UPST: Auto market is extremely inefficient

Squeezed a couple things into one post to avoid clutter.

Newest Leaders in Lending podcast:
Listened to it, good discussion on personalizing marketing for financial institutions but didn’t gain any new information pertaining specifically to UPST (other than Unison credit union is probably a partner. A little discussion on CUSOs in the podcast too. They are small, at $284M in assets and located in Wisconsin).

UPST competitor, Lending Club, reported Q3 results today.
Loan origination volume increased 14% QoQ. Will need to listen to earnings call later today to parse any granularity discussed about expected loan seasonality and current macro environment.…

One last thing on Trustpilot for UPST

Organic review number count
Jan 2021   23
Feb 2021   16
Mar 2021   22
Apr 2021   28
May 2021   31
Jun 2021   29
Jul 2021   40
Aug 2021   42
Sep 2021   44

On quarterly comparisons, we get 61 organic reviews for Q1, 88 for Q2, 126 for Q3.
Q2 was 44% sequential growth over Q1 (actual Q2 loan transaction number was 68% growth over Q1)
Q3 is 43% sequential growth over Q2. (So, will actual Q3 loan transaction number be at least 60% growth over Q2?)
Take it with a grain of salt. To me it’s another pseudo-indicator that supports my belief that loan transaction number and revenue growth for Q3 will exceed at least 30% QoQ. But… if it’s another 60% QoQ growth…

The auto loan market is incredibly inefficient and ripe for disruption by Upstart.…

A consumer report research article was released today. They pulled data from loan securitization transactions and analyzed about 858,000 loans made by 17 major lenders, including banks, financial firms affiliated with automakers, and companies that cater to lower-credit consumers.

The main takeaway:
Auto loan consumers are receiving mispriced loans that are mispriced NOT just because of the use of FICO scores, but far beyond that. They are being mispriced by perverse incentives, where the dealer and lender try to get away with whatever they can - because if the borrower defaults, they can just repossess the car [1.7 million, or 13% of nonprime loaned vehicles, were repossessed in 2019].
To me this indicates that the auto loan market is WAY more inefficient than the personal loan market.
The personal loan market is mostly inefficient because of the over-reliance on FICO scores.
But if the auto market has both FICO inefficiencies AND artificial lender/dealer inefficiencies, then this is truly a greenfield space for UPST’s AI models to disrupt and operate within.

1.) A credit score doesn’t necessarily dictate the terms of the loan offered. Borrowers in EVERY credit score category—ranging from super-prime, with scores of 720 and above, to deep subprime, with scores below 580—were given loans with APRs that ranged from 0 percent to more than 25 percent.
3% of borrowers in the superprime/prime credit score group had APRs of 10 percent or greater!
There is a huge opportunity for auto refinance across all credit score bands, for sure.

2.) Many auto loans are given out to borrowers who shouldn’t have gotten a loan in the first place.
The report found that lenders verified the income reported on credit applications just 4 percent of the time. Employment history was verified at an even lower rate.
I am sure UPST’s AI verification models would be far superior than the current industry rates here - and permit proper pricing of loans.

3.) Delinquencies (overall) are surprisingly common, with over 5 percent of all loans delinquent, but this is likely covered up by the pandemic stimulus. In Q4 2019, 30 day delinquency rates for nonprime loans were at 11.2% (that is crazy!). This is all very indicative of ridiculously mispriced loan APRs.
And they all know it - a June 2021 survey of over 100 auto lenders/servicers showed that 75% of them believe subprime auto loan performance will deteriorate in the coming year.

4.) Many auto loans trigger a feedback loop: if they are so highly mispriced and offer an APR that is way above the actual risk of the borrower, that high APR causes monthly payments to become too high and directly contributes to the borrower defaulting. If the borrower were offered a true APR priced to their actual risk in the first place, they may not have ever defaulted.
An industry publication found that a payment-to-income ratio of more than 14 percent leads to “50 percent higher defaults at every credit score level.”

An example given in the report:
Lamar bought a used Toyota Tacoma truck at a local dealer in early 2019, putting down a $2,500 cash payment and receiving a $3,500 credit for trading in his older vehicle.
Lamar, 55, says he earns about $80,000 annually as an insurance account manager and that before the loan he’d never held debt of any sort. The dealer told him he needed to pay a 17 percent APR to finance the purchase over six years from Santander.
Payments were $900 per month.
Lamar made it work for a while, but by spring 2020, he fell behind. The lender gave him one extension, he says, but the truck was repossessed in June.
I’m pretty sure UPST would not have mispriced his loan to 17% APR and could have kept the monthly payment within reason!

5.) There is a racial disparity: Nonwhite borrowers pay more on average for auto loans than similarly situated white consumers. Certainly something that UPST’s AI can help close the gap, as it has with the personal loan market.

6.) Consumer report analysis couldn’t figure out why exactly markups are so high for borrowers. (But as I said above, I think it’s multifactorial - dealers can markup loans and charge finance fees themselves, and then if lenders charge too high they can just repossess the car if they default and that car can be exchanged to other subprime borrowers over and over again)

At least 80 percent of car financing is arranged through dealers, [which explains why UPST decided to position themselves at the dealership, with Prodigy] who serve as intermediaries for lenders, according to a 2020 paper published by the National Bureau of Economic Research. In a typical arrangement, the dealer submits a borrower’s information to lenders, receiving loan offers in return. Dealers then can then legally increase, or “mark up,” the interest rate, and they have been shown to typically do so by 1 to 2 percent. The arrangement isn’t good for consumers, regulators and experts say: Dealers aren’t required to show consumers the offers they received, meaning they might not provide customers with the best deal.

But while dealer markup has been cited before as one factor behind APR variation among similar auto loan customers, it doesn’t necessarily explain the disparities CR identified. For one thing, dealer markups are generally capped regardless of APR, says Paul Metrey, senior vice president of regulatory affairs at the National Automobile Dealers Association, and “there is no financial incentive for dealers to present longer-term or more expensive credit options to consumers.”

So what drives the variation in the loan data CR reviewed?

To assess it, CR statisticians built a modeling tool that looked at APR, controlling for the borrower’s payment-to-income ratio, when the loan was issued, whether a co-borrower was present, the length of the loan, the amount of equity in the car, or whether the purchaser received financial incentives on the loan, which might include a 0 percent interest introductory period.

None of these characteristics could fully explain the wide disparity in APRs offered.


Why would a dealer recommend UPST (and, by extension, a credit union or bank) instead of their typical BHPH* or recommended lenders?

If the dealer is playing games with APR, payments, and customer value (through high payments and intended repossession), what does the UPST product offer which is better or somehow more lucrative for the dealer?

How does a retail customer for auto financing (or boat, ATV, RV, etc.) find UPST if they are not currently associated with a bank or CU by process when a deal is financially hostile (my word) towards the agreement intention?

Don’t get me wrong. I love the thought that there is massive disruption in financing and lending. I believe UPST has some serious opportunity here. I’m just not seeing this aspect of the process work in that win. win. win scenario that we should all be looking for to validate their impending explosive growth into this arena.

Seeking these answers (or company strategy/execution model) will help me clarify my own view of their mission for Auto.

I’m long UPST as my largest position. Almost 30% (sound familiar?)

Buy Here, Pay Here - A term used quite frequently for used car dealers who handle most of their process internally. Thus, the term BHPH.


Why would a dealer recommend UPST (and, by extension, a credit union or bank) instead of their typical BHPH* or recommended lenders?


It is a concern. No doubt. I had wondered it myself with Prodigy a few months ago, on how can they get dealers to agree to go along with Prodigy?

Well, the answer seems to be: greed (as always)

Dealers will go with Prodigy if they stand to make MORE money with it, than without it. Simple as that.

Upstart’s website states their dealers using Prodigy are getting “69% higher PVR [per vehicle retailed] for new cars, 49% higher PVR for used cars” and “top lead to sale rate”. Their dealers are getting up to 75% increase in lead closing rates, 90 minutes saved per sale, 15% increase in appointments scheduled.

If true- then why wouldn’t dealers want to use Upstart?

All that said, entry into auto is not a guaranteed success. Execution risk is high and we only have the track record of personal loans and knowledge that management is top tier to rely on at this point.

Regarding PVR, I am no auto expert, here is a quick search I did defining it:

Per vehicle retail (PVR) has long been the measuring stick of F&I success. While it is a useful tool, it clearly does not tell the whole story. In the simplest terms, PVR – also referred to as per retail unit (PRU) - consists of two components: finance or lease reserve and the profit from F&I products.
“The most common formula for PVR is to take all the vehicles and all the income divided by the number of vehicles that were delivered and come up with an average. One of the most common averages is $1000 PVR/PRU.”


The first dealer to incorporate Upstart/Prodigy will have the advantage of offering lower rates, which will increase sales. Other dealers will have to adapt or lose business due to their higher rates. Sure, all dealers could conspire to keep rates high but that seems unlikely in such a competitive industry.

Another consideration: dealers often receive their most lucrative bonuses from selling “x amount of cars for the month”. Hitting this target is often the difference between finishing in the red or the black for a dealership (and dealers often sell cars for a loss at the end of the month just so they can hit the target and receive a big bonus). So, I wouldn’t be surprised if higher volume at lower rate is a win-win-win.…

just my moderately informed and admittedly optimistic thoughts.


F&I in above post stands for Financing and Insurance…. a sugar coated view of what they do
With many car dealers the F&I guy is just another pro persuading you to spend more than you should. Reading descriptions of the car buying process that the uninformed go through is an endorsement of the Tesla no dealer process.

I may be wrong about this, but I’m reasonably certain that I read somewhere that Upstart is not just entering the business of financing cars at the point of purchase. I recollect that they also see a very large opportunity in refinancing existing auto loans at better rates (sorry about being so vague, but I didn’t take notes as I should have).

I do not recall what the marketing plan might be, or if it was even addressed. But, if they simply invited customers of their partner banks and CUs to compare an Upstart loan to their existing car loan it seems to me that it would be a very low cost approach to finding customers. I would expect that the lending institutions would be very supportive of this approach in that something like 80% of car loans are financed by the car dealer this would represent a large number of new, high quality loans for them.


Dave Girouard, Co-Founder and CEO of Upstart, in response to the Consumer Reports article tweeted:

Dave Girouard @davegirouard
Damn straight. We’re on this.…

$UPST @upstart