Shares in fintech group Funding Circle Holdings (LSE: FCH) are up by 15% as I write, after the SME business lender said its results for the first half of 2021 are expected to be “well ahead” of previous forecasts. The Funding Circle share price has now doubled over the last year.
I’ve been taking a fresh look at this lender, which acts as an alternative to mainstream banks. Should I think about buying Funding Circle shares, or would I do better off by buying a more traditional banking stock such as Barclays (LSE: BARC)? Let’s take a look.
A Covid-19 winner?
Funding Circle’s software enables businesses to apply for loans and receive a decision within seconds. The company says that its machine learning technology uses a “data lake” containing more than 2bn data points to help it make accurate lending decisions.
New lending has increased during the Covid-19 pandemic, as the company put its regular lending on hold and focused solely on UK government-backed CBILS loans. In total, Funding Circle issued £1.7bn of these loans last year — that’s more than 80% of its total UK lending in 2020.
CEO and founder Samir Desai admits that as Funding Circle returns to normal commercial lending this year, he expects to see “some initial reduction in lending”. Even so, Funding Circle expects to report an underlying profit for the full year.
Funding Circle share price: what I’m doing
I think that when support schemes such as furlough finally end, we could see an increase in business failures in the UK. This could probably lead to an increase in loan losses, including CBILS loans.
Funding Circle’s heavy dependence on CBILS loans worries me. Although these loans have a government guarantee, this only covers 80% of the loan. The remaining 20% is at the lender’s risk.
Interestingly enough, Funding Circle’s management increased their estimated average loss rate on loans to 20.5% last year, from 12.9% at the end of 2019. If the company starts to report rising default rates this year, I think Funding Circle’s share price could start falling.
Even without this, I reckon Funding Circle stock is starting to look expensive. The lender’s shares trade at more than two times their book value, even though this business has never reported a profit.
Looked at another way, Funding Circle shares are trading on 50 times 2022 forecast earnings.
On balance, Funding Circle is just too expensive for me.
Why I’d buy Barclays shares now
FTSE 100 bank Barclays isn’t likely to double in size anytime soon. But this business is already profitable and trades at an attractive 30% discount to its tangible book value. That gives Barclays shares a forecast valuation of just eight times 2021 earnings, with a dividend yield of 3.3%.
The bullish argument in favour of Funding Circle shares is that if things go well, this smaller business could grow much more quickly than Barclays ever could. That’s probably true, but I think the risk of serious problems is also much higher at Funding Circle.
I admit that Barclays’ growth has been sluggish in recent years. But this big bank has plenty of surplus capital, a diverse business model, and a cautious valuation. For me, Barclays is a sensible investment that should deliver positive returns.
In contrast, I think Funding Circle looks like a much riskier bet, especially after recent share price gains.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.