What happened
Shares of artificial intelligence (AI)-powered lending platform Upstart (UPST -0.44%) fell 12.6% this week, in another difficult period for fintech stocks.
There wasn't any particular news out of Upstart this week. In fact, the stock was even initiated at "Buy" by a sell-side research firm on Wednesday. Nevertheless, macroeconomic concerns, specifically around very hawkish commentary from the Federal Reserve, have hurt Upstart's stock this week and over the past six months.
So what
As an exciting and high-growth fintech stock, Upstart has the worst of both worlds in today's market. Because it fancies itself a "disruptor" and displays super-high revenue growth, it was bid up to a high valuation. Even though the stock has lost 75% of its value over the past six months, it still trades at an expensive 68 times earnings and 42 times next year's earnings.
UPST Percent Off All-Time High data by YCharts.
High-multiple stocks suffered this week when Federal Reserve governors Lael Brainard and Patrick Harker came out with very hawkish commentary. The Fed also unveiled its plan for a very aggressive run-off of its balance sheet. These events spurred long-term interest rates to rise, and growth stocks to go down.
Not only that, but when the Fed tightens financial conditions to get inflation under control, that could cause a slowdown or even a recession, in which case delinquencies and charge-offs could rise. That, in turn, would hit financial stocks and lenders.
An inflationary slowdown is the worst possible environment for fintech stocks, which get it at both ends -- on both valuation and potential underwriting losses. Recent metrics on Upstart's asset-backed securities from 2021 are showing some higher-than-expected loss rates, although those vintages are very early in their life cycle.
Some may think Upstart is insulated from a recession since it has an "asset-light" model in which it uses AI to underwrite and acquire borrowers and then sells all its loans off to banks. But although it doesn't carry credit risk, Upstart's bank partners could pull back on their buying for fear of higher charge-offs, which may interfere with Upstart's growth.
This was an issue with Upstart peer LendingClub (LC -0.91%), which used to have a similar "asset-light" model. However, LendingClub has since purchased a bank, which brought along its own deposits. LendingClub now holds more loans on its balance sheet to control more of its destiny, though it also continues to sell most of its loans to third parties. LendingClub is down a lot too, so there is nowhere to hide for these types of new-age financial companies as long as recession fears are in the air.
Image source: Getty Images.
Now what
It's difficult to know what to do with Upstart at the moment. After all, the economy is strong, and unemployment is down, but inflation is outpacing wage gains. It's possible the Fed can engineer a "soft landing" in which inflation comes down without inducing a recession, but that is very difficult to do.
As long as uncertainty is high, it may be difficult for Upstart to regain upward momentum. The company just went public in December of 2020, and investors tend to be more skeptical of newer, less-proven companies than "safer" large-caps in times of market stress.
If inflation comes down this summer and more data can point to Upstart's superior underwriting, the stock could rise again. After all, it is down massively from highs, although those all-time highs were likely far too expensive. Still, Upstart gained one fan this week, with Loop Capital initiating the stock with a "Buy" rating and a $140 price target, based on its belief that Upstart has superior underwriting skills relative to banks.
As they say, the proof will be in the pudding, with the pudding being how Upstart's loans perform in a more difficult economy.
