Financial stocks are feeling the heat these days. Higher-than-expected inflation is causing the Federal Reserve to ramp up interest rates sooner rather than later, which is sparking fears of a recession.
Since the market hates uncertainty and is forward-looking, several financial and fintech stocks have rapidly corrected, as if a recession were already here. But it's not a certainty it will happen.
While it might seem prudent to wait until a recession emerges, oftentimes the market is ahead of economic results. For long-term investors, the following beaten-down financials seem like genuine bargains, making them buys today, even amid scary headlines.
1. PayPal
As a fintech stock, PayPal (PYPL 1.90%) has the worst of both worlds in today's environment. That's because fintech stocks trade at higher multiples than banks, but are also sensitive to consumer spending. So a slowdown brought about by higher rates hits PayPal not only on valuation, but also on potential growth. It recently issued disappointing guidance in its fourth-quarter earnings report, seeming to confirm these fears.
Yet there's reason to think the hate may have gone too far. PayPal has re-rated down to trade at just 23 times this year's free cash flow guidance of $6 billion, which is a multiyear low valuation for the stock. Meanwhile, its results are currently suffering from a quicker-than-expected runoff of revenue from eBay (NASDAQ: EBAY), which used to be PayPal's parent company and exclusive partner, but is switching to a new processor, while keeping PayPal as a payment option for shoppers.
The good news? The eBay declines should be over by the middle of this year. Once they end, revenue should accelerate in the back half of the year.
Because PayPal takes a percentage of every transaction flowing through its platform, it will benefit in some ways from higher prices, potentially offsetting lower economic activity. And coming sometime this year, a "Pay with Venmo" button will be available on Amazon, giving PayPal a new potential growth avenue.
While not without risk, PayPal might have fallen too far, down more than 60% from its highs.
Image source: Getty Images.
2. Bank of America
Although higher long-term rates should benefit Bank of America (BAC 0.36%), a recession certainly wouldn't. Perhaps that's why Bank of America stock is down some 8% this year, despite a setup that should allow it to earn more net interest income on loans and mortgages. Amid the sell-off, it trades at just 11.2 times earnings, making this big bank a solid value stock.
Of course, a declining stock market has the potential to lower the bank's wealth-management income, and a barren market for initial public offerings has the potential to lower investment banking fees. Yet of the large U.S. money-center banks, Bank of America is among the most exposed to traditional lending, which should benefit from higher rates.
But one might ask, "What about the inverted yield curve?" While higher short-term rates could weigh on Bank of America's costs of funds, the bank also has a huge amount of low-cost consumer and commercial deposits. Last quarter, those deposits grew to $2.1 trillion, against just $979 billion of loans and leases. Because of its national footprint and top digital tools, those deposits will likely stay put, allowing Bank of America to pay very low funding rates compared with rivals, even if short-term interest rates rise.
Meanwhile, CEO Brian Moynihan has pursued a strategy of "responsible growth" since taking the reins of the bank in 2010. That conservative posture, along with a conservative 10.6% CET1 ratio on the balance sheet, should be a comfort in times of economic stress. A safe bank with a growing 2.1% yield and a low price-to-earnings (P/E) ratio is certainly buy-able, even in today's pessimistic market.
3. LendingClub
Speaking of low P/E ratios, the stock of LendingClub (LC 0.69%) has gone from high-flying fintech disruptor to being priced even more cheaply than large-cap banks like Bank of America! After a violent sell-off, LendingClub trades at just 11 times this year's earnings estimates. Not very expensive for a company projected to grow revenue 40% and net earnings roughly 650% this year, based on the midpoints of 2022 guidance.
Obviously, investors are worrying about the safety of LendingClub's loans, which are mostly unsecured personal loans. But the company has changed and de-risked its business model in the past few years.
In 2021, management targeted Prime customers with FICO scores over 700, as management had expected the good credit conditions last year to normalize. Meanwhile, LendingClub's delinquencies from loans made prior to the pandemic are below that of the industry.
Moreover, LendingClub is not as dependent on outside funding for loans as it used to be. The company acquired Radius Bank last year, which gave it a banking license and low-cost customer deposits. That gives LendingClub the ability to retain more loans itself and control its own destiny to a greater extent.
But there is reason to think outside investors, like banks and money managers, might still want to buy LendingClub's loans. Its three- and five-year personal loans are short-duration assets, meaning investors get paid back relatively quickly. In 2021, the average loan duration was just 16.4 months, and the average yield was 12.2%. That's a lot higher than what short-term Treasuries or corporate bonds are giving investors.
While investing in a lender now might seem treacherous, LendingClub's new business model has less risk than investors might to think. It looks like another bargain amid the rubble of the fintech space.
