Upstart (UPST -1.30%) is likely one of the more frustrating growth stocks currently trading. Its AI-driven business model sent its stock higher in 2021 amid speculation that it could replace Fair Isaac Corporation's widely used FICO score.

However, seeing a now-shrinking business, its stock has lost about 97% of its value. The question for investors is whether one key struggle the company faces can outweigh the promise of its credit-scoring model.

The bear case: Management's handling of the loan slowdown

One criticism of Upstart before interest rates rose was the lack of a stress test on its model. Now, with the rising-rate environment here, the model, and by extension, the company, have to prove themselves.

In a low-rate environment, Upstart prospered as an evaluator of personal loans, and its $146 billion addressable market. Also, the consumer finance stock has entered the auto loan market and is just beginning to evaluate small business loans. These loan types offer a combined addressable market of over $1.4 trillion, a 10-fold increase in its addressable market.

Despite that advantage, expansion has not insulated Upstart from the slowdown, and revenue declined. In the third quarter of 2022, revenue of $157 million dropped 31% year over year. This came after a triple-digit revenue growth rate as recently as Q1.

Moreover, Upstart always billed itself as a loan-evaluation tool for banks. But in a bid to launch its auto loan business, it placed some loans on its balance sheet. Management promised to sell these loans earlier in the year.

Despite that pledge, Upstart carries $700 million in balance sheet loans, up from $252 million at the end of 2021. That growth appears to have weighed on investor confidence, and until it returns to loan evaluation only, Upstart stock may continue to struggle.

The bull case: The model's handling of the loan slowdown

Still, for all of Upstart's challenges, few can fault the concept of its business. Upstart utilizes artificial intelligence to evaluate a borrower's ability to repay a loan. Through this process, Upstart claims 53% fewer defaults than FICO for the same loan types. This is potentially huge for banks, as they could approve more loans and earn more revenue without increasing default risk.

It also represents a much-needed update to the credit approval process. Fair Isaac introduced the credit score back in 1989, and the lack of a major overhaul leaves it vulnerable to more innovative competitors.

Also, despite (or maybe because of) the slowdown, Upstart has tweaked its model. The company improved the model's accuracy as much in the last four months as it had in the previous two years. Consequently, instant approval for loans now stands at 75%, a record high.

Admittedly, Upstart remains dependent on just two banks for 88% of its loan volume, but it continues to diversify its client base. It reported 83 bank and credit union partners at the end of Q3, up from 31 in the year-ago quarter. Additionally, 702 auto dealerships now use its auto lending platform, more than double the 291 dealerships one year prior.

Should I consider Upstart?

At current levels, Upstart appears best suited as a speculative investment. Indeed, the FICO score is overdue for an update, and Upstart's improved model could be the advancement banks need to increase loan volumes.

However, Upstart's model will need to survive a rising-rate cycle to convince more banks and investors of its value. Also, Upstart will probably have to raise originations and return fully to its mission as a loan evaluator for the company to recover in 2023 or any time beyond. Until it proves itself, even the highest-risk investors should avoid taking large positions.