good, with the company beating consensus estimates and management raising guidance.

But the stock gave up those gains over the next few days, much to the displeasure of SoFi's cult-like investor following, leaving some baffled by the fall.

Although there are many parts of SoFi that show promise and are making progress, I think there is a clear reason that the stock can't seem to get any momentum, even after its strong earnings report.

To be a bank or not to be

After a lengthy process, SoFi eventually managed to obtain a bank charter by acquiring the tiny Sacramento bank Golden Pacific Bancorp. The bank charter offered many advantages, including the ability for the bank to gather and hold deposits on its balance sheet, which it could use to fund loans. The bank charter also allows SoFi to bring loan originations in-house, saving money and time for its customers.

But it seems management is being very opaque with its strategy going forward, and that is leading to concerns from institutional investors. Management said the company's plan with the bank charter is to hold loans for six months, collect recurring interest income payments during this time, and then sell the loans to investors. This allows the bank to legally skirt a key bank accounting rule related to whether the loans are held to maturity.

Person looking at computer screen in the dark.

Image source: Getty Images.

Banks have to reserve for loan losses in a very forward-thinking manner under the current expected credit losses (CECL) accounting methodology. So if SoFi held loans to maturity, it would have to set aside reserve capital for the lifetime losses of loans as soon as they come on the balance sheet.

For the first nine months of the year, SoFi recorded a provision for credit losses of about $39.4 million. At the end of the third quarter, SoFi had $11.2 billion of loans on its balance sheet. This equates to a provision for losses of only about 0.35%, or roughly 1.4% annualized. As I mentioned, SoFi is allowed to do this because it's classified these loans as held-for-sale, meaning the company intends to sell them, and they really can sell them at any point as long as they do so before maturity.

However, if SoFi eventually decided to hold the loans to maturity -- and it might eventually because these loans can be more profitable -- the company would have to significantly increase its provision for credit losses, probably to around 5% or 6% of the total loans it holds on the balance sheet (this is an educated guess).

SoFi currently has about $6.8 billion of personal loans on its balance sheet, which is a segment that experiences higher losses -- similar to credit cards. If the company were to hold all of those to maturity, a 5% credit provision would equate to $340 million, which would obviously hit the company's earnings hard.

So investors may be worried about a future shift to CECL accounting. However, when asked by an analyst about the company's appetite to grow the balance sheet and hold loans for longer, CEO Anthony Noto said he is looking forward to "a year in which we have continuity and stability across markets and across company-specific initiatives." He also said the company expects to reinvest 70% of incremental revenue back into the business, which means the company still seems more focused on growth than profitability.

A lurking concern

All of this does create a near-term risk, however, because SoFi will eventually have to sell all of these loans before they mature. What happens if the economy tips into a deep recession next year and SoFi's investors lose appetite for their loans? Yes, the company serves a very high-quality customer base. Its personal loan portfolio has a weighted average FICO score of 746, and its borrowers make $160,000 on average.

But if you look at what we just heard from another company in the personal lending space, LendingClub (LC 0.45%), demand for personal loans is waning. Despite robust demand among consumers for personal loans, LendingClub originated and sold $433 million fewer loans to investors in the third quarter, and its guidance for the fourth quarter suggests that it might see continued pressure in Q4.

Furthermore, the average FICO score among LendingClub's loans sold to investors is 718, which is not too far below SoFi's. For personal loans that LendingClub holds on its own balance sheet, which now have a weighted FICO of 730, the company reserved enough capital to cover losses on 7.2% of the book.

SoFi also started to see its gain on sale margins from its personal loans compress slightly, from 3.4% in the second quarter, excluding hedging, to 3.25% in the third quarter. SoFi may very well not have any issues selling loans to investors next year, but we simply don't know what the environment will look like.

More transparency would help

I can see why management might be using this approach. First, they are trying to capture more interest income from loans without having to take the front-loaded accounting charges.

I'm also guessing that they want the market to continue to perceive them as a high-growth fintech company, which would likely command a higher valuation than a traditional bank. 

But I feel like this strategy created this lurking risk in which the company may have trouble offloading these loans for a profit if the economy continues to deteriorate. I do wish management could be a little more transparent here and offer more disclosure on its quarterly financial statements.