The Nanalyze Verdict: SoFi Stock

How do you tell if someone's a SoFi investor? Don't worry, they'll tell you in the first 5 minutes of meeting them. These are usually the folks who dedicate their entire online existence to just one company. For most retail investors, they probably have no idea what SoFi does. Today we're going to look at exactly how SoFi makes money and how sustainable those revenue streams might be. Now, this is a complex business, so I'm going to explain it so simply that even an MBA could understand it. >> What are you suggesting, my dear man? >> What I'm suggesting is that investing in a company that relies on loaning money to consumers for their bread and butter is a really bad idea. So, let's talk a little bit about consumer lending. The worst kind of loans are those that have no collateral backing them. I want you to think for a second just how many family members would you loan money to without expecting anything in exchange, no collateral? >> Be honest. >> Intuitively, loaning money to people, even people we know, without collateral is not a very good idea. Characteristics of companies that rely on consumer debt, or let's say hold lots of consumer debt, pronounced cyclicality, right? So, charge-offs delinquencies funding costs, these all spike during downturns. Balance sheet and fair value volatility. So, there's this idea that once you go to actually price these loans as an asset, what they call mark-to-market, suddenly the value is quite different from what you thought. Volatility in value. Underwriting relaxation during booms. It's very easy to issue loans to everyone and boost your revenues, right? But then what you'll see often times is that your models will fail during novel environments that you haven't encountered yet. So, it simply comes down to this, we do not invest in companies with heavy exposure to consumer debt for this reason. Now, the last time we checked, 2/3 of SoFi's revenues came from unsecured loans. What's that look like today? Well, I'm going to show you exactly how to analyze this yourself. As they say, give a man a fish and feed him for a day. Teach a man to fish and he has a great excuse to tell his future ex-wife when he wants to go out drinking with his mates. Now, when you're looking for loans that are held by a lender, these are considered to be assets on their balance sheet. That's because a loan has a future economic value through incoming cash and interest rate payments. Unless, of course, the borrower decides not to pay you, then it's worth nothing. As of last quarter, SoFi had $45 billion of loans on their balance sheet. So, let's start by understanding what these loans consist of. Roughly 58% of loans, as of last quarter, are personal loans with no collateral and 35% are student loans with no collateral. So, basically, 94% of loan exposure over at SoFi is not backed by collateral. It's not good. But, here's some good news. Personal loans are declining as a percentage of total loans over time. But, unfortunately, student loans are increasing as a percentage of total loans. What this represents today is about a 10% market share of private loans. Now, these numbers change, they increase over time because of something called loan origination. So, that's the ongoing process of issuing new loans as time goes on. As you can see here, they're issuing a lot of student loans this year. Origination across personal and student and home loans is soaring this year. But, just remember this, banks charge these really high interest rates for a reason. SoFi, if they want to charge low interest rates, they must only finance low-risk borrowers. It's very important. And they can accelerate the revenues at any time they want simply by lowering their thresholds. So, we'll talk about in a second how we're going to monitor that. The surge of things like buy now, pay later has resulted in a lot of credit risk that isn't even visible through traditional credit scores. So, only when the tide goes out do you get to see who's swimming naked. Now, of course, SoFi monitors FICO scores, and this trend here you see, these are quite high FICO scores over time, even though the trend seems to be decreasing a bit. These are FICO scores at the time of origination, not based on the entire portfolio. So, one would hope that someone who has a high FICO score maintains it, right? They're a responsible consumer. However, you need to pay attention to AI and the new credit score, right? Where they're saying, "Well, people that don't have a credit score, we can ascribe this new credit score using big data." And when you look at this piece by SoFi, they talk just about that, how the markets' first new scoring model in decades are now being put to use. They say, "The goal is to make buying a home more accessible and affordable." Well, honestly, if I'm an investor, I don't really care about making homes more accessible and affordable. I care about the money that I'm loaning to people for homes gets paid back to me with a interest rate that is sufficient to cover the risk. What does that look like? Well, today US mortgage rates, let's say around 6, 6.75%. Realistically, the lender gets what? About 5%. Well, guess what? That's the risk-free rate right now. Why the hell would I loan money to somebody for a home at 5% when I can loan it to the US government risk-free, right? So, the second fastest-growing segment for SoFi when it comes to loans is home loans. It's hardly a blue ocean TAM, right? They're having to compete with other lenders that have been around for a very long time. Are they simply picking up the scraps that other lenders don't want? For student loans, so their fastest growing segment, that does seem to be the case. This recent piece here by US News titled Why banks aren't lining up to give you a student loan. Basically, they're saying for banks, it's not worth the effort. Now, the obvious elephant in the room would be AI and the fact that entry-level jobs are starting to disappear, right? That's That's kind of a big problem. But, they don't even mention that. They simply talk about things like, first of all, unsecured debt, as we said in the beginning, right? Default danger, so students have no income history. They're looking for jobs. It's hard to predict who's going to be able to pay back their money. These private student loans aren't appealing for big banks, and then SoFi can step in there. So, let's move on to talking about one of the most critically important metrics that SoFi investors need to watch. These are charge-offs. Simply put, charge-offs are a metric that reflects people who weren't able to pay their loans back. So, SoFi provides us with this information. Very useful, right? When you look at credit cards here, very small component of their business, they say, "Our charge-offs are 7.65%." That's not good at all, because the typical credit card charge-off would be around 3 to 5% in industry. So, they're not good at that. But, what do we care about? Well, personal loans, right? The lion's share of their lending. And to find out what that benchmark should be, we can pull up this chart here, which shows us the charge-off rate over time. You can see it spiking there during the 2008-2009 financial crisis. It sits at 2.64 today, which is almost exactly where SoFi sits. Or is it? On this next chart here, you can see how SoFi puts up this number, 2.62%, but above that, they give you a different number, which simply says, "Without the sale of delinquent loans." So, when you have a delinquency, you're sort of approaching a charge-off. So, just sell those loans and get rid of it and lower your charge-off rate. So, it's very important to pay attention to that metric, the real metric, that 3.7%. And also here, when you're looking at their student loan charge-off number, plot that on an appropriate chart, and it looks a little bit different, right? You start to see this trend going up, and it's not surprising why. Here's a piece here talking about how over 9 million student loan borrowers are now in default. Ask yourself, does this seem like appealing exposure? You know, you could say, "Well, buy when there's blood on the streets." Well, if everything goes right, you're going to make a reasonable return, right? Nothing that great. But, if it goes wrong, that could be a real problem. That's the issue we have with loaning consumers money. It's not something we want exposure to. Here's another important question. What percentage of SoFi's revenues come from interest on the loans we've been talking about? Well, they've got this big grand table, and when you aggregate all these metrics appropriately, here is the net interest income as a percent of total net revenue over each quarter. You can see, well, roughly floats between 60 and 65%. We're not interested in a company that drives the majority of their revenues from unsecured consumer loans. It's as simple as that. And just remember this, consumers are fickle. Consequently, any firm with money can grow their market share by sponsoring stadiums or lining the pockets of controversial athletes like Charlie Hall. SoFi spent over a billion dollars on sales and marketing last year. It's about 30% of their revenues growing their business. Now, the plan is to get enough customers using enough products so that they never want to leave the platform. That's a very formidable moat. However, Morningstar analysts are making some very good points about the durability of SoFi's moat. You can see some of this commentary here. They talk about competition in consumer finance and digital banking remains intense. Lending, they say, still drives a large portion of the revenues. Again, the point of contention that we have. Switching costs, they say, are meaningful but not at the deep level that they need to be yet. And they claim rivals can compete effectively on price or features. Again, going back to spending sales and marketing, right? Whoever's spending the most at any given time. They say the durability for SoFi is more in the 10-year range rather than a multi-decade fortress territory that we're looking for when we want to hold stocks for the very long term. Now, one thing I've noticed is that SoFi has a lot of RNMs spouting price targets. Not just for SoFi, you're going to see RNMs everywhere on social media. RNM stands for round number and these are people that pull price targets out of their asses cuz they sound good. It's easy. It's lazy. SoFi should trade at $30 a share. Why, exactly? What are the fundamental data assumptions that you're using to arrive at that number? For SoFi, now that they're profitable, you can use price-to-earnings ratios to determine whether or not a stock is trading at a fair value or not, right? So, if you take the trailing 12 months, it's very rich, 37. If you look at the forward price-to-earnings ratio, it's 22. So, relatively in line with the market. S&P's trading at anywhere from 18 to 21. However, banks trade at lower premiums than market averages, significantly lower premiums. SoFi should not be enjoying a premium. But, Joe, SoFi is not a bank, they're a fintech. Well, that's what we were told years ago. The non-interest components of their business were supposed to grow into this majority. Well, it's not happening. And when you look at those today 67% of their fee-based revenue is related to loans. There you have it. I think folks believe that SoFi should be trading higher because it's underperformed the market since their SPAC debut. It's a red flag in itself. Shares are down like 10% compared to a market return of 76%. But remember that performance is even more pronounced when you take into account dilution, something that retail investors often overlook. Now, there's certainly a lot more things we could talk about when it comes to SoFi. >> We could not talk or talk forever and still find things to not talk about. >> But it isn't a company we're interested for the reasons that we've mentioned today. If it's your cup of tea, then pay close attention to those charge-off metrics. And if they ever manage to make loans a minority chunk of their revenues and they start looking like more of a fintech and less of a bank, then we'll come around for another look. Lots of people investing in SoFi today are looking for the next big thing and this next video tells you how to find just that. Give it a watch next. Thanks so much for taking the time to watch this video today.