Upstart (UPST 2.91%) stock has rallied in recent months, going from as low as $20 per share in August to over $55 per share at the time of this writing. Despite its recent rally, however, it remains 86% below its all-time high price of $401 per share in October 2021.
Consumer lenders have struggled with the higher interest rate environment over the past several years, but things look like they could be turning a corner. Last month, the Federal Reserve cut its benchmark interest rate by 50 basis points, and more cuts appear to be coming. Upstart is well positioned to capitalize on lower rates, but is the stock a buy today?
NASDAQ: UPST
Key Data Points
Upstart is coming off a tough couple of years
Upstart stock was an immediate winner after its December 2020 initial public offering. The consumer lender benefited from the economic environment at the time, which saw low interest rates, strong fiscal stimulus, and strong consumers. The company was profitable immediately and launched a massive $400 million share repurchase program amid management's optimism.
However, the growth wasn't sustainable, as rising interest rates throughout 2022 and 2023 dragged down the business. Unlike banks, Upstart generally doesn't hold on to the loans that it makes. Instead, it partners with banks, alternative asset managers, and other institutional investors that purchase its loans and collect interest payments. For example, this year 84% of Upstart's loans are held by institutional investors or lending partners.
Throughout 2022, the company struggled to find willing buyers of its loans as the future path of interest rates was unknown. Investor demand for Upstart's AI-powered loans has been picking up once again. In May of last year, the investment manager Castlelake agreed to purchase up to $4 billion of its loans -- a sign that investor appetite for its loans was picking up.
The company has continued to secure lending partners for its loans, including numerous credit unions and small banks. On Oct. 10, Upstart announced that the alternative asset manager Blue Owl Capital committed to purchasing up to $2 billion of Upstart's consumer loans over the next 18 months.
Upstart's lending model has held up well
Upstart has solved half of its problems in the last couple of years with financing secured for billions of dollars in loans. This is an excellent sign that investors want to get in. It also validates its AI-powered lending model, which aims to take on Fair Isaac's FICO scoring system, which has been the standard in consumer credit since it was created in 1989.
Upstart's models have done a solid job evaluating risk across the credit spectrum. As the chart below shows, its models find dependable borrowers with low credit scores while identifying those with high credit scores but a higher-than-average chance of defaulting.
Image source: Upstart Holdings.
A huge refinance opportunity could await Upstart
With funding secured, Upstart now needs consumer demand for its loans to pick up. Through the first half of 2024, Upstart's total loan transaction volume was $2.2 billion, slightly above last year but well below its peak in 2021, where transaction volume was over $4.5 billion.
Upstart and other consumer lenders could benefit from a massive tailwind due to falling interest rates. Part of that has to do with ballooning consumer credit card balances. According to the Federal Reserve Bank of New York, consumer credit card balances are $1.14 trillion. These rising balances come when average credit card interest rates are 22.75%, near the highest they've ever been.
According to the CME FedWatch Tool, market participants expect the federal funds rate to be around 3.25% to 3.5% by October of next year, or 1.5% below where they are today. If interest rates do decline meaningfully, many debt holders could use this as an opportunity to refinance and consolidate their debts to lock in lower interest rates.
Is it a buy?
Upstart is a cyclical company vulnerable to economic and market conditions. This makes it riskier than blue chip stocks and not ideal for investors looking to protect their capital with a more conservative approach.
UPST PS Ratio data by YCharts
After its 100% run-up since August, the stock is priced around 9.25 times sales and 6.95 times next year's forecast sales, both on the higher end since the Fed began raising its benchmark interest rate in March 2022 but still well below its peak valuation from 2021.
The higher valuation reflects optimism that Upstart's business will rebound over the next year or two but also opens up the stock to more risk if those expectations fail to materialize. That said, Upstart has secured funding and is well positioned to benefit from falling interest rates, making it a good buy if you believe a rebound in consumer loan demand is on the way.
