3 Risks You Should Know Before You Buy SoFi's Stock

This new-age bank faces stiff headwinds to its lending business over the next year.

Investors initially boosted the stock of fintech bankSoFi Technologies(SOFI5.92%)after its third-quarter 2022 results surpassed revenue and earnings estimates and the company raised its full-year forecast. However, despite its remarkable growth during disappointing economic conditions, the stock has recently given back all of its post-earnings gains as investors realize that SoFi is still a high-risk investment.

Here are three risks you should know before you buy its stock.

SoFi primarily generates revenue through three loan businesses: student loans, home loans, and personal loans. So let's take a look at all three.

1. Student loan business risks

SoFi entered the student loan refinancing business in May 2012, satisfying demand from borrowers for a debt option with lower interest rates. And this business remained significant for SoFi until the U.S. government instituted a freeze on federal student loan repayments in response to the pandemic in March 2020. Once students knew they had no near-term requirement to make payments on federally held student loans, their need to refinance that debt declined -- hurting SoFi's business.

Management was confident student loan refinancing would rebound in the fourth quarter of 2022, before students were due to restart payments to their government student debt in January 2023. As a result, Sofi included this potential improvement in its guidance for the fourth quarter.

Unfortunately, political considerations tied the government's removal of the student loan moratorium to a student loan forgiveness program, which the courts recently blocked. In response, the president extended thestudent loan moratoriumfor 60 days after June 30, 2023, or until the Supreme Court rules on student loan forgiveness. Consequently, SoFi's student loan business will likely remain lifeless for at least the next six months.

Even when the student loan moratorium issue fades away, SoFi's student loan business might rebound less than investors expect. Over the last year, the overall market for student loans has been declining because fewer people are choosing to go to college -- a long-term risk for this business.

2. Home loan risk

Before the Federal Reserve started its campaign ofinterest rate hikes, the home loan business was one of SoFi's most solid businesses. For instance, the company originated $2.98 billion of home loans in 2021, 36% more than the previous year.

However, rapidly rising interest rates are like Kryptonite to the home mortgage market, and in 2022 the Fed raised interest rates at its fastest pace in decades, even faster than the interest rate hike cycle over 1988-1989. As a result, the U.S. central bank's benchmark interest rate now sits in a target range of 3.75 to 4%, and the average 30-year fixed-rate mortgage pushed past 7% in October, its highest rate in 20 years.

In response to high rates, mortgage demand fell off a cliff and is on the brink of collapse. According to the Mortgage Bankers Association (MBA) survey released on Nov. 23, home loan refinancing is down 86% year over year and new purchase loans are 41% lower year over year.

SoFi's home loan business is not immune from these market conditions; it too has cratered, originating $216.3 million in home loans in the third quarter of 2022, down 73% from the $793.1 million originated in the year-ago period. Yikes!

The worst part is that the MBA projects mortgage demand to decline an additional 9% in 2023. So investors should not expect SoFi's mortgage business to ride to the rescue anytime soon.

3. Personal loan business risk

The personal loan market has surged over the past decade as these loans have become more accessible and consumers seek lower interest rate alternatives to credit cards and payday loans. Allied Market Research valued the personal loan market at $47.8 billion in 2020 and expects the market to grow at a compound annual growth rate of 32% to $719.3 billion by 2030.

SoFi's personal loan business has also prospered, with originations more than doubling from $2.58 billion in 2020 to $5.39 billion in 2021. More impressively, on a trailing-12-month basis, its personal loan originations were $8.95 billion at the end of the third quarter of 2022. With this rapid growth, personal lending has been its largest business segment since the middle of 2021.

However, while personal loans outperform today, the danger with them is that they don't require any collateral like home or auto loans -- meaning higher potential loss. Additionally, these types of loans typically have higher default rates. Therefore, should the Fed err and raise interest rates too high, it could send the unemployment rate soaring, and many of these loans could sour despite its customers' high credit ratings.

The Fed plans additional rate hikes

Risk-averse investors should be cautious about investing in SoFi today; the Fed plans to raise its interest rate benchmark further, likely slowing the economy and the banking industry. While no one expects things to get as bad as the financial crisis of 2007-2009, lending could be a terrible business to be in during 2023.

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