When it comes to the artificial intelligence (AI) market, many investors may think of companies like Nvidia or C3.ai. And while AI plays critical roles in these companies, its reach also includes such industries as retail, oil and gas, and finance. Because of this, investors should take a broad-based look at AI-driven opportunities. 

One finance-related AI stock that has earned investors' attention is Upstart (UPST 2.76%). It stands out for applying AI to the process of evaluating the creditworthiness of prospective borrowers for a fee.

However, rising interest rates and internal challenges led to a massive drop in the stock price and called the investment thesis into question. Considering that volatility, the question for investors is whether it is worth the risk of owning.

Upstart's risks

Upstart competes with Fair Isaac's FICO score. The FICO score changed little since it rose to prominence in the late 1980s. With AI able to consider more factors, it appears FICO's market is ripe for disruption. More lenders seem to agree, as the number of banks and credit unions utilizing the platform rose to 99 in Q1, up from 50 in the year-ago quarter.

However, rising interest rates undermined the demand for loans. The revenue growth rate, which reached triple digits as of the first quarter of 2022, fell 67% by Q1 2023. Upstart responded by funding numerous loans, a radical departure from its original mission as a loan evaluator.

Nonetheless, only two banks originated 70% of the loans on the platform. Moreover, the largest of those lenders, Cross River Bank, had faced scrutiny from the Federal Deposit Insurance Corp. (FDIC) over its lending practices. Consequently, Cross River will face stricter compliance controls and closer regulatory scrutiny, potentially affecting its business relationship with Upstart.

Why investors should consider Upstart

Nonetheless, the rising popularity of AI seems to have helped Upstart's stock. After dropping 97% from its all-time high, it is up more than 400% from its low in May. Moreover, investment management company Castlelake agreed to purchase up to $4 billion in consumer installment loans generated on Upstart's platform.

Furthermore, Upstart operates in the personal, auto, and small business lending markets, which offer a total addressable market of around $1.6 trillion. And if it follows through with plans to enter the mortgage market later this year, the addressable market will rise by an additional $2.7 trillion.

Additionally, according to Upstart's data, its AI-driven model has shown an ability to approve 173% more loans without increasing default rates. A bank could also choose to fund the same number of loans and reduce defaults by a forecast 53%. Regardless of banks' preferred strategy, if they continue to adopt the platform, it could lead to a massive upsurge in Upstart stock over time.

Consider Upstart

Given its ability to disrupt the credit evaluation process, risk-tolerant investors may want to consider Upstart. With its potential to change a multitrillion-dollar industry and a history of profitability, it is hard not to see the potential for massive growth.

Indeed, its need to fund loans is concerning, and its relationship with Cross River brings a high level of uncertainty. But with a need to either approve more loans or reduce defaults, the value proposition of Upstart's platform is hard to ignore for both banks and prospective shareholders.