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Moving on to SoFi, a fintech company that specializes in personal and student loans, deposits, and credit cards. Their shares saw a 20% increase following the release of their earnings report, and the stock has more than doubled since May. The company is experiencing rapid growth, with a 37% increase in loan origination and a doubling of net interest income in the second quarter compared to the same period last year. Deposits also rose by 27%. Here is a visual representation of their total revenue and net interest income over the past 12 quarters:
Now, let’s discuss SoFi’s business model. They excel at originating specific types of loans and often sell them to banks or securitize them, which helps maintain a tight balance sheet. Additionally, they are expanding their deposit franchise and building various fee-generating features on top of their origination business. The success of their growth indicates that their business model is effective, although investors always hold their breath when it comes to lenders, especially younger ones, until the next credit cycle low passes.
Rather than evaluating the fundamental aspects of SoFi’s business, we would like to address our concerns regarding how they present their results. When examining their financial statements, it becomes apparent that SoFi is essentially a bank. While they did become a bank holding company last year, this statement is not meant to be taken in the official or technical sense. It simply means that SoFi operates as a balance sheet and spread business. Their goal is to buy capital on the liability side of the balance sheet and sell it on the asset side at a higher price. Just like with traditional banks, we should focus on metrics such as equity value growth, return on equity, and net interest margin.
SoFi does disclose their net interest margin, which experienced a significant expansion in the last quarter. Interestingly, net interest margin is only mentioned on page 18 of their quarterly presentation. SoFi prefers investors to view them as a technology company, where the income statement holds more weight. They want profitability to be measured in terms of “adjusted EBITDA.” However, we have previously discussed how including stock expenses in adjusted earnings is misleading. Without this adjustment, SoFi barely broke even in terms of EBITDA last quarter. Even more concerning is their decision to add back interest on corporate borrowings in their adjusted EBITDA calculation. They justify this by stating that it accounts for their capital structure. Yet, if you are a bank, your capital structure is inherently part of your business.
SoFi may argue that only half of their revenue comes from net interest income, but this is also the case with traditional banks like JPMorgan, which undoubtedly falls under the category of a bank despite their substantial technology investments and fee income. Yes, SoFi sells many of the loans they originate, but JPMorgan does the same. Simply utilizing technology in business operations does not automatically categorize a company as a technology business. Tech companies primarily sell technology, while SoFi primarily sells financial services, despite the numerous references to their “platform” during their recent call with analysts.
One possible reason why SoFi avoids encouraging investors to focus on return on equity is that they are not currently profitable. A respectable return on equity calculation typically requires a version of net profit as the numerator. Moreover, analyzing the evolution of the company’s tangible book value per share reveals a negative picture due to significant share dilution caused by acquisitions and going public as a SPAC.
Presenting a fast-growing yet unprofitable bank as a tech company with adjusted EBITDA profitability is not a wise approach. It obscures the true state of the business and makes it difficult to assess its performance accurately.
Moving on, let’s discuss the Bank of Japan (BoJ) and its recent actions regarding yield curve control (YCC). Last week, the BoJ made changes to its cap on 10-year bond yields, leaving many investors confused. YCC works by setting a trading range for Japanese government bonds, and if yields exceed the range, the BoJ intervenes through bond buying to bring them back within the set limits. The hope is that a credible commitment to YCC will prevent bond traders from challenging the system.
The mechanics of YCC are quite straightforward. However, the recent changes made by the BoJ have raised questions. While the hard-limit trading range has been widened from 0.5% to 1%, with yields above 1% being suppressed as usual, 0.5% remains the “reference” point. Between 0.5% and 1%, the BoJ will “nimbly” steer the 10-year yield at its discretion.
On Monday, when 10-year yields surpassed 0.6%, the BoJ quickly intervened by pledging to purchase the equivalent of $2 billion in Japanese government bonds. This move surprised many analysts who expected the central bank to set a looser target to reduce the number of bond purchases. Additionally, the yields were still below the hard cap of 1%.
So, what’s the reasoning behind these actions? Firstly, tighter policy aligns with the presence of sustained inflation. Inflation expectations are rising, as evidenced by the BoJ’s own inflation forecasts and the high levels of headline, core, and supercore inflation. However, there is an important factor missing from the equation: wage growth. While nominal wage growth is somewhat elevated, real wages are actually decreasing. Without consistent wage growth supporting consumer demand, it becomes uncertain if inflation can be sustained. The BoJ is aware of this uncertainty, which is why they made tweaks to YCC as a prelude to potential monetary tightening, while still maintaining flexibility in case inflation turns out to be temporary.
Although this change may seem minor, managing increased yields without causing sudden losses for bondholders is challenging. Hence, the BoJ’s intervention on Monday. This intervention allows investors to adjust to the losses in a gradual and controlled manner. The BoJ’s long-term goal might involve slowly diluting YCC without causing any abrupt changes, similar to what they have done in the past.
In terms of global investors, the impact of the YCC adjustment might be minimal, as discussed in detail by Robin Wigglesworth at Alphaville.
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