Upstart: Foreseeable Problems (NASDAQ:UPST) | Looking for Alpha


The constant problem faced by start-up fintechs involved in the lending space is access to funding capacity as the business scales and the economic cycle weakens. Assets received (NASDAQ: UPST) is an excellent example of this destructive cycle a investment thesis with stock. Fintech is not attractive at any price until the constraints of the business model are resolved.

Platform Constraints

No matter how strong a lending market‘s credit metrics are, whether AI-based or not, the platform must have a source of funding. Without an internal source to fund the loans, a platform, like Upstart, depends on banking partners to keep funding the loans.

The typical move in times of economic weakness is to withdraw especially from unproven lending platforms. Other lending platforms such as competitor loan club (CL) and Sofi Technologies (SOFI) have acquired digital banks to collect cheap deposits to fund loans and reduce these constraints in the future.

In Q2’22, Upstart saw its revenue drop to $228 million, below levels of more than $300 million in previous quarters. Worse still, the fintech had guided second-quarter revenue to around $300 million for the quarter just months before it cut guidance on July 7.

Q2'22 Financial Highlights

Source: Upstart Q2’22 presentation

Upstart CFO Sanjay Datta confirmed this standard issue the company is facing during the Q2’22 earnings call.

Macro uncertainty and the impact of economic stress on consumer delinquencies has led to less funding being available for loans on our platform, which has become the operational constraint of the business.

The company converted just 13% of loan applications in the quarter, down from 24% in the previous second quarter. Again, these numbers encourage lending partners to retreat from aggressive lending standards and reduce risk in the face of economic uncertainty when the whole point of the AI-powered lending model was an enhanced risk model. to avoid these volatile credit decision outcomes.

Upstart even ended the second quarter of 2022 with 71 partner banks and credit unions, compared to just 57 in the previous quarter when lending volumes were strong. Credit quality has returned to previous loss levels with large defaults on credit cards, personal loans and auto loans returning to pre-covid levels.

The company continues to access credit risk better than traditional credit scores like FICO. Unfortunately, that doesn’t matter when Upstart depends on banking partners to fund new loans.

Risk assessment table

Source: Upstart Credit Performance

The company posted revenue of just $170 million in the third quarter of 2022, suggesting another major pullback in partner loans. Activity will have been cut nearly in half since the peak in the first quarter of 2022, when revenue hit $310 million. In addition, the company is now very unprofitable.

Part of the problem is that expected loan results have recently fallen short of expectations. The model spent most of 2020 and 2021 beating expected results with defaults during the period 50% lower than expected. Average yields are still excellent at 9.8% over the period, but lending partners are understandably not so aggressive when expected yields drop to a benchmark level of 5.2%.

Table of gross returns

Source: Upstart Credit Performance

The new model is getting interesting

The stock becomes interesting below $30 with a market capitalization of just $2.4 billion. The company has a strong balance sheet with nearly $0.9 billion in cash. Upstart has nearly $850 million in borrowings offset primarily by $625 million in on-balance sheet loan investments. The enterprise net worth is only $1.7 billion.

Investors should understand that Upstart will never trade at valuation premiums similar to those of the past. The market will not trust funding problems not to arise in the next cycle.

Moreover, it is difficult to value the stock without really knowing the ultimate low point of earnings. The market forecasts revenues reaching $900 million over the next two years, which will make the current electric vehicle attractive.

UPST Revenue Estimates for Current Year Data by YCharts

The real key to making the title attractive is whether Upstart can solve the funding issues. The management team is working on a new plan to engage banking partners while using existing capital to fund loans during periods of reduced funding.

Any scenario offering Upstart with funding to avoid the current problem would make the stock attractive here. The current economic model is flawed and the only acceptable solution to the problem is a source of funding that will not disappear during the next weak economic cycle.

While the market loves the concept of a fintech that takes no credit risk, the business model only works when the risk model works. If banking partners are unwilling to fund the loans, Upstart should undoubtedly step up and use available capital or seek a digital banking license to fill the void. Essentially, the company and shareholders should be prepared to bet on the IA credit model, or they shouldn’t expect banking partners to take that risk.

LendingClub solved the same problems through the acquisition of a digital bank. The lending platform has seen revenue stagnate at those same levels as Upstart. Yet the company is now generating more than $300 million in quarterly revenue in the current period because it hasn’t taken the same hit to loan funding with the ability to self-fund up to 25%, or more, new loans.

Upstart has a plan to change the business model to a structure with committed capital. The stock will be more investable at this point, but as CEO Dave Girouard pointed out during the Q2’22 earnings call, the transition will take time:

As a result, we have concluded that we need to upgrade and improve the funding side of our market by bringing a significant amount of committed capital on board from partners who will invest consistently throughout cycles. We are currently evaluating various possibilities to achieve this. So we expect that will take time to materialize. Additionally, while we continue to believe it doesn’t make sense for Upstart to become a bank, we’ve decided that it may make sense to sometimes leverage our own balance sheet as a bridge to transition into this committed funding.


The main takeaway from investors is that Upstart has had predictable issues with most fintech lending platforms in the past. The new business model is too murky for an investment here, but the stock will become attractive when a more committed funding model is in place. At this stage, investors cannot properly analyze the investment opportunity based on the conditions of the committed funding model. As such, investors should just watch Upstart develop the new model on the sidelines.

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