What I got wrong about earnings

Ok, I’ll be covering the SoFi earnings in depth over the next few weeks. This is the first of at least four posts I plan on making. They’ll cover accountability (today’s post), the good, the bad, and the unknown of earnings.

Accountability is important to me, and every person I truly respect takes accountability when they make mistakes and works to do better. I endeavor to embody that ideal myself and this article is part of that process. SoFi’s earnings were not as good as what I had expected after seeing the FFIEC bank quarterly earnings. Let’s go through the differences between the two and see if we can parse out what I missed or didn’t understand.

Revenue

Here is what I wrote the day before earnings:

In 4Q22, total revenue from the bank was $266M. This quarter it is up to $343M. That's an increase of $77M. Be aware that some of this increase will cannibalize a part of their lending revenue outside of the bank.

As a quick reminder, SoFi’s lending segment has two branches. There is SoFi Bank, which includes everything done inside of the bank (lending against deposits). Then there is SoFi Lending, which is lending done outside of the bank (lending primarily against warehouse facilities). Both of those combine to make up the SoFi lending segment that is reported in the quarterly earnings report.

The entire lending segment only reported $325M in adjusted net revenue. You’ll notice that number is less than $343M that was reported by just the bank itself. Lending revenue comes from two sources, net interest income, and noninterest income. Net interest income is the amount of money they get from the interest they charge on their loans minus the amount of interest they pay on their funding source (e.g. if they are charging 14% interest on a loan and paying 4% on their deposits, the 10% difference is net interest income). Noninterest revenue comes mostly from selling loans and proceeds from their interest rate hedges.

When you break it down, net interest income for the bank was $184M. For the entire lending segment, it was $201M. The interest income from the lending segment that was outside of the bank added to the revenue (see above). However, noninterest income inside the bank was $159M while for the lending segment it was only $136M. There was a $23M hit to noninterest revenue from what happened outside the bank. This caught me off guard because in previous quarters noninterest income in the lending segment was always higher than inside the bank (see below). I expected that to be the case again this time, and it definitely was not. SoFi didn’t sell any loans in 1Q22, so noninterest income in the quarter is going to come from hedge gains and fair value adjustments. I am not sure I’ll be able to completely track that down even after the 10Q comes out, but the most likely explanation is that a higher percentage of the loans held inside the bank have residual hedges from previous quarters.

Finally, the bank numbers are GAAP net revenue, and the lending segment numbers are adjusted net revenue. SoFi’s reported revenue is actually lower than its GAAP revenue because of the changes in the fair market value of servicing rights. Basically, SoFi services its loans and gets a bit of income from that. They could sell the right to service those loans to somebody else, and fluctuations in the portfolio and rates mean that the market thinks the value in servicing the loans is worth less today than it was last quarter, and that hit lending revenue by $12M. So overall, lending adjusted net revenue was only up about $10M QoQ, a lower beat than I expected.

Adjusted EBITDA

Here is what I wrote the day before earnings:

The report doesn't have EBITDA explicitly, but it does have EBT, so this is a lower limit in EBITDA. 4Q22 they reported $46.7M in EBT. This quarter it was $100.7M, an INCREASE of $54M. Remember analysts expect a DECREASE of about $25M this quarter 🤯.

SoFi does not break out adjusted EBITDA on a segment basis. However, contribution profit gives a pretty good picture in terms of change from quarter to quarter in each segment. Contribution profit was excellent for the lending segment at $210M for 1Q23, but that is only up very incrementally QoQ, as it was $209M in 4Q22. That is nothing like an increase of $54M. A big part of the difference ($39M of it) is explained by the revenue discrepancies discussed above. Additionally, directly attributable costs increased $9M QoQ in the lending segment, probably from marketing cost increases since originations did go from $2.98B in 4Q22 to $3.57B. SoFi actually has less directly attributable expenses per origination than they’ve ever had before, a result of having the whole process in house and cross selling. That increased costs for this quarter but will result in better interest income in the coming quarters.

So, of the $54M increase in EBT, $39M disappeared between the bank report and the earnings report due to revenue discrepancies. $9M disappeared in directly attributable costs, which should have a payback over the long term, but hurts in the short term.

GAAP net income:

Here is what I wrote the day before earnings:

In 4Q22, the bank reported $30M in GAAP income. In 1Q23, GAAP net income increased to $73M, a $43M increase. Analysts are guiding for a decrease in net income but the bank saw a huge jump. Remember total losses for SoFi as a whole last quarter were only -$40M.

Much the same as was discussed previously, a lot of this increase is from the differences in the noninterest revenue inside and outside of the bank in the lending segment and GAAP vs non-GAAP revenue adjustments. That’s a $39M swing back down from what I expected to be a $43M improvement. Hence the only marginal beat on earnings. Basically, that big noninterest revenue swing really screwed everything up for revenue, adjusted EBITDA and GAAP net income.

Conclusion

Where I really went wrong is summed up in this assumption that I made:

Remember that increases in SoFi bank do take away from the other lending revenue and profits outside the bank in relative terms. However, the rest of the lending revenue should only ADD to these totals in absolute terms.

That turned out to be true regarding the net interest income, but completely false for the noninterest income. The big change in the top line trickled down to every other number that they report. This is the biggest reason that adjusted EBITDA and GAAP EPS for the entire business was less than I expected it to be. I’ll endeavor to learn from this mistake and provide better analysis from what I’ve learned.