Personal lender Upstart is feeling the pressure as the rate of missed payments on its loans is sharply increasing following the end of stimulus programs. The Silicon Valley company specializes in personal loans that fund expenses like credit-card debt consolidation, weddings and home repairs. Upstart advertises that its artificial-intelligence-based underwriting expands access to credit by looking at more than a borrower’s FICO score, and it has received praise from the Consumer Financial Protection Bureau for doing so. But with inflation and interest rates rising sharply, this is the first time Upstart’s model is being put to the test during a true economic downturn.
During the Covid-19 pandemic, low interest rates enabled fintechs like Upstart to lend money to consumers at competitive rates with little risk of default as borrowers collected stimulus checks. Now, rising interest rates and the end of government support programs are cutting into Upstart’s bottom line. Stimulus programs slowed to a halt in September after enhanced unemployment benefits ended. The delinquency rate, the percentage of loans which have late payments, on Upstart loans originated in 2021 is approaching 7%, versus under 3% for loans issued the year before, data from credit rating agency KBRA shows. Upstart’s stock has fallen 94% since its peak in October 2021, while the broader market of publicly traded fintechs is down 55%. Upstart declined to comment due to the “quiet period” ahead of its next report of financial results.
While analysts say the rising delinquency rates are a normalization after stimulus payments lowered the risk of late payments, some have been struck by the steepness of the correction. “I don’t think we’re at the point yet where default rates or delinquency rates are above pre-COVID levels, but with that snapback it’s not the levels so much as the rate of change, which has been surprising,” Citi analyst Peter Christiansen said.
Upstart serves as an intermediary between bank partners and borrowers, making money by packaging loans and selling them to third-party investors for a fee. Upstart CFO Sanjay Datta said on the company’s first-quarter earnings call that in some cases default rates had surpassed pre-pandemic levels. The rising delinquency rates, a leading indicator for defaults, have shaken investor confidence in Upstart loans, making it more difficult for the company to find investors, analysts say.
In 2021, this forced Upstart to retain the loans, surprising stockholders. In the first quarter of 2022, Upstart held $598 million worth of loans on its balance sheet, up from $252 million in the fourth quarter of 2021. Earlier this month, Upstart said in a press release that its loan marketplace was “funding-constrained, largely driven by concerns about the macroeconomy among lenders and capital market participants.”
For the second quarter, Upstart’s revenue was $228 million, $77 million below what the company had previously forecast, with an estimated net loss of about $30 million. Part of the dent in second quarter revenue came from Upstart selling the loans it held on its balance sheet to other lenders, in some cases at a loss, rather than its usual practice of bundling them into asset-backed securities. In addition to these sales, Upstart had lower loan volume in the second quarter, which cut into revenue.
The reduced volume could be a result of rising interest rates and tightened lending standards from Upstart or its partner banks. In a bundle of loans sold to investors from 2022, 30% of borrowers had FICO scores lower than 619 (the scores range from 300 to 850, with the average American at about 715). Between 2017 and 2021, Upstart focused on originating loans for borrowers with lower FICO scores. However, as losses mount with higher delinquency rates, Upstart appears to be tightening its lending standards to reduce losses. In a more recent round of loans from 2022, only 24% of borrowers had FICO scores below 619. Ultimately, Upstart is only able to lend according to its partner banks’ risk tolerance.
“Whatever A.I. model you have, you’re ultimately at the mercy of how much capital you can deploy at a given period, and the risk tolerance behind that capital,” Christiansen said.