What happened
Shares of fintech platform Upstart Holdings (UPST 2.76%) were down big today, falling about 11.4% as of 2:30 p.m. ET.
There wasn't any material news out of the company today, but macroeconomic fears over a recession have begun to take hold of the market. That's not good for any stock, particularly a lender. What's an even worse stock to own than a traditional lender on such a day? A new fintech that investors may have come to doubt, due to its short history as a public company.
So what
Upstart investors might say, "Hey! Upstart isn't a lender!" Technically, that's true. However, even though Upstart positions itself as a tech-savvy underwriting platform that sells its loans to third-party banks and investors, it is not immune from the dynamics of lending. Last quarter, due to the rapid rise in interest rates, Upstart's third-party lending customers, which buy its loans, pulled back as they recalibrated their risk and return models. That caused Upstart to retain a small portion of its loans on its balance sheet.
The market reaction to that was so bad, with Upstart falling roughly 70% immediately thereafter, that Upstart management has since said it will no longer hold loans as a stopgap measure. Rather, it will just pull back on underwriting if loan buyer sentiment wanes.
It also doesn't help that Upstart's underwriting, which is supposed to be superior to traditional FICO score-based lending, seems to be showing cracks. Last month, Wedbush analyst David Chiaverini downgraded Upstart and lowered his price target on shares to $15, as he noted some recent Upstart securitizations were starting to show increased delinquencies.
Moreover, last week, Upstart wrote in a blog post it was adding new variables and making changes to its algorithms "during a period of significant economic change." While it's to be expected that Upstart would recalibrate its models from time to time, the company seems to be scrambling to do it quickly, asking for a waiver to implement changes before they can be fully reviewed by the Consumer Financial Protection Bureau (CFPB).
With the Federal Reserve hiking the Federal Funds rate yesterday by 75 basis points in an attempt to control inflation, the largest increase since 1994, investors are now factoring in a greater chance of a recession. That's affecting all fintechs and not just Upstart, but Upstart is showing among the largest losses, likely due to these fears over its algorithm.
Now what
Upstart now trades at just 19 times trailing earnings and 12 times forward estimates. That, obviously, seems quite cheap. However, remember that investors don't have a lot of confidence in those forward estimates, since there is uncertainty about the path of the economy and Upstart's underwriting models.
However, if you feel Upstart's management team has what it takes to lend prudently even in a very difficult operating environment, then there could be lots of upside here over the long term. Still, Upstart's financials could show lower growth this quarter, and perhaps even see its bottom line-profits falling into negative territory over the next few quarters. Long-term investors should be prepared for a difficult near-term trading environment.
