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Upstart faces challenges and O

Shares of artificial intelligence lender Upstart Holdings Inc. (UPST, Financial) is trading almost 92% below its October 2021 highs. In early August, the stock fell after the company announced preliminary second-quarter results that were well below its previous revenue forecast. and net profits.

The company went public in December 2020 and its market value appreciated almost 1000% before things started to go downhill.

In early August, the stock fell after the company announced preliminary second-quarter results that were well below its previous guidance for revenue and net profit.

What caused the initial upward trend?

After its IPO, Upstart quickly became an investor favorite due to the promising technological developments it introduced to reduce default rates. The cloud-based AI lending platform works with banks to offer personal loans to eligible customers. The company says its lending model expands credit availability by considering more than a borrower’s FICO score. According to Upstart, 80% of Americans who have never defaulted on a loan do not have access to credit because they do not meet the credit assessment criteria of the scoring method, which takes a very narrow view of the solvency.

Upstart is trying to change that by analyzing data from all of its banking partners using machine learning to further assess the creditworthiness of potential borrowers. The company’s revenue and default forecasting model lowers loss rates for Upstart-powered banks by considering non-traditional criteria such as education, field of study, GPA and work history in plus income when determining a borrower’s ability to repay a loan. According to the results of its credit scoring tool, the tested Upstart model approves 26% more borrowers than traditional models and shows 10% lower average APRs for authorized loans.

The company acts as an intermediary between banking partners and borrowers, deriving the majority of its revenue from fees for software and services used by its partner banks, and thus bears much less credit risk compared to traditional banks. . The number of bank and credit union partners increased from 18 at the end of the first quarter of 2021 to 71 at the end of the second quarter of 2022. From June 2021 to March 2022, Upstart recorded triple-digit revenue of one year to the next. growth for four consecutive quarters, indicating that investor enthusiasm for Upstart has been supported by outstanding financial performance.

The Upstart Ecosystem

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Source: Prospectus

In 2021, the company moved from the personal loan market to the auto finance market by paying $89 million to acquire Prodigy, a car dealership sales platform. Upstart’s auto retail business saw better-than-expected growth, with the number of dealerships on the platform growing from 162 at the end of Q1 2021 to 640 at the end of Q2 2022. The company’s revenue and earnings growth rates have been outstanding, and its entry into the $727 billion auto loan market has been well received by investors. However, recession fears appear to be slowing the company’s growth today.

The company also intends to enter the $644 billion small business loan market, but the current economic environment may make it difficult.

What’s Driving Upstart Stocks Down?

Regardless of the success of Upstart and the potential of its AI-based risk assessment model, there are risks to consider. The stock price began to fall after the company issued a dismal outlook last October. Despite triple-digit growth, shareholders were unhappy with the company’s projected slow growth. The problem escalated in May after the release of the company’s first-quarter earnings report, when management revealed it had added a large position to loans held on its books. Because Upstart is not a bank, its lack of credit exposure was viewed positively previously, and this revelation forced investors to view Upstart as a financial services company and less as a technology company.

The slowdown in growth is caused by fears of recession and rising interest rates. Low interest rates and stimulus checks issued during the pandemic have allowed fintech companies to lend money to consumers at competitive rates with little risk of default. Today, rising interest rates, loss of jobs and halting government support programs are discouraging borrowers, impacting Upstart’s earnings. The company makes money by charging fees on loans processed by its AI platform, so it’s no surprise that revenue growth is slowing as consumer demand for loans dries up.

Upstart is also under pressure due to the skyrocketing rate of missed loan repayments since stimulus programs ended. According to the management team, in some cases default rates have exceeded pre-pandemic levels. With more loans on its books and rising interest rates, the company faces a higher risk of default. Additionally, it will discourage banks and lending partners from approving loans to Upstart customers, as accurate assessment of creditworthiness becomes more difficult in the current macroeconomic environment.

Trends in payment defaults

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Source: BusinessWire

Another factor affecting revenue is Upstart’s conversion of some of its book loans to cash. However, this is expected to be a one-time event as management said it no longer holds loans on its own balance sheet.

The revenue trajectory could deteriorate further in the coming quarters as lenders are reluctant to lend money and customers are likely to avoid paying high interest rates. However, the current problem is not one of demand, but one of supply, as lending partners seem more risk averse given the current economic climate. A drop in interest rates can also make other types of loans more affordable, forcing customers to abandon Upstart, a risk the company faces as the economy recovers in the next economic cycle. .

Rising default rates that have shaken investor confidence aren’t just a problem for Upstart. Fintech companies in general seem to be impacted, making it harder for these companies to attract investors. However, this is only a short-term headwind. But the question remains whether Upstart can regain lenders’ trust by improving the accuracy of its technology for determining borrower creditworthiness. Upstart’s success is determined not only by macroeconomic factors, but also by the performance of its core technology. There is no doubt that if the company succeeds in facilitating higher quality lending books in the current economic environment, it will become the undisputed leader in the digital lending platform. So far, the company has handled uncertainty admirably with its AI platform, which ensures higher approval rates with lower fraud and defect rates. However, the rise in defaults may call into question the role AI plays in the financial services industry.

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Investor interest in Upstart has waned in recent months, and with the company expected to experience lackluster growth over the next few quarters, the trend is expected to continue until the company can begin to facilitate loan books with rates. lower defaults and expand its customer base.

In the short term, the biggest hurdle for Upstart is gaining the trust of banking partners. If the company successfully overcomes this challenge, it will likely attract investors again.

The long-term picture remains promising for Upstart as its success over the past few years demonstrates the ineffectiveness of traditional credit scoring models. The company could revolutionize the relationship between banks and borrowers, which should open many doors for it to prosper and generously reward shareholders.