Expectations are through the roof for the artificial intelligence lending platform Upstart Holdings , which trades at roughly 295 times earnings after the stock dove roughly 24% since the company reported third-quarter earnings.
Upstart helps customers get loans in two main ways: It does the marketing on its own to find customers and then pass them off to banks and credit unions, or banks can essentially embed Upstart’s technology within their websites and branding.
Ideally, Upstart is positioning itself as a software-as-a-service company, where it provides the technology to lots of banks and credit unions that bring in the customers and fund the loans with deposits.
For this to work, Upstart will want most of its bank and credit union partners to eventually integrate its technology, stop using traditional credit underwriting that focuses on metrics like FICO, and penetrate their existing customer bases while opening their credit boxes and criteria to people they may not have historically served.
A survey from Experian toward the end of 2019 showed that fintech companies were originating nearly half of all personal loans, and plenty of fintech competitors have emerged since then.
Small banks and credit unions may also not be so likely to do these installment loans when interest rates rise, which typically leads to more bad debt, and when the financial system is not so flush with deposits — right now, almost all financial institutions have more deposits than they know what to do with.
Upstart’s CFO Sanjay Datta on the company’s Q3 earnings call said that over the past year, loan application volume has tripled as the company has had more capacity to serve borrowers across all parts of the “credit spectrum,” yet Upstart’s conversion rate in Q3 declined.
Now, I assume Upstart can continue to grow originations from here, and the personal loan market will likely get bigger, but that still means a lot has to go right over the next few years and Upstart will have to overcome challenges explained above, as well as continue to ward off fintech competitors.
CEO Dave Girouard said the interest from its bank and credit union partners for a small-dollar loan product — loans for as little as a few hundred dollars paid back over a few months — is “off the charts.” Girouard also said the company is designing a small-dollar loan product with an interest rate of under 36%, which would be extremely impressive because these loans can have interest rates over 600%.
Upstart is also interested in auto lending, which provides a $672 billion annual market opportunity, and the mortgage market, which presents an annual market opportunity of $4.5 trillion.
But to reiterate my last point, mortgage interest rates can yield some of the lowest margins in the business, especially in a low-rate environment, which is why the banking system does far fewer mortgages now than it did a decade ago, so adding another fee to the process may not be ideal.
Upstart still has a lot of work to do, including getting more of its banking partners to drop FICO, showing that they can effectively convert originations without FICO, and penetrating new lending segments that are very competitive.