SoFi is attempting to revolutionize the banking industry. But it isn’t without a few signs of potential trouble.
SoFi (SOFI) is arguably the most successful banking disruptor to date. It is not only positioning itself as a high-yield alternative to traditional savings accounts or as a better way to borrow money but also aims to completely replace its customers’ relationships with brick-and-mortar financial institutions.
Of course, if it were easy to truly disrupt massive institutions like JPMorgan Chase and Bank of America, someone would have done it already. And many investors are understandably wary of a company that would try.
In full disclosure, I’m a big believer in SoFi. I have a substantial position in the bank stock, and it has become my primary bank. But no stock is perfect. Here are a couple of the things I’m most excited about and a couple of, well, yellow flags I see that are causing me to approach my investment with a bit of caution.
2 reasons to put SoFi on your radar
Let’s start on a positive note. There is a lot to like about SoFi’s progress so far and its future potential. Here are two things in particular that I’m excited about.
The member base is getting massive
SoFi’s platform surpassed 8 million members during the first quarter of 2024. It had fewer than 2 million at the start of 2021, and the slowest growth rate since then has been a year-over-year pace of 44%.
It’s also worth pointing out that the fastest growth has been in financial products (bank accounts, brokerage, and credit cards), as opposed to loans. The ratio of financial products to loans has increased from 4.1-to-1 in 2022 to 5.9-to-1 today. This is significant for two big reasons:
- It is more cost-effective for a bank to fund its lending activities with deposits instead of borrowing money. SoFi’s deposit base started at zero in early 2022 and is now nearly as large as the company’s loan portfolio.
- The more banking customers SoFi has, the more natural cross-selling opportunities it has for other products. Plus, it will have to spend less on marketing products to non-customers. As the financial product-to-loan ratio grows, it should help SoFi lower its customer acquisition cost.
Credit card potential
SoFi offers its own credit card, but for the time being, the credit card business is rather small, making up about 1.1% of the company’s total loan portfolio. And to be fair, SoFi hasn’t really leaned into the credit card business yet. Its product is a solid cash-back credit card that earns a flat rate of 2% back on purchases, but I wouldn’t exactly call it a standout.
Management has referred to the credit card business as being “in full investment mode.” In the company’s year-end 2023 earnings call, management specifically called out “a broader credit card portfolio” as a potential future growth driver.
To put it mildly, the credit card business can be an excellent profit driver at scale. The average credit card interest rate is about 25% right now, and even with a reasonable default rate, this leaves plenty of margin potential. If SoFi gets serious about launching competitive credit card products with benefits its customers will care about, it could be a massive growth driver.
2 reasons to be cautious
As mentioned, there’s no such thing as a perfect stock. Investors are likely being cautious for several reasons, and here are two that are completely valid.
Default rates are a bit on the high side
As of the first quarter of 2024, SoFi’s net charge-off (NCO) ratio on personal loans was 3.5% (annualized), which strikes me as a little higher than I would expect. After all, SoFi targets an affluent and creditworthy customer base. For context, American Express has a net charge-off rate of only 2.1% in its credit card business, which is generally considered a riskier form of lending.
Not only is SoFi’s NCO rate a bit higher than I would expect, but the rate has also increased by about 50 basis points compared with the first quarter of 2023. To be sure, defaults and delinquencies have been trending higher industrywide, but if the NCO rate gets much higher, it could start to seriously eat into SoFi’s margins.
Growth could be slowing
SoFi stock plunged after its first-quarter earnings report, and the biggest reason was weak second-quarter revenue guidance. Not only that, growth rates are noticeably slowing in several key areas. In the first quarter, the company’s total number of products grew by 38%, but this was the slowest pace since it became a public company. Plus, revenue declined sequentially compared to the fourth quarter.
To be sure, management made it clear that the company is taking a more cautious approach to lending, given the current economic climate. But this is something definitely worth watching.
Is SoFi a buy?
The short answer is that SoFi looks attractively valued. After all, management has guided for earnings per share of $0.55 to $0.80 by 2026 and 20% to 25% annual EPS growth after that — and that’s not including the impact of any new products. With the stock trading for about $7 and growing revenue at a rapid pace, it could be a steal for patient long-term investors. But even if management can execute, there’s likely to be significant turbulence along the way.
JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. American Express is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Matt Frankel has positions in American Express, Bank of America, and SoFi Technologies. The Motley Fool has positions in and recommends Bank of America and JPMorgan Chase. The Motley Fool has a disclosure policy.
