Why Upstart is just getting started

Since the 1980s, the FICO score has remained the standard for determining consumer credit risk. But the tech loan company Holdings reached (NASDAQ: UPST) uses artificial intelligence to better understand the likelihood of consumers to repay a loan than a FICO score. By making lending smarter, here’s how Upstart’s platform could benefit consumers, lenders, and investors.

Upstart makes lending smarter

Upstart’s AI uses over 1,000 variables to judge the creditworthiness of a potential borrower. The company has spent eight years training its platform with more than 10 million data points to help banks make more profitable loans – and the more customers use the Upstart service, the more efficient it becomes.

Whether Upstart leases its platform to banks for internal use, or accepts loan requests directly from consumers for forwarding to its partner banks, it is gaining approval from more consumers and helps banks lend more efficiently – a win for everyone. Upstart claims that banks can reduce their default rate by 75% while still maintaining the rate at which they approve loans.

Image source: Getty Images.

The lending space is very competitive, and Upstart is not the only banking company to take advantage of artificial intelligence. However, it only remains neutral in the banking relationship by not taking out loans. Many of Upstart’s competitors also try to function as lenders, which puts them at odds with Upstart customers.

A huge avenue for growth

There are over 5,000 banks in the United States, holding billions of dollars in loans. Most of these banks are smaller, operating at local and regional levels, Upstart’s target customer base. Upstart is currently working with only 18 of these banks, which leaves a long way to go. Its first-quarter revenue grew 90% year-over-year, and management expects 2021 revenue to reach $ 600 million, up 157% from 2020.

Focusing on the growth of Upstart’s loan origination reveals how fast the core business is growing, as it shows how lenders are adopting the Upstart platform better than a gross number of clients would. Creations totaled 170.00 in the first quarter, up 102% year-on-year. Borrowers are also showing more interest in Upstart loans; its conversion rate on loan applications rose to 22% in the first quarter, from 14% the year before.

Until recently, Upstart focused primarily on personal loans. But the company launched its first auto loan in September 2020, and it is acquiring automotive retail software company Prodigy on undisclosed terms to help it roll out its auto loans in most of the United States.

The consumer loan industry includes student loans, mortgages and credit card arrangements, all of which are potential verticals for Upstart. The company has not announced any concrete plans to enter these markets, but if it decides to expand beyond consumer and auto loans, it could significantly increase its total addressable market, which will give Upstart more room for growth in the years to come.

A young company with potential risks

Upstart is just getting started, so there are some potential risks that investors need to watch out for. The success of Upstart came from a small sample size. Only two of the 18 banks it works with contribute 85% of Upstart’s fee income.

As Upstart continues to expand its customer base, competitors may try to replicate its vital AI. Upstart has developed its algorithms over eight years, enjoying a head start over most of its competitors. Big banks may have the money to hire data scientists and customer data to catch up with Upstart, but the company’s local and regional target customers lack these resources. These smaller lenders benefit the most from working with a neutral platform such as Upstart compared to their very large, deep-pocketed banking rivals.

What to think of the recent drop in Upstart

Upstart’s share price hit all-time highs after strong first quarter earnings, but has recently fallen as the company’s lock-in period expired this week. When this happens, insiders, employees and pre-IPO investors are allowed to sell their shares. These stakeholders are often sitting on large gains, so it is common to see them sell at least part of their stock. It doesn’t mean anything to Upstart’s business. Even after these sales, insiders still own over 15% of the outstanding shares, with CEO and founder Dave Girouard owning the majority of the shares, so shareholders can feel comfortable investing alongside a company. direction which has “the skin in the game”.

Upstart needs to expand its customer base to reduce its dependence on its current main sources of revenue. Its algorithms must continue to approve more loans with fewer defaults for banks, so that Upstart can attract new clients and partnerships. But if it continues to be successful, Upstart could be writing the start of a long-term growth story for fintech equity investors.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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