Is Upstart’s credit quality deteriorating?


artificial intelligence lender Reached ( UPST -1.03% ) is one of the most popular fintech stocks, based on its following among retail investors. As a result, there has been much controversy over whether the company’s underwriting algorithms can revolutionize lending and replace Fair Isaac traditional FICO credit scoring that has been around for decades. Some argue yes, while for others it’s a definite no.

A key determinant of Upstart’s success will be whether the credit quality of its loans holds up and whether those loans perform better than what traditional banks and other lenders can do on their own. This is particularly concerning in an environment of high inflation and as the Federal Reserve raises its overnight rate, which can put a strain on borrowers.

Let’s take a look to see if credit quality has started to deteriorate at Upstart.

Image source: Getty Images.

What has happened so far

Upstart sees itself more as a software-as-a-service (SaaS) company. Its model is to issue loans through its platform and then have banks keep the loans on their balance sheet, or bundle the loans and sell them to investors through financial instruments such as equity-backed securities. assets (ABS). It is difficult to track the credit quality on loans retained by Upstart’s banking partners, but Upstart still sells the bulk of its loans to investors through ABS.

Prior to a bond sale and intermittently throughout the life of a bond, a credit rating company will visit and thoroughly review the ABS, providing opinions on their performance as they age. The reviews include updates on cumulative net loss (CNL) rates in ABS and plenty of other loan pool information. One such company, the Kroll Bond Rating Agency (KBRA), provides these reports for free, which is a great tool investors can use to monitor the performance of Upstart loans.

The information in the chart comes from KBRA’s latest pre-sale report released on March 23 for Upstart’s first ABS deal in 2022, which contains approximately $435.5 million in loans. The report also contains information about previous Upstart ABS transactions and their performance.

Upstart Securitization Trust seasoned month LNC current rate Initial CNL rate projected by KBRA Current Projection of KBRA Base Case Lifetime Losses Initial Lifetime Base Case KBRA Loss Projection
2018-1 45 12.16% 21.58% 13% 22.10%
2018-2 41 11.81% 18.75% 12.75% 19.30%
2019-1 35 11.78% 19.89% 14.50% 21.10%
2019-2 30 8.24% 15.59% 12.25% 18.25%
2019-3 26 7.27% 14.23% 12.25% 17.90%
2020-1 23 5.59% 11.29% 11.50% 16.55%
2020-2 16 2.85% 10.44% 11.00% 17.60%
2020-3 16 2.76% 9.07% 11.00% 17.80%
2021-1 12 3.28% 7.43% 17.00% 18.85%
2021-2 9 2.70% 4.35% 17.00% 17.35%
2021-3 6 1.63% 2.20% 17.15% 17.15%
2021-4 4 0.62% 0.57% 14.90% 14.90%
2021-5 2 0.07% 0% 15.15% 15.15%

Data source: KBRA Upstart Securitization Trust Presale Report 2022-1.

The number and year on the left side of the chart represent the specific ABS, so 2018-1 is the first ABS issued by Upstart in 2018. The seasoned months represent the number of months since the ABS was sold for the first time to investors. The current CNL rate is the cumulative net loss rate at the given number of months the ABS is seasoned. The initial rate of CNL projected by the KBRA was what the KBRA had originally expected the CNL to be in the number of season months. The current lifetime KBRA base case loss projection is what the KBRA currently projects for lifetime CNL once ABS is fully matured, and the initial lifetime KBRA base case loss projection matches what the KBRA predicted the lifetime CNL rate would be when the ABS was first issued.

As you can see, for Upstart’s first securitizations from 2018-1 to 2020-3, the results are stunning. Current CNL rates are well below KBRA’s original projections at the time of the report. The same goes for KBRA’s lifetime CNL projections, which are poised to be much better than when the ABS were first issued.

So has credit quality deteriorated?

Things started to harden. As the graph shows, default rates for new vintage ABS are increasing faster in the first few months than in the past. Additionally, KBRA’s lifetime CNL projections for ABS issued in 2021 are mostly still in line with the initial projections and have not improved like previous vintages.

Also, if you look at the chart for the 2021-4 vintage, which was only four months old when KBRA released this pre-sale report, the current CNL rate is slightly worse than the initial CNL rate projected by KBRA at this point in time. ABS. ‘ the life.

Line graph illustrating default rates for Upstart securitizations.

Image source: KBRA.

It is still early in some of these vintages, so delinquencies may stabilize over time and CNL rates may improve.

There are two other big things to consider. For one thing, many seasoned vintages have gone through periods where loan losses, in general, are at historic lows. During the pandemic, which officially hit the US economy in March 2020, consumers saw record savings rates, largely because they couldn’t spend much and the federal government provided relief. like stimulus checks and improved unemployment benefits.

The second important factor is that Upstart applied its underwriting algorithm to more consumers across the credit spectrum, including those with lower credit scores. For example, in securitization trust 2020-2, no loans initiated by Upstart were granted to borrowers with a FICO score below 619. But in securitization trust 2021-4, almost 12.7% of Pool loans were intended for borrowers with a FICO score below 619. FICO score 619 or lower.

It’s still too early

The market is eagerly awaiting more definitive proof of Upstart’s creditworthiness, but I think it’s still too early to make a real decision. The first vintages The ABS that performed well aged during a period characterized by extremely favorable credit conditions throughout the banking system. Newer vintages are still in early periods and have many more borrowers lower on the credit spectrum.

The key is to focus less on delinquency rates and more on how the actual results compare to the KBRA’s initial projections. Seeing how these new vintages turn out will be crucial for Upstart’s future.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.


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