Upstart's Biggest Risk Isn't Its AI Models. It's Who Funds the Loans.
Key Points
Upstart stock is down 26% year to date.
The fintech company announced plans to apply for a national bank charter, which would allow it to fund loans.
The company remains unprofitable and has had rising expenses.
Not all artificial intelligence stocks have been going through the roof in recent years. One AI-fueled fintech, Upstart Holdings (NASDAQ: UPST), has had a hard time building any positive momentum.
And it's not because of its AI or technology, or even the unique service it offers to its customers. The risk, in part, comes from its business model, which it is looking to tweak.
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Upstart was one of the first AI-fueled fintech companies to burst on the scene in late 2020, during the post-COVID technology boom. It intrigued investors with its technology platform, which deploys AI to handle loan requests. Using some 1,500 different data points, the technology quickly examines a loan application and either approves or denies it in minutes.
Image source: Getty Images.
Upstart generates most of its revenue from fees, with most fees coming from its online marketplace, where it accepts loan requests, its AI examines them, and seeks to find a lender. It also has a software-as-a-service (SaaS) revenue stream, selling the software to banks and lenders for a fee so they can embed it in their own systems.
Banking on a bank charter
The major risk for Upstart is securing loans from its bank and institutional partners, particularly during a challenging, high-interest-rate environment when lenders tighten their credit standards and pull back on funding riskier loans. In the past, this has resulted in fewer loan originations, which translated to decreased revenue.
Fortunately, that has not been a problem for Upstart as of late, as its originations have been strong. In the first quarter, Upstart grew loan originations by 61% year over year and transaction volume by 77%. That resulted in a 44% year-over-year rise in revenue.
But Upstart management just took a major step toward reducing some of its risk, applying for a bank charter.
In March, Upstart announced plans to apply for a national bank charter, which would allow it to accept deposits and use those deposits to fund its loans. The company would still use its marketplace to source loans to banks and institutional investors, but it would also have the ability to fund loans itself and collect interest on those loans. It not only provides an additional revenue stream but also reduces the company's risk of relying solely on third-party funding sources.
If the application is approved, Upstart is planning to launch the bank in early 2027.
Big spenders
Upstart stock has risen about 18% since that March 10 bank charter announcement, to around $32 per share, but it's still down roughly 26% year to date and 33% over the past year.
Despite its surge in revenue and originations, Upstart still struggles to generate profits due to its massive spending.
In the first quarter, expenses shot up 45% year over year, with sales and marketing costs jumping 76% and engineering and product development expenses increasing 38%. Overall, it led to a net loss of $7 million or $0.07 per share, up from a net loss of $0.03 per share a year ago this quarter.
So while the bank charter could go a long way toward reducing its funding source risk, Upstart also needs to show investors that it can manage expenses and maintain profitability.
Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Upstart. The Motley Fool has a disclosure policy.