Financial stocks are most sought-after in a rising interest rate environment because of the positive correlation of their revenues with interest rates. However, given their fundamental weakness, UWM Holdings Corporation (UWMC) and Upstart Holdings, Inc. (UPST) are witnessing a high short interest. So, I think these two stocks are inappropriate for investors looking to capitalize on the rising interest rate environment.

Before discussing the fundamentals of these financial services stocks in detail, let’s discuss what’s happening in the financial sector.

The Fed funds rate has increased from near zero in March 2020 to between 4.75% and 5% now. Since last year, the Fed has aggressively raised interest rates to bring inflation down. Although inflation fell for the eighth consecutive month in February, it remains above the central bank’s long-term target.

The recent bank collapses have continued to strain the financial system. The financial sector’s stability remains a concern despite promises from the financial regulators. The Federal Reserve raised interest rates by 25 basis points for the ninth time last month, as anticipated by analysts.

Financial service providers include banking, insurance, investment management, and brokerage services. The financial services industry is expected to grow at a CAGR of 7.5% to reach $37.48 trillion by 2027.

Although the rising interest rate environment benefits financial services companies, lending has become expensive. Higher lending rates have impacted the demand for loans. Rising rates of mortgages, personal loans, auto refinancing, and an uncertain macroeconomic environment are keeping borrowers away, making life difficult for financial companies.

With the Fed likely to hike interest rates further this year, lending rates could climb even higher. This could impact credit growth for financial companies.

Let’s discuss the fundamentals of heavily shorted stocks UWMC and UPST to understand why they are best avoided now.

UWM Holdings Corporation (UWMC)

UWMC engages in the residential mortgage lending business. The company originates mortgage loans through wholesale channels. It originates primarily conforming and government loans. UWMC has a short float of 23.1%.

In terms of forward EV/EBITDA, UWMC’s 19.37x is 87.7% higher than the 10.32x industry average. Likewise, its 6.27x forward EV/S is 222.5% higher than the 1.94x industry average. And the stock’s 2.57x forward P/B is 165.7% higher than the 0.97x industry average.

UWMC’s loan origination volume for the fourth quarter ended December 31, 2022, declined 54.5% year-over-year to $25.13 billion. Its total gain margin came in at 0.51%, compared to 0.80% in the prior-year quarter. Its adjusted net loss came in at $53.31 million, compared to an adjusted net income of $177.22 million in the year-ago period. Also, its adjusted EBITDA declined 70.8% year-over-year to $60.39 million.

Analysts expect UWMC’s EPS and revenue for the quarter ended March 31, 2023, to decline 84.3% and 51.8% year-over-year to $0.03 and $396.38 million, respectively. Over the past month, the stock has gained 8.8% to close the last trading session at $5.18.

UWMC’s weak fundamentals are reflected in its POWR Ratings. The stock has an overall D rating, equating to a Sell in our proprietary rating system. The POWR Ratings are calculated by considering 118 different factors, with each factor weighted to an optimal degree.

It has an F grade for Sentiment and a D for Growth and Stability. It is ranked #44 out of 46 stocks in the D-rated Consumer Financial Services industry. Click here to see the other ratings of UWMC for Value, Momentum, and Quality.

Upstart Holdings, Inc. (UPST)

UPST operates a cloud-based artificial intelligence (AI) lending platform in the United States. Its platform aggregates consumer demand for loans and connects it to its network of the company’s AI-enabled bank and credit union partners. UPST has a short float of 40.8%.

In terms of forward Price/Sales, UPST’s 2.48x is 17.1% higher than the 2.12x industry average. Likewise, its 3.67x forward EV/S is 88.9% higher than the 1.94x industry average. And the stock’s 2.58x forward P/B is 166.8% higher than the 0.97x industry average.

For the fourth quarter that ended December 31, 2022, UPST’s total revenue declined 51.8% year-over-year to $304.85 million. Its contribution profit declined 45.2% year-over-year to $81.97 million. The company’s adjusted EBITDA loss came in at $16.58 million, compared to an adjusted EBITDA of $91 million in the year-ago period.

In addition, its adjusted net loss came in at $20.95 million, compared to an adjusted net income of $86.96 million in the prior-year quarter. Its adjusted loss per share came in at $0.25, compared to an adjusted EPS of $0.89 in the year-ago period.

For the quarter ended March 31, 2023, UPST’s EPS is expected to be negative. Its revenue for the same quarter is expected to decline 67.7% year-over-year to $100.22 million. Over the past year, the stock has declined 82.6% to close the last trading session at $16.98.

UPST’s weak prospects are reflected in its POWR Ratings. It has an overall D rating, equating to a Sell in our proprietary rating system.

It has an F grade for Growth, Stability, and Sentiment and a D for Momentum. Within the same industry, it is ranked #80. To see the other ratings of UPST for Value and Quality, click here.

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UWMC shares were trading at $5.30 per share on Monday morning, up $0.12 (+2.32%). Year-to-date, UWMC has gained 63.60%, versus a 6.60% rise in the benchmark S&P 500 index during the same period.

About the Author: Dipanjan Banchur

Since he was in grade school, Dipanjan was interested in the stock market. This led to him obtaining a master’s degree in Finance and Accounting. Currently, as an investment analyst and financial journalist, Dipanjan has a strong interest in reading and analyzing emerging trends in financial markets. More...

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