Financial technology (or fintech) company Upstart (NASDAQ: UPST) reported its financial results for the first quarter of 2023 after the market closed yesterday. And as of this writing, Upstart stock is up a whopping 33% when markets opened this morning.
Upstart's Q1 revenue plummeted 67% year over year and 30% quarter over quarter. Moreover, the company turned in a staggering net loss of $129 million, compared to a net profit of almost $33 million in the prior-year period.
Are you wondering why Upstart stock is skyrocketing on abysmal numbers like these? To understand what's happening, you need to understand Upstart's business model. And once you understand the business model, you'll see why the latest quarterly results were a huge step in the right direction for the company.
Upstart's business and what's gone wrong
In Q1, Upstart said it received $2 billion in loan funding commitments. Understanding how the company works and what it's been through will show why that's significant.
Upstart uses artificial intelligence (AI) to automate lending. Right now it's mostly unsecured personal loans. But it also works with auto loans and it intends to get into home equity lines of credit (HELOCs) later this year.
With its technology, Upstart wants to be the tech powering financial institutions; it doesn't want to be a lender. Banks and credit unions partner with Upstart to automate or improve their processes. But someone still has to fund the loans originated through Upstart's platform.
In 2022, only 30% of Upstart's loans were funded by originating lenders. Institutional investors funded the majority at 60%. But as interest rates rose in 2022 and the credit cycle turned, Upstart was faced with a difficult decision. It had loan demand from consumers, but institutional investors hit the pause button on funding, constraining Upstart. Therefore, management opted to fund the remaining 10% of loans itself rather than turn people away.
The move vastly altered Upstart's balance sheet composition. The company still has nearly $1 billion in loans on its balance sheet and almost the same amount of debt. It does generate income from loan repayments, which is good. But collecting loan payments is a different business than collecting a high-margin fee from simply being a fintech partner for banks and credit unions.
Upstart's step forward
In the second quarter of 2022, Upstart's management said revenue was dropping because its loans lacked funding. Therefore, management committed to securing long-term funding commitments from institutional investors to insulate its business model from cyclicality. Then in the fourth quarter, management said it was "in late-stage discussions with multiple potential partners." Those late-stage discussions came to fruition in Q1.
Upstart said a combination of new and existing partners have pledged to fund $2 billion in loans over the next 12 months. Moreover, management says that there are more discussions in the "pipeline," so additional commitments could be announced in subsequent quarters.
Think of Upstart's business as having three primary components: lenders, borrowers, and funders. The first two components are healthy. Upstart ended Q1 with 99 bank and credit union partners, up from 92 in the previous quarter and up from just 50 in the prior-year period. Moreover, Upstart's platform already has more demand from borrowers than what it can handle.
Only the funding component of Upstart's business model was in shambles. Therefore, investors are rightly celebrating its big step forward with $2 billion in commitments.
But before you buy Upstart stock...
Seeing Upstart stock jump so much on this news is enough to give some investors a fear of missing out. The stock is still down more than 90% from its all-time high and investors certainly want to see it recapture its former glory. But let's put $2 billion in context.
Upstart's business peaked in 2021 and took a small step back in 2022. The dollar value of personal loans through the Upstart platform was $11.6 billion and $10.7 billion during those two years, respectively. Without a doubt, loans will be funded apart from long-term commitments as they previously have been. But $2 billion only locks in funding for a small percentage of its overall volume.
Moreover, consider that the average personal loan through the Upstart platform is below $10,000. By comparison, the average auto loan through Upstart is roughly double in value. As Upstart's auto loan program grows in 2023, even more funding will be needed.
Upstart is also launching HELOCs in 2023, which could be an even more funding-intensive endeavor.
I believe the right takeaway from this news is something like this: Upstart's loans are performing well enough to attract $2 billion in funding commitments during a challenging economic time. That's an encouraging thought when thinking about Upstart's long-term future.
I believe the wrong takeaway goes like this: Upstart is completely out of the woods and has nothing left to do or prove.
To the contrary, Upstart's revenue and profits plunged in Q1 and are expected to be down next quarter as well. Therefore, there's plenty more work to be done for this to ultimately prove to be a good investment. Investors should temper expectations accordingly.
That said, I think Upstart's Q1 could be the start of an exciting turnaround.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.