Better Loan Performance and Diversified Funding Set the Stage for a Stronger 2H’24
Upstart Holdings (UPST), a company known for its AI-driven lending platform, has been upgraded from “Underperform” to “Neutral.” This upgrade comes as the company shows signs of improving credit quality, benefitting from a more accessible capital market, and positioning itself for a potential rebound in the second half of 2024. With lower interest rates and improved metrics, Upstart may see an upward inflection in loan originations and adjusted EBITDA performance.
Credit Quality and Capital Market Access
A significant factor behind the upgrade is the improvement in Upstart’s credit quality. The company’s recent securitization deal, 2023-3, has outperformed expectations in terms of delinquency rates, marking a positive shift after several years of underperformance. The improvement may be attributed to the company’s tightened underwriting standards, which have resulted in lower origination volumes but better credit performance. While Upstart’s quarterly originations currently stand at just over $1 billion—well below the highs of $4 billion seen in 2021 and 2022—this tradeoff has allowed the company to deliver more consistent loan performance.
Upstart’s access to capital markets is also improving, with credit buyer demand strengthening. This is a welcome development for the company, which previously had a heavy reliance on Asset-Backed Securities (ABS) markets to fund its loans. The recent increase in ABS deal activity shows that the capital markets have become more favorable for credit providers, the best conditions seen in the last two years.
Additionally, Upstart has made significant strides in diversifying its funding base, forming long-term partnerships with committed capital providers like Castlelake, Ares, Centerbridge, and Blue Owl. These partnerships reduce Upstart’s dependency on the ABS market and its balance sheet for funding. Most notably, Blue Owl has committed to purchasing $2 billion of loans, a move that enhances Upstart’s capital stability.
The Role of UMI and Economic Outlook
Another key metric driving optimism around Upstart’s future is the Upstart Macro Index (UMI), a leading indicator for the company’s loan originations. UMI has been improving in recent months, suggesting that Upstart could see an uptick in origination volume in the second half of 2024. This indicator, coupled with expectations of lower interest rates, could set the stage for better-than-expected loan growth.
However, the macroeconomic environment remains a wildcard. Analysts note that while their base case is for a soft landing—where the economy slows but avoids a deep recession—there remains a risk of rising unemployment. Major retailers have voiced concerns about the health of consumers, and an economic downturn could negatively impact Upstart’s borrowers, leading to higher default rates. Therefore, while Upstart’s near-term trends are promising, a recession could temper the company’s outlook.
Scaling Originations and the Path Ahead
One of the biggest challenges for Upstart remains the question of scale. While the company has successfully contained credit risk at lower origination volumes, it is still far below the peak levels seen in 2021 and 2022. The key question now is whether Upstart can increase originations meaningfully while maintaining its improved credit metrics. If the company can strike this balance, it could return to higher growth levels while keeping delinquencies in check.
That said, origination growth in recent quarters has been modest, and there remains uncertainty about how quickly Upstart can scale back to pre-2023 levels. The company has proven that it can manage credit performance at its current levels, but to achieve substantial growth, it will need to continue refining its AI-based underwriting model while securing more capital at favorable terms.
Revised Estimates and Valuation
Analysts have slightly lowered their estimates for Upstart’s GAAP EPS in 2024 and 2025, reflecting higher interest expenses due to recent convertible debt issuance. EPS forecasts now stand at -$2.27 for 2024 and -$0.70 for 2025, compared to earlier estimates of -$2.25 and -$0.65, respectively. However, 2026 EPS has been revised upward to $0.45, signaling a potential return to profitability if Upstart can successfully navigate the current economic landscape.
Upstart’s valuation remains a point of debate, as the stock is trading at 6.1 times the 2025 enterprise value-to-sales (EV/sales) estimate—higher than its neobank and fintech peers, which trade at around 4 times EV/sales. Despite this premium, analysts believe there are sufficient growth catalysts, including increased origination volumes and improved credit performance, to justify the valuation. The price target for Upstart has been raised from $10 to $45, based on a 5.3 times multiple of 2026 estimated sales, discounted back to 2025.
Conclusion: Balanced Risk-Reward Outlook
Upstart’s upgrade to “Neutral” reflects a more balanced risk-reward dynamic. On the one hand, improving credit quality, a more favorable interest rate environment, and stronger capital market access position the company for growth. On the other hand, macroeconomic risks such as rising unemployment or a potential recession could still weigh on its performance.
In the near term, Upstart’s success will depend on its ability to scale originations while maintaining credit quality. With new funding partnerships and improving loan performance, the company is making strides in the right direction, but challenges remain as it seeks to regain its footing in the competitive fintech landscape.
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