Is Upstart Stock a buy after tip cut in a rising rate environment?

It’s usually best to anticipate bad news. Seems to be the AI ​​lender’s approach Reached (UPST -20.42%) takes after announcing some preliminary second-quarter earnings numbers earlier than expected and telling investors to prepare for results well below expectations.

Upstart shares fell more than 17% in after-hours trading on the heels of the news. Is the stock a buy, now that it’s trading near all-time lows?

What happened

Upstart said it expects second-quarter revenue to be around $228 million, well below the company’s original forecast of $295 million to $305 million. Additionally, Upstart told investors to expect its contribution margin to be around 47%, which is higher than the 45% it had forecast.

The company now expects to report a loss of between $27 million and $31 million. Previously, Upstart expected to break even or report a loss of up to $4 million. As Upstart CEO Dave Girouard said in a statement:

Our turnover was negatively impacted by two factors more or less equally. First, our market is limited in funding, largely due to macroeconomic concerns among lenders and capital market participants. Second, in the second quarter, we took steps to convert loans from our balance sheet into cash, which, given rapidly rising rates, had a negative impact on our revenues.

Upstart creates personal and auto loans with the belief that it can better assess the credit quality of borrowers than traditional methods such as Fair Isaac FICO rating. It then sells the majority of those loans to whole loan buyers or institutional investors, who often securitize the loans. Upstart does this in order to get loans off its balance sheet and continue to fund new creations.

As the economy appears to be heading into recession and interest rates are rising aggressively, investors are much less willing to invest and take out Upstart loans, especially those aimed at low-end borrowers. credit. Their cost of funding has increased and borrowers are more likely to default in a down economy.

Converting the loans to cash, it appears Upstart incurred a loss on the loans it held on its balance sheet, which spooked investors when the company disclosed the information in its first quarter earnings report. Analysts and investors want Upstart to run a low-capital operation and not take on the real credit risk of borrowers.

Meanwhile, Upstart Chief Financial Officer Sanjay Datta said Upstart-powered loans held by banks and credit union partners are still performing well and delivering returns that meet or exceed expectations. For non-bank loan investors, Datta said the 2018 and 2020 vintages have significantly outperformed, while the 2021 vintages are within 1% of the company’s loss expectations.

“We believe our models are well calibrated to economic conditions and are currently targeting returns above 10%,” Datta said.

Image source: Upstart.

Is the Upstart stock a buy?

As the fintech stock, which at one point last year traded at $390, fell below $28, I would avoid buying shares of Upstart at this time. No one knows how long the funding problems will last, and even if they go away, investors are likely to demand higher returns, which will slow overall origination volume.

Investors won’t be willing to accept loans from Upstart to weaker credit borrowers anytime soon, which has allowed Upstart to really increase origination volume in previous quarters. All of this should lead to much lower origination volume this year than investors expected, and therefore lower revenue.

Additionally, Upstart needs to prove its core thesis of being able to underwrite loans better. Sure, his early vintage loans did well, but they were made when the government was pumping a lot of money into the economy, largely supporting borrowers. Seed loans held by credit unions and banking partners are likely to higher quality borrowers.

I would like to see how the loans for the 2021 vintage and those granted this year hold up in the current context. Until then, I’m staying away from stock.

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