The artificial intelligence lender upstart holdings (UPST -56.42%) suffered the worst setback of its public life on Monday when the company reported first-quarter earnings results and lowered its revenue guidance for 2022. In the current investment climate, there is very little room for error and the market can be unforgiving. Around noon Tuesday, shares of Upstart were down about 60% and trading at record lows. After peaking near $400 a share last October, the stock is now hovering around $31 a share.
Is Wall Street Being Too Hard? Does this big drop present investors with a buying opportunity? We’ll see.
Understand the bottom guide
After beating earnings estimates for the first quarter, Upstart cut its 2022 revenue guidance from $1.4 billion to $1.25 billion. The company also lowered its guidance for adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) margin, while slightly raising its contribution margin projections for the year. It’s also unclear whether Upstart will hit the $1.5 billion auto loan origination goal it set earlier this year.
What is driving all this? Well, Upstart, which uses technology and artificial intelligence to better assess the creditworthiness of borrowers from financial institutions and other investors, no longer expects the same kind of loan transaction volume it did a few months ago. The main culprit, according to management, is rising interest rates, which are wreaking havoc on various parts of the business.
High inflation, a lot of economic uncertainty and the aggressive monetary policy of the Federal Reserve, which already involved raising its benchmark overnight lending rate by three-quarters of a percentage point this year, have led investors to be very pessimistic about the state of the economy.
Investors are concerned that there may be a recession and that consumers may have trouble paying down debt in the future. Upstart is in the business of originating unsecured personal loans and auto loans. This type of consumer debt is often the first that consumers stop paying when they are in financial trouble. Additionally, Upstart makes loans to a variety of borrowers across the credit spectrum, making a certain portion of its borrowers extremely risky. Upstart has already seen default rates normalize, which the administration attributes to the diminishing benefit of the government’s stimulus.
All of this has led investors who actually fund and take on Upstart debt to be more selective about what kind of risk they take on, and also ask for higher returns for taking on that risk. Rising rates also increase financing costs for Upstart partners. CEO David Girouard said all of this essentially passes on to the borrower and has led to the average price on Upstart’s platform increasing by 3%, which can be a lot of extra interest for a borrower. This could lead to an applicant deciding not to go forward with a loan.
In addition, loans that may have qualified for a certain investor’s risk appetite based on their specific risk criteria may no longer qualify. As a result, Upstart expects to see a lower loan transaction volume than it initially anticipated, as well as a lower overall conversion rate.
Issues with funding partners
Another big red flag in the first quarter report was the fact that Upstart significantly increased the amount of loans it had on its balance sheet from roughly $252 million at the end of the fourth quarter to close to $600 million at the end of the first. . fourth part. Now, most of these loans are new auto loans, which are essentially in research and development before being sold to investors. But a small portion of those loans was supposed to be sold to financing partners. Upstart runs a market model, so you don’t want to have any loans on your balance sheet that you don’t need. You want to run a capital-light business and also not have to take any credit risk.
It appears that Upstart had to hold onto these loans as funding dried up among some of its institutional investors in the capital markets during the quarter as investors try to determine their new appetite for risk given macro headwinds. Here’s how Upstart CFO Sanjay Datta described the situation:
So when interest rates ease and investors are… deciding what their new yield hurdles are, there may be a gap or a lag in the response to funding. And that’s a situation where we’ve chosen to step in with our balance sheet and almost sort of a bridge to the new market clearing price. And since that happens often and abruptly, we’ve been playing that role with our balance sheet.
Datta said he believes the situation is temporary and the goal is to create a more automated system for his partners in the capital markets, so they can adjust their risk premiums and their appetite for certain risks more smoothly.
Buy the dip?
I will not buy the dip in these fintech stocks at this time. While the Fed’s path to interest rate hikes is hard to tell, it is expected to continue to raise rates as the year progresses, which could exacerbate or at least continue some of the funding problems Upstart saw in the trimester. Higher interest rates could also continue to dent transaction volume, which would also make it difficult to achieve new revenue guidance.
Additionally, while consumers are still relatively healthy right now, they face a much tougher economic backdrop in the future as their savings continue to decline and inflation remains high, which could lead to worsening trends. credit. Finally, it’s not good to see funding problems on the institutional side, which has led Upstart to keep loans on its balance sheet. Although management says it’s temporary, which it may be, I’m not going to take that risk in this environment.
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