Introduction
I took profits on my SoFi (NASDAQ:SOFI) position. I have been bullish on SoFi throughout my previous articles on Seeking Alpha. My reasoning for this argument was that the massive growth opportunity was ahead of SoFi through continued personal loan growth with low delinquency risks and attractive valuation. Since then, many of my reasonings for being bullish on the company have changed. First, considering the current economic landscape and the upcoming economic conditions in the coming quarters, it is likely for SoFi to see substantially higher delinquency rates on its existing loans. Further, the company may be seeing slower growth with higher delinquency rates as it becomes more strict on accepting new loans. Finally, with the large rise in the stock price, its valuation is not at an attractive level. Therefore, considering these changes, I decreased my stake in SoFi, and I now believe SoFi is a sell.
Changing Credit Conditions
So far, credit conditions have been fairly resilient on the backs of a resilient economy. Economic growth throughout 2022 and 2023 has been fairly strong with the unemployment levels continuing to be under 4%. This has resulted in a limited increase in the delinquency rates for many forms of loans. However, going forward, I believe increasing delinquency rates on personal loans could cause a headwind for SoFi.
Capital One Financial (COF) recently reported earnings, and during the earnings report, the company reported high credit card delinquency rates, which increased 60% year-over-year from 2.35% to 3.74% in 2023Q2. Sequentially, the rate increased by 2.2% from 3.66% to 3.74%. Further, the net charge-off rate saw stronger sequential growth of 8.42% from 4.04% to 4.38%. Further, JPMorgan Chase (JPM) also saw its credit card delinquencies inching up towards pre-pandemic levels as the company has said that the “30+ day delinquencies have returned to pre-pandemic levels” during the 2023 Q2 earnings report.
Overall, delinquency rates returning to pre-pandemic levels are not alarming, and it does not necessarily mean that consumers’ ability to pay down debt is deteriorating. However, I would like to argue otherwise as I believe that delinquencies could rise above pre-pandemic levels in the coming few quarters posing headwinds for SoFi’s personal loan business.
The current normalization or increase in delinquencies comes even as economic growth and labor market conditions have been strong, but as the economic conditions weaken in the coming quarters, the delinquencies could further accelerate. The Congressional Budget Office is expecting the unemployment rate to increase to 5.1% by the end of 2023 from the current 3.6% projecting about a 42% growth from current levels. Further, the Congressional Budget Office also expects the 2023 GDP growth to stall to just 0.1% before normalizing to about 2% levels. As such, the US economy is expected to weaken going forward heavily affecting credit card borrowers and raising delinquency rates.
SoFi’s past growth has relied heavily on personal loans, which are unsecured lines of credit like credit cards. Although credit cards tend to have a higher interest rate, both unsecured forms of loans are similar. Therefore, I believe it is reasonable to argue that increasing credit card delinquencies will likely also equate to increasing personal loan delinquency rates. With the economy expected to slow, rising delinquency rates could pose a headwind for Sofi. Not only will the bottom line be impacted, but I believe the top line could be impacted as well. Consumers, feeling the pinch of the economy, will be less inclined to incur more debt while the lender, Sofi, will naturally be more stringent in the loan application to protect itself potentially hurting the growth rate. Therefore, given the current economic conditions, a headwind could be brewing for SoFi in my view.
Further Headwind
The Federal Reserve is expected to hike rates two more times in 2023 before maintaining the interest rate. While some investors speculate that the FED could be bluffing, I believe further interest rate hikes are likely due to continuous strong inflation. In June 2023, the core inflation rose by 4.8% year-over-year despite constant decelerating inflation rates as the rate of moderation continues to be slow. The inflation has been decelerating for almost a year, yet the core inflation rate is still more than double that of the Federal Reserve’s target rate of 2%.
Further rate hikes could pose an additional threat to SoFi. Not only will higher rates weaken consumers, but the higher rates will also put more pressure on consumers while diminishing potential demand for loans. Therefore, for the foreseeable future, the macroeconomic conditions could cause headwinds in my opinion.
Valuation
One of the biggest headwinds facing SoFi is the company’s valuation multiples. I simply think that SoFi is unattractive at current levels, especially considering the potential macroeconomic conditions.
It is expected to report -0.18$ per share in 2023 even as the company reaches profitability during the final months of the year. Then, analysts estimate that it will see massive earnings growth throughout both 2024 and 2025. However, even then, the valuation multiple is too expensive. 2024 forward earnings-per-share is estimated to be about 261 while 2025 forward earnings-per-share is estimated to be about 48. At the current valuation level, the company will need to have flawless execution with a continued 50%+ yearly growth rate to be attractive in my view. However, because of the macroeconomic conditions, I do not think this level of growth is viable. Therefore, I believe SoFi is too expensive at current levels.
Risk to Thesis
The biggest risk to my bearish thesis is that SoFi’s main driver of growth is personal loans. Personal loans have far more favorable interest rates than credit card loans, and due to an extremely high-interest rate environment, numerous consumers may seek debt consolidation to lower interest rates driving strong demand for personal loans.
Further, SoFi has high-quality borrowers. According to the company’s management team, Sofi borrower’s weighted average income is $164,000 with a weighted average FICO score of 747. The strong and reliable customer base is likely to create insulation for SoFi in times of mild economic slowdown.
Summary
SoFi faces headwinds. Delinquency rates are expected to rise above a pre-pandemic level as the economy potentially slows and unemployment rates rise. Not only could this result in more pressure on the bottom line, but the higher potential delinquency rates could also cause diminished growth potential. Consumers will be less inclined to take on new loans in weakening economic conditions while SoFi will likely be more stringent in new loans during times when delinquencies are rising. Further, due to the massive rise in SoFi’s stock price, SoFi’s valuation is too expensive today, especially as the macroeconomic conditions are expected to create headwinds. Therefore, I believe SoFi is a sell.
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