SoFi Technologies (SOFI) -- CFO Chris Lapointe Interview

CFO Interview

Student Loan Ramping:

In the 15 years leading up to the student loan pause, $575 billion in credit was issued at 6%-7% yields which SoFi is able to refinance at more favorable terms. Of that, $200 billion presides within the credit bands where SoFi operates. There will be two sources of refinancing demand acceleration as interest begins accruing in August and payments resume in October.

First, with the student loan repayment burden as pressing as ever, borrowers will be looking to extend the terms of their loans. Even if SoFi can’t provide a lower rate to these borrowers, Lapointe offered an example of extending a term from ten to twenty years. Even at a higher rate (7% instead of 6%) this led to monthly payments falling from $775 to $540. Many will be able to maintain or cut their rates and extend terms for larger savings. This loan demand should rapidly proliferate in today’s rate environment and doesn’t require future rate cuts for support. That said, rates will inevitably come back down.

The second source of demand would be aided by rate cuts. This will come from borrowers who SoFi can refinance at lower yields. It sees a large chunk of outstanding federal volume as presently ripe for doing so. As rates are cut some time in the next year, this source of demand will ramp further. Because refinancing costs a borrower nothing and is a quick application, Lapointe sees some borrowers refinancing multiple times as rates start to fall. Most won’t be waiting for more cuts to refinance just once at the optimal rate -- there’s no need.

The largest year of refinancing demand in the history of the market was $20 billion. That’s just 10% of the opportunity SoFi is pursuing today and offers a long potential runway of demand to enjoy. With its 60% market share of the refinancing sector (vs. 40% in 2019 as some players have vacated), the business is theirs for the taking.

To Hold or Sell Student Loans? That is the Question:

Lapointe offered some updates to the student loan business’s profit structure. As of last quarter, the segment’s weighted average coupon was 4.9%. In period refi originations this quarter have risen to a more robust 6.5% rate. Considering SoFi’s cost of capital of around 3.85% (call it 3.9% now with the APY hikes) and annual losses of 0.4%, SoFi is left with a roughly 2.4% return on asset (ROA) and a 20% return on equity (ROE) with its capital structure. A 20% ROE for low risk debt is good.

Of the student loans originated around 4.9%, most were issued when warehouse debt was cheaper, SoFi’s APY was lower and so its cost of capital was lower. Lapointe didn’t tell us what the whole book’s ROE was, but hinted at those lower coupon loans still being attractive holds. Student ROE of 20% is much lower than unsecured personal ROE over 40%, but SoFi has the leverage and capital ratios to retain all of the loans rather than sell any of them. That would juice return metrics, and that’s the plan.

Lapointe ended this segment by reminding us that 6.5% yielding debt with 40 bps of annual losses is also quite compelling for capital markets. That’s why capital market demand remains “strong” and available to SoFi if it needs to tap that liquidity (which it doesn’t). There is a lot of flexibility here and, as that remains the case, its sole objective will be to responsibly maximize shareholder returns.

Personal Loan Markings:

Like every other conference, SoFi was asked about its mark-to-market loan valuations as it doesn’t use traditional current expected credit loss (CECL) methods. Again, Lapointe told us exactly how overly conservative the assumptions baked into the markings truly are. They assume 4.6% personal loan annual loss rates while -- several quarters into putrid macro -- SoFi’s actual losses are less than half that. Its expectations are that “loss rates will continue to consistently outperform.” The marking methodology also writes down loan valuations more expediently and aggressively than alternative methods. For example, after a loan turns 30+ days delinquent, it writes down 70% of the valuation and incurs the costs on its financial statements for that quarter. It is not shady in its marking methodology… it is effectively (if not overly) prudent while even using an independent third party to value the credit.

SoFi’s macro assumptions also include 5% 2023 unemployment and a pessimistic 2.5% 2023 GDP contraction. The Federal Reserve, for context, expects unemployment of 4.1% this year and 1% GDP growth.

As another interesting note, leadership reminded us how balance sheet markings are closely tied to actual capital market demand. They assume SoFi can fetch a 4% gain on sale margin for personal loans vs. 6% apples to apples returns for holding. That 4% gain on sale is based on direct communication with loan buying customers and valuations are tightly tied to this reality. The noise surrounding SoFi’s lack of whole loan sales last quarter was unwarranted. Again, it’s all about ROE optimization thanks to its balance sheet flexibility. Today, that ROE optimization requires holding and forgoing capital market sales that are fully available to the firm. Bids on residuals are less compelling than balance sheet stashing.

“What's embedded in the marks is what a buyer is willing to pay and you can assume they are baking in a level of conservatism accounting for a recession or harder times.” -- CFO Chris Lapointe

Annual Percent Yield (APY) Flexibility:

The benefit SoFi enjoys from the charter (allowing it to use deposits for funding) rose again last quarter. It sits at 210 basis points vs. around 150-190 in 2022. This gives it the flexibility to continue raising its APY which bolsters deposit growth and so loan liquidity. It thinks that its flexibility is unparalleled vs. non-banks and will let it maintain its APY at higher levels as rates are eventually cut to distance itself from alternatives.

Technology Segment:

Lapointe reiterated that tech segment margins are set to bottom from here while growth accelerates to 15%-20% by Q4 and speeds up more in 2024. It is “well on its way” in late stage conversations with a “dozen large financial institutions” which would all be very needle moving to revenue over time. We’ve heard this for a while but these “conversations” now seem to be wrapping up. The recent proof-of-concept with a top ten financial institution has been a “large win” for the firm and an accelerant to this potential demand.

Final Notes:

-Reiterated plans to add over $2 billion in deposits this quarter.

-Reiterated plans to be GAAP net income positive by Q4.

-Customer acquisition cost in its lending business fell 19% Y/Y last quarter thanks to financial service cross selling.

-Wyndham integration is going “well.” Home loan volumes are still expected to ramp in the second half of the year.

-Reiterated that stock compensation will fall below 10% of revenue by Q4. That’s a big piece of turning GAAP net income profitable.