Lending platform based on artificial intelligence Assets received (UPST -8.58%) stumbled into 2022. Management can’t make up its mind to use its balance sheet to support its lending.
Uncertainty mixed with a rapid tightening in the loan market crushed stocks, sending them down 91% from their peak. But don’t give up just yet. Here’s why Upstart could still win big in the long run.
What’s going on with Upstart’s balance sheet?
Upstart is in the lending business, but tries to operate more like a tech company. Its artificial intelligence (AI) approves a borrower for a loan and then forwards it to one of its lending partners or sells it to institutions in the debt markets. In other words, Upstart lends to real lenders who take the risk.
This model works well in a strong credit market, like in early 2021 when the economy was teeming with stimulus money. However, the rapid rise in interest rates has put a damper on things. Now, lenders and loan buyers who assume the risk want higher profit margins on loans.
Upstart could not find takers for some of its loans earlier in the year; he created loans with unprofitable prices because the market changed so fast. Upstart decided to hold a portion of these loans instead of selling them at a loss. Management quickly pivoted after Wall Street sold the shares, pledging to keep loans off its books other than those for research and development purposes.
Long-term positive change on the way
Management has realized that it is difficult to be at the mercy of buyers to get rid of loans. CEO David Girouard noted on the second quarter call that the company is changing its model, focusing on building relationships with loan buyers who will provide consistent funding throughout bull and bear market cycles. credit. In other words, Upstart wants committed finance to know that its loans have buyers before they deliver.
This is potentially a big deal for the company in the long run. Theoretically, this could remove some of the volatility from Upstart’s business, which you can see in the revenue growth graph below as growth rose and then fell.
Girouard admitted that he would rely on his balance sheet to support lending during the transition to this new style of financing, and even acknowledged that it goes against what they had said a few months before.
The flip-flop is a black eye for near-term management credibility, and it may take time for Wall Street to regain confidence in Upstart’s management team. However, the potential benefits of this new funding model might be worth the wait while the company gets on the right track.
The hard-to-ignore long-term potential
The important thing for long-term investors is that the product works as advertised. Management began sharing a quarterly breakdown outlining how its algorithms performed against a FICO credit score. Data shows that Upstart is better at analyzing risk across the board.
Additionally, Upstart continues to recruit new lenders for its network, which has grown to 71, from 57 three months ago and 25 a year ago. Lenders appear to be buying the technology, which may remain the narrative as long as Upstart’s network continues to grow. There are over 11,000 banks and credit unions in the United States. Potential partners are therefore not lacking.
The company is also branching out into new types of credit, with car loans being its promising product. Upstart has retail software tied to its lending platform and has tripled its dealership footprint to 640 in just one year. Management has signaled its desire to enter other lending areas, ranging from mortgages to small business lending. The opportunity is huge; it’s up to the execution of the business to realize its potential.
Upstart has had a rough year, and management’s flip-flop does little to ease shareholders’ minds. Investors should view Upstart as a speculative stock, but the potential reward could be worth it for long-term investors.
justin pope has positions in Upstart Holdings, Inc. The Motley Fool has positions and recommends Upstart Holdings, Inc. The Motley Fool has a disclosure policy.