05 Jul 7 Things You Should know about Upstart!
Upstart Holdings, Inc. (NASDAQ: UPST) is a cloud-based artificial intelligence lending platform that operates in the United States. The Company is a bridge between consumer demand for loans and its AI-enabled bank partners. The stock hit after an analyst downgraded it and drastically cut down its price target. Here’s what you should know about the Company!
A Dreamy Start
In December 2020, the Company made its debut on the public markets with an initial public offering. The underwriters priced 12 million shares at $20.25 for total proceeds of approximately $180 million at an initial market capitalization of $1.45 billion. The debut was met with a great response as the share closed at the end of the opening day at $29.47. The stock went on to reach an all-time high of $401.49.
Since 2014, the Company’s bank partners have originated more than $9 billion in personal loans, which have leveraged Upstart’s technology. It uses over 1000 variables and more than 10.5 million repayment events to provide banks with up to 75% fewer defaults at the same approval rate.
The Company’s targeting multiple billion-dollar opportunities, beginning with its core personnel loan business which presents a $112 billion opportunity to the $751 billion markets for auto loans that the Company has plans to disrupt. In addition, Upstart is gearing up for its entry into the mortgage business in 2023, which is a $4.5 trillion opportunity.
Upstart Holdings, Inc. (NASDAQ: UPST)
Market Cap: $2.78B; Current Share Price: 32.82 USD
Data by YCharts
Disrupting the Fair Isaac and Co. (FICO) rating system
The Company aims to revolutionize the consumer credit risk market and emerge as a preferred alternative to FICO, the current market leader. Banks and other lending institutions usually rely on and pay a considerable amount of money to access FICO scores to evaluate the credit worthiness of any entity that approaches them for a loan. FICO has been a market leader for decades with little or no competition.
On the other hand, Upstart aims to bridge the gap between the reality of risk and the outdated systems that measure it and make it accessible to Americans who are fundamentally creditworthy. The Company has set out to build technology widely applicable across a broad spectrum of financial institutions such as banks, credit unions, and lending institutions, making it a scalable model.
A Mammoth Market Opportunity
Artificial Intelligence is witnessing burgeoning demand and gaining wide-scale acceptance owing to the humongous amount of data generated by new-age organizations. There is a growing need for tools that enable advanced data interpretation and offer valuable insights that can serve both internal and external customers better. According to a report by Markets and Markets, the artificial intelligence as a service market is expected to reach USD 10.88 Billion by 2023, growing at a CAGR of 48.2%, from USD 1.13 Billion in 2017.
Companies are now using data analytics to generate actionable insights leading to better customer understanding, engagement, and loyalty. The evolution of technology is also contributing to the rising popularity of digitization, with Artificial Intelligence, Machine learning, IoT, and blockchain simplifying the complexities of Digital Transformation.
Data Analytics is bringing about exciting new changes in numerous fields such as agriculture, manufacturing, retail, healthcare, and insurance, to name a few. Many areas stand to gain from applying meaningful insights provided by machine-driven analysis of complex, disparate data available through various sources.
Implementing machine learning and artificial intelligence makes skimming through significant information sources easier. The evolution of this technology enables companies to use this information for crucial decision-making involving stakeholders, employees, and customers.
The emergence of multi-cloud-based technologies results in improved computing mechanisms and more affordable storage. Emerging technology such as blockchain also validates the need and relevance of using data analytics for information processing and decision-making.
According to a report by Allied market research, the global AI in the banking market is expected to reach $64.03 billion by 2030, growing at a CAGR of 32.6% from $3.88 billion in 2020.
Downgrade and Price-Cut
In June 2022, James Faucette, an analyst at Morgan Stanley, downgraded the Company’s stock from equal weight to underweight based on its “deteriorating” underwriting performance. The analyst stated that his view of the Company was now “incrementally negative” and cut down his price target for the stock from $88 to $19.
A Surprise Loan Portfolio
In May 2022, the Company’s stock plummeted after it lowered its full-year outlook and announced that $604 million worth of loans were moved to the balance sheet. Investors were rightly scared by the 232% surge in loans being carried on to the balance sheet, and the company’s stock bore the brunt, with year-to-date shares of upstart being down by more than 70%. Upstart positioned itself as a tech company, so it was surprising when it disclosed the loan portfolio as investors were not thrilled by its attempts at playing the role of a banker/subprime lender.
The CEO tried to justify the figures by stating that the amount on its balance sheet is still only a fraction of what other fintech companies have. He believes the Company needs more discipline and better price discovery and is working towards achieving it. Moreover, he made it clear that the Company does not intend to build loans on its balance sheet and plans to test and try out new things as a form of research and development initiatives.
The reason for taking the personal loan on the books is that there was a mismatch of supply and demand due to sudden changes in the operating environment, and their price discovery process failed to react fast enough to get the prices to realign with the changing market and supply.
Foray into other verticals
Upstart is a potential market leader in personal lending, which has witnessed an influx of billions of dollars in investment over the last ten years. This has led to double-digit growth in the personal loans industry. However, personal or consumer unsecured loans constitute a meager percentage of consumer debt, and banks do not offer these private loans at scale. Banks do not extensively focus on these loans as they do not earn enough interest to make it worth the effort.
Other categories of loans, such as auto loans, are much larger scale-wise and are a much more established business. Moreover, unlike in a personal loan where one is betting on a person, an auto loan comes with a collateral asset that can be taken over in case of default. The Company is working on impacting this industry by using its technology to deliver an experience that cuts down on the complicated process entailed in availing of a car loan, for instance. The idea is to streamline and simplify processes to be easy to access as an unsecured personal product.
In March 2021, the Company acquired Prodigy software, a cloud-based automotive retail software provider. The companies aim to deliver the world’s best car buying experience and a transparent and affordable financing option.
The first auto loan using the Company’s AI-enables technology was generated in September 2020. Upstart is helping customers refinance their expensive auto loans, delivering savings of an average of $72 per month.
Revenues
In October, the Company reported a 1,018% year-over-year growth in total revenue, which increased to $194 million from the second quarter of 2020. Total Fee revenues stood at $187 million and recorded a 1,308% growth year-over-year. Furthermore, bank partners originated 286,864 loans worth $2.80 billion, which grew by 1,605% compared to the same quarter of 2020. The conversion on rate requests also increased to 24% in the second quarter of 2021, against 9% in the same quarter of the prior year. The impressive growth numbers led to the Company revising its 2021 financial outlook.
In contrast, the total revenue from Q1,2022 was $310 million, denoting an increase of 156% from the first quarter of 2021, while the total fee revenue was $314 million, an increase of 170% year-over-year. The transaction volume and conversion rates grew by 174% and 21%, respectively. The loans originating from bank partners stood at 465,537, totaling $4.5 billion, while the conversion on rate requests was up 21% over the same quarter for the prior period.
The Company’s CEO, David Girouard, attributed the slowdown in growth to rising interest rates and the current economic uncertainty negatively impacting lending operations. While the Company’s scoring model seems effective, it will face challenges in the coming day with the rising interest rates and an increasing cost of debt, which may lead to more defaults.
There are concerns that some of its recent securitizations, including loans to individuals lower on the credit spectrum, have resulted in higher delinquencies. A Kroll Bond Rating Agency report states that the loss rates are to be higher by 3% than the asset-backed securities Upstart issued earlier. Rising rates have also led to higher prices of loans, negatively impacting its origination volume and 2022 revenue forecasts.
Conclusion
Upstart has the potential to be the next multibagger. Still, it faces an uphill task with the uncertain economic environment, issues with credit quality, lack of funding, and rising interest rates. This is one stock that you should approach with utmost caution.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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References
https://finance.yahoo.com/news/upstart-announces-first-quarter-2022-200500307.html
https://www.supermoney.com/studies/personal-loans-industry-study/
https://www.fool.com/investing/2022/06/22/upstart-stock-bull-vs-bear/
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