Upstart Holdings(NASDAQ: UPST) promised to revolutionize lending by making credit available to more borrowers through its artificial intelligence (AI)-based assessment models. The company got off to a blistering start when it went public in late 2020, but the past few years have revealed the cyclical nature of the young company.
The stock peaked at more than $400 in the year after its initial public offering (IPO) and is down 94% from its high. The company has dealt with ebbs and flows in the economy and personal lending market.
Still, there is hope that interest rate cuts from the Federal Reserve could spur lending and provide Upstart's business with a much-needed boost. Credit card debt topped $1.12 trillion in the first quarter at a time when interest rates on credit cards have never been higher. With potentially lower interest rates coming over the next year, consumers could look to personal lenders to consolidate debt balances, which could be a huge opportunity for Upstart.
Upstart's AI lending model can't overcome the cyclical nature of the business
Upstart's mission is to make loans accessible to more borrowers, even those with a limited or less-than-stellar credit history. The company is taking on traditional credit scoring models, like Fair Isaac's FICO scoring system, which it says shuts worthy borrowers out of the financial system.
The lender has developed an in-house lending model that leverages artificial intelligence to evaluate and price risk based on more than 1,600 variables and 58 million repayment events. The model has been trained and refined for over 10 years and can quickly approve more borrowers at lower interest rates, thanks to its highly automated processes.
Upstart's lending model is promising, but there is one thing it can't overcome: the cyclical nature of personal lending. Cyclical companies see their business rise during economic growth and expansion and decline during contractions. For a company like Upstart, the broader market and lending conditions greatly affect its bottom line.
During 2021, Upstart's business boomed. Pandemic-era monetary policy had interest rates near the lowest on record. Other factors, including federal stimulus spending and moratoriums on student loans and other debt, helped bolster consumer balance sheets. Loan delinquencies were low, and the money flowed freely.
As a result, Upstart hit the ground running as a newly public company and raked in $849 million in total revenue (an increase of 263% from 2020) and posted net income of $135 million. In 2022, Upstart management was quite confident and authorized a share repurchase program of $400 million.
UPST Revenue (TTM) data by YCharts
Then, inflation readings came in at the highest level in decades and the Fed began aggressively raising interest rates, which had a ripple effect across lending and other interest-rate-sensitive markets.
Suddenly, demand for Upstart's loans dried up. The company struggled to find lending partners willing to extend credit. The institutional investors who had purchased Upstart's loans backed away as the Fed hiked interest rates, increasing their funding costs.
Rising debt and falling interest rates could give Upstart a boost
There are reasons for optimism about Upstart. As the Fed stopped raising interest rates, loan investors returned, including the alternative investment manager, Castlelake, which agreed to purchase up to $4 billion of Upstart loans last year.
The Fed last raised its benchmark interest rate in July 2023. With inflationary pressures moderating, many market participants expect the central bank's next move to be a cut, which could be the shot in the arm that Upstart needs.
Another potential catalyst could be the huge credit card balances among consumers. According to the Federal Reserve Bank of New York, consumer credit card balances exceed $1 trillion. This staggering figure comes when credit card interest rates are near a record high. If interest rates decline meaningfully, Upstart could see a surge in loans as people refinance and lock in lower interest rates on these balances.
US Credit Card Debt data by YCharts
Is Upstart a buy?
Upstart has struggled to find footing amid higher interest rates, but things are improving for the lender. For one, more lending partners have come onto the platform, and there's increasing risk appetite from investors for Upstart's loans. Also, the next move in interest rates will be down rather than up.
However, uncertainty about the economy and the path of future interest rates could limit the stock's upside. The stock, priced around 3.7 times sales and 2.9 times next year's forecast sales, seems to reflect this and is on the low end of its valuation since Upstart went public in 2020.
Upstart is a young, cyclical company vulnerable to economic and market conditions, making it riskier than blue chip stocks and a bad choice for risk-averse investors. However, for investors willing to tolerate the volatility, the stock appears reasonably priced, and today could be a good opportunity to build a small position in the lender ahead of potential interest rate cuts by the end of this year.
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Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Upstart. The Motley Fool has a disclosure policy.
