Can upstart keep up the momentum?
Upstart, the AI-powered lending platform, has experienced a tumultuous journey since its initial public offering a few years ago. From a rapid surge to nearly $400 per share, the stock plunged to as low as $12 earlier this year. However, the tide has turned, and Upstart shares have made a stunning comeback. As we approach the end of 2023, they are on track to finish the year with a remarkable gain of over 100%, outperforming the broader market.
Referral Fees and Upstart’s Loan Strategy
Upstart generates a significant portion of its revenue through referral fees from its lending partners. When individuals apply for loans through Upstart, the platform analyzes their data and directs them to one of its partner banks or credit unions in a referral network. The crux of the matter is that Upstart aims to avoid holding these loans on its balance sheet for an extended period. Instead, its goal is to refer loans to its network of partner lenders, capturing lucrative referral fees. However, recent trends have shown a divergence from this strategy. Over the past 18 months, Upstart has been compelled to retain loans for longer durations. This shift has been driven by the rapid rise in interest rates caused by the Federal Open Market Committee (FOMC) raising the federal funds rate, leading to a market sell-off of Treasury bonds. When bond prices decline, yields rise, and the 10-year Treasury yield plays a pivotal role in determining economic interest rates.
The Impact of Rising Interest Rates
The ascendancy of interest rates has ramifications for Upstart’s business in multiple ways. Firstly, the company must charge elevated interest rates to maintain profitability. However, higher rates deter potential borrowers, resulting in a decrease in loan demand. Additionally, banks become less inclined to accept loans from Upstart when they have the option of investing in Treasury bonds that offer greater yields and are backed by the government. Consequently, as interest rates climbed, Upstart found itself accumulating loans on its balance sheet until it reached a tipping point where it could no longer sustain the volume. As of the third quarter, the platform held $972 million in loans on its balance sheet. However, recent indicators suggest a potential reversal. Since August, the federal funds rate has remained unchanged, and the 10-year Treasury yield has begun to decline. This shift in the bond market signifies a belief that inflation has significantly abated, and the FOMC has concluded its rate hikes.
Recovering from the Impact
It is crucial to acknowledge that any company vulnerable to external factors beyond its control faces investment risks. It is fair to note that the FOMC’s aggressive monetary policy in the past two years has played a significant role in Upstart’s rollercoaster performance. Analysts now project a reversal in the company’s revenue growth, with an anticipated uptick of almost 30% next year. Furthermore, earnings under generally accepted accounting principles (GAAP) are expected to return to positivity. Upstart’s revenue reached its peak at $1 billion before the platform expanded into new loan categories such as auto loans, small business loans, and home equity lines of credit. With the possibility of interest rates easing in 2024, investors may consider whether Wall Street will once again factor in Upstart’s growth potential. Given the platform’s volatility, establishing a precise valuation remains challenging, and stock performance may be subject to rate fluctuations. Investors interested in Upstart should weigh their confidence in the company’s business model. If they believe in its potential, gradually purchasing shares while dollar-cost averaging and waiting for stable interest rates could yield favorable long-term growth for their investment.