Fintech Lender Upstart Says It Won’t Keep Excess Loans on Balance Sheet

Chief Financial Officer

Sanjay Datta

said the company would likely scale back its lending volume if it observes weak demand for loans from investors, rather than temporarily placing loans on its balance sheet.

The company continues to use its balance sheet to hold loans in new business lines, such as auto lending, to demonstrate to investors its ability to assess credit risk, Mr. Datta said. It had about $230 million in auto loans on its books as of March 31.

Upstart is one of several financial-technology companies whose stock price has plunged sharply in recent months amid expectations for more aggressive rate hikes this year and an uptick in late payments on riskier consumer debt.

The company’s shares closed up 3.6% at $48.34 on Wednesday, a day when the S&P 500 was down 4%. Upstart shares are down from a peak of nearly $400 in October 2021 amid a larger market selloff. The company, founded in 2012, went public in December 2020.

Upstart generates revenue largely by matching financial institutions with potential borrowers and charging fees for that service. About a quarter of the loans that the company arranges are scooped up by small banks and credit unions. Most of them are originated by institutions such as Cross River Bank—a small, New Jersey-based bank that caters to fintech companies—and then mostly sold to institutional investors. Some investors then slice up the loans and sell them as securities through transactions that are sponsored by Upstart.

The company facilitated just over $4.5 billion in loans during the first quarter, which is more than double the volume recorded in the year-earlier period. The volume of loans facilitated by the company grew significantly in recent years amid strong demand from investors for consumer credit. But investor appetite cooled during the first quarter as interest rates rose and the risk of an economic slowdown increased, Mr. Datta said. “We’ve always generally had an excess of capital supply, but Q1 is an instance where that slipped,” he said.

Upstart faced a choice: pull back on lending volume, or temporarily park on its balance sheet loans made in excess of what investors wanted, something it hadn’t previously done, Mr. Datta said. The company typically gathers feedback from investors each month to determine demand.

Last week, Upstart told investors that it had decided to temporarily place roughly $100 million to $150 million of loans on its balance sheet. The company intended to maintain stability in the volume of loans it was making, Mr. Datta said.

The move surprised investors, analysts said. Upstart’s stock price fell by more than half after it made the announcement about the loans and cut its revenue outlook. “We were frankly a bit caught off guard by the visceral reaction,” Mr. Datta said.

Investors found Upstart’s business model attractive because the company mostly makes money from fees and its core loans didn’t touch its balance sheet, according to Arvind Ramnani, managing director with the investment firm

Piper Sandler

Cos. “That was not the purpose of the balance sheet,” Mr. Ramnani said, referring to the company’s decision to hold loans.

The move raised questions about its business model—and, more broadly, whether the pullback in investor demand was temporary or the beginning of a trend, Mr. Ramnani said.

Upstart said last week that its first-quarter revenue more than doubled from a year earlier to $314 million. Net income roughly tripled to $32.7 million. Still, the company trimmed its full-year revenue guidance to $1.25 billion from $1.4 billion, citing expectations for a pullback in U.S. consumer borrowing as interest rates rise.

What sets Upstart apart from other lenders is the company’s approach to credit scoring for subprime borrowers, analysts said. The company uses machine-learning algorithms that consider more than 1,500 variables in assessing a borrower’s ability to repay a loan. Upstart says it can more precisely estimate the potential for losses on a given loan than traditional credit scores.

“There was a strong fundamental belief that they offered a differentiated model that had better credit scoring than others,” but investors are now calling that into question, said Andrew Boone, managing director at investment firm JMP Securities LLC.

Consumer credit broadly improved during the pandemic as households pulled back on spending and used stimulus funds to pay down debt. But late payments on consumer loans have begun to tick up across the consumer-lending industry in recent months, including at Upstart, as pandemic-era federal aid has subsided.

Upstart’s first-quarter results fed into a fear among investors that the company might be like other fintech lenders that grew quickly and then stumbled, Mr. Datta said. But the company has confidence in its credit-scoring model and in its growth prospects, he said. Upstart said this week that it has begun to buy back its stock under a previous, $400 million authorization.

Write to Kristin Broughton at Kristin.Broughton@wsj.com