Upstart (UPST 2.65%) leverages artificial intelligence (AI) to evaluate 1,600 variables over 58 million repayment events, making lending accessible to more borrowers and (ideally) achieving lower default rates.
The exciting fintech got off to a blistering red-hot start following its December 2020 IPO, but it remains a young, up-and-coming company. Its lending model has much to prove as people grapple with multi-decade-high interest rates and near-record levels of credit card debt.
While the company's long-term potential is huge, another company with a more mature, stable business model is a better buy for investors today.
Before you buy Upstart, consider this competitor
The past several years have been difficult for personal lenders, and people are dealing with high interest rates as the Federal Reserve looks to put a lid on inflation.
The high-interest-rate environment has made it difficult for personal lenders like Upstart. They have seen muted demand for their products from both borrowers and investors. Borrowers found interest rates too high for loans, while investors held back from adding loans to their balance sheets as interest rates rose rapidly.
LendingClub (LC -0.49%) is one company affected by the challenging backdrop. Despite its struggles, what makes LendingClub a compelling investment over Upstart is its business model and the fact that the company has multiple levers it can pull to generate income in different economic environments.
LendingClub started out as a peer-to-peer lending platform in 2006 and struggled mightily in its first few years as a publicly traded company. In 2016, the company faced scrutiny for its lending practices and overhauled its management team. In 2021, it acquired Radius Bancorp, giving it a banking charter that gave it more flexibility with its balance sheet.
Owning a bank gave LendingClub a low-cost deposit base, allowing it to hold high-quality loans on its books. This allowed the lender to collect interest income on a portion of its loans (it would hold about 15% to 25%) while selling the remainder of its personal loans to investors in the marketplace.
Before acquiring Radius Bancorp, most of LendingClub's revenue came from marketplace revenue, where it earned fees for originating, servicing, and selling its loans. This is quite similar to Upstart's business model today, which mostly relies on the fintech selling its loans in the marketplace for investors.
LendingClub embraced holding on to a portion of its loans to help it generate net interest income. Last year, LendingClub raked in $562 million in net interest income, up 18% from 2022 and 163% from 2021. Net interest income was around 65% of the company's total revenue last year, up from 25% just two years before.
Growing net interest income has been a bright spot for LendingClub, whose stock has gotten hammered along with Upstart and other consumer-lending fintechs. Since the start of 2022, LendingClub has fallen 67%, while Upstart is down 85%. However, LendingClub's revenue and net income have been relatively stable thanks to its growing net interest income.
LC Revenue (TTM) data by YCharts
How LendingClub is preparing for a "historic" opportunity
Interest rate trends look like they are finally shifting, which should bode well for demand for personal loans. The Federal Reserve last raised interest rates in July last year and has since held rates steady at around 5.3%. The central bank has taken a patient approach to inflation, which has gradually fallen to 3.4% as measured by the year-over-year change in the core consumer price index (CPI).
Market participants believe the Fed will make an interest rate cut next. However, the timing of that cut has been questioned. Coming into the year, traders priced in as many as six interest rate cuts. Those expectations have been dialed back to two rate cuts this year.
It appears that falling interest rates are coming, which could help make personal loans more appealing to customers looking to refinance as credit card debt tops $1.12 trillion. With credit card interest rates near record highs, consumers could rush to personal lenders to roll debts up into a single loan and save significantly on interest payments.
During LendingClub's first-quarter earnings call, CEO Scott Sanborn told investors: "We've been preparing our personal loans franchise to meet the historic refinance opportunity ahead."
To do so, Lending Club is developing products that allow members to sweep credit card balances into payment plans. In other words, customers can "top up" an existing personal loan, making it easy to manage their debt balance.
Not only that, but LendingClub is making strides in structuring its loans to make them more appealing to big investors, like asset managers. The company has developed its Structured LendingClub Loan Certificates program, a two-tranche private securitization in which it pools loans into a portfolio and then sells a stake to investors.
Image source: Getty Images.
LendingClub retains the less risky senior security and sells a residual certificate on a pool of loans to investors. This helps LendingClub collect a more reliable stream of interest income while allowing asset managers to earn a leveraged return on those personal loans without the need for financing. The company has sold $3 billion in loans since rolling out this structured certificate program in the second quarter of last year.
Falling interest rates could be a tailwind for consumer lenders and create a potentially "historic" refinance opportunity for personal lenders. While this would benefit both Upstart and LendingClub, I think LendingClub (priced at 11.6 times its one-year forward estimated earnings compared to Upstart's 168 times) is a better way to take advantage of this opportunity.
