Upstart Holdings Inc.'s (UPST, Financial) strong business model has enabled it to penetrate the borrowing and lending market more effectively than most of its competitors.
Despite the overall bullish outlook for the fintech market, however, Upstart could not remain unaffected by interest rate hikes and inflation, causing a tremendous decline in its stock price.
While Upstart has proven itself to be a strong company with a viable business model and promising technology, in the current climate of economic uncertainty, its share price is unlikely to recover anytime soon. This is because a robust economy is essential for any business to thrive, and the company needs a stronger economic context for its stock to begin rising again. With economic headwinds projected to continue over the next several months, investors may have to wait before seeing a full recovery.
A disruptive business model
The company uses artificial intelligence to help quantify the risk of a loan more accurately. It uses discrete AI models to target fee optimization, income fraud, acquisition targeting, loan stacking, prepayment prediction, identity fraud and time-delimited default prediction. These models use over 1,600 variables and are constantly learning from the 21.6 million repayment events that have happened so far.
Upstart has a solid business model as it allows more people to gain access to loans regardless of their credit score. Instead of credit scores, the business considers factors such as education, employment history and income. The business uses AI to approve loans, and 75% of the loans are fully automated. For underwriting loans, it connects borrowers to institutional investors involved in loan funding and purchase and investors from bank partners.
The company's business model approves 43.4% more borrowers than the traditional credit issuance model with a 43% lower average annual percentage rate. On top of that, the approval rate is also slightly better than its competitors.
Another reason for the company's increased approval rate is that even though eight out of 10 Americans have never defaulted on a credit product, 52% of them still do not have access to prime credit. By removing the credit score model, artificial intelligence can accurately predict an individual's ability to pay back and substantially reduce default chances.
With its innovative approach, Upstart has truly disrupted the traditional perceived risk associated with investing in loans and delivers high returns with low-risk levels that attract attention in today's investment world.
Upstart's earnings will remain muted for the next few quarters
According to a Reuters report, U.S. consumers' delinquency and default rates will reach their highest level since 2010 this year. For personal loans, the delinquencies could reach 4.3%. Furthermore, the credit card debt in November was 20% more than the previous year, and delinquencies and charge-offs show a significant year-over-year increase. In addition, 8% of mortgaged homeowners are likely to default on early payments.
These metrics are important as Upstart does not pay the loans, but rather relies on its partners. The increased defaults and delinquencies will force its lending partners to be more selective and increase their margins. In addition, the funding costs have increased slightly in the past year, so an additional increase would decrease the number of borrowers. The approval volumes are likely to decline in the coming years as well.
This is a stark contrast to 2021, when it reported a year-over-year revenue increase of 251.6% and the earnings per share significantly outperformed the market consensus. Due to interest rate hikes and inflation, however, investors pulled their funding in 2022 and, as a result, the company had to issue some of the credit on its own. In its latest quarter, Upstart's revenue declined by 31% year over year and its recorded a net loss of 24 cents per share. Moreover, the company's guidance took it further into bear territory when it projected a net loss of $87 million for the fourth qaurter of 2022.
The market environment in 2023 is not expected to any better and the macroeconomic headwinds and recession fears are likely to keep the profits for Upstart at bay.
The steep decline in share price is not cause for major concern
Upstart's recent stock crash should not be taken as a sign of the company's downfall. As is typical for any young company, there was an initial surge of post-initial public offering hope driving up costs.
But as reality has set in and traders' assessments of Upstart have taken into account actual tangible financial information, prices have predictably fallen in tandem. This is not indicative of any trouble with the product or service, nor lack of competence from the management team.
Upstart is a prime example of the ebbs and flows of bullishness to bearishness seen in new businesses. After early optimism around the company's idea resulted in strong shareholder appeal, there was an inevitable transition as it moved into its more mature stage and demonstrated that we were more likely to see steady growth than immediate, large profits.
This does not indicate that Upstart is any less sound from a business perspective; it just means investors have come to understand at what rate they can realistically expect returns.
Takeaway
Upstart is a unique fintech company that takes a novel approach to providing credit access to people that otherwise would have to jump through countless hoops to get it. While the stock was riding high going into 2020, interest rate hikes and rampant inflation has caused its market value to plunge.
All hope is not lost, however, as experts expect the fintech sector to grow substantially in the coming years. With recession fears looming over investors for 2023, however, many are uncertain about Upstart's prospects.
