SoFi Made 2 Genius Moves in 2022 to Avoid Silicon Valley Bank's Fate

With the recent demise of 40-year-old Silicon Valley Bank (SVB) and the recent desperation sale of 167-year-old Credit Suisse, some may be especially nervous about their own bank stocks. That may especially be true of investors in newer banks and fintechs, such as SoFi Technologies (SOFI 1.97%).

Yet investors going through SoFi's recent annual report should be encouraged. That's because SoFi did basically the opposite of what Silicon Valley and other troubled banks did last year, in two important ways. 

While this high-growth neobank still has a lot to prove, SoFi management's recent decision-making is looking pretty smart today, and that's encouraging for investors going forward.

Genius move 1: Becoming a bank

The first genius move SoFi made last year was getting a banking license, which it obtained through the acquisition of Golden Pacific Bancorp in February of 2022, renaming the bank holding company SoFi Bank.

The acquisition meant SoFi is now officially a bank and can accept deposits. Now, some may be wondering why that was so smart, given that some of the beleaguered regional banks today are having trouble with deposit outflows.

There are two reasons why this isn't a big deal for SoFi. First, customer deposits, while paying out a higher cost today than last year, are still cheaper than alternatives. Last year, SoFi had to either sell its loans to other financial buyers or use higher-rate warehouse facilities and securitization debt, each of which carries higher rates than even SoFi's high-rate demand, savings, and time deposits. So while interest rates galloped higher in 2022, SoFi's average cost of funding actually fell from 2.62% in 2021 to 2.47% in 2022.

The bank license also allowed SoFi to retain more loans on its balance sheet rather than having to sell them to keep up growth. That's a great option to have since loan buyers are likely pulling back from the market amid so much uncertainty or at least demanding higher returns. So if SoFi has confidence in its underwriting, it can hold more loans if it doesn't like what's being offered.

While many regional banks are now having trouble with deposit outflows from shaky depositors, SoFi has mostly focused on consumer depositors, who are less likely to exceed the Federal Deposit Insurance Corporation (FDIC)-insured $250,000 threshold. According to its most recent Federal Financial Examination Council (FFIEC) Call Report, SoFi only had $642 million in estimated uninsured deposits out of $7.34 billion in total deposits, or less than 10%. That's far less than most banks and can be easily dealt with if those deposits in excess of $250,000 decide to leave.

The risk is somewhat mitigated now, as just yesterday, SoFi announced it would insure deposits up to $2 million through a partnership with other smaller banks, but this is likely an offensive move, not a defensive one, to bring in deposits from shakier regionals. 

So by its decisions to become a bank and focus on smaller consumer deposits, SoFi is looking pretty smart these days.

SoFi made sure it was well funded at the beginning of 2022. Image source: Getty Images.

Genius Move 2: Originating high-rate, short-duration personal loans

In addition to having too many uninsured deposits, the second way some regional banks got into trouble was by originating too many low-rate, long-duration loans just before the federal funds rate skyrocketed from zero to nearly 5% in one year.

When anyone buys a fixed-rate, long-duration security, such as Silicon Valley Bank did with Treasuries and government-guaranteed mortgage-backed securities, the value of those assets will go down in the near term if interest rates spike.

SoFi was actually not in a great position in this regard heading into 2022, as it had unfortunately concentrated on student-loan refinancing. Student loans are generally medium-rate loans that are fairly long in duration. However, at the end of last year, the Biden Administration forgave Federal student loans up to $20,000 for people making under a certain income threshold, which had the effect of limiting demand for SoFi's lower-rate refinancing product.

Still, what normally would be a downside may have been a lucky break. Either due to necessity or prescience about the coming higher-rate environment, SoFi increasingly turned to its higher-rate personal loan products, which typically have terms of just three to five years and are much higher-rate than student loans. In addition, SoFi actually sold down the small amount of mortgages it held, which was also smart, as home loans are even longer duration and lower rate than student loans.

Data source: SoFi Annual Report. Chart by author. YE=year end.

As you can see, Sofi was greatly able to increase the average yield on its loan portfolio by aggressively ramping up personal-loan originations instead of its former core product of student loans. This allowed the company to expand net-interest margins and grow its net-interest income by 132% last year.

Is SoFi in the clear?

Some may wonder why all banks didn't pivot to higher-rate, short-duration personal loans in response to the rapid rise in interest rates. Of course, this is because not every bank is set up to underwrite personal loans, and default rates are typically much higher for personal loans than for student and home loans. Moreover, personal loans aren't backed by an asset as home loans are.

Still, Silicon Valley Bank and others didn't go bust because of defaults; after all, SVB was invested mainly in government-backed securities. However, because it had a lot of uninsured deposits, the bank was forced to sell these "risk-free" assets at a loss to pay off declining business deposits.

So it appears SoFi was very wise to take more credit risk in personal loans, as the alternative duration risk in "safer" loans was actually much, much worse.

While it's possible a severe recession could cause so many charge-offs in high-rate personal loans that SoFi will get in trouble anyway, at least SoFi made it to this point. And so far, the personal-loan charge-offs have been very manageable and are actually still below 2020 levels. Meanwhile, SoFi has generally targeted graduate students with high incomes and high FICO scores of 742 on average.

So, barring a catastrophic Great Recession scenario in which even high-FICO customers get laid off en masse, it looks like SoFi's two big decisions in 2022 are turning out to be genius moves. As we've seen, investing in banks is really about trusting management, so this all bodes well for SoFi's stock going forward.