Specialty lending platform operator Upstart Holdings (NASDAQ:UPST) has stopped going up. UPST stock rallied from its initial public offering (IPO) price of $20 to as high as $400 last year. It has since given back almost all those gains. Shares were trading around $80 heading into the company’s most recent earnings report. Then disaster struck. The earnings report was a major blow, with the company slashing guidance going forward. But, arguably, the even bigger problem is buried in the details.
Upstart’s unique pitch is that in can use artificial intelligence (AI) to help make better lending decisions. Upstart intends to make loans and sell them to banks, thus not taking on credit risk from the lending itself. If the loans succeed, banks will want to do more business with Upstart in the future, meaning there would be more opportunities to grow loan origination volumes, and, in turn, revenues. A big part of UPST stock’s stratospheric valuation in 2021 was that the company didn’t take credit risk.
However, this past quarter, Upstart decided to retain a sizable chunk of its loans on its balance sheet instead of selling them to banks. For the quarter ending Mar. 31, Upstart held $604.4 million of loans on its balance sheet. That figure more than doubled from Upstart’s $252 million of owned loans at the end of 2021. With the sharp rise in held loans on its balance sheet, Upstart’s loan position now makes up for more than a quarter of its entire balance sheet assets. This is far from the no credit risk view that surrounded UPST stock in 2021.
CNBC pundit Jim Cramer interviewed Upstart’s Chief Executive Officer (CEO) Dave Girouard following the earnings fiasco. Cramer summed up why the stock has collapsed: “Why do you have any loans on your balance sheet? I thought you were a platform […] I did not know Upstart, I thought I did […] I was shocked at the bad loans, potentially bad loans, on your balance sheet.” Upstart’s CEO responded that it was holding loans on its balance sheet to test new products and loan models and that it still isn’t a large portion of their overall business.
However, Cramer cast doubt on this justification, saying: “It was certainly ill-advised to have that many loans on your balance sheet. And a lot of the bankers tell me it was because you couldn’t get rid of them.” If that last part is true, it could suggest that Upstart is facing systemic risks going forward. The whole business model is built on selling loans to banks. If the banks stop buying, the company will be in trouble. Throw in rising interest rates and surging inflation, and Upstart’s lending model is about to be tested dramatically. Until investors can regain confidence in Upstart’s business strategy and capital allocation choices, UPST stock is an exceptionally difficult investment.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.