What happened

Shares of fintech stocks Upstart (NASDAQ: UPST), Affirm (NASDAQ: AFRM), and SoFi (NASDAQ: SOFI) were in crash mode today, with each down between 8% and 9% as of 2:27 p.m. ET.   

Lately, these beaten-down fintech stocks have been among the most volatile to both the upside and the downside, and their movements are largely based on macroeconomic news.

Today happened to be a big down day in the market following yesterday's big rally, as interest rate and recession fears, along with perhaps some end-of-quarter liquidations by hedge funds, likely played a role in their synchronous decline.

So what

Stocks have been in free fall in September, especially technology growth stocks following a recent spike in long-term Treasury bond yields, and fintech stocks appear to be caught up in the selling.   

Young, high-growth fintech stocks appear to be seen as a risk-on trade by investors, and investors are fleeing risk today amid so much global uncertainty. Today, U.S. jobless claims came in lower than expected, reflecting the very tight job market and potentially fueling "sticky" inflation. That could spur the Federal Reserve to continue hiking interest rates at a rapid pace.

If inflation and interest rates continue their rapid rise, higher interest rates may actually help some mature, profitable banks with low funding costs, but smaller, unprofitable fintechs will likely see their value diminish, since their profitability is still well into the future.

On the other hand, there is also another danger that central banks "overdo it" in their fight against inflation, pushing rates higher until we have a broad recession. That could lead to joblessness and higher charge-offs for loans. Investors will likely also take a skeptical stance with these three stocks, as they don't have as long a history of underwriting as large, older banks. This is especially true for Upstart, which claims its AI models are a new and better way to underwrite loans than traditional FICO scores.

Fintech stocks also have the problem of funding their loans when rates rise. Large, national banks such as Bank of America (NYSE: BAC), for instance, can charge very low deposit rates due to their size, national scale, and recognizable brand. That allows them to generate lots of leverage in net interest income as rates rise, as they can charge higher interest rates without having to raise deposit rates as much. 

That's not the case with fintechs. For instance, Upstart had to resort to using its balance sheet this year to fund some of its loans. That was a departure from its initial business model of selling all loans to third-party banks and credit unions, as loan buyers balked when interest rates rose rapidly.

For its funding, Affirm relies on warehouse facilities, securitizations, and other forward-flow commitments. These are generally higher-rate options than bank deposits.

Yet even SoFi, which acquired a bank charter earlier this year that gave it access to deposits, has had to raise its deposit rate APY up to 2% as of August, up from 1.5% as recently as June, in order to attract depositors.

Basically, the smaller you are and the earlier you are in your corporate life as a financial company, the higher your funding costs will be relative to large institutions. That tends to put these companies further out on the risk curve, which opens them up to charge-offs.

Now what

With these stocks down so much from their highs, between 82% and 95%, they could have substantial upside if the economy avoids a recession and interest rates moderate. However, there is significant uncertainty on those fronts, with most economists skeptical the Fed can engineer a "soft landing."

Thus, these former highfliers remain high-risk, high-upside bets that a recession will either be avoided or that it will be shallow and mild. They remain appropriate only for investors comfortable making volatile, high-upside bets that could also yield very big losses.     

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post Why US Fintech stocks crashed today appeared first on The Motley Fool Australia.

What happened

Shares of several consumer fintech companies fell today after the popular artificial intelligence lender Upstart (NASDAQ: UPST) disappointed the market with its latest earnings results and guidance.

Shares of buy now, pay later company Affirm (NASDAQ: AFRM) were trading nearly 16% lower as of 12:09 p.m. ET today, shares of the one-stop financial services company SoFi (NASDAQ: SOFI) were trading nearly 18.5% lower, and shares of the digital marketplace bank LendingClub (NYSE: LC) were trading about 9% lower.

So what

Last night, Upstart reported adjusted diluted earnings per share of $0.61 on total revenue of $310 million for the first quarter of 2021, both numbers that beat analyst estimates. However, Upstart also lowered its revenue guidance for the full year from $1.4 billion to $1.25 billion. The stock plummeted and as of this writing had fallen roughly 60%.

While the company increased its contribution margin guidance, it also lowered its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) guidance for the full year. Additionally, Upstart earlier this year guided for $1.5 billion of auto loan originations in 2022, but now it seems that goal may be in question as well.

Over the past few months, the Federal Reserve has raised its benchmark overnight lending rate aggressively, by 0.75% in two meetings, sparking concerns among investors that it might tip the economy into a recession. Upstart is currently in the business of originating online personal and auto loans to a range of borrowers across the credit spectrum. These kinds of debt are often some of the first that consumers will stop paying down when they start to face financial pressure. Already, Upstart has seen default trends normalize as help from stimulus has gone away. 

With all these concerns, Upstart's partners that actually fund and invest in Upstart loans have asked for higher returns, as there is now a higher likelihood that consumers will default in the future and as investors are facing their own higher funding costs. This has resulted in Upstart having to raise pricing on its platform for borrowers. Higher interest rates may also push out of qualification some borrowers who qualified for certain loans based on certain investors' risk appetite. All of this will result in lower loan transaction volume and lower conversion rates, which is how Upstart generates the large majority of its revenue.

Upstart also had to hold a small portion of loans that it normally sells to investors on its balance sheet in the first quarter, which spooked investors. That's because some of Upstart's investors, particularly those in the capital markets, are still determining what kind of risk they want to take on, which has resulted in a lack of funding for Upstart loans. Upstart's management has said this is temporary, but the company is supposed to act as a marketplace, and if funding in the capital markets dries up, that would be extremely problematic for future growth.

Now what

Affirm, SoFi, and LendingClub seem to be taking the hit because the market is clumping all these consumer fintech lenders together with Upstart. In Affirm's case, I can understand the concerns because the company is also somewhat beholden to the capital markets to fund and take on a large portion of its loans.

But I don't think LendingClub and SoFi deserve to be clumped in here because both now have bank charters. Bank charters give them access to cheaper deposits, which they can use to fund a large portion of their loans, making them much less reliant on the capital markets.

Additionally, while Upstart originates loans to borrowers all over the credit spectrum, LendingClub and SoFi lend more heavily to prime borrowers and above, who were less affected by stimulus funds and are in much better financial shape. SoFi will report earnings results for the first quarter of 2022 after the market closes today.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post Why the Affirm share price is tumbling today appeared first on The Motley Fool Australia.