Why SoFi may see limited gains from restart of student loan payments

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Companies that refinance student debt — reeling from the pandemic-era moratorium on federal student loan payments — spent years lobbying for the policy to be ended.

The industry's largest player, SoFi Technologies, even sued the U.S. Department of Education, alleging that the payment pause was unlawful and had cost it a minimum of $150 million in profits.

Now after nine extensions, the moratorium's end is finally approaching. There's just one problem: Rising interest rates seem likely to prevent private student lenders from capitalizing to the degree they may have once hoped.

"The returns on equity that could be generated in this current interest rate environment are not as high as they were a year or two prior," said Kevin Barker, an analyst at the investment banking company Piper Sandler.

The student loan refinancing market is highly concentrated. Three companies — SoFi, KeyCorp and Navient — hold roughly 90% of the market share, according to an estimate by the research firm Oppenheimer. And SoFi alone accounts for an estimated 60% of the market.

The San Francisco-based neobank has stuck to the student loan business even as it has lost some luster. The payment pause, which began in 2020, reduced borrowers' incentive to refinance. At SoFi, loan origination volume dropped by nearly 61% between the first quarter of 2019 and the same period four years later.

SoFi has diversified revenue sources, including mortgages, personal loans, credit cards and investment products. Still, student loan refinancing has long been a backbone of SoFi's business — serving as a source of customers for other business lines.

"To have it pretty much dormant for the last two or three years has certainly been a challenge for them," said Michael Perito, an analyst at the investment bank Keefe, Bruyette & Woods.

SoFi dropped its suit against the U.S. government in the wake of debt-ceiling negotiations earlier this year, which included an agreement to end the student loan moratorium this fall.

The deal between President Biden and House Speaker Kevin McCarthy raised expectations that there could be pent-up demand for refinancing, especially among SoFi's target market of young adults who have relatively high incomes. The neobank's stock price, which is up about 89% so far this year, rose 11% the day before the U.S. House of Representatives voted on the deal.

SoFi said last week that it anticipates demand for student loan refinancing from borrowers who are looking to lower their monthly costs, as well as from some individuals who want to reduce the total costs of their loans. 

"There's a substantial market for people to find value, either by extending their term to reduce the monthly expense or by lowering their interest rate and maintaining the term to save money overall," CEO Anthony Noto said in a statement to American Banker. 

Noto said that the company's guidance this spring, which included elevated demand for student loan originations in the fourth quarter of 2023, has remained unchanged. That guidance also called for lower monetization levels on student loans, given the interest rate environment.

Back in early May, SoFi was projecting that the moratorium would end on June 30, and Noto said on a conference call: "So we do expect to see an uptick in demand, but probably not to the levels that we saw back in Q4 2019."

In the back half of the year, analysts at Piper Sandler project that industry-wide demand for refinancing will increase by twofold or threefold. That forecast is based on an estimate that 26.3 federal borrowers will return to making payments.

"You would expect their origination to come back significantly," said Dominick Gabriele, an analyst at Oppenheimer, said in reference to SoFi.

But others said that the types of borrowers that SoFi has traditionally targeted — those who have solid credit scores, sizable incomes and larger-than-average student loan balances — tend to care more about interest rates than the size of their monthly payments.

"My experience with that type of higher-FICO borrowers is they're not as sensitive around monthly payment dollars," Perito said. "They're more sensitive around rates."

The upshot is that the refinancing opportunity for SoFi could be more limited than some may anticipate.

"I don't have them reaching back to that 2019 level of origination in the student loan refi business in our forecast period," Perito said. "I will need to see at least a couple of consecutive quarters of elevated volume before I'd be comfortable thinking that the markets are in a position to support [that] origination capacity."

So with rates expected to stay high for the foreseeable future, the near-term impact of the moratorium's end might not be as significant for SoFi as was hoped.

"I would think it would have a minimal, maybe incremental impact. It wouldn't have a dramatic impact on SoFi this fall," Barker said. "The potential spread that you can earn on student loans is diminished."

Of course, SoFi could broaden the range of customers it accepts. SoFi did not comment on whether it is looking to work with more customers or take on more market share.

SoFi's top competitors in student loan refinancing are less dependent on the business. But they have also seen loan volumes fall amid the nationwide moratorium and rising rates.

Navient, which holds about a fifth of the market through its subsidiary business Earnest, reported loan origination volume of $135 million in the first quarter of 2023, down from $984 million in the first quarter of 2019.

But Navient is primarily a loan servicer, and its refinancing business accounts for a relatively small share of its profits. "It's gravy to them," said Sanjay Sakhrani, an analyst at the investment bank Keefe, Bruyette & Woods.

Key, the third major player in student loan refinancing, accounts for 14% of the market, according to Oppenheimer's estimates. Its Laurel Road subsidiary helps doctors refinance what are often high-balance loans accrued during medical school.

SoFi will 'always' stay in student lending, despite challenges: CEO Noto

The Cleveland-based bank declined to comment on its expectations about the impact of payments resuming. It noted that it does not serve the broader population of borrowers.

But during a March conference call, KeyCorp Chief Strategy Officer Clark Khayat said he expected that certain tranches of student loans could "start to look attractive to refinance" in the near future. "We'll be around and ready to take that business when it's available," said Khayat, who later became the bank's chief financial officer.

Until rates start to decline, opportunities across the industry will be limited, Barker cautioned. "Curb your enthusiasm," he said.