Upstart Holdings (UPST 2.76%) was an artificial intelligence (AI) stock before it was cool. The company came public near the end of 2020, and it was already successfully monetizing its AI model, which is designed to originate loans for banks and financial institutions.
Upstart stock initially listed at $20 per share but quickly soared to $401 in 2021 on the back of record-low interest rates, which drove surging demand for car loans and unsecured personal loans.
Unfortunately, those trends have reversed because interest rates have climbed at a record pace over the last 18 months. It has crushed demand for credit, tightened lending conditions, and sent Upstart's revenue tumbling.
As a result, Upstart stock has come full circle, plunging 94% from its all-time high to trade near its IPO price of $20 once again. So, can the company ever reclaim its former glory? Three signs point to brighter times ahead.
1. Upstart's artificial intelligence continues to improve
Upstart is on a mission to transform lending practices. It says banks are too reliant on old methods, particularly those that include Fair Isaac's FICO credit scoring system because they take a very narrow view of a borrower's creditworthiness.
While FICO considers five core metrics like a person's existing debts and their payment history, Upstart's AI model considers over 1,600, including where they went to school and their employment history. Upstart says its methodology is more accurate, approving 44% more loans at an interest rate that is more than one-third lower, on average.
But in the third quarter of 2023 (ended Sept. 30), Upstart launched its Model 15.0, which is the biggest leap forward in five years, with a 15% improvement in accuracy.
Here is the best part for Upstart's bank partners: Its AI assessment process is fully automated, and it delivers approvals instantly 88% of the time. That number will increase as Upstart's accuracy improves, saving even more time and money for banks over human-led manual processes.
The benefits could be enormous. Upstart has begun offering a home equity line of credit (HELOC) product to customers in four U.S. states. The company says banks take more than a month to process a HELOC and get the funds to the customer, but it plans to cut that down to under five days.
2. Economic challenges could begin to resolve in 2024
The broader economic climate has been the greatest challenge for Upstart over the last 18 months. Demand for credit among consumers, while improving, has plunged on the back of higher borrowing costs. Banks are also less willing to take on unsecured personal loans originated by Upstart right now because they are trying to cut down on potential risks.
The company wrote 113,252 personal loans during Q3, which was up 6% compared to Q2 just three months earlier. It signals some demand is slowly coming back, but the figure was still down a whopping 39% compared to the same time last year.
Upstart's car loan segment fared even worse, with originations down 52% compared to Q2 and down 58% year over year. Demand for new cars is cooling off, with many automakers slashing prices this year to entice buyers. On the positive side, the number of dealership chains using Upstart rose to a record-high of 69 during Q3, covering an estimated 70% of the U.S. population.
It implies dealers are very happy with the AI-driven approach, and when the market eventually recovers, Upstart will be in a better position than ever to capitalize.
When might that be? Well, according to a Reuters poll conducted earlier this month, 87% of economists believe the U.S. Federal Reserve has finished raising interest rates. Furthermore, 58% predict a rate cut before the middle of 2024, which could help reignite consumer demand for credit.
Image source: Getty Images.
3. Slow and steady wins the race
In his third-quarter conference call with investors, Upstart CEO Dave Girouard said the average interest rate in the Upstart marketplace is at the highest level in the company's history. Not only is that a function of higher rates in the broader economy, but also because Upstart is taking a responsible approach in this uncertain environment -- it isn't charging lower rates to attract more business.
The coming expansion of its HELOC product to another four states is another defensive move the company is making. Home equity loans typically have loss rates of under 1%, yet they can be a great alternative to personal loans because customers typically use them for similar purposes. Plus, they attract a much lower interest rate.
Managing costs is another defensive step. Upstart slashed its operating expenses by 17% during Q3 on a year-over-year basis. While it still generated a net loss of $40.3 million, it delivered positive non-GAAP (adjusted) earnings before interest, taxes, depreciation, and amortization (EBITDA) after stripping out non-cash expenses like stock-based compensation.
Unfortunately, playing defense has a price. Its revenue sank 14% in the quarter to $135 million, which was lower than Wall Street's estimate of $140 million.
Simply put, Upstart is focused on surviving this tough period and emerging from the other side a much stronger business. That is critical because there is a combined $891 billion worth of personal loans and car loans originated each year across the U.S., yet Upstart has only originated $35 billion in total loans in its entire history. Plus, it's staring down the barrel of a $1.8 trillion market for home loan originations, which will be its largest segment yet.
In other words, Upstart hasn't even scratched the surface of its long-term opportunity.
