Inflation is at its highest level in 40 years and is putting strong upward pressure on interest rates, hurting consumers’ wallets and lowering demand for loans. This is bad news for fintech Upstart Holdings (UPST 17.75%)which released its preliminary financial results for the second quarter of 2022 on August 9.
The day after Upstart’s exit, its share price fell more than 11% as investors digested news of slowing revenue growth and a bleak near-term outlook. The company’s banking and credit union partners have been reluctant to take on the risk of unsecured loans amid deteriorating credit conditions.
But there is still a very attractive story unfolding, which makes the steep drop worth buying for the long haul. Here are two reasons.
1. Despite concerns, Upstart’s lending models are working as intended
Upstart uses an artificial intelligence-based algorithm to create loans for its banking and credit union partners. The company’s goal is to deliver better and more inclusive lending decision technology than Just Isaacdecades-old FICO credit score system.
Upstart aims to achieve this goal by analyzing up to 1,600 different data points on a potential borrower, compared to the handful assessed by FICO. In addition, Upstart’s algorithm makes an instant decision 73% of the time, eliminating days or even weeks of manual assessment, which represents a great cost saving for its banking partners.
A few years ago, Upstart conducted a study that suggested that loans created using its algorithm defaulted 75% less often than loans rated the traditional way. But investors have expressed concerns more recently because its models have never been battle-tested in tough economic times or recessions.
But according to a presentation released alongside Upstart’s second-quarter results, the company’s algorithm only improved its accuracy in 2022 when it comes to its ability to separate high- and low-risk loans. The industry as a whole has seen an increase in default rates as pandemic stimulus wanes, but it remains in line with Upstart’s forecast.
Additionally, the company points out that loan consolidations issued in 12 of its quarters outperformed, while five underperformed. He says he calibrated his algorithm in anticipation of a significantly worse economy than the 2014 to 2019 period, so the company appears well prepared.
2. Upstart continues to add banks and car dealerships
Upstart is a loan originator, so it’s not lending money itself – or at least it’s not supposed to. The company currently has $623 million in loans on its balance sheet amid deteriorating credit conditions, which has led to funding constraints from its partners, who typically buy them. This has understandably spooked investors, but the company says its balance sheet is only being used as a transitional bridge, not a long-term solution to solve funding problems.
Although banks and institutions are risk averse right now, they are still joining Upstart’s network in droves. The company reported a total of 71 partner banks and credit unions in the second quarter, a jump of 184% from the same period last year. Its auto sales and financing platform is also active in 640 car dealerships, more than triple the 199 it served in the second quarter of 2021.
In the first quarter of 2022, the company told the market it had 11 banking partners who had completely dropped a minimum FICO score requirement thanks to Upstart’s algorithm, a number that had dropped from seven just three months earlier. .
It would seem that, despite some short-term funding issues, more banks and credit unions are more willing than ever to try new, innovative ways to issue loans through platforms like Upstart. It’s entirely possible that if Upstart can prove its mettle during the economic turmoil and come out the other side with consistent lending performance, it could see a wave of rapid adoption that could accelerate its growth.
Upstart stock is a down buy
Upstart reported second-quarter revenue of $228 million, up just 18% from the prior year period and much slower than the triple-digit percentage growth investors are expecting accustomed to this company. It also saw a 98% reduction in net profit to just $1 million in the quarter.
To make matters more difficult, it withdrew its full-year 2022 guidance and revised down its third-quarter revenue and net profit, so the short term is expected to be bumpy.
But Upstart has flagged a $6 trillion annual opportunity across its two existing lending segments and two more (mortgages and business lending) it may pursue in the future. Not to mention, its secured auto loan origination business is booming, with a 734% increase in transactions year-over-year in the second quarter.
Upstart has more than $790 million in cash on its balance sheet, plus the $623 million in loans it’s likely to offload in the near future, so it has plenty of breathing room to weather this tough time.
There are some signs that inflation has already peaked, which could limit interest rates until 2023. This could signal the end of Upstart’s recent problems. If so, investors buying the stock now could be handsomely rewarded in the long run.