The consumer lending industry is somewhat run down, to put it mildly. Only 48% of Americans have access to prime credit, but 80% have never defaulted. Why the imbalance? Traditional consumer credit metrics fail to properly assess the risk to people with little or no credit history, leaving millions of deserving borrowers falling through the cracks.
Holdings reached (NASDAQ: UPST) is a new public consumer credit company that attempts to expand access to capital and address this systemic problem. Here’s what it does, how things work, and why I think it’s a buy.
About the Upstart approach
Upstart is a true banking partner. Instead of financing loans itself, Upstart creates loan products for banks and offers quotes on its own site on behalf of banks. Upstart does not try to replace banks and inherited creditors, but rather tries to elevate these entities through larger and better lending operations.
Specifically, Upstart finances only 2% of the loans it obtains with its own balance sheet, with the remaining 98% financed by banking partners, as well as the pooling and sale of these loans to other institutions. Upstart charges a fee per loan taken out, which means it can be seen as an ally of the banks rather than an adversary.
Why is this important? Upstart is still a relatively new company and therefore cannot match the amount of data that century-old banks can access. Therefore, Upstart’s supporting role makes it easier for banks to decide whether to share keys to their data realms, and this is where Upstart realizes its advantage.
Upstart’s risk algorithms can analyze over 1,600 unique data points on a consumer (up from 22 in 2014), while banks typically mine 8 to 15 data points over time. As a general rule, the less summary the risk quantification, the more precise it will be.
Upstart can factor in things like education, cost of living, and more because it uses machines rather than people. Simply put, artificial intelligence can digest and scale a lot more information than we can, and do it faster. Perhaps this is why Upstart has grown from 10 banking partners to 15 since its IPO in 2020, and recently became a preferred partner of the National Association of Federally Insured Credit Unions (NAFCU).
Quantifying the advantage of Upstart
It’s one thing to talk about the benefits of data, algorithms, and machine learning, but it’s another to translate that benefit into performance. Upstart does exactly that.
According to the Consumer Financial Protection Bureau (CFPB), the company is able to generate an annual percentage rate (APR) that is 16% lower than the average. Beyond that, Upstart offers a 27% spike in approval rates for banks while keeping loss rates constant, also according to CFPB. Upstart isn’t just about a big game, it delivers.
This combination is quite sticky. Consumers are encouraged to use Upstart because the loans are cheaper and more frequently approved. Banks are encouraged to use Upstart because more approvals without more defaults gradually and directly feed their results.
These leads give Upstart its core value proposition, and sustaining both will be critical to the success of this investment. On a related note, CEO and founder Dave Girouard told investors in the latest earnings call that the Upstart industry, the leader in APR, approval and default, continues to grow thanks to a updated the company’s mix of algorithms. He did not specify the exact boost.
Finally, the company also updated its user interface to reduce friction between users and increase conversion rates. The conversion rate represents the number of Upstart loan sources divided by the number it cites. As a result, the conversion rate fell from 14.1% to 22% year over year, a clear signal to company executives that they need to put more energy into growth.
How it goes and where do we go from here
The company’s last quarter has been remarkable. Revenue climbed 90% year over year as the company increased its 2021 sales forecast by 20%. Its contribution margin (which represents fee income minus the costs of acquiring, verifying and managing borrowers) has increased from 38% to 48% year over year. Impressively, the company already has a positive net profit margin of 8.3%. And these results have come despite the fact that loan demand has been hit by the government’s stimulus measures, which means there are even more tailwinds to come.
To find even more growth, Upstart recently bought Prodigy Software to expand further into auto lending. This purchase multiplies its loan market by almost seven. Although it is still very early days, Upstart has increased its car dealership footprint by 45% year over year.
At Friday prices, Upstart is trading for 14 times sales over the next 12 months and 210 times prospective earnings – which isn’t ridiculous when you look at other hyper-growing names, but not cheap either. more. In my opinion, execution warrants evaluation, but it is a decision that you have to make yourself.
Upstart is a winner
Upstart’s concrete, multi-pronged value proposition is already translating into rapid growth and a compelling unity economy. It makes the lending process more even and modern, while fundamentally blossoming in the process.
The company is poised to dominate in the future, and I think investors should take a serious look.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.