Upstart Holdings, Inc. Q4 FY2023 Earnings Call

Good day, and welcome to the Upstart Fourth Quarter 2023 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jason Schmidt, Head of Investor Relations. Please go ahead.

Good afternoon and thank you for joining us on today's conference call to discuss Upstart's fourth quarter and full year 2023 financial results. With us on today's call are Dave Girouard, Upstart's Chief Executive Officer, and Sanjay Datta, 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 fourth quarter and full year 2023 financial results and published an Investor Relations presentation. Both are available on our Investor Relations website, ir.upstart.com. During the call, we will make forward-looking statements, such as guidance for the first quarter of 2024, relating 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 a non-GAAP financial measure and are reconciled to 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 limit yourself to one initial question and one follow-up. Later this quarter, Upstart will be participating in the Citi's 2024 13th Annual FinTech Conference on February 27th; Morgan Stanley Technology, Media & Telecom Conference on March 4th; and the Citizens JMP Technology Conference on March 5th. Now, we'd like to turn it over to Dave Girouard, CEO of Upstart.

Good afternoon, everyone. I'm Dave Girouard, Co-Founder and CEO of Upstart. Thanks for joining us on our earnings call covering our fourth quarter and full year 2023 results. Despite the difficult lending environment, we delivered solid results to end the year with revenue up 4% sequentially and our third consecutive quarter of positive adjusted EBITDA. Without question, 2023 was a challenging year for both Upstart and the lending industry and we're glad to be done with it. With interest rates at their highest in decades, elevated consumer risk throughout multiple bank failures leading to extreme caution and conservatism among lenders and a significant dislocation in capital markets the environment presented one hurdle after another. Considering the challenges 2023 presented, I'm happy with the decisions we took and the progress we made for the long-term success of Upstart. Looking ahead, we remain cautious about the near-term outlook for our business and we'll continue to operate responsibly in this environment. But I'm hopeful that you'll begin to see the benefits of our work as the economy continues to normalize in 2024. The numbers will show that we actually become far more efficient. And even while becoming more efficient, we've laid the groundwork to become a more resilient and diversified company that can thrive through a wide range of economic conditions. With regard to efficiency, in Q4, we increased our contribution margin, both percentage-wise and in absolute dollars versus the year ago quarter. We also finished 2023 with 26% fewer headcount than at the end of 2022. Despite this, we hired almost 200 new Upstarters in 2023 as we continue to strengthen our teams and reinforce our priorities. Improved efficiency sets us up well for a return to profitable growth in the future. But 2023 was not all about efficiency, we also focused intensely on building a stronger Upstart for the future. Let me share six areas where we've made significant progress recently and why I believe they'll lead us to a bigger and brighter future. Number one, managing the macro. In the last two years, we experienced an economy unlike any in recent history. In fact, if you look even further to the past, you would be hard-pressed to find an economic cycle similar in form to what we've experienced since the beginning of the pandemic. While most of our innovation historically has been focused on selecting the right borrower at the right price, we learned that disruptions to the macro economy can reduce banks' desire to lend altogether, particularly in unsecured credit where risk is naturally greater. In 2023, we took on this challenge by releasing the Upstart Macro Index, a tool that provides lenders with a clearer picture of the current state of the economy and enables them to make more refined decisions about their lending programs. We also developed Parallel Timing Curve Calibration, which helps calibrate new versions of risk models faster than what was previously possible. While we believe predicting the economy's future is unrealistic, we do think lenders can be far more data-driven and nuanced in their decision-making. UMI and PTCC represent a giant first step toward offering a proprietary set of macroeconomic management tools that we expect banks and credit unions will demand for all their lending programs. Such a tool set is vital to Upstart's mission because it has the potential to make appropriately priced credit readily available to more Americans in all parts of the cycle. Number two, extreme automation. Because so much attention goes to our risk models related to credit decisioning, it's often less well appreciated how much progress we've made in building a highly automated and efficient credit origination process. Automation and efficiency are a winning combination in any economic climate. In Q4, we once again achieved an all-time high with 89% of our unsecured loans approved through an instant and fully automated process. Though we expect this number to vary quarter-to-quarter, the long-term trend has been clear, and it's a big win for us. We believe process automation is a durable advantage for Upstart that creates an obviously better user experience. Who wouldn't want to be approved instantly for a loan rather than having to upload documents, schedule phone calls, or wait hours or days for a response from a credit analyst? We believe a fast automated approval is essential to winning over borrowers who have lots of choices and little patience or time, and these tend to be the best borrowers. And it's not just a better user experience. In Q4, 92% of automatically approved applications converted to a funded loan, while only 27% of those involving manual steps converted. That's an astounding difference, more than 3x the conversion rate. Improved conversion from automation mechanically reduces up-funnel costs associated with customer acquisition and data associated with generating the rate offer. Of course, automated loans cost Upstart far less to process in the verification step, contributing directly to our efficiency and allowing us to pass the savings along to our lending partners. We recently began to brand and market our automated approval process to applicants as 'Fast Track.' Just by pointing the benefits of Fast Track to applicants, we've increased our funnel conversion by more than 2%. Number three, strengthening our core. We've also focused on strengthening our core personal loan product for periods of higher interest rates and elevated risk, such as we've been experiencing in recent quarters. In the coming months, we expect to release an optional feature that allows borrowers to provide collateral to support their personal loan application. This option will help borrowers access credit at lower rates than would otherwise be possible, particularly at a time when rates and risk are elevated. We've also identified a somewhat different opportunity to assist our lending partners in periods of reduced liquidity, when banks tend to prioritize retaining existing customers over acquiring new ones. We're hard at work at developing tools and techniques to help our bank and credit union partners do just that, strengthening their relationships by better serving existing customers. We expect to share more about this later in 2024. As I mentioned last quarter, we've also upgraded our investment in servicing and collections and are hopeful we'll see dividends from this investment in 2024 and for years to come. The product team working on our servicing platform grew by more than 60% in Q4. Much of the effort is focused on simply making it easier for borrowers to pay and for servicing agents to handle borrowers' issues quickly and efficiently. But we're increasingly excited about applying our machine learning expertise to this aspect of our product as well to maximize repayment and optimize handling of borrowers who may go or have already gone delinquent. We've begun programmatically gathering the data that will unlock the type of efficiency and efficacy gains in servicing that we've long seen on the origination side. Number four, upgrading the money supply. In our first 12 years, the lion's share of our innovation has been focused on AI-enabled credit origination. In parallel, we've also developed capabilities related to efficient customer acquisition that are serving us well. But we've directed far less innovation towards the supply side of our business, i.e., the money, and this needs to change. Today and in the coming years, we are increasing our innovation on the money supply and have a healthy head start in this area. Success in this domain means our funding across products will be more scalable, more reliable, and more competitive with respect to cost. We believe this innovation can be unlocked by long-term partnerships that combine novel risk sharing and returns moving structures with direct and proprietary access to our credit origination engine. After the quarter end, we closed an agreement with Ares, a leading global alternative investment manager for them to acquire $300 million of personal loans. Additionally, we signed an agreement with a lending partner that we expect will originate approximately $500 million in loans over the next 12 months. Number five, products for all environments. We're building a set of Upstart offerings that are countercyclical to each other with the goal of developing a more balanced portfolio of credit products with less volatility in overall volume. We're particularly excited about rapid progress in our first home lending product, a HELOC. This product is popular in high-rate environments when consumers are reluctant to sell their homes or refinance their mortgage. We recently crossed our first $5 million in cumulative HELOC originations, and our month-to-month growth is quite encouraging. We've now expanded to 11 states plus Washington, D.C. and expect to add a few more states in the coming weeks. In Q4, our average HELOC time to close was down to nine days. This is amazing progress against our long-term goal of a five-day close and already dramatically better than the industry average of more than five weeks. In Q4, we also launched our first instant approvals for the HELOC product. This means we're now often able to instantly verify identity, income, and home value without any tedious document upload or waiting. We're hopeful this will become a meaningful percentage of our originations this quarter. We expect to drive this instant approval percentage up for HELOC, just as we've done successfully with unsecured personal loans. Lastly, we successfully integrated our HELOC within our personal loan application. This means personal loan applicants who are homeowners may be offered a home equity option in addition to an unsecured loan. This is an area ripe with opportunity, and we expect to refine and expand this product integration over time. In contrast, high interest rates made 2023 a difficult year for auto lenders. Regardless, we continue to make progress with our auto offering. We used the time to grow and strengthen our relationships with auto dealers, rounding out our retail software with key features most requested by dealers. We also expanded our finance offering with 88 dealerships now offering Upstart auto lending, up from 27 a year ago. And we recently announced that we're expanding our AI-powered financing capability nationwide, expecting to reach 90% of US consumers by the end of this quarter. We're confident that steady focus on the auto vertical will be rewarded once interest rates begin to decline. Number six, extending Upstart's AI leadership. While the last couple of years have been challenging, I believe they've ultimately extended our leadership in the application of AI to lending. Our models learned more than at any time in our history. We've navigated extreme changes in macro conditions and built tools and capabilities to manage through such changes in the future. With our small dollar product, which I consider to be at the frontier of AI-enabled lending, we've tripled approval rates since August, and this product now represents about 15% of first-time borrowers on the platform. This type of rapid improvement, along with increasing automation and efficiency, gives me confidence that our forward progress in this domain is unparalleled. To wrap things up, I'm pleased to share that in January, we brought Upstarters together in Austin, Texas, to kick off 2024 with our largest Upstart gathering ever. We spent significant time talking about why our mission is so vitally important, and we left with a greater sense of purpose for our work. Upstarters across the country are confident and undeterred by the challenges involved in pioneering AI lending because they appreciate the size of the opportunity before us and the impact that access to affordable credit can have on the lives of all Americans. While many fintechs and even banks retreat from the lending business, we remain strongly committed to it. Americans will always need access to affordable credit. And by continuing to serve borrowers through this difficult time of extending our advantage in training data, model calibration, products, and process. Once the economy inevitably normalizes and lending becomes fashionable again, I believe it will be difficult for others to catch up with us. We're excited for the new year and optimistic for what it holds for Upstart. Thank you. And I'd now like to turn it over to Sanjay, our Chief Financial Officer, to walk through our Q4 and full year 2023 financial results and guidance.

Thanks, Dave, and thanks to all of you for joining us today. The hallmark of our economy in the second half of 2023 has been the remarkable and unrelenting growth in personal consumption, which continued unabated through the balance of the year. This trend stands in contrast to the flagging level of disposable income, which on a real per capita basis peaked before last summer and has since languished. These contrasting portions of consumption and income over the back half of last year have left personal fiscal health in as precarious a state as it has been since the Great Financial Crisis, with personal savings rates hovering close to all-time lows. With respect to the corresponding impact on unsecured credit performance, we continue to see clear signs that the rising default rates of lesser prime lower FICO borrowers that has played out over the past two years is now stable and showing signs of imminent recovery. However, the same pattern of rising defaults is now in the progress of working its way through higher cycle, higher prime borrower segments, as well as primary and more secured products. According to our recent report released by the New York Fed, auto loans and credit cards have now spiked to their highest delinquency rates since the Great Financial Crisis and continue to rise. Within unsecured lending, our view is that the near-term risk in credit has shifted to the primary customer segments and as a result, we are becoming increasingly conservative in our underwriting of these higher cycle borrowers. The funding markets continue to be oversaturated with assets on offer in the secondary markets, largely coming from banks who continue to reduce the size of their balance sheet through asset sales. Despite these ongoing distractions, institutional loan buyers appear increasingly comfortable with the prospect of a soft economic lending or perhaps even that no lending will be required and there is an increasing anticipation of rate cuts at some point later in 2024. The general outlook on the macro economy seems increasingly consistent with our own long-held view that inflation is on the wane and that significant unemployed risk in this labor market is unlikely. We are optimistic that our ongoing partnership efforts with the institutional funding markets will become increasingly constructive over the course of the coming year, should these macro trends unfold. The examples of the partnerships that Dave announced earlier that have closed since the end of last year are hopefully indicators of more good things to come in 2024. With this environment as context, here are financial highlights from the fourth quarter of 2023. Revenue from fees was $153 million in Q4, slightly above our guidance of $150 million and up from $147 million last year. Net interest income was negative $13 million in Q4, with continued R&D portfolio charge-offs in line with expectations and a downward revision to the outlook of our risk capital co-investments, reflecting the deterioration in the prime borrower loan performance. Taken together, net revenue for Q4 came in at $140 million, above our guidance and up 4% from the prior quarter. The volume of loan transactions across our platform in Q4 was approximately 129,000 loans, up 12% sequentially and representing over 82,000 new borrowers. Average loan size of $10,000 was flat versus the same period last year and down 9% sequentially. 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 came in at 63% in Q4, just ahead of guidance and up 10 percentage points from last year. As Dave highlighted, we continue to benefit from high levels of loan processing automation and fraud modeling efficiency, achieving another new high in the percentage of loans fully automated at 89%. Operating expenses were $188 million in Q4, down 9% year-over-year, but up 5% sequentially as increasing sales and marketing spend somewhat offset efficiencies in automation and servicing costs. Altogether, Q4 GAAP net loss was $42 million, while adjusted EBITDA was positive $1 million, both just ahead of guidance. Adjusted earnings per share was negative $0.11 based on a diluted weighted average share count of 85.6 million. We completed the full year with net revenue of $514 million, down 39% from 2022, a contribution margin of 63%, up 14 percentage points from the prior year and adjusted EBITDA of negative $17 million, representing a negative 3% adjusted EBITDA margin versus 4% a year earlier. We ended the year with loans on our balance sheet of $977 million before the consolidation of securitized loans, down from $1.01 billion the prior year. Of that balance, loans made for the purpose of R&D, principally auto loans, was $411 million. In addition to loans held directly, we have consolidated $179 million of loans from an ABS transaction in the third quarter, from which we retained a total net equity exposure of $38 million. We ended the year with $368 million of unrestricted cash on the balance sheet and approximately $590 million in net loan equity at fair value. Some amount of the core personal loans added to our balance sheet in Q4 were aggregated in anticipation of a secondary loan sale that was completed following the close of the quarter totaling $300 million. Despite the promising economic indicators around inflation and employment, we believe we are not yet completely out of the woods from a macro perspective. The excess money in our collective savings accounts, plentiful during the stimulus years, has been spent after accounting for the effects of inflation and with historically low savings rates, the cash account balances in the economy continue to contract. As noted, we believe rising delinquencies are now making their way over to the primary and more affluent segments of the borrower base, which is causing us to increase the conservatism in our loan pricing for those borrowers. Considering the lingering credit risk and keeping in mind traditional seasonal softness in the first quarter of the year, for Q1 of 2024, we expect total revenues of approximately $125 million, consisting of revenue from fees of $133 million and net interest income of approximately negative $8 million. Contribution margin of approximately 61%, net income of approximately negative $75 million, adjusted net income of approximately negative $33 million, adjusted EBITDA of approximately negative $25 million, and a diluted weighted average share count of approximately 87.0 million shares. Having observed the stabilization and recovery of delinquency trends from lower prime borrowers, we believe to have cause for optimism coming into the new year. And so it has been disappointing to see how the primary borrower segments are now quickly following suit and extending the strain of the current environment. We will, as always, continue to act in the best interest of credit by quickly reacting to raised prices and lower conversions in these segments, confident in the belief that this will always lead to the best long-term outcome for our business. If the earlier arc of the less affluent borrowers is any indication, the same cycle amongst primary borrowers will soon normalize. And when it does, we continue to have conviction that we will be very well positioned to capitalize. Continuing thanks to all of the Upstarters who are persevering through this. With that, Dave and I are happy to open the call to any questions.

Thank you. Our first question is from Kyle Peterson from Needham. Please go ahead, sir.

Great. Good afternoon. Thanks for taking the questions. Just wanted to start off on funding and what the kind of constraint of growth right now is. Is the constraint right now on funding, whether it be committed capital or other buyers or this kind of a borrower demand and getting people below that 36% threshold? Just kind of want to see what the different gating factors are right now?

Hi Kyle, this is Dave. I think that there's not an obvious excess of funding or borrowers. It does kind of bounce back a little bit back and forth because the pricing of loans is so high; the approval rate is relatively low compared to our history. But it's still a funding constrained environment. So, it's not definitively leaning one way or the other right now.

Got it. That's helpful. And then just a follow-up on core personal loans, health, and balance sheet at the – sequentially, it ticked up quite a bit. I guess, adjusting for that, the loan sale looks like it did continue to glide down. But I guess, excluding some noise in the loan sales and some of the timing issues, should we expect the core personal loans on the balance sheet to continue to run down at least outside of the committed capital and risk-sharing agreements? Or could that bounce around a bit?

Hey Kyle, this is Sanjay. Yes, I think one of the things we referenced is that one of the reasons we aggregated a bit more than usual in the prior quarter on our balance sheet was in anticipation of the balance sheet deal that we did that closed, subsequent to the end of the quarter; we've disclosed it as a subsequent event, but it's a transaction that Dave referenced. That was a $300 million transaction.

Okay, that’s helpful. Thanks, guys.

Thanks, Kyle.

And our next question is going to come from David Scharf from Citizens JMP Securities. Please go ahead.

Yes. Good afternoon and thanks for taking my questions. Sanjay or Dave, I'm wondering, in light of your commentary about sort of delinquencies stabilizing more among kind of the lower-tier borrowers and kind of seeing more deterioration among prime. Can you remind us sort of what the borrower FICO mix is that you're targeting? I mean, I know from securitization docs very often had sort of an average FICO in the 670 range. But can you define for us a little better sort of how you're viewing the core target borrower base right now, sort of how you're defining near-prime?

Hey David, it's Sanjay here. Historically, we've indicated that FICO is not the best measure for understanding our portfolio due to its broad distribution across different grades. Over the past 18 months, we’ve noticed that less affluent borrowers have become riskier, which has led us to adjust their loss estimates and reduce their approval rates, resulting in a lower presence compared to the past. However, these borrowers are starting to show improvement in repayment trends, while more affluent borrowers seem to be following a similar path. This shift will influence our pricing and cause changes in our portfolio mix. It’s challenging to summarize our platform using a general FICO metric because of the broad distribution across grades and the differing loss rates by funding channel, whether it be a bank or a credit union. Those details often don’t appear in securitization data, whereas institutions typically experience higher loss rates and returns. Due to this complexity, capturing our platform through a conventional lens is difficult, but overall, you can expect to see higher loss rate borrowers recovering from previous trends while lower loss rate borrowers may start to decline.

Got it. It's helpful color. And maybe just as a follow-up, focusing on the Q1 guide. Would you characterize the origination outlook in the fee revenue guidance as sort of the normal seasonality that we typically see in Q1 tax refund season with non-prime borrowers usually paying down balances? Or is there any kind of further tightening of credit that we should read into that?

Sure. Yes, David. I think there's probably two components to call out, and one of them certainly is what you're describing, which is I think, usually in Q1 you run into a bit of a slump in borrower demand as you get into tax refund season, and we're certainly anticipating that. I think that you could probably assume is what we've seen on average in prior years. And then the second one is what we described, which is that, in fact, we are reacting to rising loss or sort of default trends in the primary borrower base by increasing loss estimates and reducing conversions a bit. But those two things combined probably make up the gap or the bridge to our Q1 guide.

Great, very helpful. Thanks so much.

Thanks, David.

And our next question is going to come from Ramsey El-Assal from Barclays. Please go ahead.

Hi, gentlemen. Thank you for taking my question this evening. I was wondering if you could comment on the on-balance sheet loans and that amount and whether, given the additional committed capital you are securing, we should expect that to decrease from current levels next year or if this is about where it will remain for a while?

Hey, Ramsey, it's Sanjay, again. I believe there are a couple of factors to note regarding our loan balance at the end of the year. First, similar to the previous quarter, we have consolidated a recent ABS deal from 2023, which adds to our balance sheet. However, we have a much smaller economic basis in this than the total amount of the consolidation. The second factor is that we announced after the quarter ended that we completed a balance sheet transaction with an institutional funding partner, which was around $300 million. In Q4, we were accumulating loans in preparation for that deal closing, so many of those loans are now off our balance sheet. Looking ahead, as we hopefully have more to announce regarding committed capital deals, those will replace our balance sheet and account for more of the volume. Additionally, we are always looking for liquidity sources for our existing balance sheet, which depends on market pricing and returns. Together, these two factors will influence how much we can reduce our balance sheet in the coming quarters.

Got it. Okay. And a follow-up for me. I wanted to ask about auto loans. On Slide 23, it looks like the number there declined pretty significantly again quarter-over-quarter. I guess two questions are, when do you expect that to maybe bottom out and begin growing again? And then secondarily, is there a business risk that your auto customers get turned off because your approval rates are quite a bit lower than they were? Is there any kind of ancillary business risk of managing the credit side of the business at this point as you're trying to build the business? Thanks.

Sure. Good question. Let's just say, obviously, rates have been very high in the auto lending world, both because interest rates are high and because the price of cars is very high. So, I think that's really contributed to an environment where the volume is down. We are very careful working with a fairly tight group of dealers that we work on lending with. And we're very aware that we need a certain throughput with each of these dealers. So, it's something we do manage carefully. We've done a lot with our software beyond lending. So, I think there's a lot of value we are delivering to these dealerships irrespective of the loan volume going through our part of the platform, managing their online parts of their business as well as the in-store process of selling cars. So, there's a lot more to what we do for dealers than just the loans. So, we feel pretty good about that.

Fantastic. Thank you very much.

And our next question is going to come from Peter Christiansen from Citi. Please go ahead.

Good evening. I appreciate your responses. Dave, I want to revisit Ramsey's comments because I believe they are significant. Regarding our forward flow agreements and the innovation you aim to achieve, should we consider having an equity stake in some of these agreements as standard practice? Will that be a common occurrence moving forward, or do you intend to gradually reduce that balance sheet exposure completely?

Good question. I think we generally think that we're headed in the direction of having a number of large long-term relationships where there is risk-sharing and alignment structured into the process. And we think this is both necessary and important to having that type of relationship and having the capital committed over long periods of time. So, we are exploring different structures to those and some participation in those. But I think this is the nature of what we believe will be important and necessary to have long-term funding partnerships with the types of partners that can really help us rescale this business and get to where we were and far beyond.

Thank you for that information. I have a follow-up question, perhaps for Sanjay. With many forecasts out there predicting two or three cuts from the Fed this year, how should we consider the impact on the conversion ratio? Should we expect to see cuts of 25 to 50 basis points? Is there a general guideline we should follow if these cuts occur later this year?

Hey Pete, I mean interest rate reductions would obviously be helpful to conversion. And I think the extent to which it improves conversion is a bit depending on, let's call it, the premise of the borrower. I think maybe a rough rule of thumb in aggregate could be for a 100 basis point reduction, something on the order of 10% to 15% relative conversion boost, but that will vary by borrower type.

Sure. Sure. Thank you very much. Super helpful.

Thank you, Pete.

And our next question is going to come from Rob Wildhack from Autonomous Research. Please go ahead.

Hi guys. I wanted to ask about the $300 million loan sale to Ares. Could you comment on the terms associated with that sale? What was the execution price? And if there's any risk or loss sharing associated with that?

Yes, hi Rob. We don’t have anything to announce regarding the terms, but we are very excited about that partnership and the potential it holds. It was a beneficial deal for both parties, and it sets up a framework for an ongoing relationship tied to the performance of the collateral. Over time, we hope to evolve this into a more extensive partnership.

Okay. And then, Sanjay, maybe one for you or another one for you. Unrestricted cash, it was almost $400 million at the end of the period, but also finished I think as low as it's been since March 2021. So, how do you think about the cash needed for 'run the business' purposes? And then how should we think about cash generation going forward in the context of the new outlook for negative adjusted EBITDA and earnings in the first quarter?

Thank you for the question, Rob. To start, our cash balance was a bit low and loans on our balance sheet were higher than usual due to this transaction. After the year closed, we completed the transaction which lowered our loans and increased our cash. Currently, we feel our cash position is adequate. Looking at our operating outlook, we have projected a negative EBITDA for the first quarter, partly due to seasonal factors as we are in a yearly low period. We anticipate some recovery from this. Additionally, fair value plays a role in our EBITDA, impacting it in a noncash manner, and some of our guidance for Q1 is affected by delinquency trends in our primary borrower base, which influence our fair value marks. Thus, some of the negative EBITDA is seasonal, and some is due to noncash factors. Generally, we have a strong focus on profitability and managing the business wisely, and we aim to achieve EBITDA breakeven or positive results as swiftly as possible. If we can do that, our cash balance, especially after the transaction we announced with Ares, will be sufficient.

Okay. Thank you.

And our next question is going to come from Simon Clinch with Redburn Atlantic. Please go ahead.

Hi guys. Thanks for taking my question. I wanted to follow-up on the question about committed capital actually. And just if we take a step back and think about the announcements you've made, the relationships you've built, how should we think about the current and the potential I guess, quarterly cadence of committed capital that you can build? Because I think the original case was that you were looking to build enough committed capital on a sort of run rate basis, on a regular basis to allow you to be breakeven whatever the cycle. So, I was just wondering, could you just update on that with some figures around it, please?

Sure. Hi Simon, this is Sanjay. I want to reiterate what we've mentioned in previous discussions. A rough guideline we have for our run rate is that if half of our origination volume is backed by committed capital, that’s a solid starting point. I believe we are currently in that position. Our origination levels over the last few quarters and the guidance for the next have not increased significantly, so the capital we have available is adequate for building that foundation. As we aim to scale the business this year, we will need to increase our committed capital base accordingly, and we are quite optimistic about achieving that. Regarding the nature of our deals, as Dave mentioned earlier, we see this as having a limited number of large committed bilateral relationships that we can develop alongside our growth. The partners we’ve discussed in relation to our deals are the types of collaborators we can foster long-term as our models validate and our partnerships develop. This means we’ll be pursuing additional deals and also enlarging the size of those deals as we rebuild the business to its previous scale.

Thanks for that. I have a follow-up question. Is there potential and interest in using your technological expertise to create new recurring business lines instead of focusing solely on transactional ones? Additionally, how significant could this opportunity be for Upstart?

That's a great question, Simon. We definitely recognize that a revenue source with high volatility has its challenges. Therefore, we are very interested in finding ways to establish more stable revenue streams, particularly those not solely reliant on lending volumes. Our first focus is to develop products that have countercyclical tendencies. We're excited about our HELOC product, which has gained significant popularity in the current high-rate environment. This is largely about finding the right product mix. Additionally, we see potential in offering more straightforward technology fees, similar to the modest fees we currently charge car dealers. We will explore other avenues for monetizing our technology, and as we expand our product offerings, that potential grows. Furthermore, we've demonstrated our ability to automate credit origination independently of the credit models involved, which holds great value. As we enhance automation in personal lending, we're starting to replicate this in both auto and HELOC sectors. These automation capabilities could be unbundled and made available, significantly improving the user experience, irrespective of the pricing or risk models used elsewhere.

Great. Thanks for that color. Thank you.

And our next caller is going to be John Hecht from Jefferies. Please go ahead.

Afternoon everyone. Thank you for taking my questions. My first question is about accounting. For the securitization that you're including on the balance sheet, do you show the net residual value in the assets from an asset liability perspective? How should we understand this on an accounting basis? Also, does the interest income and interest expense related to that securitization impact the profit and loss statement as well?

Hey John, this is Sanjay. On the balance sheet, the securitization is displayed on a gross basis rather than a net basis. This means the total amount of assets from the securitization appears in our asset line, and the total amount of liabilities appears in our liability line. Regarding the P&L, the net effect is what is ultimately reflected since both interest revenue and interest expense affect net interest income. Therefore, on the P&L statement, you'll only see the net figure in the net interest income line. If you look at the note for net interest income, you would find the gross numbers for civic revenue and expense within the interest income section, but they won't appear on the main P&L statement.

Okay. And then, Dave, I think you mentioned starting to get collateral in the installment loans. I'm wondering from a contractual and then just a physical basis, if you can give us some more information about how that might look?

Yes, generally speaking, one of the things we're moving towards is really a single application for credit where the resulting loan that might be the best one for the borrower could be an unsecured loan. It could be one secured by some asset, maybe in auto or something else, it could also be a home equity loan. And depending on who the person is, the use case, how much cash they're looking for. But doing that through one product, I think, is really helpful because it allows borrowers to kind of see different choices. Also, collateralized loans, generally speaking, you're going to get lower rates. So, there's a trade-off there. You might have a better product at a better rate or be able to borrow more if it makes sense for a home renovation or something like that. So, I think that's pretty unique. Most of what we see in the market are products that you apply individually for different types of loans. And this is really aimed at being able to give the best product to the person with all the right trade-offs in one really fast efficient experience.

So, you would be getting collateral and then you could make a different type of loan with that collateral as a backup?

The application process will be somewhat neutral regardless of the type of loan you may receive, and you might receive two or three different offers for unsecured loans or loans secured by your car, or possibly a home equity loan, which is secured by your home. There may be trade-offs and choices among these options, and we hope to present that as clearly as possible to the applicant. We believe that we can improve our conversion rate by providing better choices through a single, streamlined process. We are just starting this initiative; our HELOC product is now integrated into what we previously considered our personal loan application. This reflects our direction towards being borrower-centric, emphasizing choices and trade-offs rather than focusing solely on products. We see significant potential for improvement in this area.

I got it. Thanks very much.

You bet.

And our next question is going to come from Arvind Ramnani from Piper Sandler. Please go ahead.

Hi. Thank you for taking my questions. My first question relates to your expectations at the end of last year compared to the beginning of this year. Did I understand correctly that you mentioned things have worsened or are consistent with your previous thoughts?

Hi Arvind, this is Dave. I think things have gone, to a large extent, the way we kind of suggested even a year ago, and that was that less prime, lower-income folks were being hit earlier. And then during 2023 really began to improve and reemerge. And there was a belief that people at higher incomes, higher FICOs were going to be affected later. And that's really what we've seen more recently. So, in the grand scheme of things, it's really gone the way we expected, and I think we communicated our expectations there. And you can see that in the Fed numbers that were released, I think, just last week. So, it is an unusual situation to have default rates of credit cards and auto loans at their highest since the Great Financial Crisis, yet unemployment remains quite low. So, it's not a typical scenario that anybody has seen out there. But having said that, our models are doing the right things. They're tightening and recalibrating constantly. And we're very hopeful that this will be the year where this will get put behind us. And I think there's good reason to believe it's a faster trip to a correction for primary borrowers who are employed, et cetera. And all that to us looks pretty solid.

Great. As you consider the rest of the year, are you referring to your hopes for 2024 or are you still focused on 2023?

I'm sure we were referring to 2023. Despite the near-term challenges, we remain very optimistic about 2024 as a year.

Okay, I just wanted to clarify. When do you think you'll be able to reinstate annual guidance, or are you not in a position to discuss that?

I think when there's a lot of things that are outside our hands, the Fed's move interests and whether inflation is, in fact, tamed or is going to reemerge, et cetera, the sort of precarious situation, we think a lot of American consumers are in financially where they're still spending more than they probably should, given their income. So, there's a bunch of things out there that we don't control, and they're pretty important to our business as it exists today. We're certainly working towards being less dependent on those. But the reality of today is those matter a lot to us. And so we would really want to be in a more of a steady state place economically, and we're just not there yet.

Perfect. Thank you so much.

Thanks, Arvind.

And our next question is going to come from James Faucette from Morgan Stanley. Please go ahead.

Hi thanks. I wanted to just touch really quickly on OpEx levels. It sounds like you feel that the environment and the potential quick rebound in more primer-type borrowers could rebound pretty quickly. And so, as of now, it doesn't sound like you're anticipating any OpEx trimming. I just want to make sure I understand that correctly. And when you talk about getting back to EBITDA breakeven et cetera. Is that something that you're, as a result of anticipating should happen this year roughly? Or are we thinking more into next year once we've had the ability for stabilizing environment to really take hold?

Yes, hi James, it's Sanjay. Thank you for the question. I believe there are a few factors affecting our Q1 EBITDA guidance. One of these is the seasonality, which presents a challenge to our volumes for this quarter. Another factor is the fair value component of EBITDA, which is a noncash item but is influenced by some default trends we are observing, especially in the primary sector. We hope these challenges will be temporary. To answer your broader question, we definitely aim to reach EBITDA breakeven this year as it is a key priority for us. As Dave mentioned, there are some factors beyond our control, but if we can overcome these issues and identify a clear path to recovery, it should lead us back to breakeven.

I understand. Regarding the primer and your responses, the comments on seasonality are clear. Could you share when you began making adjustments from a primer perspective and how this has affected you? Did this start recently, perhaps in February, or did it begin at the end of last year?

Hey James, I would say that in rough terms, I think we noticed this starting to happen at the end of last year. And by this year early, they were sort of persistent enough that we reacted.

Okay, that's great. Thank you so much.

Thanks, James.

And our next question is going to come from Michael Ng from Goldman Sachs. Please go ahead.

Hey good afternoon. Thanks for the question. I had a follow-up to some of the questions about the outlook for the rest of the year. But perhaps you could just talk a little bit about the visibility that you might have in origination volume and recovery throughout the rest of 2024? Should Q1 be the low watermark because of the seasonality piece? And is there anything that you saw as it relates to the stabilization and the lower-prime borrowers that might be a helpful framework to think about when we should see more stabilization and potential recovery on the primer side? Thank you very much.

Hi Mike, that's a great question. I would just note that the impacts of the pandemic, particularly the unusual effects of stimulus followed by de-stimulus, have been significant. These impacts were felt most acutely by lower-income individuals, although we have seen some improvement. This suggests that there might be certain behaviors that develop when people have excess cash but struggle to spend it, leading to habits that don't make sense in the long run, but they eventually overcome these challenges. The effects seem to have been delayed for higher-income individuals, and I believe they will not endure as long or be as damaging as for those with lower incomes. We anticipate a phase where consumer behavior and savings patterns will begin to normalize, and we are optimistic that 2024 will mark the start of this change. Additionally, even though inflation may be decreasing, it’s important to recognize that prices are still higher than they were in 2019. It will take time for people's incomes to align with their spending, which is the current situation we're witnessing.

Thank you, Dave.

And our next question is going to come from Regi Smith from JPMorgan. Please go ahead.

Thank you for taking my questions. Most of them have already been covered. However, I would like to ask about how high-income and prime consumers are feeling the impact and tightening their credit access. Could you share who you are currently approving? What does the profile of a successful applicant look like today?

Well, Regi, we are not making drastic changes to who is approved as loss assumptions increase, which means that some individuals who were previously approved may not be anymore. When we mention that the credit box is tightening, particularly for prime consumers recently, it means they are likely to face slightly higher rates than before. This does not automatically indicate that they are not approved, but it does affect conversion rates. For prime individuals, this means slightly higher rates and the loan size they qualify for may not match exactly what they requested. However, they are still likely to receive some form of approval. On the other hand, for those at the less prime end, many end up exceeding the 36% rate and as a result, are declined. This is the typical scenario we see whenever rates rise or credit models become stricter.

Understood, that's helpful. I have a quick question about a slide towards the end of your presentation where you adjusted the returns. Can you clarify what the Upstart loan performance chart on Page 36 indicates? It seems like it hasn't affected your cash flows, but how would you address concerns from people questioning the effectiveness and thoroughness of your underwriting models in light of this issue? Thank you.

Yes, sure. Thanks, Regi, it's Sanjay. So, yes, this chart, I'll say, so it's a bit of a specific artifact. The point of this chart was really to try and aggregate loan performance across our entire platform of funding channels, which obviously no single investor or lender is. But really, it's just meant to show the impact of the macro conditions on the overall business and how we've reacted to them. The specific thing we're calling out on this chart is that in updating the forecast methodology of this chart we realized we were making a calculation error in the old way that we've been using that resulted in us overestimating the forecast of the expected returns on this chart. So, first of all, importantly, this is just an error that's isolated to this particular PowerPoint slide. It's got nothing to do with underwriting. It does not impact in any way any of the numbers we report or present. It really doesn't impact our conversations with individual parties because those are on a specific basis, not platform-wide. And I don't really think it even necessarily changes the shape of the trends that we've been describing, which is that at a high level, we've historically overperformed prior to COVID, we were impacted by macro trends, which peaked in our case, sometime in early 2022. And we've since been re-converging the target. And so I think in updating the methodology, we've refined that and I think we're just calling out maybe some of the differences in the fine print, but that's what we're trying to lay out for you here.

Okay, that makes sense. Thank you.

Thank you, Regi.

And that's all the time we have for questions. At this time, I would like to turn the conference over back to you for additional or closing remarks.

Alrighty. To wrap-up, 2023 was a pivotal year for Upstart. We made strides in personal lending and in our auto business. We launched a home equity product and released two tools that are proving to be invaluable for improving model calibration. And we accomplished these goals while running an operationally and fiscally tight ship. That focus will continue in 2024, regardless of when the economy normalizes and the advantages of our leadership in AI lending become clear to all. So, thanks all for participating today. We look forward to speaking with you again next quarter.

And this concludes today's call. Thank you for your participation. You may now disconnect.