Financial services company and digital bank SoFi Technologies (SOFI 4.55%) went public in June 2021 with lots of support and plenty of hype. Both its fintech super app and its CEO Anthony Noto were lauded, and investors flocked to the stock. In its efforts to build its brand, the company launched massive marketing campaigns on TikTok and purchased the naming rights of the Los Angeles Rams football stadium.
But as we near the end of 2022, SoFi is under fire from lawmakers in Congress over its crypto activities and it saw the federal student loan moratorium extended, which will likely hurt its business. It's also taking an unusual approach to bank regulatory capital rules. All of this created a lot of uncertainty for investors. At this point, SoFi finds itself in a bit of a regulatory headache.
More student loan issues for SoFi
When SoFi first launched many years ago, it was primarily in the student loan refinancing business. Up until the pandemic, that was its largest segment, and it originated as much as $2 billion of student loans per quarter. But in March 2020, the federal government put a moratorium on student loan repayments in order to help ease the financial hardships caused by the pandemic.
Image source: Getty Images.
Nearly three years later, that pause on repayments is still in place, and since it began, there were only two quarters when SoFi originated more than $1 billion worth of student loans. Recently, President Joe Biden announced he was extending the moratorium again, either until June 30 or until the Supreme Court ruled on his plan to forgive student loan debts of as much as $20,000 apiece to tens of millions of borrowers.
The moratorium had been set to expire at the end of the year, so I suspect analysts' projections for SoFi's 2023 earnings and revenue will take a hit.
Eventually, however, the moratorium will expire, and even if Biden's student loan debt forgiveness plan doesn't get blocked by the courts, there will still be heaps of student debt left that borrowers will likely seek to refinance. So while I'm not overly concerned about the moratorium as a long-term issue, it still is remarkable that it has been in place for this long, and also somewhat of a variable in terms of when it might end.
SoFi is now facing crypto issues
In the wake of the implosion of cryptocurrency trading platform FTX, lawmakers from the U.S. Senate Banking Committee sent letters to SoFi and various banking regulators citing concerns about SoFi's crypto activities.
SoFi became a bank holding company earlier this year, and at the time, the Federal Reserve noted that some of the activities conducted by its crypto brokerage, SoFi Digital Assets, were impermissible for such institutions. The Federal Reserve gave SoFi two years to divest itself of the division conducting those crypto-asset-related activities or otherwise get itself in compliance with the law, although SoFi could apply for extensions. During that conformance period, the regulator also stipulated that SoFi should not expand its crypto offerings.
But, as the senators note, SoFi expanded its crypto offerings by allowing its customers to invest part of their direct deposits into crypto with no fees. SoFi also greatly expanded the number of cryptocurrencies it offers to more than 30, which is more than most other brokerages that aren't pure crypto exchanges.
Some people are asking if this Senate inquiry would have happened had FTX not gone down. It's hard to say, but regulators and lawmakers are certainly preparing to give all things crypto an even sharper look than they had previously -- and rightfully so.
I do find it hard to believe that SoFi would so openly violate its agreement with the Fed, but the Senate Banking Committee has other concerns, among them how SoFi will get into compliance with the law per that agreement, how the bank is determining the appropriate amount of capital to hold on its balance sheet to back digital assets, and how it determines which cryptocurrencies to offer on its platform. So while this inquiry may be a reaction to the FTX meltdown, it still might uncover risky behaviors at SoFi.
Regulatory capital treatment questioned
The question of how SoFi is treating its regulatory capital has seemingly gotten less attention, but it may be the most important issue of the three. Banks are required to hold a certain amount of capital in reserve when they put risk-weighted assets such as loans on their balance sheets in case those assets lead to losses. That's a cost of doing business for any bank.
But SoFi took a unique approach. It holds loans for just six months, collects the recurring interest payments for that period, and then sells those loans to investors. Because it does this, it technically doesn't have to set aside reserves for those loans in case of losses. Also, because its student loan business was struggling, SoFi leaned into the personal loan niche. As of the end of the third quarter, it had quickly built up a total of $6.8 billion of personal loans on its balance sheet.
Meanwhile, there was a shift in the capital markets where SoFi sells those loans. Not only are the investors that purchase them facing increased costs of capital to fund these loans, but they are getting more concerned about the possibility of higher loan losses if there is a severe recession in 2023. SoFi has an extremely high-quality loan book consisting of borrowers with high credit scores and annual incomes. But those personal loans are still unsecured consumer debt, and loan loss rates are expected to normalize to pre-pandemic levels. The longer SoFi waits to sell these loans, the higher the likelihood that its losses will start to pile up, which could force it to sell loans at a loss.
But if SoFi suddenly decided to start holding all of its loans to maturity, it would need to take a big charge against earnings because it would need to add likely hundreds of millions of dollars to its reserves. This, too, might be concerning investors.
Should investors be worried about SoFi?
All of these issues could be resolved. The federal student loan repayment moratorium will end at some point, crypto-related concerns could be overblown, and if conditions in the capital markets clear up, SoFi will have no trouble offloading its loans.
But the potential risks are piling up and I don't necessarily love the way management is running the company right now, particularly in terms of its regulatory capital strategy and its decision to hold all of these personal loans for a period, but with the intention to sell them. Also, its expenses are still incredibly high. And the stock is not exactly cheap, trading at 36 times adjusted EBITDA.
I'm definitely becoming increasingly less bullish on SoFi. In the long term, it may still be a winner for investors, but right now, I think the bank needs to make some operational improvements.
