Q2 2022 Upstart Holdings Inc Earnings Call
Good day and welcome to the upstart Q2, 2022 earnings call. Today's conference is being recorded at this time I would like to turn the conference over to Jason Smith head of Investor Relations. Please go ahead Sir.
Good afternoon, and thank you for joining us on today's conference call to discuss upstart second quarter 2022 financial results.
With us on today's call are Dave Gerard Upstart, Chief Executive Officer, and Sanjay Shah, our Chief Financial Officer.
Before we begin I want to remind you that shortly after the market closed today upstart issued a press release announcing its second quarter 2022 financial results and published an Investor relations presentation and credit that thank you.
All 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 third quarter of 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 uncertainties and assumptions.
Actual results may differ materially.
As a result of various risk factors that have been 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 have addressed 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 the Goldman Sachs commit a cookie up plus technology Conference September 13th.
Piper Sandler growth Frontier Conference September 14th.
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 second quarter 2022 results and Dave Gerard co founder and CEO of upstart.
Today, we reported a decline in revenues, which is obviously disappointing and unacceptable to us.
I want to explain where this decline came from and what we're doing to address it.
Natural for you to question, whether upstart to AI powered risk models arent working as designed but we're confident this isn't the case.
In fact, our models continued to improve with respect to accuracy and risk separation, but there's no getting around the fact that a decline in revenues as a business problem that we need to address and today, we'll share with you the actions, we're taking to address it.
Today's Sanjay and I will discuss a variety of topics, including credit performance, the unfunded lending partner sentiment and some of the actions, we're taking right now to make sure upstart <unk> future is bright.
I also want to share with you the progress we've made in many important aspects of our business and how they are setting the stage once again, perhaps starts growth in the future.
I don't want to spend too much time restating, what you've already heard about the current economic climate, given the nature of our product and our borrower. We do however have a unique lens into what's transpired in the last two plus years and what may transpire in the coming months and years.
We believe we're at the end of a unique economic cycle related to the pandemic that included two distinct phases. The first phase was triggered by a pandemic constrained consumer spending.
Unprecedented government stimulus throughout 2020 and early 2021.
Used together drove significant improvements in consumer savings levels and liquidity, which in turn led to dramatic over performance of credit during this phase.
Our platform experience about a 50% reduction in credit defaults compared to the pre COVID-19 timeframe.
And the second phase toward the end of 2021 and into 2022. This effect begin to unwind that stimulus was discontinued and consumers against the travel dine out and spend once again.
And as expected default rates returned to pre COVID-19 that looks or in some cases, even higher well virtually all consumers benefited for naturally from reduced spending during the early stages. The pandemic. This cycle was concentrated in consumers, who received government stimulus checks and demographic, which is also more likely to be upstart borrowers.
Our risk models largely captured these attacks and performed admirably, but not perfectly throughout but I'll get to that in a bit.
We believe we're now at the end of the two phase cycle and an important question for all of US is what's next.
Efforts to slow inflation major recession, and unemployment while no one knows the future. We do expect a significant slowing of the economy and a worse than normal macro for the next year and beyond we will speak to that as well.
Our job to all of this is to ensure the future of our platform into protect upstart ability to pursue our mission for years to come.
Alongside our earnings release, we today shared some responses two important questions regarding credit performance an upstart platform.
It goes without saying that measuring credit performance is vital and it's also non trivial compared to one platform to another can be challenging different products different borrowers different return targets, Montana book prepayments hardship policies add more there's no simple apples to apples comparison, we believe be a central measurement for Craig.
Performance is actual dollar returns compared to the lenders or institutional investors target at the time of origination bulk stopped.
And today, we provided this information for all let's start cohorts going back to the beginning of 2018.
The bottom line is yes, our 70, plus bank and credit Union partners. It typically retained loans in the lower risk grades appropriate to their businesses have seen to date portfolios consistently meet or exceed expectations. Since the program began in 2018.
However, our institutional loan buyers done against the target of approximately 8% gross return since Q1 2018 institutional buyers have so far seen 12 quarterly vintages over perform with five expected to underperform.
I'll highlight that alone buyer, who invested equally in all cohorts. Since Q1 2018 would have experienced a positive return on all vintages, thus far with an overall 9008 gross annualized return.
This compares to a return of less than 3% in the U S high yield bond index over that same period.
Lastly, we believe it's not reasonable to expect above target loan performance irrespective of the economic cycle. So it is fundamentally important to separate the impact of macro conditions from imperfections in the credit model. The essential litmus test for motto performance separation of high and low risk borrowers as demonstrated in the loss rate by grade and.
Youll see metrics, we shared today our model is positively differentiate us in this respect and it continues to improve.
In an effort to deliver unparalleled transparency and analytics, we will provide this detailed information to each of our lenders and loan buyers.
Today, we're in a funding constrained environment, which is the primary cause of our revenue shortfall.
I want to share some thoughts on this situation and actions, we're taking to address it.
As we have said recently our goal is to operate as a marketplace for credit over the long run.
Loan transactions to take place when they make sense for the borrower and the lender.
Certainly lending is a category, which we'd expect to experience some volatility overtime due to macroeconomic factors, having said that in the last few months lenders and institutional credit investors reacted more quickly and abruptly than we anticipated. Despite the fact that our bank partners have seen consistently strong credit performance meeting.
Portfolio is performing at or above plan across quarterly cohorts several of them have paused or reduced originations due to fear about the future of the economy to be clear these lenders and institutional investors have not left upstart platform, but are temporarily paused or reduced their originations.
As we shared in our credit performance today, we believe our models are well calibrated to the current economic environment and in fact include a generous accommodation for a recession over the next 18 to 24 months.
And given funding constraints, we believe the opportunity for lenders to generate strong returns and upstart is unusually high right now yet the reaction of lenders is often binary in nature more so than we would have anticipated.
As a result, we've concluded that we need to upgrade and improve the funding side of our marketplace, bringing a significant amount of committed capital onboard from partners, who will invest consistently through cycles. We're currently evaluating a variety of opportunities to do just that so we expect this will take some time to bring to fruition.
Furthermore, while we continue to believe that it doesn't make sense for upstart to become a bank. We've decided it may make sense to at times leverage our own balance sheet as a transitional bridge to this committed funding.
I acknowledge that this is a shift relative to what we planned and communicated earlier this year, but are changing and volatile environment suggests we need to be flexible and responsive in our approach.
We're taking this step for a few reasons first there is an obvious information asymmetry, where we understand better than anybody how our model is performing today and how well it's calibrated for the current economic environment.
Secondly, we believe the opportunity to generate outsized profits on our platform is unusually high right now.
Third we can bring a level of stability to our business that's important to our longer term goals, while we work to put these committed capital structures in place.
We will share some more about this in his remarks shortly.
I want to also highlight that we are building a business that can survive and thrive through a variety of market conditions to make sure. We achieve these ambitious long term goals our fixed costs are low and our gross margins are strong. So we can continue to invest in our roadmap and in our future through a variety of macro environments.
We continue to make rapid progress in the newer parts of our business and we're optimistic that this progress is setting up the next stage of growth for upstart, which I'm sure you're all looking forward to it.
First we continued to add new lenders to our marketplace with a total of 71 banks and credit unions as of today up from 57, when we last spoke to you in may despite the cautionary outlook in the financial services industry forward thinking banks and credit unions continue to choose upstart.
We now have 640 dealerships using upstart auto retail software and just a few weeks ago industry analysts to automotive market data declared that I'd start with the nations fastest growing auto retail software provider in the second quarter.
Subaru and VW, where the latest Oems that announced support for upstart auto retail joining Toyota Lexus, Mitsubishi and kiosks as well as top franchise dealers from 37 brands, including Ford Honda and BMW.
We also extended our auto retail lending product up to 29 dealerships and saw the first $10 million in retail loan originations in the second quarter.
And just the last couple of weeks, we merged our machine learning model for automated income verification originally developed for our personal loan products into our auto retail lending growth. We expect this improvement to more than double the percent of applicants for whom we can now automatically verify their income.
I'm also pleased to announce that we quietly launched our small business loan product at the end of June well ahead of schedule.
We've already seen some more than 40 small business loans originated totaling more than a million dollars in principle in just a few weeks.
That team has quickly ironing out operational issues with an eye toward rapidly expanding this product in the coming months and years.
Lastly, the small dollar loan team launched support for Spanish speaking applicants another giant step towards serving those left out of the countries mainstream financial system.
Some of you have questioned whether I'll start geared to quickly into lending to riskier borrowers in 2021 in order to grow and our post IPO phase, but I believe we have done exactly what we set out to do and what we said we would do.
It starts mission is and has been to leverage modern technology and data science to improve access to affordable credit there are tens of millions of Americans, who deserve access to reasonably priced credit from our nation's banking system. Yet are denied access through no fault of their own.
We're unique among our fintech peers and that we aim to tackle this problem directly.
The terms non prime near Prime and subprime. These are words the industry invented to describe people that our current systems don't understand.
Truth is that the vast majority of these Americans are entirely creditworthy upstarts mission is to identify those borrowers and provide them with access to affordable credit and we haven't wavered from that challenge.
This growth rate in <unk>.
We approach our business as a waterfall of priorities in a way analogous to structured credit.
Starts highest priority or a bond if you will is credit quality. Our goal is to reliably deliver the return the lender or investor expects for a specific allocation of risk or be bond or next highest priority is unit economics or gross profits. We don't strive for loan transactions that lose money for upstart and generally seek to avoid.
Hmm.
Finally, whatever is left over goes to platform transaction growth our residual so to speak in true growth isn't a specific target for us, it's a plug and based on our waterfall our priorities. There isn't this ordering are clear without strong credit performance and solid unit economics growth over the long term would be unsustainable.
To close I want to acknowledge that we've experienced some setbacks in our business, but our fundamental economic engine is strong our risk models are better than ever and I'm confident that we'll be on the growth path again soon we're taking decisive action to bring committed capital to upstart into.
Those who say that we should focus on the traditionally prime market I'd say that there are plenty of others focused on that improving access to credit for all Americans is too important to go ignored and I'm sure. It has the right stuff to get it done.
Thank you and now I'd like to turn it over to Sanjay Our Chief Financial Officer to walk through our Q2 financial results and guidance Sanjay.
Thank you, Dave and thanks to everyone for joining.
The environment were operating in has continued to evolve rapidly since our previous call.
Industry data shows the general rise in delinquencies across all segments of unsecured credit disproportionately impacting the higher risk tiers that is comprised a significant component of our borrower base.
The impact of this dynamic on the credit performance of upstart loans can be seen in the supplemental credit performance information that was released today together with our investor materials.
The macro uncertainty and the impact of economic stress on consumer delinquencies have led to a decrease in available funding for loans on our platform, which has become the operating constraints of the business.
Well today's results are in line with the preliminary numbers, we pre announced on July the seventh.
Real quickly call out the key financial headlines.
On the top line origination volumes and revenue from fees were both down from last quarter and below our internal expectations, driven primarily by funding constraints in the capital markets.
While profitability was also below guidance, we began to systematically improve unit economics in the second half of the quarter.
Pivoted to optimizing for in quarter cash flow generation, which will carry over into our third quarter contribution margin.
Following our recent share repurchase authorization, we have repurchased approximately $4 4 million shares of upstart totaling $150 million in repurchases.
Additionally, we sold a meaningful amount of the loan assets from our balance sheet in Q2 in order to fortify our cash position.
With these dynamics in mind here now, it's a more detailed summary of our numbers.
Net revenues in Q2 came in at $228 million up 18% year over year.
Revenue from fees constituted $258 million of that amount representing 113% of overall revenue.
And up 38% year over year, but down sequentially, 18%.
Net interest income was a negative component of net revenue this quarter as we entered into multiple loan sale transactions, some of which incurred a negative fair value impact and is the valuation marks of a remaining loans continued to be negatively impacted by the rising interest rate environment.
The volume of loan transactions across our platform in Q2 was approximately 321000 loans up 12% year over year and representing over 233000, new borrowers.
Average loan size was up 5% over last quarter, largely owing to auto loans, representing a higher proportion of the mix.
Our contribution margin, a non-GAAP metric, which we define as revenue from fees minus variable costs per borrower acquisition verification and servicing was flat sequentially at 47% and 200 basis points ahead of guidance without the inclusion of the fledgling auto loan volume our contribution margin for our core personal.
Lending would have risen to 51%.
As we optimize our fees and marketing spend for lower near term volumes. We expect that unit economics will continue to show a meaningful sequential improvement.
Operating expenses were $260 million in Q2 down 5% sequentially we.
We reduced our sales and marketing by 21% sequentially as we downsize their marketing campaigns to reflect our constrained funding supply.
Engineering and product development grew 14% sequentially and remains our priority areas of investment although by the end of the quarter, we had slowed down hiring significantly and concentrated most of the remaining hires into key technical roles.
Growth in general and administrative spend grew 8% sequentially.
Taken together these components resulted in Q2, GAAP net income of negative $29 $9 million.
Adjusted EBITDA of $5 5 million contracted.
Contracted 91% Q on Q.
Adjusted earnings per share for Q2 was one cent based on a diluted weighted average share count of $93 3 million.
We ended the quarter with $790 million in unrestricted cash mildly up from $758 million in Q1.
Our balance of loans at the end of the quarter was $624 million.
Of which $484 million, representing R&D loans, principally in the auto segment.
Our balance of core personal loans at $140 million was only marginally down from Q1.
It's still a significant number of loans that had accumulated on our balance sheet subsequent to the end of Q1, but prior to our earnings call in May.
Earlier today, we published some key data regarding the credit performance of upstart loans.
Just to recap a couple of the key points.
Our models continue to provide around five times the amount of risk separation than a credit score and the statistical accuracy of our models continues to improve this has not changed.
Most vintages from 2021 will underperform their return targets.
This volatility comes on the heels of vintages significantly over performing targets for 12 consecutive quarters.
Despite this latest volatility and investor who invested equally across all upstart cohorts would expect a nine 8% unlevered gross annualized return.
Notwithstanding the performance of the credits we must confront the fact that the largely uncommitted nature of our third party funding has proven inadequate to the task of navigating the current market turbulence.
And we have turned our efforts towards building a more resilient funding model overtime.
Despite not having suffered any adverse loan performance some banks are moving to limit their overall exposure to unsecured lending.
Investors who've earn significant excess returns during the benign cycle over the past few years are now anxious over the state of the economy and worry over the future prospects of less affluent borrowers who have been the most impacted by the termination of the stimulus.
Despite significant conservatism in our current underwriting and the prospect of historically high returns.
Investors have been reluctant to re enter the fray.
Consequently, our intention is to significantly increase the fraction of forward committed capital deployed on our platform.
Hartman ships with investors that are comfortable investing through cycles with an eye towards longer term outcomes and in exchange for predictable future access to yield.
As David said this will not happen overnight.
In the interim we are prepared to be more proactive with our own balance sheet operations, if we deem it necessary to provide a level of stability for the business in this transitional period.
As well as to demonstrate our own confidence and the models to the funding markets.
Please note that this does not represent a change in permanent strategy and we continue to maintain the view that it is not in our long term interest to run a large balance sheet or to become a bank.
However, in the context of the current extenuating circumstances, we will be flexible in determining whether a temporary change in tactics around balance sheet usage would be in the best interest of supporting the business through to its next stage.
Okay.
Given the volatility of the current funding environment and the difficulty in forecasting the timing of changing macro sentiment.
We feel it is prudent to limit our guidance for now to the coming quarter and withdraw prior full year guidance.
With that for Q3 of 2022.
We're expecting revenues of approximately $170 million, representing a year over year contraction of 26%.
Contribution margin of approximately 59%.
Net income of approximately negative $42 million.
Adjusted net income of approximately negative $9 million.
Adjusted EBITDA of approximately zero.
And the diluted weighted average share count of approximately $85 5 million shares.
Our gratitude and admiration once again to all the folks at upstart who are remaining resilient through the choppy waters that we are currently navigating to the company.
We remain as focused and with as much conviction as ever about the purpose and opportunity before us.
With that Dave and I are now happy to open the call to any questions.
Operator back to you.
Thank you.
If you would like to ask a question. Please signal by pressing star one on your telephone keypad and if you are using speaker phone. Please make sure that your mute function is turned off to allow your signal to reach our equipment.
Again press Star one to ask a question.
And well pause for just a moment to allow everyone an opportunity to signal for questions.
And we will go first to Simon quenched with Atlantic equities.
Hi, everyone. Thanks for taking my question.
I was wondering Dave or Sanjay if you could talk a little bit more about what how you actually go about refocusing your institutional by our investor.
Investor base too.
Longer term investors and.
How long that might take and and essentials.
The steps that you need to take to achieve that goal.
Hi, there sure. This is Dave I'll give a quick answer and then Sanjay.
Maybe one on China and sure. So so essentially you know the nature of our agreements today by larger are at will agreements, where the volume that anybody any particular entity is originating or purchasing is decided on a month by month basis, and we're talking about instead about structures, where theres committed funding over a significant period of time.
Many months or even years and really that's in it.
In return in some form for access to yield over that period of time.
Some form of economics that makes sense for those entities. So we don't have more specifics to share than that.
Certainly I think a lot of marketplace businesses.
Many different types of industries take actions.
To secure it effectively secure inventory on their platforms, one way or another and.
And we've decided this is just necessary for us and so we're beginning the steps, we're taking and are getting that done.
Yeah, I'll just add David that there. This is Sanjay I think that we are we have demonstrated and we'll be able to demonstrate certainly as we go through this cycle pretty attractive long term yields for anyone who's willing to hold an investor cycle and Dave.
Some of those numbers and we've got some of those in the releases.
And so I think theres a classes a capital provider out there for whom access to that would be attractive and you know those are.
Those are sort of.
No more arrangements that will take a while to put into place.
But I think that you know predominantly what we have today are on a capital.
Capital providers, who are you know vintage by vintage and in some sense may depend on either leverage or liquidity to the ABS markets, which creates more volatility. So I think now that we have some proof points, which demonstrate what youll it looks like through a cycle.
We will use that to enter into negotiations and and arrangements with the parameters that are more of the style of wanting predictable stability.
Or is it access to yield.
And so I think that's all we really have to share at this time as Dave said these aren't going to happen overnight, there pretty complex relationships, but.
I think we're all very convicted that that's that's the direction that will provide stability for our platform to get to the next level of volume.
Okay.
And just as a follow up.
I think in your opening comments you mentioned your views that are there.
We're heading for a significant slowdown in the near term recession. The next sensor months and and I guess, a slower economic growth outlook beyond fiscal 'twenty three and I was wondering if you could expand on your thoughts there and.
I guess sort of what you're seeing and what.
It gives you that much bleaker outlook than perhaps I've heard from some others.
Yeah.
Yeah sure Dave I wouldn't say that it's my outlook per se I'm definitely not a macro forecast or.
Start does not try to hold limit and it skills, you know kind of a crystal ball about the next phase.
And the economy, what I was trying to state, though is that we try to build in what you would think of as some form of market consensus where the market thinks you can.
He's going to go with a degree of conservatism sufficient for banks and investors and credit unions et cetera, they feel comfortable in the platform. So we necessarily take a what you might consider a conservative viewpoint on them only because.
It's a good starting point for those who are on the platform with capital at risk. It doesn't necessarily mean, it's my personal outlook are up starts personal out what youre really trying to reflect a reasonable and a conservative take on where the economy could be in the next couple of years.
Great. Thanks, I'll jump back in the queue.
And we'll go next to Mark an Oldman Sachs.
Hey, good afternoon. Thank you very much for the question I just have two.
First could you talk a little bit more about the fee revenue as a percentage of your originations. It was quite strong in the quarter. I was just wondering if there are any specific drivers that led to that increase whether those are.
Price increases or the loan mix and then second just on the guidance for the third quarter for $170 million of revenue.
Could you just talk a little bit about the mix between our fee revenue and net interest income and any any any.
Notable points around fair value adjustments. Thank you.
Sure Michael This is Sanjay.
Sure on the first question.
And you're sort of talking about take rates.
When you say strength you are talking about okay.
Yeah, I mean, I think it's as simple as and I think we've signaled this in the past.
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<unk> typically been optimizing for not in term pasche.
Production, but sort of long term volume and how we price.
And so our take rates are generally always been at a level where.
We are able to produce more volume that will lead to model acceleration and learning and will lead to future value and in the form of repeat loans.
And obviously in a situation like we're in today, where we are funding constrained and we're much more focused on in quarter of cash generation.
We've sort of.
Our fees are at a more optimal level, if you will and so we've we've we've priced them higher and that has the effect.
The effect of creating a more resilient and quarter P&L and so that's I would say an artifact of how we're managing the business through the Choppiness that where we were experiencing in the market.
And the second question really was around the guidance and and fair value in particular at least I mean, I think most of our revenue.
As an expression of transaction volume and fee revenue.
There there still is some you know some downside in terms of fair value them.
We disclosed in our investor materials, Besides that I don't see we're holding which is pretty much on par with last quarter.
And you know to the extent theres more interest rates.
Closure, if the rates continue to rise because we'll necessarily depressed asset values.
Create some some fair value exposure, but we're not making them I would say large assumptions, one way or the other about macro.
Variable, where really I was trying to express.
The direction of transaction volume in the end.
Consequence of your revenue.
Great. Thank you for the thoughts Andrea that's very helpful.
Thank you Michael.
And we'll go next to Andrew Boone with JMP Securities.
Hi, guys. Thanks, so much for taking my questions.
We think about you moving more loans onto the balance sheet can you help us understand the guardrails that youre thinking about understood. It's still early here, but how do we think about just what's the potential for using balance sheet.
And then as you talked about lenders and just the attractiveness of yields that are available right. Now can you talk about just how you're educating your partners to be able to step back and how could you proactively.
Them come back thanks, so much.
Hey, Andrew this is Dave.
Our on balance sheet usage I would just say first of all we will most certainly be prudent and usage of our cash in any way as Sanjay said earlier. It is not our intention to become a large balance sheet lender whatsoever. Our long term strategy Hasnt changed we aren't becoming a bank, but certainly we see ourselves in a transitional phase.
We are recognizing the need for permanent or more committed capital on the platform and as a bridge to that we want to have the freedom to do the right things at the right time to get from here to there and it doesn't really change our overall philosophy, but nor do we think it's great. At this time to have sort of a litmus test of not using our balance sheet whatsoever with a law.
Lot of cash on balance sheet, and we want to use it to the advantage of the business over the long haul so but but for sure. We're a company that has always been.
I'm very much capital efficient as a private company, what we raised very modestly compared to others. How we used it we've been profitable most of our time as a public company. So I think we had the genetics of the company that likes to be cash efficient and we certainly will do nothing to put our operational capacity at risk or our business at risk with our balance sheet.
Irrespective of whether or not we choose to use some of it within the marketplace.
I'm trying to get anything to add to that.
Yeah, I mean, I guess I sure Andrew I'll, just reiterate it.
It's still our intention in the long term to be a platform that decision.
Decisions third party capital.
You know wanted to be in the business of being a balance sheet.
Now as you've seen where we're sort of signaling a contraction in our guidance.
We recognize that when he left that we're funding more committed funding.
And they've got a suite of that point.
What we're expressing is not so much an intention.
Is it a need for flexibility in making that transition.
As Dave said, we've always been very.
Very.
You know very very a very careful stewards of the capital that are on our balance sheet, we've always run a very lean company. So.
This is really more about I'm, just making sure we have a what's the stability of our model in order to make that transition and then the second question. You asked is how are we engaging the capital markets in the funding markets.
In order to provide them this comfort and Theres a couple of ways.
Certainly.
The amount of information that we've provided to the to the broader public in the form of the <unk>.
So if it's used in the blog posts and the and the and the additional.
Additional investor information, we've released today.
We have a much deeper level of information that we take to the funding markets and in fact in the same way that we hold that sort of a conference broadcast in order to discuss business results with the equity markets, we're going to have a similar construct.
With the funding markets and so.
We do have I think it's much more information about anybody is the current direction of the delinquencies in and very real time, and we're going to do our best to express that and then part of this goes back to your question on balance sheet.
In some sense that the markets are we'd like to signal the confidence in the way that the loans are currently being priced and then the macro assumptions that they've talked about and.
Using our balance sheet to some extent as a signal I think and can provide a lot of.
A lot of a lot of comfort in the funding market. So that's something that's not lost on us given the asymmetry of information that we have around how the models are calibrated and how the loans are currently trending.
Yeah.
Thank you.
Well go next to Ramsey El <unk> with Barclays.
Hi, Thanks, so much for taking my question. This evening can you give us some color on what you're seeing most recently in the business quarter to date in July .
Yeah.
Yeah, Hey, Ramsey as Sanjay are you, referring to any particular aspect of our of the business.
The financials of the sort of volume is the credit performance or just sort of general sort of.
Candidly it was it was quite it was quite general.
Oh, Okay, I mean, I think the best expression of what we're seeing to date are in the business is I said.
So it reflected in our guidance if you will.
So.
I think that as we've said.
There's a continuing contraction on the top line, which is which as you know it is evident that anyone and I think that's.
Probably the headline for.
What really what we're managing through right now.
And would you characterize that as as having gone down and you're sort of things from some stability and performance at this point or is it still something where you have relatively limited visibility as trends are sort of maybe unstable and still sort of on the move.
And when you say performance guarantee.
The credit performance or.
I am.
I am referring to credit performance, but also I guess in addition, perhaps like the demand environment.
I don't think there's too much to comment on with respect to the demand environment outside of what we're signaling with guidance I think that's probably the best reflection, we have of it.
With respect to credit trends I would say this.
The macro environment remains very fluid obviously.
And it's something that I think as soon as a month by month.
And so I would characterize that as.
As you know continuing fluidity.
I would say with respect to how our model is sort of consuming and predicting.
The future I think theres been significant recalibration in our model since the beginning of this year. So when you. Therefore look at how the loans are performing against how they're being priced.
Pretty big changes.
In in those curves.
Maybe starting as recently as January and February and so due to that I think the model is very much recalibrated to where the macro is and as they've said in terms of how it's thinking about the future of significant conservatism any assumptions around you know what will happen in the macro and we don't have any specifics.
Knowledge or ability to forecast the macro than you or anyone else has.
But with what we have and the trends we're seeing I think that you could say that the assumptions are very conservative.
Got it thank you very much.
Okay.
Well move onto our next question from Pete Christiansen with Citi.
Good afternoon, and thanks for the question.
Two.
Steve is it real.
The relationship with the CFPB can you just walk through some of the changes that I know, there's a bunch of nuances.
But if you can give your take on how that relationship is is moving and then my second question is as it relates to the <unk> guide.
Are there any assumptions that there'll be ABS issuance in the quarter. Thanks.
Sure. Thanks, Pete I'll take the first question I'll, let Sanjay handle the second one.
We continue to have what we consider to be a great relationship with the CFPB. We've had that relationship since the very early days of the company through three different administrations.
So we have a lot of history with them, we consider it constructive we've always been very transparent and forthright with them.
We.
As many know we hadn't had this form of a no action letter agreement that started way back in 2017 renewed in 2022.
And a few months back we requested terminated early.
Really in the sense that it was mission accomplished the it had done what we hoped.
In terms of getting a lot of feedback from the CFPB on how to properly test for fairness in a sort of a modern lending model.
And so through a long period of time 10 years, we've rebuilt our what we consider to be very sophisticated forms of testing that we do on behalf of all of our bank partners.
So we have a continued strong relationship with CFPB that structure of no action letters et cetera is something the CFPB internally decided they want to move away from so I think that's you know okay.
Okay by US as we said we felt in the early days of our.
Existence, and before we had really behind how to do certain testing right. It was very useful but today. We continue to believe we have state of the art furnace testing you do that reliably on behalf of all of our lending partners.
And we do continue to have an open communication with CFPB and we'd expect to do so in the future as well.
Hey, Pete this is Sanjay to your second question.
There's no explicit assumptions, we're making with respect to our ABS issuance in our guidance and when we can.
Continued issue regularly obviously the execution in the market right now.
It's quite volatile, but we don't.
We don't have an explicit assumption around what that looks like or dependency on it.
Yeah.
Okay, Thanks, gentlemen, I'll get back in queue.
Thanks Pete.
And well we will go next to Arthur from Knight with Peter Piper Sandler.
Hi.
Thanks for taking my question just a couple of questions you know as you're deciding to use your own balance sheet or use your banking partners for some of your loans what are some of the trigger points are.
We will use to kind of make that determination.
Hey, Alvin this is Dave.
Let's just say I mean, we don't have specific.
Trigger points per se.
What we just wanted to really have this flexibility I think.
Being able to transition from one state of our funding supply to another.
It is one we want to make sure it goes smoothly and with some competence in just in and I'm getting from here to there in a way that's not disruptive to our to our partners who are employees to anything else. So we don't have any definitive trigger points other than we absolutely intend to be a cautious and prudent with the use of our cash.
We are confident that there.
There's a real profits are available on our platform. Today. So you know for that sort of basic reason it makes sense for us to do so.
But it isn't our goal to build a giant balance sheet and it's certainly not our intention over time this is too.
Sort of switched towards that form of every business. We do believe that it makes most sense for us for our employees for our shareholders for all of our partners to have some flexibility in how we navigate through a pretty unique economic time that we are sitting in today.
Yeah, Yeah that's.
Is that something that you really.
Like sort of plan to communicate to investors.
As you look to expand the balance sheet or is it kind of going to be part of the regularly regularly scheduled earnings call.
If you plan to go that route.
Hey, everyone. This is Sanjay I think I think it'll make.
<unk>.
Be a component of our regular communications with the market I don't necessarily foresee anything that is so extraordinary that would require it.
In terms of communication, but if the rates, we'll certainly make it.
But just as an aside I guess just as an aside I mean, I don't know if you've seen it but we are sort of breaking out the balance sheet and the exact components of it in their investor materials now.
Yeah, Yeah, Yeah, I didn't see that and then.
Just what are the things that you talked about certainly was.
How are you continuing to see a model.
Better equipped to price loans.
And I know in prior earnings calls you've talked about some banks, preferring to use upstart versus like a FICO score.
But are you seeing similar validation through our partners that's that may sort of ease up the funding sources are you know in terms of like.
So really validating that that your your models are better to price loans tend to shift volume drove it.
Yeah.
Well every one of the things that we've kind of tried to make it pretty clear that the 70, plus banks and credit unions, who tend to originate and hold as a primary under the credit have all done really well through them.
To all sides all parts of the cycle, if you will and have actually performed at or above expectations. So I don't think we necessarily.
Do you need any more than that some of them have stated publicly and we can see it in the data and their shared the aggregate data.
So so I think that you know.
That's all a very good thing, but I think a lot.
The issue out there really is about what may happen in the next year or two years and everybody has the right to have a different opinion about that and take actions based on that opinion. So you know.
That's part of.
Of course, the challenges is it's about the future and not about exactly what's gone on in the last year or two years and.
That sense, that's why we have sort of said we want to move toward our investor relationships that have a long term approach across through cycle approach towards investing and that will be in the end lead to a much stronger platform for a start.
Alright, perfect. Thank you very much.
Thank you.
Well go to our next question from Vincent.
Stevens.
Thanks for taking my questions I have.
First question so on the the balance sheet usage.
So I appreciate your comments on that and if you could talk about your balance sheet strength. So you've got over $900 million of cash and I guess, if you were to leveraged at conservative leverage maybe you could do two to 3 billion of originations.
The origination should support the business in the interim and so I was just wondering if you could maybe talk about some of the guardrails or sort of how you're thinking about the balance sheet usage and then relatedly.
I think you spoke about in our prior press release about selling some of the loans that were on the balance sheet. If you could talk about how that performed etsy, there's still about 600 million. This quarter you know how was the how did that go and.
What was the I guess the par value. Thank you.
Yeah.
At the end of this.
This is sanjay so just to maybe put some parameters under balance sheet.
That's correct, we have sort of about 900 million in restricted and unrestricted cash.
I would say, we have about $400 million of alone equity on the balance sheet and about $600 million of assets. So maybe like 200 million of that is financed.
Oh that will.
We don't have an intention of getting into a large amounts of financed.
Loans. So the numbers that you alluded to on Europe , and I don't think it would be anything approaching that I think it would be much more modest.
And you know this is an environment in which.
Hi, rich and candidly, it's not readily available. These days are at reasonable prices anyway. So.
Yeah, I I think of our loan balance sheet I'm sort of flexibility is being.
We noted in.
In values, maybe a couple of hundred million dollars.
With respect to loan transactions.
I would say so at transactions like the main force of gravity on those is what's going on with rates.
In the environment as you're transacting and most of that most of the transactions. We've had has been older vintages. So vintages.
That'll be accumulated maybe in Q1 of this year and six months later interest rates have gone up.
And so to the extent that they have executed below par and we've indicated that that has created some of the negative fair value pressure.
In our P&L.
It's really a function of the fact that some of the more seasoned loans.
Has just been impacted by the midstream this year.
Okay. Thank you for that I appreciate it.
One question just following up on on guidance, just if you could talk about.
So the $170 million in revenues.
If maybe you can talk about the cadence of that like are you seeing an improving.
No performance as we go through the quarter and on the contribution margin. So I'm calculating 59% so a nice.
Expansion there.
Just wondering what would be driving that maybe you know.
Maybe less marketing expense or more efficiency. If you could just talk about that thank you.
Sure Yeah, I guess in terms of the guidance, we're not really telegraphing any directionality I would say things are volatile right now and so.
And so that's more of a level than a trend if you will.
With respect to the contribution margins, yeah, and it's a sort of a bit of what we referenced earlier, which is you know when we were in a period of contraction like this we optimize for the new quarter cash generation and candidly, it's one of the <unk>.
Important and economics.
The characteristics of the business, which is we can you know were essentially suffering or sort of telegraphing, a roughly 50% contraction between the forward guidance and what was it last or in Q1, and yet we can weather that with still guiding to a breakeven EBITDA.
And the reason is because we have quite a bit of control in in terms of.
Our ability to set fees, we tend to be inelastic and below.
Optimal fee levels in normal times, and so we can raise them to buffer a lot.
Contractions and as you said when when we have less funding availability, our marketing programs, we tend to sort of keep the more efficient ones and described the more expense experimental and so as a result of our take rates go up.
Our our acquisition costs tend to go down and create some margin expansion, which in some sense tends to push against the volume contraction and it allows us to be a somewhat resilient as a business model.
Okay very helpful. Thanks very much.
Mhm.
And we'll go next to profit with Morgan Stanley .
Thanks, very much and thanks for all the detail and supplemental information I'm wondering.
When we look at kind of your expected.
Turns on by by quarter.
Right.
We're showing that you expect a pretty significant improvement on.
The cohort from Q1, 'twenty two versus Q3 and Q4, even though the total or the target gross return is some water.
Or even a little bit lower can you talk a little bit about the changes that were made for that Q1 'twenty two.
And that you're that are driving your expected.
Return on higher versus what was being done in the second half of last year.
Hey, James This is Sanjay sure.
The simple version is youre seeing the model.
Recalibrating to the changing environment and in particular.
Starting in <unk>.
Q3 of 2021.
The delinquency trends in the industry started to rise and it's been disproportionately.
Born by the I would say the less affluent borrowers if you will.
And so our models observe that and react to it and change pricing.
As that is happening and so in some sense.
Because that trend that happened between Q3 of 'twenty one.
And early this year, maybe call it Q1 or two of this year. Our model has been reacting to that adjusting recalibrating and on top of that we do what you might think of as Emmanuel overlay, which is we we have to make some estimate of what we think the future macro holds because that's not yeah. That's something that's in the training data for our machines.
And so in addition to the model Recalibrating to loss trends as they change we are making more conservative forward predictions with the macro will sort of do in the future.
And we're to the point now where I would say on a macro accommodation is fairly conservative in terms of what we're expecting to happen or maybe.
That's the wrong with what we're prepared to happens in the macro given inflation and unemployment et cetera.
And so those are really the two variables that are changing the models estimate of loss depending on.
As a as a function of the changing actuals and it's our forward prediction of how to prepare for macro continued macro volatility.
Got it and then you know when.
Can you talk about looking to add committed capital and and and expanding that range of partnerships and agreements.
What's your expectation for what that's going to do on cost of capital and what you would need to do if anything and if there is an impact where you would need to do around these and and and those kinds of things just trying to figure out like what you may have to give up in order to achieve that.
Longer better are stickier capital I guess.
Yeah, It's a great question James.
I would say that.
On the one hand, it will make notionally, certainly do a capital provider who's committing capital forward.
There is a cost for that I think it'll make capital on the margin more expensive in good times, but maybe on the margin less expensive in times like now because they are investing through the full cycle.
And the other variable is that as we sort of talked about in some of the other questions. We are quite margin rich and so we ourselves.
<unk> tradeoffs economics in the good times.
Where economics are in the in the choppy periods and in the next economic cycle.
Such that you know that the investors whole end, we're creating more stability for the platform. So I think that's it.
It's been there.
Committed capital is more expensive than a benign period.
We can we can we can offset that through our own business model and then make it up when I'm. When there are down cycles is there inevitably will be so we view our margins to be a lever that we can use to make sure that the investors are stable and the platform is stable and the borrowers are getting some amount of stability, even though as you know our mission is to is to fund.
Mentally.
You know lend lend to that for a proportion of the population, which notionally or risky.
Great. Thank you.
And well go next to no Schindler with bank of America.
Okay.
Yeah, Hi, guys I think a lot of my questions been asked already but one thing I wanted to go over.
Well two things one you said.
That you are you're going to go out to lenders.
And you have now a cross cycle vision of how are you.
Your performance are we really cross cycle are you modeling that this is the bottom and we've turned the.
The corner on kind of the low end consumer that is contrary to what.
Most of our economists are saying at this point.
Wanted to just understand what you mean and whether or not you think that these delinquencies are going to get worse from here or better.
Also I'm, a little confused on the back and forth or.
Of the.
Balance sheet with no balance sheet, using the balance sheet not using the balance sheet.
One why this oscillation.
And two how much of your how much do you really think that you're ever going to get to on their balance sheet. I mean, originally you were saying youre going to be only about 5% and that's for experimental purposes. I think in Q1, you got up to 15 and you said you would go down from there that was experimental with auto anyways.
And now you're saying you're gonna go onto the balance sheet again.
What kind of level do you think makes sense.
And final question on top of that I'm, sorry for the three but.
Who are these.
Investors that you haven't talked to who are you going out to two.
Kind of increase your supply.
Just.
Are the people that don't do personal loans are the people that are new to this market who is out there, but you are trying to evangelize what product to on the supply.
Thanks, Hey, Matt.
Jay I'll I'll take your first question.
And then Dave.
Dave and I will.
Richard on the on the on the last to the first question was about do we really think we're past the bottom of the cycle.
I think that in a short word no.
But I'll just give you our view on a couple of different nuances. So first of all I do think that what's happened to date.
While in the aggregate I think that.
Maybe there's a view that it hasn't been too bad to date and there's more to come.
I think I think the picture is.
Sort of a little bit different in a nuanced way, depending where you are in the credit spectrum I mean, if you look at the industry data.
If you're if you're a very affluent borrower.
You talk about like what has been the.
The best sort of credit performance and last year was sort of mid 2021, and where are you compared to their Europe, mildly Europe, Europe, 30% and you're still below pre COVID-19 numbers.
If you are a.
The less affluent side of the spectrum.
You were up much more than that in your well pass where you were pre COVID-19.
I think that the the timing of all this is a little bit different I think that the the less affluent side of the spectrum piece.
Peaked a little bit sooner and it's come up a little bit sooner and maybe prime borrowers are still sort of in that in that.
In that schedule somewhere.
So and then I think the second component is we've largely to us it's not just that it's the rate of change of things and Theyre very sudden changes in the delinquency trends in our core borrow or we'd sort of caught up to and we're making significant conservative assumptions about the future. So I think we're expecting further degradation.
In loss trends, but I think that the differences compared to like mid 2021, when everything was rosy and everyone's still have a lot of stimulus in the bank account and delinquencies were still like 50% of long term normal.
We are now projecting it in prepared for it. So there is still a world in which these vintages underperformed.
Going forward, but it would have to be a very very significant economics.
Setback.
In our view and so what what we really care about demonstrating to someone who will before committing capital.
That's sort of a cross cycle kind of a way is they like what what's the cycle of the returns and if you just look at the sort of returns that we by cohort that we talked about in the investor materials, you can see that it's sort of trust.
With the Q3 Q4 vintages, the Q1 looks like it's sort of working its way back and I think that you'll see that when you see the Q2 numbers.
Our belief is we will be able to tell a story that the returns have gone through this cycle and we are on the front edge of whats coming and of course, you can never fully predict the future, but just the preparedness of our models and the the conservatism of the macro assumptions are such that I think where we're ahead of the curve now so that that's the question with them.
To answer the first question I think your second question was about balance sheet usage. So I don't know, Dave do you want to chime in on that.
Yeah, sure Nat and not asked I don't know exactly how to put it what's with the back and forth on balance sheet usage, maybe the short version of it but.
Look I'd just say we're.
As a company I founded and co founded 10 plus years ago. The thing that's made us successful over the years is being nimble and thoughtful and responsive when when needed by the market and.
We certainly have a long term view that we are a marketplace business, meaning to bring lenders and investors together with consumers borrowers on the other side and that's how we view ourselves long term, having said that we came to the conclusion that having.
Sort of a litmus test that thou shalt not use the balance sheet at all does it makes sense, particularly when you see reaction to the supply side of our business.
Happen in ways that it's almost a contrary to fax to us meeting credits generally performing well and and yet for reasons that are obviously be many of which are beyond our control lenders or investors take decisions that they take so I just think in the interest of our shareholders and everybody else.
It's it's prudent for us to use our balance sheet wisely, we don't intend to become a large balance sheet lender, but at the same time.
It's important to state too.
To the community out there that we're going to do the right things for the business and we don't believe it makes sense to have a sort of ironclad litmus test that thou shall not use your balance sheet in the marketplace and that's the conclusion. We came to we think it really is as we've said numerous times now a transitional step toward a <unk>.
Where we have committed third party capital.
And that's what we think also is Ah represents a significant chance to upgrade our business structure and so.
So put those altogether and we think this is the right step forward for I'm, sorry, it's going to be part of building a much larger a much stronger upstart overtime.
And we will go.
Well go next to David <unk> with Wedbush Securities.
Hi, Thanks for taking my questions. The first question is on the take rate and it makes sense to increase the take rate in this environment I was curious how high should we expect the take rate to go over the next couple of quarters.
Yeah, David it's Sanjay.
I think maybe one way of putting this is given the given the guidance we've put out for Q3, you might imagine that we're doing.
All that we can to ensure that our P&L remains resilient.
Got it and then somewhat similar question on originations for the third quarter, I guess zooming out back to the second quarter are you able to share with the June origination number was and how that compares to July .
Yeah, we're not breaking out specific months, David I would just I would say that the trend right now is as volatile.
So theres no real directionality and our numbers are with respect to June versus July .
Got it and then quickly on the buyback can you can you talk about your appetite from here.
Yeah.
Sure David as you know, we have a board authorization to up to $400 million of which we've used 150.
I mean, it's sort of an ongoing equation between where the prices versus what we think is fair value and now of course, what other sources and uses of cash or I guess uses in particular, we might have and so.
There's always opportunities, whether it's buying back the stock and reducing them.
The dilution or looking at some of the convertibles and the market that are either ours or or buying loans, which as Dave said, we think.
Kind of a very lucrative return right now so I would just say that we're monitoring that on an ongoing basis.
We're certainly interested in.
You are making efficient use of our cash bonus so on behalf of the shareholders.
Thanks very much.
Thank you David.
And now I will turn the call over to Dan for any additional or closing remarks.
Thanks, all for being with us today.
Sanjay and I, just want to make clear, where we're not happy with our results we're not a company.
That likes to have a declining revenue from one quarter to the next.
But we are we feel doing the right things to make the company.
<unk> is a strong and.
As powerful as it can be in the future we are as committed as ever to the mission of improving access to credit for.
For those who deserve it and we are making steps to make the company stronger and better and do anticipate we'll be back on a growth track. So we appreciate.
I'll hope sticking with us through this and we're going to get back to work at.
Making up start the great company that it is.
And ladies and gentlemen, this concludes today's call.
You for your participation you may now disconnect.
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