What happened
Shares of fintech stocks Upstart (UPST 0.79%), Affirm (AFRM -2.08%), and SoFi (SOFI 0.26%) 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 (BAC -0.13%), 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.
