What happened

Upstart Holdings (UPST 0.79%) has inked a deal to sell up to $4 billion in consumer installment loans to investment firm Castlelake LP. Investors are pleased to see there are buyers for Upstart's loans, sending shares of the fintech company up more than 20% on Monday afternoon.

So what

Upstart is attempting to upend the traditional credit scoring system, deploying artificial intelligence to evaluate potential borrowers. The company claims its model provides a more customized, and accurate, projection of whether a customer will repay their loans, but it will take time, and a complete credit cycle, to fully evaluate that claim.

Upstart shares have lost more than 90% of their value since late 2021 as investors fret a slowing economy will lead to higher defaults. The company has also had to keep more of its loans on its balance sheet than it had intended due to poor market conditions.

But the shares shot higher last week after Upstart said it had secured long-term funding agreements that could deliver more than $2 billion in loans to the platform in the coming year. That was seen by many investors as a sign of confidence in the platform.

On Monday, Upstart got another important endorsement when it announced Castlelake is interested in taking a substantial number of loans off its balance sheet.

"Against a backdrop of increasing economic uncertainty, Castlelake is committed to helping support Upstart's mission of unlocking mobility and opportunity for millions of U.S. consumers," John Lundquist, a specialty finance partner at Castlelake, said in a statement.

Now what

For now, the agreement simply frees up more capacity for Upstart, giving the company the resources needed to continue scaling its platform and making new loans. It is also a good sign for investors that a sophisticated investor like Castlelake is interested in working with Upstart.

But investors need to be aware that little has changed concerning the long-term viability of Upstart. The only thing that can truly stress-test the AI that Upstart is using is a complete credit cycle, or perhaps a couple of credit cycles, and until then there is no way of knowing if Upstart can really outperform other credit evaluation methods.

Upstart is moving in the right direction, but investors need to remember this is one small step on a long journey.