Q4-20 Q1-21 Q2-21 Q3-21 Loans transacted 123,396 169,750 286,864 362780 QoQ% +52.5% +37.6% +69% **+26.5%** Avg loan size $10121 $10185 $9743 $8628 QoQ% +0.63% -4.34% **-11.45%** Origination vol 1249M 1729M 2795M 3130M QoQ% +38.4% +61.7% **+12%** Total fee rev 84.4M 116.2M 187.3M 210.4M QoQ% +34.3% +37.7% +61.2% **+12.35%** [Huge disconnect from loans transacted growth!] Fee take rate% 6.76% 6.72% 6.70% 6.72% Conversion rate 17.4% 22% 24.4% 23% QoQ% +14.5% +26.4% +10.9% -5.74% Inquiries 709,172 771,590 1,175,672 1,577,304*** QoQ% +33.2% +8.8% +52.4% +34.16% Automated loan% 71% 71% 71% **67%** Contrib margin 49% 48% 52% 45.6% ***this figure is not including fraudulent inquiries
This was NOT a good quarter based upon my lofty expectations!
Loan sizes are down considerably which directly impacts fee revenue (loan transacted number grew 26.5% QoQ but fee revenue only grew 12.35%!). Although the new influx of lower FICO score borrowers means they tend to borrower smaller amounts, it’s clear the macro environment is not picking up faster than I thought, and that their marketing campaigns brought in less borrowers than I anticipated - as the absolute number of borrowers also came in far lower than I wanted.
My two immediate thoughts:
My high expectations for Q3 of greater than 30% QoQ loan origination volume growth were heavily based upon my use of alternative/high frequency data from reviews/google trends/site traffic estimates. My modeling was flat out, 100%, completely wrong – blindsided by fraud attempts - something I was not smart enough to have thought about as a possibility at all!
For example, the google search term “upstart login” increased by over 110% QoQ. But it turns out, fraud inquiries were nearly equal to the number of actual true inquiries this quarter, so thatcould account for much of the increase in popularity of that search term.
Long term thesis for this company is intact. Upstart continues to be a fast growth first mover AI company in the credit industry with massive TAM and impressive cofounder led management.
Clearly, insiders truly believe in the mission, as they have not done any additional selling of shares outside of automatic trading plans adopted in May and their largest shareholder (hedge fund Third Point) didn’t sell any since August.
BUT the question for me is: does UPST continue to qualify as a hypergrowth company that deserves an overweight spot in my portfolio?
Conference call highlights:
Auto refi: 2000 loans were completed in first half of 2021, although they only finished expanding it to 47 states by end of Q2. Now, another 2000 were done in Q3 for a total of 4000 YTD.
Ok, this is faster than 100% QoQ growth (off of a very small base) for auto refi, but still very small numbers. I am personally let down by that, although they might still be smoothing out the kinks?
Let’s suppose they grow 100% QoQ for auto refi throughout the next 5 quarters. Then they’ll have 4000 + 8000 + 16000 + 32000 + 64000. Which is 120000 total auto refi loans in 2022. Can they keep triple digit growth on this front?? It will probably be necessary, since average personal loan sequential growth may slow down further in 2022.
Of note, on the Q/A, it is mentioned that auto refi is very analogous to personal loans in terms of margins/unit economics.
Upstart Auto Retail: “tripled the number of dealers on our platform from a year ago…in Q3, added an average of more than 1 rooftop a day…just last week, the first Upstart powered loan was originated through our auto retail software…”
Ok, they look like they are moving as fast as possible with auto retail at the dealership.
On the Q/A, it is also mentioned that this is expected to have higher margins than auto refi due to less borrower acquisition costs involved.
Potential TAM expansion across FOUR fronts
1.) “Working on small dollar loan product, such as those who need a few hundred dollars and expected to be repaid in just a few months, to help financial inclusion for the underbanked…we aim to bring millions of marginalized consumers to our platform in the coming years so their lending partners can serve them with a host of affordable financial products over time…the interest in this small dollar product from our bank and credit union partners is off the chart, and we hope to bring it to market before end of 2022”
2.) “…there is an unmet need to provide…affordable installment loans to business owners…we aim to deliver the zero latency affordable credit solution that modern businesses require. This is in high demand from our bank and credit union partners and we hope to bring it to market during 2022 as well.”
3.) “The home mortgage market. It’s by the far the largest consumer lending category. We’ll begin to invest significantly throughout 2022.”
4.) Expanding their TAM to prime/above prime consumers. They’re no longer just limiting to below prime/near prime.
“Borrowers who use Upstart often see rapid improvements in their credit score and suddenly become very interesting to the entire consumer finance industry. Our bank partners want to serve these customers over their lifetime…by serving consumers across the entire credit spectrum…we’re beginning to deliver instant loan offers with no origination fees and rates as attractive as any on the market…”
And the CFO also said “we are expanding our footprint to serve more of the traditionally prime borrowers…as the proliferation of bank deposit funding on our platform enable us to be more rate competitive”
Conversion rate and fraud comments
Conversion rate fell QoQ from 24.4% to 23% and automation 71% to 67% for three reasons:
- “borrower segments newer to our models will initially tend to convert at lower rate than those segments which we have longer history…more conservative rates of instantaneous approval until greater loan volume for our models to train on”
- Volume of applications at top of funnel increased, so naturally conversion will drop
- A large coordinated effort to obtain loans fraudulently on platform… ”expect that episodes of this type will become increasingly common”. This impacted automation rate but not conversion rate because they removed fraud attempts from the calculation. However the fraud attempts were apparently immaterial to company performance.
Comments on macro
“We expect macro dynamics to ultimately lead to an increase in borrower loan demand, although that has yet to manifest in our results and remains upside to our forecast, as the exact timing is unclear”
The call mentioned they had 315000 new borrowers, implying that about 48000 borrowers in the quarter were repeat customers. That’s a 13% proportion. My comment is that this proportion is higher than I would like at this stage; I wanted their personal loan growth to be expanding way faster than this (there should be way more new borrowers).
4 partners have now dropped FICO requirement. That’s very positive.
There are now 31 partners total, up from 25 in Q2. Fewer than I was hoping for Q3, but on Q/A, they reiterated confidence that bank partners “will continue to sign up at a rapid clip and there continues to be large demand”.
Summary of my thoughts from the call:
Long term, the company appears poised to do well and grow fast. TAM remains massive and they are working on more than just personal/auto with possibly business lending and small dollar products in 2022, then home lending in the future, and more immediately have expanded to above prime segments.
However, a sustained HYPERgrowth story is cloudier. While I believe they can grow, at minimum, ‘non-hypergrowth-fast’ for a long time, there are already many other great companies that can do that too.
As we know, UPST is not SaaS. Growth is expected to be lumpy, as management repeatedly states. I knew that, and I definitely would have been fine with sequential growth decelerating from the monster 60% QoQ Q2 results. But I was looking for at least 30% QoQ for Q3, instead of 12% QoQ!
Growth simply decelerated more than I expected. And for a non-SaaS company, a higher growth bar needs to be set, to justify overweighting.
I think the answer for me is I am definitely no longer overweighting heavily to UPST. I just needed to see core personal loan growth faster than today’s report. Since it is not, there appears a greater risk of heavier revenue growth slowdown in 2022.
So, I think keeping a huge position in UPST is more investing based on hope that:
- macro will improve faster than expected (this just can’t be forecasted),
- auto will grow quick enough to counter personal loan growth slow down (auto is still too unknown, and also adjacent LPRO earnings were disappointing today***),
- the new lines of TAM expansions will contribute meaningfully next year (they probably won’t, it’s just going to be too early and unknown unit-economics)
I did sell my entire position the instant I saw the loan volume numbers reported in after hours. While it’s disappointing to be now way off my peak YTD portfolio gains, UPST still contributed the vast majority of my current portfolio YTD growth of 228%, so I have no regrets for my >90% position before Q2 and Q3 reports as I truly believe I made my decisions based upon the data best available to me - even with the mistake of not thinking of fraud accounting for alt data.
It’s still very possible UPST will surprise on the upside again next couple quarters! Their guidance is interestingly positive (all things considered) for Q4. I will likely buy back some shares tomorrow to continue to keep an eye on the business.
***Adjacent competitor in auto lending is LPRO (Open Lending): their results today after hours were disappointing. They completed 49332 certs from 46408 certs which was only QoQ growth of 6.3%, and lowered guidance. The auto environment is not looking great, although yes, UPST is starting out from a negligible base.