Q2 2023 Upstart Holdings Inc Earnings Call
Please standby.
Good day and welcome to the upstart second quarter 'twenty twenty-three earnings call Today's conference is being recorded.
This time I would like to turn the conference over to Jason Schmidt Vice President of Investor Relations. Please go ahead.
Good afternoon, and thank you for joining us on today's conference call to discuss upstart second quarter 2023 financial results with US on today's call are Dave George Upstarts, Chief Executive Officer.
And Sunday, Dr. Tom Our Chief Financial Officer.
Before we begin I want to remind you that shortly after the market close today.
I'll start issued a press release announcing second quarter 2023 financial results and published an Investor Relations presentation. Both are available on our Investor Relations website, IR Dot upstart dotcom.
During the call we will make forward looking statements such as guidance for the third quarter of 2023 brought into 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 our reconciled against our GAAP results, which can be found in the earnings release and supplemental tables.
To ensure that we can 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 up start will be participating in the Goldman Sachs committed there'll be up close technology Conference September seven and the Piper Sandler growth Frontiers Conference September 12.
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 2023 results I'm, Dave Gerard co founder and CEO of upstart I.
I told you last quarter that I was hopeful Q1 was a transitional one for upstart and I continue to believe that's the case I'm pleased we delivered a quarter on quarter growth in Q2 for the first time in more than a year and more importantly, we achieved record high contribution margin and positive cash flow a result of our efforts over the past year to improve it.
Patiently and operating leverage in our business.
This is despite an environment, where banks continue to be super cautious about lending interest rates are as high as they've been in decades and capital markets remain challenged.
A closer look at our financials in Q2 suggests that upstart has the opportunity to grow quickly and profitably when we return to a normalized economy.
I'm also pleased to see clear signs that inflation is ebbing. Despite a continued strong labor market.
Our lens on inflation is different from that of others from our point of view wage growth in excess of goods inflation is a new and positive development, particularly for the less affluent segments of the U S that we tend to serve.
It is increasingly optimistic that the fed can achieve their 2% inflation target without a serious recession.
While the recession remains a possibility our view is it's likely to be a shallow white collar recession, one less likely to result in significant unemployment for less affluent Americans and I'm like 18 months ago. The fed now has readily available tools to handle a significant slowing of the economy. They can lower rates to spur growth once again.
We continue to be confident that our core personal loan risk models are properly calibrated and had been so since November of 2022.
We expect these recent vintages to deliver at or above target returns.
Funding markets remain cautious and risk averse banks and credit unions are generally focused on deposits and liquidity while capital markets are beginning to show signs of normalization.
Added another committed capital partner in July and are in conversations with several more interested parties. We also completed a securitization after the close of Q2, we significantly tighter spreads than our prior deal earlier in the year.
Meanwhile, we continue to manage upstart consciously, but optimistically and our funding constrained environment every week I remind the upstart team to focus maniacally unimproved every aspect of our business strengthening our company for a time when the markets will inevitably returned to center.
As I said to you last quarter I focus our team's energy on improving upstart in four key dimensions first best rates for all the core thesis of upstart is that superior AI enabled risk models will improve access to credit for all.
And the company that can build superior risk models faster than anyone else stands to benefit from this dramatic transformation of the lending industry.
In this light I want to share an exciting breakthrough.
We call parallel timing curve calibration. This is a technique aimed at accelerating the pace of model calibration and thus model development.
The challenge with launching a new model and lending is that you have to wait many months to see how it performs in the real world. If you're originating three year loans, then you need to originate some loans and then watch them perform for 36 months to have clear feedback on model calibration across the timing curves.
But with parallel timing curve calibration, the new model can be used to re underwrite all in process loans I think in the past generating new predictions for how they will perform in the remaining months.
This is not a back test the new model is used to predict how all outstanding loans in the platform will perform in coming months not how they performed to date.
In this way within a few months you can have a clear signal as to calibration across all months in the timing curve. This.
This results in a dramatically faster calibration process for new models from the point of view of our lending partners and credit investors. This is a giant win because it means we provide a tighter and faster feedback loop regarding model performance.
Very excited about its potential to extend our leadership in AI lending and are in the process of patenting this technique.
Next more efficient borrowing and lending.
Last quarter, we reached an all time high of 88% of unsecured loans fully automated that.
That means incident and automated approval with no waiting no documents to upload and no phone calls this matters a lot because even the most accurate loan pricing model is useless, if applying for a loan is too time consuming or laborious.
The notion of building an entirely software driven credit origination process. One that can run 24, seven and are fully lifestyle environment has been with me since upstart founding and was inspired by my years at Google. Please bear with me as I share a short story.
2003, I was interviewing for role at Google The company was still private at the time, so the world knew little about the financial Giants that was growing in mountain view.
At one point in the process. The external recruiters said I Couldnt interview that week at Google because the entire company with skiing at Lake Tahoe.
Thought to myself that is a great company.
Then she said, but get this the company is still making seven or $8 million a day in revenue I thought to myself you know that's an amazing company and the idea has stuck with me.
So how have we done.
In 2016, we began to pursue the goal of fully automated loans zero human involvement from our rate request to transfer of funds.
Proved in a matter of seconds lights out.
By Q2, 2017, 29% of our unsecured loans were fully automated and <unk>.
Q2, 2019, it was 64% in.
In Q2 2021, it was 69% and in Q2 2023, this past quarter it was 88%.
Automation doesn't just allow us to scale originations faster than head count it creates a wild moment for consumers, who have never experienced such a fast nevertheless loan application process.
We should probably have done years ago. This breakthrough experience is a signature of upstart and the lenders that we serve.
Next more resilient.
In addition to ongoing initiatives to strengthen the funding side of our marketplace, we continue to optimize our fixed costs.
This increases the leverage in our business, so that upstart can thrive across future economic cycles. In Q2, we identified another $7 million in annual technical infrastructure costs that we can eliminate bringing our total annual cost savings in tech expenses to nearly $17 million, we continue to hire very modestly.
And only in strategic situations.
We also achieved a contribution margin of 67% our best ever by a long shot. This is a sure sign that our focus on efficiency is bearing fruit.
A principal driver of this record contribution margin was our efforts to build a stronger relationship with our existing customers. As a result of these efforts 38% of our originations in Q2 came from repeat borrowers also a record for us and as a consequence of that we also saw a record low acquisition cost.
Per loan in Q2.
Next expanding our footprint.
We continued to make progress in our newer products and are excited to see the progress we'll make through the rest of 2023.
The second quarter, we made significant strides in our auto retail lending business, we expanded our footprint from 39 rooftops without start lending implemented last quarter to 61 rooftops today.
We also added 12 additional states, we now support covering more than 65% of the U S population.
We launched new risk models for both our auto refinance and retail lending products delivering as much accuracy improvement as we've seen in the last year from our personal loan models.
We continue to improve our auto recovery performance, reducing delays in recovery cycle by 75%.
The feature side, we launched a new device agnostic in store application that expands access to desktops laptops and tablet browsers.
We also brought on our second and third lending partners for auto retail no easy feat given the current market environment.
We're also making rapid progress on our small dollar relief loans. These loans started just a few hundred dollars and are currently offered only to upstart applicants who don't qualify for our mainstream personal loans for this reason they are entirely incremental to both our approval rates and our model training set.
Our first vintages have now fully reached maturity and our model is now fully calibrated with observe losses in line with expectations for our most recent model version.
First for upstart, we began using cash flow data as part of the risk model for small dollar loans.
This incremental data has led to increased approval rates and will eventually become available for all our loan products are fully automated rate in Q2 for small dollar loans was 90% an incredible achievement demonstrates the power and impact of AI in lending.
Q3 will move beyond offering this product exclusively to those declined for personal loans and will finally enable direct consumer applications.
Last but not least I'm happy to let you know that our home equity product is officially off the ground with a pilot program in the state of Colorado.
We expect a fast follow with the state of Michigan and also hope to be in a handful of additional states by the end of Q3.
This is the first stop start products, specifically designed for prime borrowers or a superior process enabled by automation is the richest source of differentiation than loan pricing itself.
As a reminder, I mentioned last quarter that we're targeting online approval in less than 10 minutes and closing process are less than five days for an upstart powered HELOC against an industry average closing time of more than a month.
To wrap up we're not yet certain the economy is headed to a better place. So we continue to be cautious while investing for the long term.
And you're now beginning to see the benefits of our disciplined approach regardless of the economy's direction in the coming months I'm confident that we're building a better stronger enterprise for the future.
We're in the pole position to lead the industry to an AI enabled future one that represents a giant leap forward for both borrowers and lenders and we do this not because of fascination with AI, but because of what brought us here the potential to dramatically improve access to credit for tens or even hundreds of millions of Americans.
There are many dimensions, along which you can weigh our efforts to make up start stronger speed of model development strength of unit economics, low fixed costs demonstrable leverage in our business improved funding supply and growing product diversity.
The dimension that gives me confidence more than any of these is talent density.
At both the executive and the individual contributor level.
So those excited about AI and passionate about its potential to improve lives. We know of no better place to an upstart to build a career.
We're hiring strategically and with extreme caution our digital first approach is enabling us to hire top talent across the country.
More than 90% of job candidates have accepted our offers in recent months an incredible success rate while much of the world is debating how to return to the office full time, we're very happy with the results of our digital first approach.
Close with a huge thank you to all up starters as well as the family and the friends that support them.
Were on an incredible mission together and it wouldn't be possible without each of you.
Thank you and now I would like to turn it over to Sanjay Our Chief Financial Officer to walk through our Q2 2023 financial results and guidance Sanjay.
Thanks, Dave and thanks to all of you for joining us today.
We're pleased with our return to sequential growth in EBITDA profitability this past quarter.
Our work to unlock committed funding rationalized, our fixed cost base and expand margins begins to bear fruit.
We accomplished these objectives, despite ongoing macro challenges for our lending partners.
And despite a U S borrower, whose recovery from the stimulus driven effects of 2021 and 2022.
Yet to fully materialize.
Our best measure of forward delinquency trends the upstart macro index has tread water over the past few months and in fact, even seen a more recent seasonal increase versus earlier 'twenty. One 'twenty three levels as we came off with the favorable tax refunds seasonality that ran through April .
Despite a continuing recovery in the disposable income stemming from the ever strengthening labor market.
Any incremental earnings over the past quarter has been directed almost entirely towards higher consumption, which has continued to increase in lock step.
And consumer balance sheets have not benefited from incremental savings as they had earlier in the year.
Despite these latest dynamics, we believe our underwriting models remain well calibrated to this environment.
And we are expecting our vintages since late 2022 to deliver or exceed their targets.
On the funding side of the ecosystem. Thanks remained conservative in managing the asset side of their balance sheets generally seeking to rationalize long positions and conserve cash in aggregate.
The ongoing supply of loans on offer in the secondary markets by sellers anxious for liquidity.
Contributes to a challenging market dynamic with.
With loan books being sold at bargain prices and creating no shortage of buying opportunities for selective investors.
Our view is that it will take some time for the market to work its way through this surplus is cheap available yield.
Despite this we continue to pursue a number of promising discussions with prospective funding partners.
Aimed at bringing more committed capital to the platform.
And believe that we will be well positioned once the loan market returns to a more traditional state of pricing equilibrium.
With these items as context.
Here are some financial highlights from the second quarter of 2023.
Revenues from fees was $144 million in Q2.
Certainly above our guided expectation of $130 million.
It is by a beneficial mix shift towards institutional funding as well as ongoing take rate optimization.
Net interest income was negative $8 million.
Virtually all into higher than expected discount rates and unrealized fair value adjustments on some existing assets as well as the impact of rising bar, where charge offs, particularly in our legacy R&D portfolio.
Taken together revenue for Q2 came in at $136 million.
The above guidance and representing a 40% contraction year over year.
The volume of loan transactions across our platform in Q2 was approximately 109000 loans.
Up roughly 30% sequentially and representing over 43000, new borrowers.
Average loan size of $11000 was up 4% versus the same period last year, but down sequentially due to growth in small little islands.
Our contribution margin, a non-GAAP metric, which we define as revenue from fees minus variable costs for borrower acquisition verification and servicing.
As a percentage of revenue from fees.
And at 67% in Q2.
Up 20 percentage points from 47% last year.
Seven percentage points above our guided expectations for the quarter.
Continued investment in loan processing automation and fraud models have led to a new high in fully automated rates at 87%, bringing down loan onboarding costs and improving the conversion efficiency of our marketing dollars.
I have a numbers of repeat borrowers have similarly improved our overall cost per acquisition.
The mix shift towards institutional funding has benefited our take rates.
Taken together our contribution margins are stronger than they have ever been.
Operating expenses were $169 million in Q2 down 35% year over year and 28% sequentially.
Its workforce restructuring initiatives announced in Q1 are now translating into reduced operating burn.
In addition, as Dave alluded to we have done a significant amount of work to improve the efficiency and decrease the overall expense of our technical infrastructure.
Each represents a large portion of our fixed cost base.
Declines in other categories, such as sales and marketing and consumer our customer operations were largely in line with the decline in the loan volumes that drives them.
Altogether Q2, GAAP net loss was $28 $2 million and adjusted EBITDA was positive $11 million both comfortably ahead of guidance.
Adjusted earnings per share was <unk> <unk> based on a diluted weighted average share count of 91.0 million.
We ended the quarter with loans on our balance sheet of $838 million down sequentially from 982 million the prior quarter.
Of that amount loans made for the purposes of R&D principally within the auto segment represented $493 million of the total.
Just after quarter close we completed a one off $200 million ABS transaction funded entirely from our own balance sheet.
As you May recall, we traditionally sponsor ABS transactions on behalf of our loan buyers who are usually the principal economic agents and loan contributors to the transaction.
In this case, we took the unusual step of funding the deal from the Q2 vintages accumulated entirely on our own balance sheet.
We did this both to reset the market understanding for how our more recent vintages should be expected to perform.
As well as to serve as a visible signal to the market of our confidence and the adjustments that have been made by our own underwriting models and adapting to the new environment.
Our corporate liquidity position at the end of Q2 remains strong with $510 million of total cash on the balance sheet.
Approximately $558 million and net loan equity at fair value.
Looking ahead, while there remain good reasons to be optimistic about the general longer term direction of the U S consumer.
In the short term, we remain circumspect about the timing of the recovery of board delinquency delinquency trends.
And the recovering health of the funding markets more broadly.
In particular until we see a definitive inflection in reversal in the trajectory of U M. I <unk>, we will continue to err on the side of being very conservative in our assessment and pricing of borrowers.
With this context in mind.
For Q3 of 2023, we.
We expect.
Total revenues of approximately $140 million.
Consisting of revenue from fees of $150 million.
Our net interest income of approximately negative $10 million.
Contribution margin of approximately 65%.
Net income of approximately negative $38 million.
Adjusted net income of approximately negative $2 million.
Adjusted EBITDA was approximately $5 million.
The diluted weighted average share count of approximately $84 5 million shares.
Notwithstanding a promising direction this past quarter.
There is still much work to be done to restore our business to the scale and growth that we aspire to.
We have made encouraging recent strides in execution operational discipline technological innovation and dealmaking.
We will continue to push for further progress in all of these areas.
When we were finally clear of the environmental turmoil around US we are convinced that our business will be as formidable as ever.
Thanks to all of the teams that upstart, who continue to execute ahead of expectation.
This is obviously not been an easy past few quarters.
I am confident that we are pointed in the right direction.
We have the right people in place to seize the once in a generation opportunity that remains before us.
Or as we like to say internally.
Under the Maple tree.
With that Dave and I happy to open the call to any questions.
Operator.
Thank you if you would like to ask a question. Please signal by pressing star one on your telephone keypad.
You are using a speaker phone. Please make sure. Your mute function is turned off until all of a sudden built to reach our equipment again, if you would like to ask a question. Please press star one.
We will take our first question from Simon clinch with Atlantic Equities. Please go ahead.
Hi, guys. Thanks for taking my question I appreciate it I'm really interested in.
What levers are.
You Oh.
How how you respond when you start to see the EMI.
Or flattened or improve.
What are the levers that you would you would be able to pull.
And how should we think that for about the speed of which you can you can start to get a recovery in your conversion rates and annual general loan growth and your market share gains as a result of that.
Alright. Thanks, I mean, this is Dave basically where we are watching me or my trends and are effectively maintaining.
What we hope to be a buffer between the assumptions that are in a new.
Loan model or are in the loans that are being produced in any particular time to the trend in your mind so as.
As we will hopefully see overtime Youre my trending back down.
At some point the underlying assumption is in the models will stick with that and again maintaining are always.
Aiming to maintain a buffer, but it should trend down so you am I as you see it really.
Is the output of whats going on out there in the economy.
And we always want to stay ahead of it and the best thing. We can really do is make sure. Your line is as accurate and as recent as possible. That's why we're continuing to innovate on it but it will be a good indication of when.
The assumptions that go into the.
Next loans that are being originated.
Okay, I understand and just as a follow up then.
I was wondering maybe Sanjay you could talk through the slide on.
The long term funding commitments and your share of the risk.
Make sure we understand sort of what's going on in that particular.
Situation of example.
Yeah, Hey, Simon as of Sunday happy to do it yeah. So we have a new slide in our materials thats meant it.
So to pull together the punch line for our essentially what we have at risk as part of our committed capital partnerships and they are a little bit hard to pull together in the financials directly because the contracts are a little bit different and they're all accounted for a little bit different differently, but like I said at a headline level.
As part of those deals we have invested are co invested to date.
On the order of $40 million.
So that I guess, you can think of that as the.
Maximum exposure, we have that $40 million over time will be worth as little as zero or as much as around $80 million or 83 million I guess, depending on the.
The timing and extent to which these loans over or underperform.
Our best current estimate given the trends is that that $40 million. We believe is on track to be worth about $52 million just a marginal over performance there.
But that's something that we will obviously our forecast and in fact for you guys over time.
Okay.
Thanks, guys.
We will take our next question from Lance Jessa run with BTG. Please go ahead.
Hey, Thanks for taking my question guys first one just around kind of the governor on your growth right now, which is that 36% APR any commentary or color around how many you kind of have to turn them back right now because there you know the the risk model is turning them above 36%.
How should we kind of think about that going forward in the coincide and sort of where you see.
Fed funds going.
Hey, Lance.
Let's see so I guess that that 36% APR cap.
With the current levels of U M is a significant <unk>.
Constraint on our business in fact, I think as we stand today.
The the bigger constraint on growth on our platform, it's very punitive.
From the perspective of our approval rates, which are quite low right now.
How to think about this evolving going forward well the 36% APR cap will not change that that's something that is sort of sacred to us.
Hi decline.
Declines sort of as Simon said in his question is are observed.
The observation of U M I declines overtime, because presumably the macro economies come back into equilibrium.
We will accordingly, reduce the forward assumptions being fed to the model.
And that will essentially reflect lower loss estimates over time and that will pull.
Borrowers who are currently excluded from our our our credit box they'll pull them back into the approval universe. So that's the mechanism by which we would expect to grow as loss rates and the economy subside and as it comes back down.
Got it. Thank you and then in terms of.
July did I know theres been some alternative data sources out there, but anything you can kind of call.
Frame around July data, and where it's come in and.
How do you kind of see that.
In terms of a quarter or in terms of a monthly run rate through August and September .
So you're asking about July deadline.
Yes, yes.
Yes.
And I think that really really in a position to comment at all on.
July numbers hopefully we'll have a good report for you when we are when we talk about Q3.
Got it thanks.
We will take our next question from Ramsey El <unk> with Barclays. Please go ahead.
Hi. Thanks. This is John coffee on for Ramsey I was wondering if you could tell me a little bit more about the loan balances you have on the balance sheet I know some came off in Q2 I think from some of your new partners and clearly those got built up.
Up a little bit again could you just maybe talk briefly about how we should think about the cadence of those loans on the balance sheet for the remainder of the year and if that billion dollar Mark is still sort of like maybe a sort of a informal high watermark that you won't go beyond or have you rethought that a little bit.
Hey, John .
I guess.
Specific comment a general comment the comment specific to Q2 would be yeah. It is true that while the the net loan balance from Q on Q2 went down.
We sort of went down further and then built it back up.
One of the things we were doing.
Deliberately was to build up some very.
Very fresh collateral to be able to put into an ABS deal.
And that ABS deal as I said in my remarks happened after the end of the quarter. So those loans sort of sit on our balance sheet at the end of the quarter and shortly after we put them into an ABS deal a bit unusual for us to run an ABS deal off of our own balance sheet as I said, but.
There's a couple of important reasons for why we wanted to do it we wanted to put fresh collateral into the AR securitization reporting so that people could see how.
The models are changing how they pay.
They might expect.
Freshly a freshly originated loans to two.
So that's maybe one dynamic that's specific to the quarter more generally I think our contract has not changed.
We're comfortable going up to a number around 1 billion or so in loan assets.
And that's a number that leaves us with still I think.
A comfortable amount of cash too.
When you're running the business and have some safety stock.
And within that within that parameter will sort of flex up and down as we are as we believe benefits the business.
Alright, Thanks Sanjay.
Mhm.
Yeah.
We're just gonna put it on one side for Ya Uhm, but the short answer to your question is no. It's not it's not really hitting the P&L in a way where fair values being you know recognized in the net interesting combined.
Okay. Thanks, and then of the of the 2 billion longer term funding commitment you announced may how much of that was founded in the second quarter.
I mean, I would say approximately 50 sort of.
Remove the back book component that was a component of that original deal roughly a quarter.
Okay. So one quarter in excess of the 352 that you sold.
Got it wrong.
No I think he dropped from me quickly.
I I, just said that that's correct.
Correct.
Okay.
The Bachelor sale or was about a quarter of the remainder.
Great. Thanks.
Sorry about that.
We will take our next question from James Fossette with Morgan Stanley . Please go ahead.
Thank you very much.
To get a little bit of clarification really quickly here.
Maybe I missed it and the Guy who are looking for around.
Minus 10 million.
Tom and the third quarter.
That being driven by uhm loans on the balance sheet or the way that the funding from it's worked through the P&L just trying to make sure I understand that mechanism.
Yeah, I would say a major factor.
Is the fact that.
Large our balance sheet now, particularly after the a b S Joey completed which where we clear that most of our recent uhm.
Core personal the remaining balances are R&D and a lot of it is very seasoned and some of those older vintages of say auto loans, you know auto loan from a year and a half ago.
Their charge offs are starting to.
Uhm to grow both because they were originated at a time where models were still.
You know sort of in calibration and as well they were originated in an environment that was it.
It has rapidly deteriorated.
Maybe you could think of this partly as some of the cost of doing R&D. We've got a book of R&D loans, now and and the charge offs are elevated.
Okay, Great and then you know I guess just as.
Related to demand and originations.
Are you thinking about the impact from from higher take right.
You know how should we think about all those could move and how overall <unk>.
Sequential basis through the room, the rest of this year 24.
Hey, James.
Sure our our rates are kind of as high as they've ever been I believe and that part of that is a function of U U M I being Super high part of it is.
The return demanded by the market is much higher of course related to fed race and also are take rate is high in all three of those contribute to the rates being.
We would anticipate those things kind of coming off together.
So so you know as you see you am I turned down and maybe at some point interest rates will trend down as well, but also heartache rate is probably higher than we would see it being any kind of normalized scenario. So all three of those very high driving price for high and for sure. The reason you know I mean, the counter to that is that.
The market for you know the loan demand is very strong.
For that reason, that's why you're seeing you know very low tax.
And so that's kind of in the <unk>.
Place, where we are today prices for credit or Super high demand remains Super high.
And that sort of nets out to where we are right now.
Okay. Thank you.
We will take our next question from Richie Smith with J P. Morgan. Please go ahead.
Hey, Thanks for taking my question guys, it's kind of a.
Follow up to to the the last question it sounds like.
Pricing is up right now.
Thinking about you know managing.
Selection.
Talk a little bit about.
Sensitivity people.
Two price.
See that your your approval converging raised down and then they will just you component to that I would imagine approvals account, but maybe you could talk a little bit about the acceptance.
Officers as well.
<unk> follow up thank you.
Uhm.
Sure So, let's see a little bit about adverse selection I have a selection tends to be an impact that is greater.
The market or the segment is more competitive so when there's a lot of competing alternatives.
Had to raise your rates, you'll typically a separate from adverse selection and of course. The the you know when when segments are less competed adverse selection.
You know this is less of an effect in our case for you know a lot of the segments.
We tend to learn a lot of volume.
You know even with higher rates, we tend to still have the best rates available uhm, so even with heartache rates and higher lots of assumptions uhm.
In many instances are still significantly below what you might think it was the market clearing right out there based on the on the credit scores and so in that instance, there's not a lot of discernible.
Reflection, if we were to try and raise our take rates significantly in very highly competed segments very prime borrowers then.
Being that we will be thinking about a lot more.
Let's do it.
And your second question, which was about <unk>.
Yeah Yeah.
Yeah.
It's very simple, it's a it's a pretty classic sort of supply and demand construct whereas we raise our rates and not only do our approval rates go down because of the 36 per cent.
Cut off but for those who remain approved there'll be less likely to take alone.
And typically at least what we've observed in our data is that people, who don't take loans with us don't necessarily take them.
From a competing source the majority of them just don't take the loan.
So it it causes people's demand to reduce.
Sure got it in one quick follow up on the Bitcoin Best Man I appreciate the disclosure how should we think about that book is are these.
Coordinated to the rest of the structure is there a certain ratios you must hold relative to what you you run through these.
Because the committee facility did any any color mucus sure there will be helpful.
Let me think about that.
Sure Yeah, I mean, they do tend to sit in the equity part of this back if you will.
<unk> senior money, and maybe mezzanine money and sort of equity a residual money.
To the.
At at the equity side of the.
Of the stack.
No.
Mmm Mmm, there's not necessarily any sort of specific ratios I think each time there is an investment made by one of our.
Partners, we tend to have a coinvestment that varies depending on the relationship.
I just need to I guess, there's no way to kind of.
Think about or know how large that could be like do you have expectations over the next few quarters like.
I'll be connecting.
None that we're talking about explicitly but I guess I would say like what we consider this to be a part of the overall sort of risk budget of the business and we've talked about.
Making sure we stay at or under a level of about $1 billion and asked at risk and you know this is part of that envelope uhm. So I would anticipate over time.
More of our capital sort of falling into this category, maybe less under direct loan assets, where we can sort of use our capital to unlock broader pools of capital and coinvest as opposed to having loans directly on the balance sheet, but I think we're gonna try to do with you guys have a conversation about the overall sort of risk.
Physician and risk budget of the company and and we'll certainly have some views on on how big was it ever want that to get.
Understood. Thanks, so much.
We will take our next question from Giuliano Valonia Wescott. This point. Please go ahead.
[noise]. Thanks for taking my question is.
Okay. I'm curious about is you'll see put him out of it you were sharing disclosure.
Curious about my history of his progress somewhat different because you <unk> and you have some other forward funding agreements funding in the corner I'm curious if you could provide a rough sense of how much you know principle, <unk> 40 million or so.
Rick sharing covers.
Hey, Julianna on the order of 800 line.
That sounds very very helpful.
Then.
Actually I'd be curious about is just thinking about my perspective, obviously took off the balance sheet.
I'm 33 <unk>.
Alright, I'd be curious if you have a rough sense of how much.
<unk> how much the volume was the <unk> the second quarter.
Was.
Yeah, I don't I don't think we have that explicitly broken out, but I think that's something that you could probably deduce from the cash flow statement.
For you in the right direction when we chat later.
Oh, probably also come out very cute when that comes out as well.
Question, I think which is a little bit of a follow up obviously, if you're on the floor Refunding Brittany sorry, you had mentioned you know in the past roughly 500 million per quarter.
You mentioned, an additional some additional partners I'd be curious if that number changes and obviously that will impact kind of where the risk sharing goes because.
May not have mortgage loan so I was going forward.
Just to get their perspective on that.
Sure so sorry, you're asking if the amount of committed funding.
Per quarter expectation is graff.
Yes that has changed.
Okay.
She was roughly 500 million per quarter I'm curious if that has changed now with the new phone agreements been based on the current arrangements of course.
I would say not in a new meaning.
Meaningful enough way to sort of.
Re announce it if you will as Dave mentioned, we did we are working with a new partner.
In the community capital World in there now.
Sure.
Getting into refunding, but some of our constraints an hour on the borrower's side and so I think you know given that we're probably in a similar ballparks.
That's very helpful. I appreciate it.
And I will drop out.
We will take our next question from David Scharf with J M. P. Securities. Please go ahead.
Good afternoon, and thanks for taking my questions a lot of been asked I guess these are kind of extensions of what's already been.
But Sunday.
Just back to.
<unk> I guess, the the funding side and it is and.
And how it impacts kind of how you're thinking about the origination. So I I know you've reiterated sort of the comfort level of that billion dollar.
Ceiling on retained assets.
But is there any sort of targeted roadmap.
You know for year end, where you'd like to.
To get the balance sheet contracted to I mean, she should should we be thinking about all these new funding partners as vehicles for stepped up asset sales in the second half just just trying to get a sense of how we ought to think about.
On balance sheet exposure going out six months and ultimately how much room you have to you know <unk>.
Reaccelerate volumes when the.
Macro environment dictates it.
Hey, David.
Sure.
Let's see I mean.
A lot of it is dependent on the environment of course, I mean in an ideal world.
What we'd love to do is reduce the balance sheet significantly apply it to R&D and begin to maybe apply more of it.
Very surgically to these committed capital type condiments, where we can unlock much larger pools of third party capital Uhm. That's the ideal now we're an environment where borrowed demand is high funding markets are tight and frankly the collateral has.
A lot of excess value I think that the price for very high yields and we can provide a lot of value to the business with one extra dollar origination.
From the perspective that you know, we obviously and lots of allowed to take right and then.
Similarly, I think these loans are price for video so it's it's a it's a rational economic decision in the current environment.
We'd love a normalised environment, where there was plenty of third party capital to satisfy the borrowed demand and we weren't in a position of using arts, but uhm that will require essentially a normalization of your mind, a normalization of the funding markets.
Got it kept trying to say whether that will happen by the end of the year or not.
Understood It may be a follow up.
Regarding the.
The negative fair value Mark's you know again this quarter.
Where the downward revisions are they mostly related to kind of discount rate prevailing rates as a more credit performance related or is it just based on.
You know with somebody underperforming loans for sale out there you know just kind of prevailing market.
Data points here, you're saying and kind of related to that.
Sort of evenly distributed those fair value decreases to personal loans and auto is a more concentrated on it.
Sure Yeah, so in in Q2.
There's two things of about equal magnitude.
One was on the unrealized fair value side, where where some of our assets, notably some of the call investments we made.
And some of these deals. They they were you know they had apply to them a much deeper discount rate than we are anticipating by the third party valuation.
So that was sort of an unrealised value reduction.
And the other was what I mentioned earlier, which is you know <unk> well I mean are R&D portfolio, which is predominantly auto.
You know, they're they're getting to a level of charge offs and all that.
Down.
Uhm I think everything about two three and forward. It's it's predominantly the ladder. It's it's you know old loans and the auto segment that were originated in a very different environment with a model that was still undergoing calibration and so now that you know I think we've learned a lot.
In our calibration of the auto product in in terms of the size scale and timing of that R&D effort I think there's some some great lanting's, we've had and how we will apply differently to the next set of products that we're gonna calibrate, but you know the order book that we have that and that's really at the root of the charge offs that are coming through the piano now.
Alright, thanks, so much.
We will take our next question from Vincent can't take with Stevens. Please go ahead.
Good afternoon. Thanks for taking my questions first question, just kind of a big push fix your question about your funding partners when.
When we last spoke about the the casually $2 billion I think that was a proof of concept. So just wondering if you could talk about the conversations to appetite you've been having from from potential partners and kind of a mix between.
Institutional investors versus the bank and all the guys are presumably.
This this co investment capital Coinvestment sides very helpful.
Seeing that the assessed value is higher than the initial capital invested soda, presumably that implies that the performance is better than.
The initial agreement so just sort of wondering if you could talk about the appetite earlier discussions with your partner's. Thank you.
Sure Yeah. So a couple of questions and that is a Sunday I'll I'll sort of.
Talk through them the first question.
But the nature of the discussions around these sort of somebody's capital type deals Uhm, we've done a couple of deals now.
Slightly different flavor, but they all sort of get to the same thing which is it's it's a counterparty that has the wherewithal to spend you know through a cycle and for some committed period of time and in exchange. We think there's some pretty attractive returned profiles.
For them and as we've shown we're willing to put our skin in the game alongside.
And I think that's that is on the one hand, a very attractive conversation right now and I think there's a lot of people who are engaging on the other hand as I said you know it's a it's a it's a market with a lot of distraction in it right now and so these conversations are making progress, but I think they are you know there's a lot of company [laughter] and any investigate selective right now has a lot.
Interesting options available some are you know.
AD hoc and one off others or more programmatic like the ones. We are talking about with them and so I think that it's proving to be an interesting and attractive option, but in a crowded field right now the the split between institutional money and bank money I would say as we said in our remarks some of our take rates.
Benefited this quarter because there was a further shift towards institutional money.
No secret that banks have challenges right now with liquidity a lot of them as we said are looking to harvest cache and.
And so you know that that that was a that was a sort of a mixture if that happened and Q2 it wouldn't surprise me.
If if that trend health or continued in Q3.
S for as for the.
The committed capital.
We outlined in our investors slide.
And how to think about it I guess first of all we're saying that you know the the a large part of that initial investment.
Investment of capital on our part wasn't just new originations as you recall there was a backup transaction.
That was a part of the Catholic deal that you mentioned.
And so there was a sort of a one time sort of retention of basis in that deal. That's part of the $40 million I would say most of the new originations that we produced under the guise of these committed capital deals in Q2 are sort of on track and at par if you will.
The majority of the upside that we have between the $40 million that we invested in the 50 that were sort of.
Assessing or forecasting is has to do with how the the Bath book itself was price and how it was expected to perform and it is in fact, you know beating those expectations.
So it's less with their reflection of new originations more reflection of the of the backlog, which is a pretty sizable portion of that $40 million I guess the other implication is as you think about how that might grow in the future. It's certainly no girl a clip of $40 million a quarter based on the agreements we have in place.
Okay. That's super couple of quick follow up so to take rates, presumably from the the make shift in funding it would it be unreasonable to assume that the take rate holds or even gets better going forward just wanted to confirm that thank you.
I guess, an aggregate you can see that we sort of guided two relatively flat contribution margin next quarter maybe.
At marginally lower.
And so I think maybe you could fly infer from that that Arctic rates were assuming that they are gonna be roughly stable to this quarter and the medium to longer term Miss Dave said, we would expect with a normalizing economy for our <unk>.
To to slowly.
Subside.
Okay. That's very helpful. Thank you.
Thank you.
And we have time for one more question and we will go to Simon claims with Atlanta Equities. Please go ahead.
Hi, guys. Thanks for taking my second Patrick questions I was actually wondering I mean, maybe David you could talk a bit more about the parallel timing curves calibration because.
Most tech savvy person and it it sounded an awful lot like back testing to me, but you say it isn't so I'll be very interesting or how it <unk> how it differs.
Why isn't it back to us to N y U.
I guess, what this really means in terms of your ability to to capture the next.
The next wave of well I actually managed through the next cycle is that we see in much better fashion than you have done in the last couple of years.
Yeah sure Simon I mean, ultimately it comes down to being able to calibrate a model as quickly as possible, which really just leaps you into developing the next model and and so at the heart of it is it's about you know the model development speed, but the way it generally works as a Baptist is when you.
You know you apply you apply a new model to a bunch of old loans and see if we can accurately predict the outcome I mean, that's sort of the way that models are developed in the first place is is something like a very large backed us it's essentially what AI training is but in this case, what we're actually doing is not predicting the patch.
Last but predicting the future for loans that a different model had originated and so what that really means as I said earlier.
Normally you know if you have 36 month loans, if you Wanna get accuracy.
<unk> you know the performance of the model to the entire time encourage you need to wait 36 months of course, but if you have a diverse set of loans that were originated in all sorts of times in the past several years.
Even in the first month, you're getting observations into all 36 months of the timing curve and that's because you have re underwritten model loans that were originally down under a different model, but you're not predicting the past are predicting what they'll do in the next month and the month after that so that's what's really unique about it is it is the true model. It is.
Predicting future.
Future performance of loans, but it's predicting the future of loans that it didn't originally was not originally used to originate.
And that's kind of the magic of it is it just gives you a lot more data about the performance of your loan specifically about the timing curve, then you could get which would normally again take much longer time and and that's the heart of it. It's it's it's a very novel notion. It helps you have a very clear understanding of how your models performing very very quickly.
And and not all goes toward towards speed.
Okay, great. Thanks for that I'm Gonna have to go back to school and that one thank you.
We might try to write something up on this to get for for the for.
For the nurse you really Wanna dig deep in to have is something like this works, we we'll probably tried to put something out there.
And that concludes today's question and answer session I will turn the conference back to Dave derived for any additional are closing remarks.
Alright, thanks to everybody for joining us today, I'm confident the financial services and lending in particular will be one of the bright shining stars for a I in the coming years and in the coming decades, and we believe there's no company better position to leave that transformation an upstart. So thanks for joining us today.
See you next time.
This concludes today's call. Thank you for your participation and you may now disconnect.
[music].