Upstart reported earnings last evening and beat for the quarter on top and bottom line however it cut its outlook for the year as they now expect the surge in interest rates to lead to lower demand for loans and therefore slowed growth.
This is really a side story. The major issue is the rise of Loans held-for-sale. From their 10-k: “Upstart-powered loans originated by bank partners are either retained by the bank partners, purchased by the Company and immediately sold to institutional investors under loan sale agreements, or purchased and held by the Company for a period of time before being sold to third-party investors, or held to maturity by the Company for the primary purpose of product research and development. Loans retained and held on the Company’s consolidated balance sheets are classified as either held-for-investment or held-for-sale, and loans purchased for immediate resale to third-party investors are classified as held-for-sale. Immediate loan resales to institutional investors are accounted for as transfers of financial assets when the Company surrenders control of these loan assets. These sales typically occur shortly after the origination of the loans by the bank partner and the Company’s subsequent acquisition of the loans from the originating bank partner.”
Upstart has reiterated multiple times that they do not want to take on significant credit risk. They want to be the platform where loans are originated, not the bank where funds are financed. Despite this Held-for-sale loans on their balance sheet are as follows (in millions):
12/31/20 $60,232
12/31/21 $142,685
03/31/22 $372,098 ESTIMATE (142,685+443,190 purchase of HFS loans -20,328 payments – 50,765 HFS sale)
During the earning call, management indicated that as they roll out new products, they need to show the underwriting logic is pricing risk accurately. Until the new product is accepted by the banks, management may need to continue financing these loans. When asked on the earning call if the held-for-sale loans in this quarter should be seen as a high-water mark management basically said no.
So why down 50%? Well, you have unproven software underwriting new loans that are apparently unable to be sold to the market. Since the purchase of held-for-sale loans is part of how their operations are working, this purchase is a draw on their cash produced from operations. In other words, if there were no held-for-sale transactions, Cash from operations for Q1 would have been $105 million. When you include the purchases, CFO was -267 million. Does that sound like a good thing?
On the flip side, should Upstart obtain liquidity for these loans the operations look pretty strong given their continued revenue growth. Now that they are buying these loans, cash from operations is sucked dry.
If you are betting that Upstart’s platform will price risk well, this is likely to be a short-term issue as new products mature. Having said that, this dynamic may continue in the future as new business lines are added and tested.
I went long UPST at $75 or so and have not determined if I will be adding or selling. Please do your own due diligence and don't put your faith in a random guy on the internet.
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