Wow! Did we do the right thing exiting Upstart when we did?

First Quarter 2023 Financial Highlights

  • Revenue. Total revenue was $103 million, a decrease of 67% from the first quarter of 2022. Total fee revenue was $117 million, a decrease of 63% year-over-year.
  • Transaction Volume and Conversion Rate. Lending partners originated 84,084 loans, totaling $997 million across our platform in the first quarter of 2023, down 78% from the same quarter of the prior year. Conversion on rate requests was 8% in the first quarter of 2023, down from 21% in the same quarter of the prior year.
  • Income (Loss) from Operations. Income (loss) from operations was ($132) million, down from $34.8 million in the same quarter of the prior year.
  • Net Income (Loss) and EPS. GAAP net income (loss) was ($129) million, down from $32.7 million in the first quarter of 2022. Adjusted net income (loss) was ($38.7) million, down from $58.6 million in the same quarter of the prior year. Accordingly, GAAP diluted earnings per share was ($1.58), and diluted adjusted earnings per share was ($0.47) based on the weighted-average common shares outstanding during the quarter.
  • Contribution Profit. Contribution profit was $67.6 million in the first quarter of 2023, down 54% year-over-year, with a contribution margin of 58% compared to a 47% contribution margin in the same quarter of the prior year.
  • Adjusted EBITDA. Adjusted EBITDA was ($31.1) million, down from $62.6 million in the same quarter of the prior year. The first quarter 2023 adjusted EBITDA margin was (30%) of total revenue, down from 20% in the same quarter of 2022.
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I’m not quite exited… still have a 2.6% position… pre-spike.

An important aspect of the report was the announcement they will get $2B in loan funding over the next year. More loans without incremental exposure on the balance sheet. I haven’t listened to the earnings call to learn particulars.

There is a very large short position. That will probably drive a short term spike and then a retreat to “some level”. I haven’t tried to figure out where this thing should be valued at.

I’m thinking I’ll sell exactly at the upcoming peak and then buy back at where it settles down… and maybe I got too much sun exposure on my head today as it hit 90 or so here… :wink:

Rob
He is no fool who gives what he cannot keep to gain what he cannot lose.

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And yet…

This was the first call in over a year where I have heard analysts congratulate Dave Girouard on the quarter. They beat their guidance on the top and bottom lines. Their Q2 guidance exceeded consensus estimates. It was the most confident sounding call I’ve heard in a very long time.

Most importantly, they secured $2B in long-term capital agreements with partners (both new partners and those they’ve had for awhile) to buy their loans. They signed their first external funding agreement for auto retail.

They now have 99 lending partners up from 50 a year ago and 10 at their IPO. They are up to 39 auto dealerships, having just added Mercedes-Benz last quarter.

They successfully expanded into the lending category of small-dollar loans, which is turning out to be huge for them, and will be rolling out HELOC (Home-equity line of credit) loans later this year.

Compared to large US banks, Upstart loans have 53% fewer defaults at the same approval rate and 173% more approvals at the same default rate.

Their AI models have an immense data set to train on. And it is growing. According to their investor deck, they have over 100 billion cells of performance data with an average of 90k loan repayments each business day.

Their AI is being enhanced so quickly that they delivered 23 model upgrades in Q1, “including the single largest accuracy improvement measure in Upstart history for small dollar loans.” (Quote and other data above from investor deck. No transcript yet.)

The UMI tool they rolled out in Q1 (Upstart Macro Index) has helped them to better price interest rates and is also improving with data.

They took a 30% haircut in headcount in Q1 and are renting out office space to get back to profitability. As I recall from Q4, a lot of the layoffs came from areas where they dropped current plans for new products–SMB loans and mortgages in particular.

Yes, my Upstart position is still deeply underwater. I have not sold any shares since the end of 2021, and have added to the position when it hit bargain basement levels. But my portfolio is grateful for the 50% pop in the share price on the earnings release.

While I realize a lot of that is likely short covering (at one point after hours shares were up 62.26%!), judging from the tone of the call and the questions, I would expect at least a couple of analyst upgrades in the days to come.

Of course none of that means anyone was wrong to sell; you do you. For myself, I still do not have a broken thesis for Upstart.

Did I pay too much too early? Definitely. But the call made me happy for them, happy for me, and happy for the people who will now get access to credit because they are continuing to prove that their model is superior to FICO.

JabbokRiver
(After the release now 13.32% UPST)

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Thanks Jabbok for a great summary.

I still own a small amount of this also, and have bought more this year. I did it just so that if this survives and thrives one day it might be my first hundred bagger. (A man can dream) Currently, this is the single worst investment in my life from a total $ lost standpoint. My cost basis is around $60. I don’t think we are supposed to discuss turn-around stocks, but I still think this has a chance to be great again.

My 5 attempts for 100-baggers:
UPST - lowest price shares at $13.00
TMDX - lowest price shares at $12.87
LMND - lowest price shares at $11.07
SOFI - lowest price shares at $4.47
DOCN - lowest price shares at $24.47

My total cost basis is higher for all, and for some I only bought tiny amounts at the low, but it will be fun to see if any of them can achieve the 100x goal.

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The 2 billion in additional funding they received can only be used for personal loans, and they had to give up part of their margins in order to secure the funding. But yes it looks like they are turning a corner and will go into sequential Revenue growth next quarter so I would say we have seen the worst.

Andy

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In hindsight, you might have exited sooner…

All time UPST chart

I exited on November 4, 2021 only two days after I bought the stock losing only $200. While I don’t remember exactly what happened it just didn’t pass the smell test.

Lending is a cyclical business, in good times people have money to pay off their debts, in bad times they go bankrupt and banks fail in chain reaction fashion until the government steps in to stop the panic creating future instability. 2009, after the crash, was a great time to buy stocks. Where are we in the current crash? My hunch is that, for the market, the worst is over. That would not mean an Upstart turnaround but a market turnaround.

Denny Schlesinger

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I didn’t get out when the mass exodus started during pandemic/rates/inflation issues, but I did start using that position for options income over time. (Off-Topic).

That led to some selling of shares, and then I had too many other growers to put my money into, so that led to the last of the shares being sold. I never looked at it as “lost” money (for once in my life) but that the remaining value could earn me more in other locations (TOST, DUOL, etc).

This report is ok, I would not call it good, and I totally agree with the short squeeze probably being part of this. I had ALL my shares loaned out for income for as long as I had them.

I am not ready to say I missed the boat here. If there are more quarters of good reports then I will start to watch again. I want to see them doing business on their own merits and not needing funding sources at some point.

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I think you want them to have funding sources so they can grow their business. I would like to see them have more funding sources that will take their loans through all market conditions, without having to give up any of their margins. If the banks that they are partnered with were not freezing up then they wouldn’t need another source of funds.

Andy

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Castlelake, L.P. (“Castlelake”), a global alternative investment manager with 17 years of experience investing in asset-rich opportunities today announced that Castlelake, together with a co-investor and minority partner Eltura Capital Management, has reached an agreement to purchase up to $4 billion of consumer installment loans from Upstart (NASDAQ: UPST), an artificial intelligence (AI) lending marketplace. The purchase agreement consists of the acquisition of a back book of loans and a forward flow arrangement.

Shares currently up 18%.

I believe this makes a total of $6 billion in secured funding. Exactly the kind of partner they needed, imo.

Through the transaction, Castlelake will leverage its experience underwriting consumer credit and small business loans to provide Upstart with the ability to upsize its business.

JabbokRiver

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UPST is inevitably sacrificing some profit in pursuing long-term institutional investors, but in the long run, it will reduce cyclical fluctuations. UPST is gradually moving towards recovery.

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I still have around 5% (hard to calculate due to some options positions). I got way too excited about UPST and can’t seem to let go. I am utterly convinced that FICO must die, and UPST is the only viable alternative I know of, plus, they were touting AI before we had even heard of Chat GPT. And as a writer on SA recently calculated, if they can get back to 2021 earnings even at half the valuation, it’s a $200 stock. That said, the losses I have suffered over the past year and a half have taught me to be at least somewhat skeptical, and it isn’t clear to me what UPST’s “partners” have agreed to do, other than be named in a press release. Castlelake will buy “up to” $4 billion but it seems like the actual number could, at least in theory, be $1. In other words, there’s a maximum, and the language of the release suggests that some amount has actually been purchased, but there is no minimum.

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The past 12-18 months clearly showed that UPST business model is highly risky. Why? Because they need to have a secondary market to sell the loans. They should have problems/limits with putting all the loans on own balance sheet as they don’t have banking license. In a credit crunch - which by the way was not severe until now - they clearly had problems and if there will be a severe one, I question viability of the model. There will be 0 buyers for the loans and they won’t be able to expand own balance sheet at some point.

To cheer now that someone extended a credit line/buying loans is fine, but these institutional folks will be cancelling all the lines/stopping buying loans as soon as they see smoke.

To stress, every business has (probably) a value and Upstart is worth some type of value. Not saying UPST worth zero. In case of upturn it will be able to generate good profits.

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If they have a banking license, their TAM will depend on the deposit ratio. (If they are like SOFI, I would leave immediately.)
Regarding the buyer issue, I believe that after this training model, buyers will have more trust in their model. Furthermore, they are also seeking long-term institutional buyers, which will further reduce volatility.

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This thread is getting really long, but I still have a question. At one time, UPST was supposed to be aiming to sell a ‘service’. The software allowed other banks to make more loans, across more audiences, with lower risk.
Most of this thread seems to talk about them becoming a bank or an originator and then relying on secondary markets to make money. That was never the original thesis, so what has changed?

Is UPST really heading toward eating it’s own dogfood? (which is not the thesis I invested in a long time ago)
or
Or are we changing the story line amongst ourselves and looking at the wrong thing?

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Upstart has repeatedly stated that they have zero interest in becoming a bank. Here’s what the dialogue has sounded like to my ears over the past year and a half or so:

Market: Oh, dear, it looks like we have bumpy economic waters ahead. Upstart has proven it has a superior model in boom times, but they are untested in a bad economy. Risk! Risk! People will default!

Upstart: Well, yes, more people will default in a bad economy; but a better model is still a better model. All defaults will go up for any company offering loans. Our model will still have a lower rate of defaults than those using FICO; because it’s a better predictive model of who will pay off their loans. Loan volume will go down because rates will have to be higher. But the loans we accept will still have a better return than loans judged by FICO. Because Our. Model. Is. Better. Moreover, our model is improving with every loan, while FICO’s model is static.

Market: Risk! Run! They are unproven! Don’t buy those loans!

Banks: (the industry whose system is being disrupted by Upstart’s model) Okay, we’ll go for Treasuries.

Upstart: They don’t trust us, but the people we serve really need credit and we know our model is reliable. We trust us. So we’ll keep loans on our balance sheet because we know they will perform better than FICO loans. That will help us both further our mission by approving more borrowers and cushion the financial impact of the downturn on our company as the loans mature at a profit for us.

Analysts: (who are mostly paid by and immersed in the industry Upstart’s model is disrupting) Gaaaah! You’ve filled your balance sheet with super, ultra-risky loans when the economy is tanking! Sell! Sell! Horrible management!

Upstart: Well, okay, if that’s what you really want, we’ll get those loans off the balance sheet. But we’ll be taking a loss to do it.

Analysts: Do it! Do it!

Upstart: Okay. Done.

Analysts: Gaaaaah! Look at the huge losses! This company is trash! Sell! Sell!

Upstart: :rage:

Credit Unions: (Peeking out from behind the bushes) We’re actually having pretty good luck with our Upstart loans. We don’t have massive reserves like big banks, and we need to make loans, even in this environment. These loans are doing well for us and right by the people we serve. We have to price them higher, which will decrease volume, but we’re in.

Upstart: The market hates us, and everyone is saying “sell.” We’re tied to the 2-year treasury, which is flying higher with Fed rate hikes, which is going to depress loan approvals. Still, we don’t yet have enough bank partners to originate the volume of loans that come through us, so bundling them for sale is still necessary. No one seems to understand that a better model is a better model in any climate, and they won’t until it’s proven through this downturn.

We have to do what is best for the company and, ultimately, for those we are trying to serve. Our reputation can hardly get worse, and we know the value of the loans we approve. So let’s go back to making more loans and holding them ourselves. That will both improve our bottom line over time and watching those loans more closely will allow us to keep improving and training our model, which keeps our first-mover moat in place and expanding.

Analysts: Gaaaah! They took big, scary loans on their balance sheet, then they said they wouldn’t, and now they’re doing it again! Sell! Sell!

Upstart: Whatever. The macro is really bad for all lenders. The loans we’re holding will pay off at maturity, but since others don’t yet trust us enough to buy them, we could face a liquidity problem. So let’s put off our work on SMB loans and mortgages. We’ll have to lay off the folks working in that area, but the alternative is to (again) sell off loans at a loss. The market will hate us either way, so let’s make the cuts.

And we’ll do more intense work with institutions who already understand the value of our loans (or can be convinced by our data) to get them to commit to buying our bundled loans until the day when we have enough lending partners to pass along at least most of the originations to them.

Market: :yawning_face: :-1:

Upstart Q4 2022: Hey, even though you hate us, big banks, we’re still fighting for the people who need loans, which means helping you as well as ourselves. So here’s what we’ve been developing while you’ve been clutching your pearls:

(From the Q4 2022 call transcript. Dave Girouard speaking)

We also took advantage of the volatile economy to significantly upgrade our model’s ability to understand and react to macroeconomic conditions.

Last quarter, I announced our plan to productize the Upstart Macro Index or UMI. This new metric measures how changing economic conditions like inflation and unemployment are impacting credit performance. We continue to make breakthroughs in our methodology for calculating UMI, and we expect to launch this monthly metric to the public later this quarter. This is an exciting development from our machine learning team.

In an industry-first, Upstart will provide lenders with near real-time insights into the financial health of the American consumer, allowing them to adjust their lending programs accordingly. This is a big step toward providing banks and credit unions with lending infrastructure that autonomously, continuously, and rapidly adapts to changes in the economy.

Oh, and you know what else?

Despite the fact that our lending volume in 2022 was down 14% versus the prior year, our contribution profit was actually up 13% year on year. Optimizing our pricing represents a large surface area of opportunity, which we’ve only just begun to explore. In addition to these major improvements, we’ve also continued to innovate across our platform in support of future growth. In fact, I believe we made more progress with our technology in 2022 than in any year in our history.

And as capital markets and the overall economy normalizes, I expect this will become obvious to all of you. Some important areas of progress from last year include model accuracy. Our AI models continue to separate risk significantly better than a traditional cycle-based model, and we continue to increase our pace of model development. The increase in our model accuracy in the last seven months is more than what we delivered in the prior two and a half years.

And…

Today, our small-dollar product includes loans from $200 to $2,500, with tenors from three months to 18 months. To date, we’ve originated more than 24,000 small-dollar loans to individuals who otherwise would not have been approved for our personal loans. More than 12,000 of these loans were originated in Q4 alone. This expansion of borrower coverage means we are dramatically increasing the pace at which our machine learning models are improving.

And just as importantly, in Q4, 88% of small-dollar loans were fully automated. Lending partners. In our earnings call a year ago, I told you we had 42 lenders on the Upstart platform. Today, that number is 92, representing growth of 130%.

Despite the hostile 2022 environment, banks and credit unions recognize and appreciate a fundamental secular change in technology when they see it. These partners are starting cautiously with us, but they represent a significant expansion of potential lending capacity on the Upstart platform once there’s a bit more clarity on the direction of the economy.

A satisfying line from the CFO, Sanjay Datta:

Net interest income came in above forecast, largely a result of choosing to retain more loans on our balance sheet than anticipated given the market conditions in Q4.

And the irony in the final question from a Stephens analyst made me laugh out loud.

On the balance sheet, if you could discuss how much capacity you do have for increasing the amount of loans that you have on balance sheet and if there’s maybe other ways to increase that capacity.

So yeah, now you can see Upstart loans are performing and suddenly want us to take MORE loans on our balance sheet. You can’t make it up.

Market: Boy, it’s fun buying puts on Upstart.

Cramer: AI is really going to change the world–every company. But not Upstart, they’re not a good company.

Upstart Q1 2023 call:

I’m pleased to tell you that we secured multiple long-term funding agreements together expected to deliver more than $2 billion to the Upstart platform over the next 12 months. This is a critical first step toward building resiliency and predictability into our business.

And…

We pushed 2023 new and improved versions of our AI models into production during the first quarter alone about one every three days. We’re confident that our AI has never been as sophisticated or as accurate as it is today. But in order to deliver the best rates for all, we also need a diversity of bank and credit union partners, each with different priorities, business objectives, and balance sheet issues to solve. Today, we have almost 100 such partners in order of magnitude more than the 10 we had when we went public in December 2020.

We additionally need a strong presence and reputation in institutional and capital markets because the limited risk appetite of bank balance sheets will never serve the needs of the entire U.S. credit market. This quarter, we expanded our roster of institutional partners in ways that should help us deliver quality offers to consumers through all parts of the cycle. Second, more efficient borrowing and lending, every quarter we aim to make our platform more efficient for consumers and bank partners.

Market: :exploding_head:

Shorts: :grimacing: :man_running:

Some Analysts: Congrats on the quarter!

Other Analysts: You had big losses! This is terrible!

Castlelake: Hey, we’ll take $4B of those loans off your hands, either ones you’re holding now (we’d like those profits that are obviously coming) or new ones you’d like to make.

Me: :white_check_mark: :flight_departure:

JabbokRiver

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Very concise and digestible. Thank you!
I am one of the small few, it seems, who share your view of upstart. As an investor the attentive thing to do would have been to cut my losses long ago and then buy in again now, but I am not a very competent investor… Still, I think their ideas are excellent, and while they clearly did not think of everything, they have done quite well at keeping the boat afloat and pointed into the wind. They look likely to make it through fine, and this has been about as strict a test of their models, management, character, pretty much everything that a sceptic could ask for.

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Seems that they continually need either:

  • to find a savior like Castlelake
    or
  • for banks to stop being so fearful

Does that make you question the business model at all?

Bear

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Notwithstanding the fact that companies like Castlelake will demand a much higher yield than securitization markets will and will provide a much lower overall capacity than those markets.

I’m been harping on UPST on this board for quite some time. Remember back a year ago when they told us that they are not dependent on securitization markets only for those markets to de facto shut down their lending?

Let me remind to anyone who is in this stock that they do not just own what could be an amazing AI company but first and foremost they own a company that is in the business of lending money. They may not be a bank but they sure act like it. Unlike a bank, however they have no deposits to lend and therefore are totally dependent on others to provide this funding. As I’ve said over a year and as we are seeing now this lending is extremely volatile and so will be UPST ability to write loans and make money.

Moreover, UPST is one step away from facing regulatory action that could deem this type of lending, conducted outside of the banking system, illegal.

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Bear,

The only thing I question is their timing for going public. I think they greatly underestimated the resistance to change in the financial industry when it comes to models for lending. My sense is that they thought their data would be enough to prove the model and quickly gain trust. It was not.

If they had spent longer proving themselves as a private company, they wouldn’t have had to worry about the bad press from nervous public markets and investors and could have spared themselves the back and forth with holding loans on their balance sheet. They would have just held them, profited through the downturn, and then had that as proof of concept in good times and bad with, say, a 2023-4 IPO. But hindsight is 20/20.

I’m not sure what other model there is, apart from being a bank. But their core mission is to expand access to credit everywhere, not to become some super bank that takes away customers from other lenders with their proprietary AI risk model. That kind of mission means getting financial institutions with significant assets to trust them.

As someone whose primary job is trying to effect change in churches–perhaps the only institution more resistant to change than financial institutions–maybe I’m just more sympathetic to what it takes to overcome that kind of headwind.

You’re right–they need trust in their model to achieve their mission. Trust is established when both parties are willing to take risks, and lending has been a risk-averse industry for millennia.

We’re also in an age when trust in any and every institution is at least close to their all-time lows–some deservedly so, others whose reputations have been purposely eroded by hostile actors. And what company doesn’t flounder if trust in its product is lost or can’t gain traction in the first place?

I don’t know of any business model in any industry where trust isn’t needed for success. And we live in times where trust is less freely given than perhaps ever before; skepticism that is often warranted. The higher the stakes, the harder it is to earn the trust. And lending is a very, very high stakes industry. It’s not a business-model issue, imo.

JR

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Hi Bear,

In short I think this is a sign of Upstart finally getting going again and their model is working.

I don’t believe that Castlelake is a saviour and I do know that banks will stop being fearful. It comes back to timing. My timing with Upstart has been horrible and my conviction has ruined my portfolio performance. Nevertheless I think Upstart’s moat is based on having the best model, which means traning it, which means generating loans and finding a way to bankroll those loans.

I believe that they are adding funding partners can only be a good thing and if it means giving up short term margin for being capable of originating more loans, improving the model and futhering the business so be it.

Nik

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