Upstart Stock: Bull vs. Bear
The Artificial Intelligence (AI) Lender Assets received (UPST 8.79%) has been an extremely divisive stock, with many investors fully buying into the company’s story and the huge market opportunity, while others are more skeptical.
Upstart has developed algorithmic loan underwriting models that it claims can better assess the creditworthiness of borrowers than traditional underwriting scoring methods such as Just Isaacfrom FICO. Upstart currently offers personal and auto loans through a number of lending partners and has ambitions to apply its technology to other loan categories.
Since its IPO in late 2020, the company has skyrocketed to $400 per share before dropping back to around $35 now. Given all of this price action, let’s revisit the bull/bear case for Upstart.
Bull: the long-term opportunity remains
Jennifer Sabil: The issues highlighted in Upstart’s 2022 Q1 report are certainly important to consider in your investment decision, and it’s no surprise that Upstart’s price has come down as a result.
But much of the original bullish thesis remains intact, and management’s transparency and quick response to issues raised demonstrates that it takes responsibility for its issues and is making plans to address them. Every new business has some growing pains at some point, and what you want to see is strong management.
Upstart’s potential is huge. The company sees a $112 billion opportunity in its core personal lending business, plus a $751 billion market for auto loans, as well as $4.5 trillion in mortgages, a market it is preparing for. to enter in 2023. There are several other markets it expects to enter. at one point.
In the first quarter of 2022, revenue increased 156% year over year to $310 million, and net income increased 224% to $35 million. Banking and credit union partners have grown from 18 in Q1 2020 and 42 in Q4 2020 to 57 at the end of Q1 2022, and that’s adding about one lender every week.
Car dealerships grew from 162 in the first quarter of 2021 to 525 in the first quarter of this year, and Upstart facilitated more than 11,000 auto loan refinances through its platform in the first quarter, almost double the amount of the whole of 2021. Upstart’s model is working, and more lending partners are seeing the appeal.
As an AI platform, its model is constantly refined as it adds data points, improving results and making it even more competitive. At the current price, shares are trading at just 23 times trailing 12-month earnings, which is cheap for a company with triple-digit (or even double-digit) sales growth. Market volatility and rising interest rates could hurt Upstart in the short term, but the long-term opportunity is huge, and at this price, it seems like the perfect time to start a position.
Bear: The company still has a lot to prove
Bram Berkowitz: After the stock’s huge sell-off this year, Upstart’s valuation is much more attractive. But my main issue with the company is that there are so many things we still don’t know and big issues that still need to be resolved.
For example, Upstart’s central claim is that its credit underwriting algorithms can approve as many loans as traditional banks, but with lower default rates. Although the company has shown its credit scoring model to be more efficient so far, it has never been through a rapidly rising interest rate environment like the one we are currently experiencing. As the Federal Reserve raises rates, the cost of debt will rise, making borrowers more likely to default.
As government stimulus waned, defaults at Upstart in the first quarter quickly escalated from outperforming modeled expectations to meeting them. Additionally, some of Upstart’s more recent securitizations, which include loans to borrowers lower on the credit spectrum, have begun to show higher defaults than previous vintages and are underperforming modeled expectations.
In a recent securitization of Upstart loans, ratings agency Kroll Bond released a report saying it expects loss rates to be more than 3% higher than asset-backed securities. Upstart issued earlier this year. Rising rates also forced Upstart to set higher prices for loans, resulting in lower origination volume and leading management to lower its 2022 revenue forecast.
My other big concern is Upstart’s funding model. The company is not a bank and therefore does not intend to hold loans on its balance sheet. It relies on banks and credit unions using its technology to fund these loans with deposits and keep them on their balance sheets. Upstart also sells certain loans to whole loan buyers or other institutional investors who bundle loans into asset-backed securities.
However, with the macroeconomic environment so volatile amid fears of recession and stagflation, investors are wary of personal loans as they may default at higher rates. In the first quarter, Upstart revealed it was to hold a small portion of the loans on its balance sheet that it would normally sell to investors, who recalibrated the level of risk they were willing to take. Investors are concerned that Upstart may not be able to generate enough investor demand in this environment to continue to fund all of the company’s loans, which could have a chilling effect on origination volume.
A risk-reward proposition
Upstart is a true risk-reward proposition. If the company revolutionizes lending and replaces much of what FICO does, investors could turn to the proverbial 10 bagger or even more. However, there are risks and uncertainties ahead, such as the resilience of the credit quality of its loans and funding issues in a rising rate environment. This stock is probably best suited for investors with a higher risk appetite, or at most a small position in your portfolio.