The fintech Upstart (UPST -2.94%) has been good to investors so far in 2023. The stock price has surged 127% year to date as of June 26. That's an impressive performance. But that huge gain needs to be viewed from the right perspective.

Roughly 20 months ago, Upstart's stock was trading above $400 per share. The price fell off a cliff beginning in October 2021 partly over concerns about the potential for rising interest rates to combat outsized inflation. By the end of 2022, the stock could be bought for around $12 per share. Yes, Upstart stock is doing well in 2023, but it is still only trading at $32 per share and about 91% down from all-time highs.

All this is to say that, while there is a lot to like about Upstart as a short-term stock trader right now, there are also some major concerns that make Upstart a stock to tread cautiously around if you are a long-term investor.

The good news about Upstart

When Upstart burst on the scene in 2021, investors were intrigued by its technology, its business model, and its growth. Upstart is a fintech that uses artificial intelligence (AI) to evaluate loan requests, generating what management considers to be a more accurate assessment of loan applicant creditworthiness while also managing the process quicker and more efficiently. About two-thirds of the loan requests are approved instantly through the platform, and roughly 84% are fully automated. Management contents its AI platform is more accurate, allowing for higher approval rates and lower default rates than traditional models.

Upstart does offer loans to individuals directly from its platform, but it is through its partnerships with banks and financial institutions that it generates most of its revenue. These banking partners use Upstart's platform to initiate the loans, then take them over. Upstart earns a fee for every loan that originates from its platform. At the end 2023's first quarter, Upstart had 99 banking partners, up from 50 as of Q1 a year ago. Since then, its list of partner banks now exceeds 100.

Upstart isn't a bank, so it doesn't fund most of these loans internally for more than a few months. It typically offloads the loans it does carry on its balance sheet to third-party partners within six months. This limits the amount of credit risk it has to manage.

Through Q1 2022, Upstart saw meteoric growth, with seven straight profitable quarters and seven straight quarters of triple-digit year-over-year revenue gains. Then interest rates started to rise, creating multiple headwinds for the company, including reduced applications, reduced approvals of applicants, and more loans staying on its balance sheet longer before being taken over by a banking partner.

Some concerns about Upstart

The drop in loan activity on its platform was sharp. In Q1 2023, lending partners originated about 84,000 loans totaling $1 billion, which was down about 78% from the same quarter a year ago. Fee revenue was down 63% year over year, while total revenue fell 67% to $103 million. As a result, Upstart had a net loss of $129 million, or -$1.58 per share, in the quarter, down from $33 million in net income a year ago.

Overall, the conversion rate on loan requests dropped from 21% a year ago to just 8% in Q1. This is due to higher interest rates, but also default premiums placed on loans, given a weakening economy. This has resulted in fewer loans approved, and among those approved, fewer loans actually taken on by partners because of the higher costs associated with them, as CFO Sanjay Datta explained on the Q1 earnings call. 

The other issue is that Upstart has been carrying more loans on its balance sheet because interest from investor partners has waned in this more difficult environment. Many had underperformed their return projections. This raises the amount of credit risk Upstart has. 

Is this a cyclical issue for Upstart?

The Q1 metrics beg the question: Is this just a case of cyclicality, or is Upstart's business model flawed with too much reliance on third parties to fund loans during difficult economic times? Either way, investors should know what they are getting into.

Upstart management is aware of the issue and recently secured $2 billion in long-term funding to infuse some capital into the operation. On the earnings call, CEO Dave Girouard said it is the "critical first step toward building resiliency and predictability into our business." It may also be viewed as a vote of confidence by angel investors in the business model.

Still, there is just too much uncertainty right now as economic headwinds persist to expect much change in lending activity or earnings growth over the short term. Investors should also note that the recent stock price performance has pushed its price-to-sales ratio back up to over 3. That's nowhere near the high P/S ratios it was sporting in early 2022, but it is still high considering the drop in revenue and earnings.

While this innovative fintech could certainly become a long-term winner, it is a stock I'd monitor -- but not buy -- right now.