Upstart (UPST 0.79%) has taken the lending industry by storm with a platform that helps make affordable credit available to more Americans. The company's product competes primarily with the FICO credit score, which, while historically critical to lenders, is a flawed method for determining a person's creditworthiness. As a study conducted by Upstart in 2019 found, 80% of Americans have never defaulted on a debt, yet only 50% of Americans have access to prime credit based on their FICO scores.
The flaws in those simple credit score formulas have left a broad swath of the U.S. population without access to credit at affordable interest rates.
Upstart is trying to change that. Its artificial intelligence platform considers more than 1,500 variables to make lending decisions on each individual borrower. This generates a more holistic view of creditworthiness. Primarily, its determination system has been used by its lender clients to make decisions about personal loans, but in April 2021, Upstart bought Prodigy -- an auto retail software company -- to accelerate its expansion into the auto loan niche. That looks to be a major opportunity for the fintech.
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Customers are signing up left and right
Like the traditional personal loan business, the auto financing system has a lot of flaws. More than $1 trillion worth of cars are purchased at dealerships in the U.S. every year, and most of them get financed -- but only 1% of buyers say they are satisfied with the process. Since the Prodigy acquisition closed, Upstart has been working to do better and has grown the number of dealership locations using its platform by 106% to 410.
The number of banks that partner with Upstart to offer auto loans has also been expanding: It now has 10 bank partners on its auto platform. If the rate at which its personal loan business has grown is any guide, the number of banks using Upstart to make auto loan decisions could grow at a rapid rate: At the end of the third quarter, the company had 31 bank partners. By the end of Q4, that number had increased by 35% to 42.
Upstart has created a retail solution -- where car buyers can navigate through the entire car-buying experience -- to further the growth of its auto loan segment. This retail site connects every part of its business: It has partnered with manufacturers like Subaru and Volkswagen (VWAGY -1.13%) to offer cars, which can then be purchased through its dealership partners, while its bank clients finance the purchases.
It is important to note that Upstart doesn't take on any of the risk in the loans. It simply gets paid for each application determination it conducts, a business model that provides a stable and consistent revenue stream.
Optimism about the future
In the company's fourth-quarter conference call, CEO David Girouard noted that the "auto [refinancing] funnel performance is now comparable to where our personal loan funnel was in 2019." For reference, the number of loans facilitated with Upstart's AI engine grew by 527% from Q4 2019 to Q4 2021, so there could be plenty of growth ahead.
By the end of 2022, management expects that its auto loan transaction volume will reach $1.5 billion, which is incredible considering that it originated its first auto loan in late 2020. The company also generated over $135 million in net income and $153 million in free cash flow in 2021 -- funds that could be reinvested in fueling this growth.
How big is the opportunity?
Upstart Auto is working in a massive market: The loan origination opportunity in auto is worth $727 billion annually, so the company's $1.5 billion in loan volume guidance is peanuts compared to its potential.
This is a young company with a lot to prove, but with the better system that it has built on the back of artificial intelligence and machine learning, it looks poised to capitalize on an immense opportunity. If Upstart lives up to its potential over the next decade, investors could see Upstart Auto become one of the company's biggest revenue generators.
