The online consumer lender Upstart Holdings is experiencing funding difficulties, with investors souring on purchases of the company’s personal loans as fears of a recession grow and its credit quality deteriorates.
Upstart acknowledged in a press release Thursday that its loan marketplace — where it sells loans that it makes to consumers looking to refinance credit card debt — is “funding constrained.”
The San Mateo, California-based company attributed investors’ hesitation largely to “concerns about the macroeconomy among lenders and capital market participants,” which have “put banks and capital markets on cautious footing.”
But Upstart’s funding woes also may reflect worries about its loan underwriting model, analysts said, pointing to deterioration in the company’s credit metrics. Losses and late payments on some of Upstart’s loans, which the company bundles into securities and sells to investors, have ticked up faster than expected.
“The concerns among credit investors is that the underwriting is still not under control and that consumer credit is going to get worse,” said Vincent Caintic, an analyst at Stephens.
Investor demand for Upstart’s loans has “come down significantly,” and buyers appear to be requiring a higher rate of return for the loans than they did before, he added.
Upstart, which went public in 2020 and is scheduled to report its quarterly earnings in August, released a preliminary version of its quarterly results after the stock market closed on Thursday.
The company said it now anticipates revenues totaling $228 million in the second quarter, down from its prior guidance of around $300 million. It also said it expects to record a net loss of $27 million to $31 million, a significant decrease from prior guidance that projected a range between flat profits and a $4 million loss.
The company’s stock price sank when markets opened Friday and was down 20.4% to $26.88 in the afternoon. Its share price has fallen 81.2% this year.
Upstart’s second-quarter revenue projection appeared to fall partly due to lower loan volumes, which decreased the fees that the company gets when it sells loans to investors. The volatility has prompted Upstart to hold more loans on its balance sheet in recent months rather than sell them to investors. But the company also said it “took action to convert loans on our balance sheet into cash,” which led to another revenue hit.
The results were “not surprising,” given that Upstart’s “business model appears under pressure” and some of its borrowers appear to be defaulting on loans faster than once expected, Jefferies analyst John Hecht wrote in a note to clients.
Upstart touts its artificial intelligence models as a way to better predict customers’ ability to repay loans — and in doing so, to lend to people who would otherwise qualify only for more expensive loans.
But that narrative is “in contrast” with the fact that at least one of Upstart’s securities to investors breached a covenant on cumulative loan losses, and that other Upstart securities are at risk of doing so, Hecht wrote.
In May, the bond rating agency KBRA said two of the company’s securities from 2021 “could breach” certain triggers tied to customer default rates. Those securities “are performing worse” than earlier asset-backed securities, KBRA analysts wrote in a report.
In Upstart’s press release, Chief Financial Officer Sanjay Datta said the company’s loans “have performed exceptionally well” despite a “tumultuous economy.” The company said that particular loans it helped banks and credit unions originate have consistently exceeded expectations.
For other loans purchased by nonbank investors, the securities from 2018 to 2020 “delivered significant excess returns.” Upstart said. Losses on the 2021 securities are “within 100 basis points of our loss expectations,” Datta said in the press release.
The Silicon Valley fintech expects to make $1.5 billion in auto loans this year after implementing key elements needed to achieve scale, said CEO David Girouard. The expansion comes as the automotive market continues to boom.
Upstart CEO Dave Girouard said the consumer lender is continuing to develop its underwriting models.
“Despite limiting hiring to critical areas, we continue to invest in our models and products and are confident Upstart will emerge from this cycle a stronger company,” Girouard said in the press release.
Upstart’s funding troubles point to the risks of relying on outside investors rather than more stable deposit funding, said Caintic, the Stephens analyst.
“When the going is good, then that’s fine,” Caintic said, but those funding sources can “collapse” when credit starts to deteriorate. For Upstart, the worry is that loan volumes will decline, and its revenues “could dry up very quickly,” he said.
The situation is not something Upstart “can’t overcome,” Caintic said, noting that the online lender could try to become a bank and get more stable funding. But that is a “lower multiple business” that would require the company to shoulder more credit risk and spend more money on regulatory matters, he said.
