analyst question re UPST mortgage prospects

I have now pared down my UPST exposure to a more reasonable 12% and I still think there’s a lot to like about this company despite the questions raised by jonwayne and others. One question I haven’t seen raised on this board, however, relates to mortgage. Mortgage is of course the 100lb gorilla when it comes to lending, and so the biggest potential contributor to TAM, but I was given pause by this exchange toward the end of yesterday’s call. It sounds like there are lots of uncertainties when it comes to Upstart’s ability to have a meaningful mortgage business. This seems like the type of uncertainty Saul likes to avoid when it comes to stock picking.

I have pasted the exchange below and the link is at the bottom.

Matt Schindler – Bank of America Merrill Lynch – Analyst

Yes. Hi Guys. I just wanted to talk a little bit about what you guys mentioned about longer-term, about how you could use your platform on other loan types. Obviously, personal loans and auto loans are sold in the ABS markets.

If you are better than – you can prove you’re better than FICO, great, you’re going to get a premium on that. You’re going to be able to sell your loans better in that you can get funded well. But when you mention things like homes and mortgages, basically sold entirely into GSE s, how could your system work in that world where Fannie Mae is basically deciding who gets a mortgage?

Dave Girouard – Chief Executive Officer

Hi Matt, this is Dave, it’s a good question. And let’s just say mortgages are funded in lots of ways first of all, and some are qualifying some are not qualifying. The GSEs rules can change over time. So there’s just a lot of – there’s a lot of ways this market could go.

But having said that, if people don’t have access to a reasonably priced mortgage today at all, we certainly think there’s an opportunity to serve them better. And again, whether funding is from bank balance sheets, whether it’s from securitization markets, whether it’s from GSEs, or whether it’s some combination of those things is certainly something we’ll look at over time, but we feel very confident given what we do and who we are that better underwriting somebody who wouldn’t otherwise fit easily into a qualifying mortgage using the models that most mortgage originators use today. There’s a very large number of people who aren’t well-served by that market, and we think we can – together with our bank partners build a better product, and that’s what we expect to do.

https://www.fool.com/earnings/call-transcripts/2021/11/09/up…

7 Likes

Mortgage is of course the 100lb gorilla when it comes to lending, and so the biggest potential contributor to TAM, but I was given pause by this exchange toward the end of yesterday’s call. It sounds like there are lots of uncertainties when it comes to Upstart’s ability to have a meaningful mortgage business. This seems like the type of uncertainty Saul likes to avoid when it comes to stock picking.


  1. That is a small gorilla. :slight_smile:

  2. Not sure why any pause or uncertainty over a possible product expansion that was stated to not even be material to 2022, as it would require ramping up behind the scenes for quite a while.

We knew personal loans were a TAM. They are adding these micro/small loans. They discussed business loans. And of course they are entering Auto loans, which is so new that it isn’t even material yet. Auto would be the more important thing, imo, to look at in coming Q’s to gauge any progress and/or uncertainty around their ability to execute.

I believe the mortgage comments were simply an acknowledgement, and not a new one, of Upstart’s previously stated goals of applying their tech in a disruptive way, in areas they believe will be profitable. My guess is there will be job postings and other ancillary info that investors would notice over the next 12 months, related to mortgage, and rather than be top-secret about it, UPST mgmt simply said “hey guys…heads up…we are looking into this. But just know it won’t be a thing until at least 2023”.

I made a mental note that future TAM expansion was still very much in play, beyond even auto, and went back to the rest of the CC.

Not sure it needs to be anything more than that at this point.

my 2 cents,
Dreamer

28 Likes

To respond to your confusion around the analyst’s mortgage question:

Mortgages are tough because most of them are sold to Fannie and Freddie. Fannie and Freddie have very tight rules and that’s why mortgage lenders/brokers make you jump through hoops - because if they don’t get things exactly right, Fannie / Freddie won’t buy them, and the goal is to get them off the books.

Convincing Fannie and Freddie to take loans that don’t meet their criteria is a very tough sell. It’s a HUGE HURDLE for Upstart.

So, what the CEO is saying is that there are three options. The LEAST likely IMO in the beginning is that the GSE rules will change and restrictions will be loosened in response to Upstart’s superior risk analysis. I mean we are talking about the government here. But I’m sure they will be working on this.

So the other options are that the banks will keep the loans (some banks already choose to do this, but most of them are offering shorter loans or adjustable rates, not 30 year fixed rates) and also the loans can be securitized and sold (big Short, anyone? Just kidding, this is exactly the opposite.)

My take is that this is why mortgage will be tackled later, and when it is tackled, they will start very small and securitize. Once they prove the default rate is as superior as with personal loans, and as good or better than Fannie / Freddie criteria (preferably better), then dominos will start to fall. Recognize; however, that mortgages take a lot longer to default than personal loans so this is a very long game. And while the AI/ML from personal loans can be used to start the process, I imagine in the end it will have to be retrained because there will be differences between personal loans and mortgages.

Keep your expectations in line with reality. I think going after SMBs and also auto and micro loans is a smart move as these spaces are natural first adjacencies.

63 Likes

I usually just read the call transcripts and don’t listen. But I listened to this one. It’s a pity it wasn’t a video call–I would have loved to see the body language.

What I heard in the BoA analyst’s question–from tone as well as content–was that he barely had his head wrapped around what Upstart was doing in other areas and he saw the leap to a hugely complicated prospect like mortgages as simply a bridge too far.

BoA already had a sell rating on the stock before this report. I have no doubt he’s successful at BoA, but a visionary he is not; and I’m sure what he was thinking as he listened was more…errr…colorful than what he actually said. The minute I heard him I knew he was already dropping the price in his head, which has now been announced. The price he would recommend to his family and friends is $0.

Overall, it’s hard to imagine a more conservatively-minded industry than banking. And the bigger the bank, the more that is so. I have no doubt the actual visionaries at UPST already have at least some idea of what a disruption in this area looks like. But, like when they started with personal loans, they will take on the risk themselves first to refine their models and prove that it works before trying to convince banks.

Given how pro-active they were with the CFPB, I think there’s a good possibility there have already been some very preliminary meetings with some folks at Fannie and Freddie. If past is prologue, they will go to the regulators and gatekeepers first, not last.

JR
(Who still hasn’t sold any and doesn’t plan to–the long term is too amazing on this one.)

31 Likes

I have been in the mortgage business for too long…

My take - if the mortgages are NOT agency eligible (and without FICO, under current GSE underwriting standards, they will NOT be), these loans can easily be sold under a flow agreement to Wall Street trading desks, mREITS (NRZ, NLY and MFA all buy residential loans), hedge funds, PE firms. If the loan quality is good (LTV, debt service, etc…), the loans can be originated for ~102% (including cost for warehouse financing and interest rate hedge) and sold for ~104% (price will be based on yield, which is derived by many factors, including prepay, default and loss severity assumptions). Under a standard purchase and sale agreement, there will be a defined period of time when the buyer can PUT the loan back to the seller for predetermined issues (typically 3-6 months), including default and misrepresentation. Once one of these buyers securitizes the loans, UPST can begin use this as a financing methodology if desired (will also balloon the balance sheet).

22 Likes

Given how pro-active they were with the CFPB, I think there’s a good possibility there have already been some very preliminary meetings with some folks at Fannie and Freddie. If past is prologue, they will go to the regulators and gatekeepers first, not last.

UPST leadership continually boasts about making lending accessible to under-served communities. Fannie Mae and Freddie Mac feature the same kinds of mission statements in their web pages. Fannie and Freddie assume the risk when they buy the loans. They benefit from more reliable risk assessment. The government benefits with more people able to get loans and repay those loans.

I expect UPST leadership to try for some kind of advance support from Fannie and Freddie like they got from CPSB. If the algorithms can be tuned for better risk calculations, everyone wins.

9 Likes