Q1 2022 Upstart Holdings Inc Earnings Call
[music].
Yeah.
Good day, ladies and gentlemen, and welcome to the upstart Q1 fiscal year 2022 earnings call.
Today's call is being recorded.
At this time I would like to turn the call over to Jason Schmidt Vice President Investor Relations. Please go ahead, Sir good afternoon, and thank you for joining us on today's conference call to discuss Upstarts first quarter 2022 financial results.
With us on today's call are Dave Gerard upstart Chief Executive Officer.
And Sanjay data, our Chief Financial Officer, before we begin I'd like to remind you that shortly after the market close today.
<unk> issued a press release announcing its first quarter 2022 financial results and published an Investor Relations presentation.
Both are available on our Investor Relations website, IR dot upstart dot com.
During the call we will make forward looking statements such as guidance for the second quarter and full year 2022 related to our business and our plans to expand our platform in the future. These statements are based on our current expectations and information available as of today and are subject to a variety of risks.
Ts and assumptions.
Actual results may differ materially as a result of various risk factors that are described in our filings with the SEC.
As a result, we caution you against placing undue reliance on these forward looking statements.
We assume no obligation to update any forward looking statements as a result of new information or future events.
Except as required by law.
In addition, during today's call unless otherwise stated references to our results are provided as non-GAAP financial measures and are reconciled to our GAAP results.
Which can be found in the earnings release and supplemental tables.
To ensure that we address as many analyst questions as possible during the call. We request that you. Please limit yourself to one initial question and one follow up.
Later this quarter upstart will be participating in Barclays emerging payments and Fintech Forum may 16th.
So beyond the basics conference may 24th.
Bofa Securities Global Technology Conference on June eight and Morgan Stanley Technology Media and Telecom Conference on June 14.
We will also be holding our annual stockholders meeting on May 17th.
Now I'd like to turn it over to Dave Girard CEO of upstart.
Good afternoon, everyone. Thank you for joining us on our earnings call covering our first quarter 2022 results I'm, Dave Gerard cofounder and CEO of upstart.
I'm pleased to say we're off to a great start in 2022, the upstart team just delivered our seventh consecutive profitable quarter, and our fourth straight quarter with triple digit year on year revenue growth as a recognized innovator in AI lending, we continue to expand our leadership position in personal lending and are now often running in or out.
Our lending product as well.
Despite the macro headwinds that appeared over the first quarter, we saw loan transactions of more than $4 5 billion a record for the upstart platform and perhaps for the industry as a whole.
At the same time, we added a huge number of lenders and car dealerships during Q1.
We have more than 500 dealerships are not start as well as 57 banks and credit unions, which is up from 42 when I last updated you in February .
At this point, we're adding about a lender per week. This is real progress considering we had just 10 lenders on the platform will not start IPO in December 2020 <unk>.
Additionally, we now have 11 lenders with no minimum FICO score and their credit policies up from seven the last time, we spoke I am confident that our momentum and pipeline for both dealerships and lenders has never been stronger.
We continue to make rapid progress with our auto refinance product as well in the first quarter, we transacted more than 11000 auto refi loans on our platform almost twice as many as we did in all of 2021.
We also launched our first AI model for auto refi that is partially trained by our own auto lending performance data. This kicked off the process of building and deploying increasingly accurate versions of our model, which is our primary source of competitive advantage in the market.
In Q1, we also more than doubled the rate of instant approvals for auto refi applicants another major step towards increasing funnel throughput and delivering a differentiated product experience.
Of course in the recent weeks and months, it's become apparent that 2022 is shaping up to be a challenging one for the economy and for the financial services industry in particular.
In my remarks in our February earnings call I mentioned that the omicron variant the clear signs of inflation and the fed's plans to counter it and the market rotation out of high growth technology. Since then it's become clearer just how aggressive the fed will be with interest rates in order to combat the level of inflation that we haven't seen in decades.
The 10 year Treasury note, which is the most relevant industry benchmark for our business has risen more than 200 basis points since October .
Of course, the war in the Ukraine, and the zero Covid policy in China has only increased the risks and uncertainties facing the global economy.
As I said in February lending is a cyclical industry and always will be so we expect volume and pricing in our platform to vary accordingly.
As a result of increased risk in the economy as well as the corresponding higher returns demanded by banks and credit investors. The average loan pricing on our platform has increased more than 300 basis points since October .
In addition to increasing rates for crude borrowers and this also has the effect of lowering approval rates for applicants on the margin.
Given the hockey stick knows from the fed we anticipate prices will move even higher later this year, which will have the effect of reducing our transaction volume all else being equal.
But if you've been following us start for a while you know that we've been through several disruptions in our industry over the years and each time I'll start gained market share in emerged a stronger company when the economy gets turbulent and nimbleness is at a premium the advantages of a founder led company with a closely knit and tenured leadership team become apparent.
And that's what you have an upstart three founders involved in the business day in and day out and a proven leadership team half of which have dealt with upstart almost since inception.
I'm proud of how upstart performed in the last two years, particularly during an economic cycle with no precedent in the worst year of the pandemic 2020, upstart grew revenue, 42% and generated a modest profit.
And of course, our growth rate and our profits. Since then had been extraordinary by any measure.
Even in this challenging environment 2022, our guidance for full year revenue implies a growth rate of 47% over 2021, and we expect to be cash flow positive.
With respect to credit performance were pleased how our models performed on behalf of our lenders. During this tumultuous period, while not perfect. Our model significantly outperformed traditional FICO based risk models and learn quickly while doing so for I'll start loans originated and funded by our banks and credit Union partners, we saw significant over performance.
Since the beginning of Covid, which is normalized to on target performance in recent months Theres been no meaningful underperformance of returns with any of our more than 50 lending partners since the program's inception in 2018, despite significant periods of economic disruption.
The loans funded by institutions in capital markets, we've observed more volatility, which is natural given their broader risk aperture. The unprecedented level of government stimulus caused the majority of these post COVID-19 vintages to over perform significantly.
Termination of these stimulus programs has caused some of the more recent vintages to underperform.
Finally, we're confident that our models are currently well calibrated to the latest consumer credit conditions performing in line with expectations and a more accurate than at anytime in our history.
Let's turn now to our new product efforts whenever most important initiatives for 2022 is the accelerated rollout of our auto retail product.
Since acquiring prodigy in April of 2021, we expanded our dealership footprint from about 100 rooftops at the time of the acquisition to more than 500 today, making upstart one of the fastest growing auto retail software in the industry.
I'll start to active dealership footprint over the last 90 days spans 35 different Oems, including Toyota Subaru and VW.
At this point, we're also well into phase II, which is the introduction of upstart powered loans into our auto retail software. This represents the next critical step in modernizing the car buying experience.
Without question, our early progress and delivering loans through our retail software has exceeded our most optimistic expectations. While lending has enabled and just a handful of dealerships in California, the uptake and win rate for the loan product technically termed a retail installment contract it's been far better than anticipated.
Our auto teams are working quickly to smooth some of the product edges filling in a few missing features and completing integrations with various legacy dealer systems. All in the interest of moving toward a broad based rollout. Our goal is to enable lending and a few dozen dealerships in four states this quarter, representing about 25% of the U S population.
Led by a full nationwide rollout in Q3.
Based on what we now know we expect the auto retail lending business to contribute meaningfully to upstarts monthly transaction volumes by the end of the year setting us up for a significant ramp in 2023.
As I've said before auto retail is perhaps the largest of all buy now pay later markets. So this is one of the most exciting developments and upstart history, you should feel confident that we have a lot of executive attention on getting it right.
I'm also pleased to share that we began publicly testing are small dollar loan product in the past few weeks.
First mentioned this to you in our earnings call last November it's designed to help consumers with unexpected and immediate cash needs.
Few hundred dollars repaid in just a few months, but it is also important to remember that we're building a bank ready product at bank friendly Apr's always operating within 36% rate cap prescribed to nationally chartered banks and to those who serve U S. Military service members. This is just <unk> initiative to our mission.
To improve access to credit and we believe it will accelerate the pace at which we can bring more and more marginalized Americans into the mainstream banking system.
What I told you in November that we aim to launch the small dollar long before the end of 2022 are small dollar team set an aggressive goal to launch the product by the end of Q1 and I'm pleased to report that they achieved this ambitious goal of course, we still have lots of work to do to realize the opportunity in small dollar lending, but the team's ambition is inspiring.
Additionally, I'm happy to share that our small business lending team is likewise, making impressive progress and is aiming to have their product in the market within a few months.
The first version of our SMB pricing model will include more than 500 variables about both the applicant and the business. It will also feature our loan month modeling framework, which is one of the most impactful innovations added to our personal loan product a few years back.
Our initial testing suggest that version one of our SMB model will deliver higher accuracy as measured by area under the curve or AUC than peer models that had been in the market for years, we'll begin to cautiously test this new product in the second half of the year.
I'm excited about our SMB product for two reasons first business lending is central to far more banks than us consumer lending. So our bank partners are ready and waiting for this.
Despite the interest banks have in business lending the FDIC data suggests that 77% of large banks and almost 90% of small banks have no online application process whatsoever.
We're also hard at work on some fundamental upgrades to the infrastructure that underpins, our AI models and how we develop them.
Important to realize that the surface area over which we're implementing AI has expanded dramatically first we're now working on seven or eight unique models that target different aspects of credit targeting an origination.
And we're implementing these different models across five different credit products as of now.
The amount and types of data used to train our models has grown exponentially and we'll continue to do so as such the time and processing power required to retrain. Our models has similarly increased.
So naturally the opportunity to improve the infrastructure, we use to build train and deploy AI models is enormous and in effort broadly referred to internally as machine learning to have it or M. L to H, we're working to dramatically upgrade this infrastructure.
Our goals with ml to HR to allow hundreds of research scientists to seamlessly and securely build new models and that data to existing models trained and test them in an automated fashion and deploy them across the entire model ecosystem simultaneously.
The system, we're working toward will provide maximum leverage to our research scientists prioritizing and automating our new models, the crane tested and deployed.
Another important area, we're investigating as the means by which our AI models include assumptions about the macro economy.
Our models have long considered the current macro context at the time alone is priced we've consistently said that we arent and don't aim to be macro forecasters and yet macro events will always have some degree of impact on the performance of upstart powered months. So given our product is designed to target a particular return to lending partners that implies theirs.
Some deal with the macro future inherent in our models.
Given this reality, we intend for our product to explicitly shari the macro adjustments there are embedded in the models and Furthermore to allow our partners to put their own macro assumptions. This will provide significantly more transparency through our lending partners will also put our focus squarely on our risk ranking which is the heart of what makes up starts.
Model's unique.
A few weeks back we celebrated upstarts 10th anniversary. It was a wonderful opportunity to remember all we've been through to stop for a moment to reflect on how we got where we are today.
And to show the gratitude that I feel for all those who have been part of that journey, our employees past and present, our investors and partners and of course, our friends and families that made us all possible some of the old timers. The O G. Upstart yours, if you will shed some of their favorite moments and upstart history, we talked about the street curb we sat on for lunch each day.
In our Palo Alto office, because we had no better place to gather.
When I had the chance to speak to the team I told him that I'm, not particularly adept at celebrating the past it's just not me.
Far too excited about and paranoid about the future to spend too much time testing to our success in the past.
As we shifted towards talking about the future I told our team we need to act with urgency today with a healthy dose of paranoia, where a company grounded in reality with our eyes wide open as to the evolving risks, we see in the industry and in the world and at the same time, we have to pair this urgency about the present with optimism and absolute determined.
<unk> about the future.
Fortunately most of our leadership team has been here. So we know the drill and are confident that we can navigate whatever 2022 and beyond.
And we know we can blame that urgency for today with the optimistic guy on the horizon, because although we serve a cyclical industry. We represent a secular change that the financial services industry desperately needs artificial intelligence will reshape the economics of lending in ways that will reverberate for decades.
We're today pursuing opportunities that represent more than six trillion dollars in annual originations. So there's little question about the scale of the addressable market.
See a clear path to building a company with more than $10 billion in revenue in the coming years maniacally focused on achieving that goal.
Thank you and now I'd like to turn it over to Sanjay Our Chief Financial Officer to walk through our Q1 financial results and guidance Sanjay.
Thank you, Dave and thanks to everyone for being with us today.
Just a quick recall out the key financial trends before diving into the more detailed numbers.
On the topline origination volumes and revenue from fees were both slightly up from last quarter, which is encouraging given the seasonal drop we typically see in Q1.
Profitability was ahead of guidance, but as anticipated was down sequentially from last quarter, partly due to the ramp up of auto lending.
We've continued to deploy our balance sheet assertively in the service of R&D and those auto lending and your segments, if personal lending as well as using it to smooth fluctuations hunting a core personal loans.
And as Dave outlined the macro environment has become an increasing headwind to growth this past quarter with birth, both rising interest rates and rising consumer delinquencies, putting downward pressure on conversion.
With these dynamics in mind, you know is a summary of our numbers.
Net revenues in Q1 came in at $310 million up 156% year over year.
Revenue from fees constituted $314 million of that amount, representing a 101% of overall revenue and up 9% sequentially from last quarter.
Net interest income was a negative component of net revenue this quarter as the loan assets on our balance sheet, which we mark to market each quarter sustained declines in valuation due to the rising interest rate environment.
The volume of loan transactions across our platform in Q1 was approximately 465000 loans up 174% year over year and representing over 350000, new borrowers.
Average loan size was up 18% over last quarter and indication for us that fundamental loan demand from borrowers is back on the rise after being suppressed for more than a year due to government stimulus.
Our contribution margin, a non-GAAP metric, which we define as revenue from fees minus variable costs per borrower acquisition verification and surfacing.
<unk> declined from 52% in Q4 to 47% in Q1.
A level, which was nonetheless, a 100 basis points above guidance.
Our decline in contribution margin was almost entirely a function.
<unk> ramped in auto lending.
Which remains contribution negative at this early stage.
Would that be effective auto loans, our contribution margin for personal lending would have clocked in at a robust 51%.
Operating expenses were $275 million in Q1.
Growing 13% sequentially over Q4.
Sales and marketing and customer operations spend.
Typically viewed as variable costs, each outgrew revenue this quarter at 16, and 18% Q O Q respectively.
The additional owners requiring an onboarding auto loans.
Engineering and product development grew 8% sequentially due to slower hiring than targeted.
It remains a priority area of investment.
Growth in general and administrative spend grew 3% sequentially.
Taken together these components resulted in Q1, GAAP net income of $32 $7 million.
224% year on year and above our guidance, but down 44% sequentially from Q4.
Similarly, adjusted EBITDA exceeded guidance at $62 $6 million and grew 198% year on year, but slid 31% quarter over quarter.
Adjusted earnings per share for Q1 was 61 cents based on a diluted weighted average share count of $95 5 million.
We ended the quarter with $1 billion in restricted and unrestricted cash down from $1 2 billion at the end of last year.
As more of our capital base flowed into loan assets in support of R&D programs, primarily in auto refi and some newer segments of personal loans.
Additionally, we have started to selectively use our capital as a funding buffer for core personal loans in periods of interest rate fluctuation with a market clearing prices in flux.
Our balance of loans notes in residuals at the end of the quarter, Wisconsin currently up to $604 million from $261 million in Q4.
Since our prior earnings release, the level of uncertainty in the macro environment has continued to grow.
After remaining at historically low levels for the past 18 months loan default rates rose quite abruptly towards the end of last year and are now back to or in some cases above pre pandemic levels.
This is the dynamic we have observed consistently across the full breadth of our portfolio.
The one which appears to be disproportionately impacting higher risk tiers, which are generally composed of borrowers who one might assume has a greater exposure to lots of government stimulus.
As a way to keep investors abreast of such credit trends, we have introduced new information in our investor materials.
Which shows in aggregate for all historical vintages.
Loan defaults compared to the aggregate defaults that were predicted across those vintages at the time of origination.
The drop in subsequent reversal in default trends that is shown on the chart.
In our view a function of the injection.
Subsequent waning of the government stimulus and as a consequence virtually all of our pre 2021 vintages will substantially outperformed their return targets.
There are two or three most adjacent sort of reversal in trend at the end of 2021.
To underperform.
Yeah.
Separately interest rates, which continue to climb in response to inflation signals instead Peyton.
The combination of inflation and monetary tightening imply the nontrivial risk of a recession potentially later this year.
Given the general macro uncertainties and the emerging prospects of a recession. Later this year, we have deemed it prudent to reflect the higher degree of conservatism in our forward expectations.
With this as context for Q2 of 2022.
We are expecting Rev.
Revenues of $295 million to $305 million, representing year over year growth rate of 55% at the midpoint.
Contribution margin of approximately 45%.
Net income of negative four to euro million dollars.
Adjusted net income of $28 million to $30 million.
Adjusted EBITDA of 32 to <unk> $34 million.
The diluted weighted average share count of approximately $96 2 million shares.
For the full year 2022, we now expect revenue of approximately one point to $5 billion, representing a growth rate of approximately 47% from the prior year.
Down from $1 4 billion guided last quarter.
Contribution margin of approximately 48%.
Adjusted EBITDA of approximately 15%.
Hi, Thanks, once again to everyone, who is working hard to move our mission forward.
And with that David and I are now happy to open the call to any questions.
Operator back to you.
Thank you, ladies and gentlemen, if you would like to ask a question. Please see note by pressing star one on your telephone keypad.
You're using a speaker phone. Please make sure your mute function is turned off to allow your seeking to reach our equipment begin press star one to ask a question.
Our first question from Ramsey El ASO.
With Barclays. Your line is open. Please go ahead.
Hi, Thanks for taking my questions. This evening.
My first question is on the conversion rate it came in a little lower than our model and Sanjay I know you mentioned that some higher delinquency rates might have it might be putting some pressure. There. So I guess I guess first in quarter, maybe talk about the sort of puts and takes with the conversion rate and then also what should we be expecting as we as we move forward throughout the year.
Hey, Ramsey this is Sanjay yeah. Thanks for the question I think it's related what we just described which is two things that you know the the rates.
A newspaper in the economy go up and consequently.
Hurdles for <unk>.
Thanks, and for institutional buyers go up and similarly, as we've talked about between November and February delinquencies in the economy.
Reverted as well they had been an unnaturally low for about 18 months and with the with the winning of the government stimulus.
Those those trends have reversed and those.
Those two things results in higher higher rates interest rates quoted to them.
To consumers and that results in lower conversion.
That's the totality of the story of how that plays out for the rest of the year I think it's a function of those two things we view the the reversal.
And the delinquency trends to be stable now and has been stable for about 60 days in our view.
There is the as I said that there's the prospect of higher a higher rate hikes or I guess higher interest rates came at the end of the year there is.
The risk of a.
The recession as our inflation.
How it plays out and as the fed continues to tighten and so those two things could present further risk to the conversion rates.
But I guess, what's sort of depending on your view of how the how the macro environment will evolve for the rest of the year.
Fair enough.
I also wanted to ask you about the the ABS side of your business you mentioned that.
You'd seen some dislocation that sort of worked its way back.
Back to something more normal I guess.
Talk about the demand environment for your learned as you know as we stand today and then also maybe clarify whether you foresee needing to incur any kind of residual liabilities or any other kind of handholding measures and get an order to get those transactions kind of consummated or whether you think the environment is not really going to demand that as we move forward.
Yeah sure so the ex the broader the rider control on loan demand. So as you know there are a variety of different channels by which the loans get funded I think that the.
The the the loans that are getting funded through bank balance sheets or credit Union balance sheets, I would say is among the more resilient them because they have a cost of funds from their deposits that tends to be a little bit insulated from you know the way that the yield curves are moving in the economy.
And then we have buyers that are a part of the institutional world that are buying and holding on balance sheet and I would say those are a little bit more exposed to interest rate movements in the economy, but I'm still somewhat resilience and then there's the amount of the loans.
That are getting are you now from those buyers sent to the ABS markets and that's that's a fraction that is changed.
Historically as a result of how constructive the ABS markets had been obviously the ABS markets in 2021, where historically constructive so you could make a very healthy gain by purchasing alone and selling it to a b S wells until a lot of that activity happen.
You know that that opportunity as rates have tightened in this cost of funding has gone up.
<unk> is a far less today and so the amount of product getting sent to the ABS markets.
It is a lot less in 2022 than it was in 2021, but I don't think that really changes our equation with respect to how we participate in the ABS markets, we've always been a little bit at arm's length.
In the sense that it's it's not our balance sheet, that's contributing meaningfully to those ABS deals. It is.
Home buyers and investors and other institutions that are making the decision to contribute or not and we don't really retain any residual risk and those are in those deals and it's not a plan to do so going forward.
Perfect. Thank you very much for your answers.
Thank you Amy.
We take over next question from Chris.
Christiansen with Citi.
Good evening, Thanks for the question.
Sanjay.
I was just hoping you can elaborate a little bit on that last comment Sanjay made about I guess credit trends seem to be stable over the last 60 days.
If you look at some of the rollovers on delinquencies I guess, there's there's some concern that you could trigger some of the a b S.
C N L thresholds just just wondering if there's a concern there at some point and could this impact your ability to attract funding.
Then just my second question sorry.
<unk> you mentioned.
You've up the balance sheet risk here, a little bit how far are you are you willing to go and in terms of supporting.
Uh huh.
Loans and <unk>.
Warehouse liabilities.
The balance sheet.
Yeah, Hey, Pete Thanks for the question, it's a Sunday, let's say your first question is about.
The pattern of delinquencies and ABS triggers.
The delinquency is just sort of in an absolute level as I said, so they they they they re normalized to pre pandemic levels fairly abruptly starting in October and November I think that pattern are stabilized.
In sort of roughly February March and April were very stable months.
Of triggers an ABS deal. So it's somewhat technical thing, but what will breach triggers on an ABS deal RMB sort of in period delinquencies, but its the charge offs from delinquencies the prior months.
And.
You know we've done some modeling on that I think that with respect to our large ABS deals.
I don't think there's much concern that breaching triggers we do some smaller monthly.
Pass through issuance and there is a possibility that those triggers will be breached them.
That is somewhat technical thing and it basically means that the rigid holders.
You know were locked out of cash flows for you know a couple of months, while the bondholders get replenished.
Replenished them and then the cash flows begin to.
To flow again, so it'll it would impact their returns.
And it's it's not something that rises to the level of seriousness of worrying about ability that traffic those deals I think it's sort of a temporary technical thing that will.
Caught some intra interaction of cash flows between bondholders and residual holders so.
And then your second question is how we plan to use our balance sheet and as I said I mean, historically, our balance sheet has been almost.
Exclusively for the purpose of R&D.
We have.
Use our balance sheet in the last quarter to do what I call sort of a market clearing mechanism and by that what I mean is when interest rates and the economy change quite quickly.
I think it would be fair to say that our platform is its ability to react to the new market clearing price is probably not as nimble as we would like them somewhat manual it requires a bunch of conversations and phone calls.
And so Ah witness straight smooth and investors are so each deciding what their new.
Our return hurdles are there can be a gap or a delay.
In responding to the funding and invert it and that's a situation where we've chosen to sort of sticking with our balance sheet and almost sort of bridge to the new market clearing price and as that is happening.
Austin, and AR, and AR and AR and are roughly where we've been sort of playing that role of the balance sheet I don't view that to be a long term or necessarily sizable activity for us I think that you know developing the mechanisms to respond to respond more.
Nimbly to Sydney price discovery as rates change, it's something that's on our roadmap and it's something that we want to start to invest in so that it can happen in a much more automated way you know at the end of the day, we view our platform as being a platform that responds to risk in rates in the environment and so the faster we can do that the faster we'll be.
To deliver the new returns in any given scenario to the investors and not have to bridge it with their own balance sheets.
I kind of I would view it through that lens.
Thank you Sanjay.
Thanks Pete.
Next question from Simon clinch.
Atlantic equities.
Hum Sunday.
David I'm.
So I just wanted to in terms of your guidance for the year you explicitly at least building in a recession scenario late in the year. So I was wondering if you could help us just sort of bridge the gap to sort of what's changed in terms of the mix of your loans, you talked about before having embedded $1 billion of auto loans for the year.
You know what's changed there what changed in the personal loan side and and then I'll have a follow up just probably the last points you guys are making.
Okay. Sure. This is Dave I might as well jump in at least once here.
Yeah, I mean, I think it's actually fairly simple, we expect less volume than we would have a few months ago based on.
Pricing in the marketplace being higher and that's a function of both our underlying base rates you know being higher.
As well as the risk in the environment and the risk premium that either lenders or investors are demanding so you put that altogether and it's been an increase in you know sort of average rate to the consumer and several hundred basis points.
I think I've always said we're not.
In some sense, a terribly interest rate sensitive thing and we've kind of said no interest rate changes of 50, or 100 basis points or something that could well be offset by improvements to our platform, but in this case, it's much more significant than that and of course in the last few months, we've seen and it is probably 300 basis points or higher.
And so that's that's what's giving US you know our guidance for the rest of the year, we aren't we're not.
In no way of predicting a recession or anything like that it's not really our job to try to do that we're just reflecting the prevailing rates in the marketplace and the loan transactions that that typically translates to and that's that's what you're seeing there.
Okay, and just a follow on on the last point I'm kind of surprised to hear that you're using your balance sheet too.
To put some loans on them, which I'll just for R&D purposes and.
It strikes me as it's.
It's just not a normal course of business can you give me your platform business. So I'm, just wondering what kind of message that might send to your bank partners or to the others in the in the system.
Just curious about that.
Okay, I think it's Sanjay you kind of explain this in general we view ourselves as a marketplace where.
Ultimately price discovery happens in loans are funded or not funded when they make sense by our bank partners or.
Or by you know capital markets are institutional investors et cetera. Some of this works very fluidly, particularly on the bank and the credit Union side, where they have very direct controls to change their return hurdles et cetera, we don't have those mechanisms in place as well on the other side, it's more of a manual process. So.
When when something changes as quickly as it did and in interest rates and the.
The risk premiums in the market changed very rapidly.
We stepped in to sort of bridge that but it sort of a temporary thing.
And as Sanjay said it is an intention of ours to make the system more automated and more fluid. So we don't have any need to do that it's not part of our business to hold loans and generate net interest income from loans on our balance sheet, but we certainly want to make sure of the fluidity in the system and we're definitely going to do some more work. So we can do that without any of our.
Balance sheet participation in that.
And Simon just to maybe put the numbers into context I E.
Out of the total platform ones that ended up on our balance sheet. This quarter was still a single digit percentage and of that amount.
Probably close to three quarters of it is still we're still R&D style spending on predominantly auto loans and other new products and segments. So.
It was there were still a relative minority relatively small percentage, but it is just sort of an important new thing that we haven't been doing in prior quarters, just because of the solidity of the environment.
Understood. Okay. Thank you.
Well take our next question from Andrew Boone with JMP Securities.
Alright, thanks for taking my questions.
As we think about rising interest rates that you're offering can you just help us understand the spread between what consumers are replacing right. So if I think about credit card rates going up another credit card products also rising are you guys, implying that the spread between what is being refinanced.
Me out and widening can you help me understand that and then secondly, as we think about auto refinancing there are clearly some headwinds going on there with oil prices coming down rates coming higher how are you thinking about the auto refi business for 2022, and you just double click on that thanks, so much.
Sure. Thanks, Andrew on the first question I mean, it's actually fairly straightforward.
And it's not even as you don't have to think as deep as like what a person might be refinancing through an upstart powered loan it's really as simple as win win.
The consumer rates go up that means on the margin a whole bunch of people that would have been approved or no longer approved. So so there's a whole bunch of just loans that never happened at all.
And there's a bunch of people about that are still approved but the interest rate is is a few percentage points higher.
A certain fraction of them are going to just decide that's not the product that they want they don't need it and in many many cases, it's it's a discretionary loan where they're buying.
Buying something or paying off something that they just they don't necessarily have to so there's a fair degree of price sensitivity and just put those together when when average rates go up youre going to see less volume with average rates go down and you're going to see more volume. There's a lot of things we're of course doing in the mix of that too.
It makes us more efficient and more perform it but but all else being equal of course, if rates go up that those are the effects that you're seeing there.
Auto refi I I would just say, there's a lot of influx because it is a new product and because it's also or refi product, meaning it has interest rate sensitivity to it so a little hard to judge how those things will balance over over the course of the year and and that's kind of you know it's a new product of course, we don't have as much history as we do in <unk>.
Personal lending, but certainly you know again, it's an interest rate sensitive product so that works against us.
But we're also making some pretty rapid progress in terms of automating people refinancing loans getting much more focused on digital signatures away from wet signatures et cetera et cetera. So there's been some really good progress there, but how those will trade off over the course of the year is I'm, just a little hard to predict right now.
Thank you.
Well take our next question from Vincent Kindig with Stephens.
Hey, Thanks for taking my questions.
I appreciate all the products, you're rolling out and to talk about the addressable market, but I guess.
Biggest investor Investor worries on the funding side and not having the funny to fuel your origination volume so.
Two parts question, so first on that balance sheet $600 million.
Understanding it's not supposed to be a long term thing, but if you can maybe.
Size, what your appetite is and I guess my understanding was that only loans that were approved by the funding partners where to be originated so I'm just wondering what's different there and then secondly, if you could talk about kind of the.
The funding partnership so how its interests that saw that you had 50, New bank partners. This quarter. So if you could talk about that and then the forward flow agreements. If you could talk about your conversations with the with your institutional investors thinking.
Yeah.
Yes, sure maybe I'll start off on the on the institutional side.
I don't think we have a specific target or a number in line with respect how we're managing our balance sheet I mean, it's sort of an ongoing trade off between.
You know wanting to spend those dollars in R&D and new products to sort of incubate new models and calibrate your models versus buffering the core business.
Through interest rate interest rate shocks, while we're waiting our turn.
Investing in making the platform more nimble to reacting to to finding those market clearing rates and how we balance. The two is a let's say a bit of a fluid equation. So I don't think we have that.
Neither heuristic.
And how we would prioritize the two but certainly in Q1 with all the.
The volatility we saw even though I would say that the majority of our of our balance sheet spending was still of the R&D flavor I'm, just making sure that the core business was stable.
To be an important are important component for us.
And I don't know, Dave do you want to talk a little bit about the lending partners side.
Yeah.
We actually had a phenomenal quarter.
Typically our best ever in terms of signing up new lending partners and deploying them as well so doing exceptionally well, particularly with credit unions. So I think both in terms of what.
What we signed up and deployed onto the platform as well as what our current pipeline looks like is there has never been stronger. So we're extremely pleased with the progress. We've made we're adding about one lender every week and I think there's certainly an opportunity to accelerate from there. So you know.
Lender adoption has certainly been a highlight.
Okay. Thank you and just a follow up question on the guidance so the.
The revenue adjustment to your guide is that all transaction volume or is there.
Any change to assumptions to your take rate and if you wouldn't mind if you.
If you do.
Have an assumption for your transaction volume that'd be helpful. Thank you.
Okay.
All of them, but I think I would say the entire difference as transaction revenue related we don't have any explicit assumptions on.
On balance sheet right.
Of that nature.
Okay. Okay. Thank you.
We move to Mike <unk> with Goldman Sachs.
Hey, good afternoon. Thanks for the question.
So I just had a follow up on the on the revenue outlook change it sounds like it was mostly driven by lower origination outlook due to lower demand from rising rates I just wanted to see if you're seeing any change in the.
You know lending parameters or a shrinking of the credit box due to what's happening on the on the funding side.
Hi, Mike This is Dave no I don't I don't think there's any any significant change in that in that regard I would say generally most most.
On the on the banks and credit Union side, there's been very little movement in any direction am I was I would say you know in some cases, they've raised target returns a bit but I think it's just at the margin. So largely that side of the house has not changed significantly it's really on the other side where expectations of investors and.
Et cetera has gone up in terms of our return targets.
So no it's not really any real change with respect to the credit.
Credit box of the of the various lenders.
Okay, great. Thanks, Steven I, just wanted to follow up on some of the discussion around the loans on the balance sheet.
What's your what's your assumption for where that goes for the rest of the year.
Do you plan to simply allow those to mature or are you going to kind of sell them into the market and when you have the opportunity just any thoughts there would be great. Thank you.
I would say those are being held as held.
Held for sale loans, obviously, it'll be a function of.
You know what that secondary market looks like and.
We will Oh, you know, what we'll make an economic decision on them, but I think that the preference would be to get liquidity and get cashback on the balance sheet rather than to hold the loans and earn interest income.
Okay. That's great. Thank you Dave Thanks Andre.
Yeah.
We'll take our next question from David <unk> with Wedbush Securities.
Hi, Thanks for taking the questions I wanted to ask about the recent change to your loan modification policy in which he made it easier for upstart borrowers to obtain forbearance and these delinquent borrowers would be considered current on their loans can you discuss why you made this change and.
Our delinquent borrowers automatically entered into the forbearance program or do they have to opt into it.
Hey, Thanks this is sanjay.
Yes, so on loan modifications I guess, the simple way to describe it is and even independent of the macro environment.
We'd certainly through the early days of Covid when unemployment shut.
Shut up and there was a lot of requests for forbearance, we have a lot of data that led us to conclude that you're always or you generally better off creating in times of <unk>.
Macro stress.
Creating flexibility for borrowers and helping them work through those periods of turbulence I think in rough terms do you charge off alone.
Getting something in the order of 10 10 o'clock sense a dollar on the recovery.
If you run and in fact, a forbearance program you can sort of get sort of on your 30 to 40 cents on the dollar. So we had had plans any ways to a sort.
Sort of begin to optimize the way, we managed modifications and forbearance.
But I would say that this macro environment environment accelerated those plans because it's made it that much more.
Valuable to the borrowers.
It's not an automatic enrollment thing it still does require an application an overview, but I would say we are we have all done we loosened our standards to to make it a program that was sort of more widely applicable.
Great. Thanks for that and my follow up question relates to the fair value adjustment. It looks like in 2018 when interest rates were rising the fair value adjustment was about a 40 million dollar headwind to revenue and then when interest rates fell the fair value adjustment was about.
A 30 million dollar tailwind in 2021, which probably would fall right to the bottom line of EBITDA could you discuss how we should think about that line item this year and how it impacts your EBITDA forecast given the rising rate environment.
Yeah sure I guess, so that that's always been our I would say a small component of volatility on the P&L as you know.
It's sort of de prioritizing our business model.
The reason of the magnitude for it in 2018 was a bit of a technical one.
In the early days of our securitization program, we were doing a risk retention ourselves because now we are relatively new entrants into the market.
If anyone to do it for us So we had to consolidate a lot of those securitizations onto our balance sheet and as a result, there is sort of big positives big negatives, we didn't actually have any economic exposure.
To those to those deals so some of that is a bit optical.
I would say in 2020 in 2021.
You can see our balance sheet reduce quite meaningfully. So some of that is just the deconsolidation of those ABS deals.
I would think about it going forward is it sort of a function of the scale.
Of our balance sheet and what's going on in the economy. So for right now or you know the scale of our balance sheet, a little bit bigger than it was last year.
And obviously when you put loans on the balance sheet.
There's two different accounting treatments are our particular accounting treatment as we mark our loans to market.
Every quarter and so when interest rates Youre holding alone in the interest rates are going up you'll pick up that value hit and so that's what's happening right now.
I guess the answer to your question depends a little bit on what happens to interest rates. Obviously, if they continue to go up and in particular as Dave mentioned, the one that's particularly relevant to US is the two year treasury.
So it's about a 250 basis points higher than it was.
Late last year.
If that's popped out and it's stable we shouldn't see any further.
Further fair value.
Devaluations, but for holding the loans on our balance sheet and that number continues to go up there will be further.
Further devaluations, so I guess in the Grand scheme of I kind of view that says you know, it's it's going to create some positive and some negative volatility from year to year I think in the long term sort of framework of the business, we don't really view it as as meaningful to the business opportunity, we're trying to execute against.
Thanks very much.
Yeah.
We move to Arvind <unk> with Piper Sandler.
I think things are taking my question I just wanted to ask about.
Some of the topics we've talked about we're putting loans on your balance sheet and I know Sanjay you clarified most of it is more for R&D, but there are some oh, you don't kind of stuff.
Unfortunately, I don't know, if you're able to sort of quantify what.
R&D versus what's just kind of.
Taking on like a regular risk and then the second part of the question is.
Ah you know under what circumstances should we see that number go from the single digits to double digits is that is that possibility.
On the table.
As we look out for the rest of the year.
Sure Yeah, I guess the answer to the first question I have and is a I think in Q.
Q1, probably about three quarters of our loans are R&D side. The majority of what we balance sheet. It was still in the auto in the auto segment, now, which we consider to still be sort of at the.
The R&D phase.
Yeah.
You know where does that what are the potential future scenarios.
It's a good question to some extent it depends on the you know.
It's a function of the level of dislocation in the economy and the progress we've made in I would say automating, our platform's ability to react to new market clearing rates.
So you know in a world, where our platform because I said it does today and there's no further sharp sharp shocks to the interest rate and whats happening is that the prices on our platform are not reacting.
In real time to the to the return requirements or the investors is it changing.
That's the situation in which our balance sheet has sort of stepped into to create stability.
So I you know I would hope that on the one hand, we're creating more of an automated mechanism in our platform's ability to react to those.
Changes in the economy, so they would happen in.
In real time investors, maybe at the limit could just set their own rates as they change.
And and you know it sort of depends so to some extent on the stability of the rates in the economy. So those are a bit hard to.
But you know, it's sort of a real time.
Equation for us is as the as the environment changes.
Great and then just a follow up on auto.
I remember when we had met and New York, maybe it's been a couple of months now.
One of the topics you discussed was auto.
Can you kind of look to kind of take a large part bush from the auto loan.
To kind of work with the banking partners is that like a timeline change just given the circumstances changed quite a bit in the last couple of months or you still feel like you can you can stick to the original sort of timeframe.
Yeah.
Well I don't I don't think that's changed I mean, we've kind of thought of this year for the refi product we are bringing.
Lenders on 12 signed up now so our first priority is bringing lenders onto that platform and we'll do that through the second half of this year. The auto retail product is different in much earlier, and and I would view that as something where.
We will move toward bringing lenders and.
Hum on and towards the beginning of next year. So there are different timeframes, but I don't think and I don't think our expectations for either of those products have changed.
Okay.
Perfect. Thank you.
Moving forward to shut these are all fee.
<unk> Securities.
Yeah. Thank you very much. So so I was impressed by your 18% sequential growth in your average loan amount.
And so it hit $90700, but you were at $13000 at the beginning of 2020 do you think you can.
Perhaps that number anytime soon.
Yeah.
Okay.
Aye.
Oh go ahead.
But oh, well why don't I start you know, we don't expect that I would not expect it to go back to 13000, I think basically our.
Our.
Systems get better proving more people at the margins you are going to trend toward smaller loan sizes.
There's a lot of good things about having better support for smaller loan sizes in terms of what people need we're now.
Launching the small dollar product, which is of course, even smaller so I don't.
I don't see a dynamic other than maybe a short term thing here and there that would drive loan size up significantly.
Can be just driven up.
By demand in and we May get some high quality very prime bank lenders on the platform, which would typically have larger average loan sizes. So it can be some puts and takes like that.
But if you looked across the whole platform.
And you look across a significant period of time, it's actually kind of hard to imagine.
Loan types is going back to where they would've been back then.
Okay and my follow up is that.
The loan amount on your balance sheets about $600 million.
So can we or can you say at least that was the high watermark for the year or that's going to be the high watermark for the year or do you think it can grow meaningfully over the next couple of quarters.
Yeah, I I don't know that we could say that that's the high watermark I mean are you know.
Plans to continue.
With R&D programs and their mandate is growing as we get out of the auto refi sort of balance sheet program, we're going to start to shift some of those dollars total retail as they become more significant later in the year and as Dave said, we think we'll be in market with small business lending.
These are all programs that investment markets and banks are going to want to see you know some amount of curves in history before they start investing significant dollars. So that they now have you will require some incubation.
And you know the other side of the equation is if the economy does remain very fluid right now and if we do need to step in.
Our balance sheet to tourists to stabilize the core business I think that's an important tool for us.
We would ever do it in any way that started to exhaust our capacity or even come close to it but you.
It is a tool that although it's not no. It's not a it's not our objective. It's it's an important stabilizer of the business as a win win when the waters are choppy so to speak.
Okay. Thank you.
Next question from James Faucette with Morgan Stanley .
Hi, This is sandy BD on for James.
Can you remind us how the user limits impacts what your platform can do particularly for those lower end consumers and.
And I guess are there scenarios, where you run into issues here just in terms of capping what would otherwise be approved as APR offers move higher.
And how does that impact your market share trajectory.
Sure. So so so basically there's 50, some 50 plus lenders on the platform they each have their own.
Sort of statutory arrangement they operate under could be state chartered could be nationally chartered.
So so they have different rate caps that they observe themselves and we have no say in that whatsoever.
If you look across the entire platform. We have made a decision a long time ago that we don't support any lender.
Originating loans above 36%. So that's that's the statute that all sorts of nationally chartered banks are under and and we just kind of made a decision a long time ago, that's where we want to put put the limit for the platform overall, so we can't control that.
So the bottom line is.
We when there were a lot of people back three months ago might've been approved close to 36% that today would not be approved at all so it for sure.
When when rates go up at a return hurdles go up it has the effect of pushing people out of the approval band and into the decline band and that's just the nature of the business and when the model gets a little smarter. It will approve some of them in or disapprove, others that it might've approved before and that also as you know the nature of the business the nature of it.
Product getting better, but that's the bottom line. We don't we don't per se have any say in what a bank or credit unions maximum APR is that's a function of both their own business model and their own regulatory regime that they operate under.
Got it thank you and just as a quick follow up.
Take rates.
In a tighter funding environment.
With with downward pressure on conversion is there a scenario, where we could see changes to unit economics I'm just within that funding backdrop, just just wanted to make sure I asked.
Yeah, he sent it sounds like.
I guess the short answer is yes.
As macro environment becomes more challenging you might.
She has become more conservative in how we're managing the business and that could result in higher take rates or.
You know a big bigger.
Luxury unit economics from lower marketing and operations costs.
Got it thank you.
We had to go find the final question from Matt Schindler with Bank of America.
Yeah.
Yes, hi, guys. So yeah.
You mentioned that the you outperformed heavily during the pandemic because of the stimulus and makes sense and now your loans are showing signs of underperformance, particularly in the worst of the lowest.
Quality along the way.
Louis FICO score loans I'm guessing.
You did though the bulk of your low FICO scope before photo score lending really started late.
Late last year.
And.
What does that mean for your the performance of your entire portfolio of loans that have been.
2022 or later.
Are we looking at or maybe even Q4 2021 originations and later are those going to be even significantly worse than you're suggesting because they're weighted towards those lower quality loans.
So not a couple of things that clarity because the statements you're making aren't.
Entirely accurate first of all.
Most most of the effect we saw from the decline from there was sort of retraction stimulus was across the board all flavors of loans. So I mean, there was some marginal difference between the highest risk loans on the lowest risk loans, but.
But largely it was a an effect that we saw that was universal and for US. It's a very clear sign that it's a macro effect.
So.
That's one important thing to say another important thing to say is actually has nothing to do with FICO whatsoever, it's really by our own risk grades that we look at these things like <unk>.
And you can actually see this in some information we put into the investor deck.
Our risk separation was dramatically more than fight go so it's not really related to FICO scores whatsoever.
But but there you have it I mean, I think that we're very happy with how the model is performing now.
It has been stable as Sanjay said for the last 60 days.
I think the bottom line is when you go through a period, where the government.
Essentially pays everybody's salaries for most of the year and then suddenly stops it's a pretty damn difficult thing to calibrate exactly right and so I don't think we're exactly right, but but our risk ranking it's been exceptional the product is stable today.
And none of our banks and credit Union partners have seen any underperformance. So over overall, we're actually feeling quite good.
What's the rate limiting legs.
Oh, sorry.
Right now, it's just getting maybe again.
Describe.
I know you're sort of the direction, we're heading and but the the effect was broad as Dave said it was maybe slightly more on a high risk loans and low risk loans, but there the real.
The real relationship to cohort performance is on timing and by that what I mean is if you were sort of the if you were an investor buying heavily or a bank sort of originating happily across the past couple of years, what you'd see is probably 12 vintage quarters of over performance.
The ones that were timed right around the injection of the stimulus so call. It late 1919 too.
Sort of early 2021 those will over perform dramatically. So maybe kind of like two X the return target.
And then the the the sort of the two or three vintages that were right around the time of what we call. The reversal of the loss trend and you can see that's in our investor deck. It was sort of like you know the Q2 into Q3 2021 low margin they underperform to the tune of we'll call. It you know 2000.
20%, so really the underperformance, we're talking about it's tempting to kind of want to relate it to the change in mix, we've had over the last year, but really what it is is it lines up almost exactly with the injection and the the sort of the the evaporation of the government stimulus.
And as Dave said, there's marginal differences between the low and the high end of risk.
But the I think that's the secondary story, it's not it's not the main.
The main driving factor.
But then it would be reasonable to assume.
Our student loan forbearance and as expected that it would have.
A compounding effect on this it would be the opposite of stimulus.
If forbearance ends meaning if they start demanding the repayment of student loans or if they.
Start demanding repayment again.
Yeah, I think that's still unknown, what theyre going to do but.
He keeps getting delayed.
Yeah, I think that would be another example of reversal of that stimulus right. It's sort of allowed forbearance for a long time and so I think it was just maybe be a continuation of the trend I'm, describing I think you know the the the the majority of the excess balance sheet and our economy has been.
And on one unwound.
You'd see like the personal savings rates they shut up in a couple of different instances.
Over the course of 2020 and early 2021 and those savings rates are right back down to where they were before so yeah. There may be some you know maybe not all of the stimulus has been drained out of the economy are you could sort of describe it that way, but we think a lot of it is not the majority of it has.
And so there may be a bit more to go but as I've said, we've seen stable trends now for a couple of months.
Okay is there any the demographic I'm trying to.
Are you more demographically targeted towards younger people, who are likely to be you know.
You have student loans.
Or are you more broad.
Are you targeting somewhere else.
Just wondering how much how big of an in fact that could be on your borrowers.
I would say in the past, we do we definitely like the inception of our company.
Largely it was around 10 file borrowers, but I don't think that's the case anymore. I think we have a pretty broad broadly.
Broadly distributed portfolio across the risk grades and the demographics now so.
You know I don't know.
The biggest platform in this space will probably be I think you could imagine trends will be roughly proportional to the general population.
Well, that's all kind of at this point.
Thank you. It appears there are no further question at this time I'd like to turn the call back to Dave for any additional or closing remarks.
Just want to say thanks to everybody.
We are actually quite pleased and quite happy with the results definitely appreciate and also that 2022 is a.
A complicated year, an economy and a lot of open questions, but we are exceptionally confident in the strength of the business and are optimistic about our future as we have been so thanks to everybody for joining us today.
That concludes today's call. Thank you for your participation you may now disconnect.
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