A prediction that Assets received‘ (UPST 1.74%) stock prices would rise ten times in 10 years may not seem so insightful, depending on the point of view. With the stock down 93% from its all-time high, a 10x gain wouldn’t even take it to its original high.
So let’s broaden the speculation and say that Upstart offers a loan assessment tool that could indeed be a game-changer in the industry. This tool, and the company’s efforts to pursue larger lending markets, means a 10x price gain could be just the start for this consumer credit stock.
The Upstart Way Forward
Upstart centers its business model around an artificial intelligence-based loan assessment tool. Instead of acting like a bank, it assesses credit risk for potential borrowers and then connects those borrowers with a partner financial institution that originates the actual loan. Upstart collects a fee from the partner bank for assessing the loan applicant.
Its AI-based valuation model takes into account many more variables than the well-established FICO credit score of Just Isaac (FICO 1.97%), and it claims to be much more accurate in assessing credit risk. Upstart approved approximately 73% of its loans through an instant and fully automated process. This automation may partly explain its growing popularity with loan seekers as well as banking partners. The company partnered with 71 banks at the end of the second quarter, down from just 25 in 12 months.
Upstart’s lower default rates have everyone talking about Upstart’s stock. According to the company’s data, defects among applicants with an A+ rating from Upstart (its highest rating) did not vary significantly, regardless of their FICO score. But default rates among applicants with Upstart’s lowest rating, E-, were high for applicants even if they had a high FICO score. This indicates that Upstart could approve more loans without increasing default risk because it was more efficient at assessing an applicant’s ability to pay.
Upstart expands its potential markets
Also, if rising popularity doesn’t generate 10x growth, pursuing bigger markets may. Upstart got its start by assessing borrowers for fixed rate personal loans. It’s a $129 billion market, according to Trans Union.
Upstart has since ventured into auto lending, which TransUnion data shows is a $770 billion market, nearly six times the size of the personal loan market. In less than two years, 640 dealers had adopted Upstart’s platform (as of Q2), more than triple the number reported in the same period a year earlier.
Additionally, Upstart entered the $644 billion small business loan market in June and plans to venture into the home loan market, a market valued by TransUnion at $4.2 trillion. As he takes a more central role in the loan process, he could significantly increase his commission income, sending profits – and probably the stock – much higher.
Be Aware of Upstart’s Business Risks
Despite the prospect of gains, investors should remain aware of the risks. Upstart presented itself as a loan appraiser rather than a money lender. However, investors wrote down on the stock as it temporarily held loans on its balance sheet amid its entry into new lending markets. Moreover, despite the promise to remove these loans from the balance sheet, it increase the total of the loan on the next quarter’s balance sheet. Upstart held $624 million in loans at the end of the second quarter, compared to $598 million in the first quarter and $252 million at the end of the fourth quarter.
An additional risk concerns its customers. Cross River Bank originated 52% of loans on the platform in the first half of 2022. A second bank accounted for 37% of loan volume during the same period. That’s 89% of its lending volume tied to just two banks. In the same period a year ago, two banks together accounted for 92% of lending volume, which means it does not significantly resolve a heavy reliance on two banks.
Another challenge comes from the economy itself. The Federal Reserve’s job is to raise interest rates in an effort to stem rising inflation. Higher interest rates tend to reduce the number of loan applicants. This will likely reduce Upstart’s revenue from loan appraisals as consumers take out fewer loans.
Is the Upstart stock a buy?
Upstart’s business struggles to manage some significant risks, and risk-averse investors should probably steer clear of this company. However, for all the company’s problems, its loan assessment model can approve more loans at lower risk than the established FICO score. If Upstart can persuade more banks to use its model instead of the FICO score, a 10x gain in 10 years or less could just be the start of this stock’s growth potential.
Will Healy holds positions at Upstart Holdings, Inc. The Motley Fool holds positions and recommends Upstart Holdings, Inc. The Motley Fool recommends Fair Isaac. The Motley Fool has a disclosure policy.