What happened
Shares of several consumer finance stocks were falling this week amid negative sentiment in the banking sector, worries over an expected recession, and other, more-company-specific news.
Shares of credit card company Capital One (COF 0.66%) were down by roughly 12% for the week as of market close Thursday, according to data from S&P Global Market Intelligence. Meanwhile, shares of the artificial intelligence-assisted lender Upstart (UPST 0.79%) traded roughly 10.4% lower, while shares of the one-stop-shop financial services company and digital bank SoFi (SOFI 0.26%) were down nearly 22%.
So what
SoFi delivered its first-quarter results earlier this week, and on its face, the report looked pretty good. SoFi beat estimates on the top and bottom lines, and slightly raised its full-year outlook. But that didn't assuage investors' fears about the loans sitting on its balance sheet.
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SoFi has built up a portfolio of personal loans that exceeds $9.5 billion. The company designates those loans as held for sale, meaning it plans to sell them before they mature.
This type of accounting treatment enables the company to avoid making significant provisions for loan losses on those assets, which would cut into its earnings. However, due to the high interest rate environment, investors have not been interested in buying these personal loans because their cost of funding has risen. They also have concerns about the credit quality of those loans if the U.S. economy experiences a hard landing, which is quite possible at this point. In the first quarter, SoFi didn't do any whole loan sales, although it did execute an asset-backed securitization.
Following the earnings report, Wedbush analyst David Chiaverini lowered his rating on SoFi from outperform to neutral and lowered his price target from $8 per share to $5 per share. Chiaverini thinks the fair value of the loan portfolio, as well as the margins on loan sales, may not hold up.
In other news, shares of Upstart sank after it came to light that the Federal Deposit Insurance Corporation (FDIC) had entered into a consent order with Cross River Bank, alleging that some of the privately held institution's practices related to fair-lending regulations were unsafe or unsound.
Cross River not only originates loans for Upstart, which serves as a key part of the company's operations, but the bank also retains a lot of those loans on its balance sheet. A Cross River spokesperson said the consent order does not restrict any current relationships with its fintech partners. But if the bank did have to pull back, that would likely be a tough blow for Upstart, which already faces immense funding pressure.
Finally, all consumer finance companies were apparently struggling this week because of broader pressure on the banking sector and because the market continues to brace for a recession. The Federal Reserve's latest interest rate hike did not help the mood, and banks continue to tighten access to credit. In a recessionary scenario, consumer finance companies can expect elevated loan losses.
What now
I don't think SoFi's earnings or the FDIC's consent order with an Upstart client were particularly beneficial for either fintech stock this week, and I continue to view these stocks as risky.
While the looming end of this interest-rate-hiking cycle should benefit both of their business models, neither of these companies has operated through a real credit crunch yet. That creates even more uncertainty about how they will fare.
I do, however, view Capital One to be attractive at these levels. While the company is likely to see higher loan losses, partly due to having more subprime borrowers than some of its peers, Capital One has been through recessions before. Furthermore, management is proactively provisioning for credit losses, which should prepare it for a recession.
