Upstart Holdings Inc
NASDAQ:UPST
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Upstart Holdings Inc
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Good day, and welcome to the Upstart First Quarter 2024 Earnings. Today's conference is being recorded.At this time, I would like to turn the conference over to Jason Schmidt. Please go ahead.
Good afternoon and thank you for joining us on today's conference call to discuss Upstart's first quarter 2024 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 first quarter 2024 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 second quarter of 2024 and the second half 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 measures 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 1 initial question and 1 follow-up.Later this quarter, Upstart will be participating in the Needham Technology Media and Consumer Conference, May 14; Barclays Emerging Payments and FinTech Forum, May 15; B. Riley Securities Institutional Investor Conference, May 22; and Mizuho Technology Conference, June 12, as well we will host our Annual Shareholder Meeting on May 29.Now, I'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 first quarter 2024 results. I'd like to start by saying I'm quite proud of the work of Upstarters around the country continue to do to build the world's leader in AI-enabled lending. With credit availability as constrained as it's been in more than a decade, we've never felt the urgency of our mission more than we do today. We're off to a solid start this year and have made significant progress with our products and with funding. There are many reasons to believe our business will return to growth soon, but we're also prepared for the current macroeconomic conditions to persist. So we continue to focus on improving our efficiency and financial performance while investing responsibly for the long term.In pursuit of efficiency, we minimized hiring, reduced the size of some teams, flattened org structures, and reallocated resources to our highest priorities. Since the beginning of 2024, we've cut fixed expenses from headcount by approximately $20 million on an annual basis. Our headcount today is as low as it's been since Q3 of 2021. We've also improved the efficiency of our cloud infrastructure and reduced our model training and development costs. Year-over-year, our compute and storage costs have been reduced by 23%, and we expect to generate additional savings in this area. We believe these actions set up Upstart to return to profitability sooner and to rebound more quickly through the company we know we can be.I'm happy to report that the funding situation on our platform is beginning to improve for banks and credit unions, as well as for credit investors. We're hopeful this trend will continue through 2024. Unfortunately, consumer risk and interest remain at or near all-time highs, conspiring to constrain the volume of transactions on our platform. Given this combination, and assuming rates on Upstart remain at or near their current high levels, we expect to reduce the use of our balance sheet to fund loans that are not R&D purposes. This will allow us to make better use of those funds elsewhere, so we will continue to be flexible and responsive in using our balance sheets to do the right thing for the business.We continue our work to make Upstart a platform that can thrive in any macro environment. This work comes in the form of improvements to our core personal loan product, as well as progress in the newer products in our portfolio. Last quarter, I mentioned an initiative to allow applicants to provide collateral to support their personal loan application, with the goal of helping borrowers access credit at lower rates than would otherwise be possible. Today, I'm happy to report that we've successfully launched our auto-secured personal loan as a pilot in 7 states. Our approach allows qualified applicants to make an informed choice between an unsecured or an auto-secured personal loan, which commonly offers a lower APR. Thus far, ASPL rates are an average 20% less than the rate on an unsecured loan. The ASPL also helps many applicants qualify for a loan who would otherwise be declined.Last quarter, I also shared that we were developing tools to help our lending partners strengthen relationships with their existing customers, which is often their priority in periods of reduced liquidity. To that end, 2 weeks ago, we announced Recognized Customer Personalization, or RCP. With this new feature, lenders can identify when an existing customer is actively shopping for a loan on upstart.com, and strengthen their relationship by making a compelling offer of credit. This is a capability many banks and credit unions have long requested, and we're pleased with the initial response. 30 of our bank and credit union partners have signed up for RCP already.In Q1, 90% of unsecured loans on the Upstart platform were fully automated, an all-time high for us. For the borrower, this means no documents to upload, no phone call required, and a final approval in just seconds. For Upstart and our lending partners, it means there's no human in the loop whatsoever to process and complete the loan application. Automation is a hallmark of AI-enabled lending, and Upstart aims to be the best at it. We continue to make progress in our auto business, with 103 dealer rooftops now live with Upstart-powered lending versus 39 a year ago. In keeping with the times, we've tasked our auto team to move more quickly toward profitability. This means doubling down on credit quality, making improvements to our in-store platform, and focusing on overall dealership success, along with the goal of improving the unit economics of each dealership. We've somewhat reduced our go-to-market investment in auto retail for now, and believe a more focused effort today will allow us to scale more quickly in the future.We're making fast progress with our home equity product, which continues to exceed our expectations. We knew it would be an attractive product in a high interest rate environment, and the team's progress thus far has been impressive. Less than a year after launch, we're offering Upstart HELOC in 19 states plus Washington D.C., covering 33% of the U.S. population. This is up from 11 states last quarter, and now includes Florida, our largest state to date. I mentioned last time that we were beginning to automate verification of borrower information, and I'm happy to report that we're now able to instantly verify 36% of HELOC borrowers. This includes instant verification of identity and income, without any tedious documents to upload. In another sign of progress, when we offer applicants a HELOC as an alternative to a personal loan, we see a list in the percentage of applicants taking 1 of our offers. This validates our approach to integrating our personal loan and HELOC applications, creating a single unified funding form for multiple products. Lastly, but perhaps most importantly, we signed our first funding deal for the Upstart HELOC and expect to begin selling loans on a forward flow basis to this partner in the next few weeks. I'm excited to see this product scale through 2024 and beyond.Our small dollar loan product continues to expand rapidly, with Q1 originations up 80% quarter-to-quarter. Consumers love these small relief loans because they're fast and simple and so much more affordable than the more expensive flavors of credit normally available for them. Today, about 60% of applicants can come to us for a small dollar loan and initially qualify to actually get the loan, which is a super strong conversion rate at this stage. From a what's in this Upstart perspective? I'll say first that this product is core to our mission. We're meaningfully expanding to percent of Americans, we invite into the world a bank quality credit with a small but important first step. The beauty of this relief loan is that, it's primarily offered to those who don't today qualify for our personal loan. So instead of declining them entirely, we give them the opportunity to perform on a small loan and start them on a better financial path. And, of course, our risk models are learning rapidly by extending credit to someone who would otherwise be turned away. These small loans are rapidly expanding the frontier of understanding of our models and represent a long-term opportunity to serve Americans with fairly priced credit. We continue to invest in our ability to service Upstart loans and help those borrowers who become delinquent return to financial health.For example, we made it simpler and easier for borrowers to adopt auto-pay, a key leading determinant of credit performance. These efforts have led to an increasing number of borrowers enrolled in auto-pay for 24 straight weeks. In another example, we launched a new channel for contacting delinquent borrowers. Just in its initial deployment, this channel is projected to reduce gross losses more than 3%. This is just the beginning. We see a wealth of opportunities to reduce loan rates, improve recoveries, all while helping borrowers get themselves on a better financial footing.As I mentioned earlier, we're seeing improvements in the funding side of our business. These improvements are both in the bank and credit union segments, as well as on the institutional and credit fund side. The liquidity challenges many banks and credit unions experienced in 2023 seem to be waning. Many lenders now, once again, facing a shortage of assets. This new challenge is compounded by the fact that the cost of funding for many regional and community banks has risen that are now paying more for deposits. We are still cautious about the direction of the economy. Many lenders are now looking for ways to generate healthy and appropriately risk-adjusted yield from their balance sheet.We saw 8 new lenders join our platform in Q1, and a number of existing lenders increase their funding. The number of new lenders and the total available funding on Upstart from lending partners are both at their highest since prior to the 2023 bank failures a year ago. We also continue to make progress with institutional capital, working to renew and extend existing partnerships and to bring investor partners who paused in the past back to the platform. And as mentioned previously, we signed the first partnership to fund Upstart's home equity product. As a result of this product, we expect to be borrower-constrained as long as the rates on Upstart platform remain as elevated as they are currently. Altogether, we are hopeful that we're headed into a period of stable funding in excess of our needs. We expect this will allow us to reduce the use of our own balance sheet and redeploy that capital to other important goals.To wrap things up, our lean organization is making rapid progress on building a product portfolio and a platform that will accelerate the financial industry's migration to AI-enabled lending. With the interest in AI soaring, just last week we launched a first-of-its-kind AI certification program to help bank executives prepare for this brave new world. Just in the first couple days, several hundred individuals registered for the course, reflecting the broad demand to upscale in this area. Some of you on today's call also may find the course to be of interest. I want to thank Upstarters for their resilience and perseverance through a clearly challenging period. We find strength and durability in our focus on the mission and the satisfaction we find in pursuing it together. I approach every day confident that the Upstart team is unmatched in both its capacity to execute, as well as its unity of purpose.Thanks. I'd like now to turn it over to Sanjay, our Chief Financial Officer, to walk through our Q1 2024 financial results and guidance. Sanjay?
Thanks, Dave, and thanks to all of you for joining us today. As was the case in 2023, the dominant influence on our business so far this year remains the macro environment, and the trends we highlighted last quarter have remained consistent. Real personal consumption in our economy continues to surge, more recently powered by the gathering momentum of the services economy, and now increasingly compounded by the rapidly growing outflow of interest payments. Despite healthily growth in wages, overall disposable income has, in fact, languished over the past year due to the combined headwinds of falling government transfer payments, sagging asset income, and as of the new year, a significantly higher personal tax burden compared to 2023. The consequence of continuing consumption growth against flat disposable income has been a downward trend in the personal savings rates, which have fallen back towards the 3% level after peaking almost 1 year ago, and matched by a continuously falling balance of real savings deposits. In an economy with strong headline growth numbers and low unemployment, the anemic savings rates and declining real savings balances are the clear problem statement.Regarding credit performance, we spoke last quarter about the trend of deterioration at the primer end of the borrower base, which has continued. Our models have reacted to this trend over the past quarter with higher loss estimates and correspondingly higher [ APRs ] for more affluent borrowers in order to maintain the returns investors expect, which has further reduced loan volume on our platform. This had a partial adverse impact on our Q1 results, and its full impact is being felt in Q2.On the funding side of the platform, liquidity amongst banks and credit unions is beginning to improve. We are seeing encouraging signals of funding capacity increases from existing lenders, as well as new lenders joining the platform, including our first forward flow buyer of HELOCs. In the institutional markets, we are in the process of extending and rolling over all of the committed capital relationships that are coming up on their 1-year mark, as well as in some cases working on meaningful upsizing, which we are pleased to interpret as a positive endorsement of our program. We currently expect that these efforts will result in approximately $2.7 billion of funding through committed capital and other co-investment arrangements over the next 12 months, with additional opportunities in the pipeline. Separately, we are starting to see more signs of formerly active investors once again reengaging with the platform.With this environment as context, here are some financial highlights from the first quarter of 2024. Revenue from fees was $138 million in Q1, up 18% from the prior year but down 10% sequentially, and in line with the decreased origination volumes, resulting from the increased pricing of prime loans. Net interest income was negative $10 million, reflecting the impact of prime loan performance on our risk-sharing positions, as well as some realized fair value impact taken as part of a secondary sale transaction. Taken together, net revenue for Q1 came in at $128 million, above our guidance, and up 24% year-over-year.The volume of loan transactions across our platform in Q1 was approximately 119,000 loans, up 42% from the prior year but down 8% sequentially, and representing over 68,000 new borrowers. Average loan size of $9,500 was down from $12,200 in the same period last year, driven by robust growth in small dollar loans.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 59% in Q1, down 4 percentage points sequentially, primarily reflecting increased investments in servicing and collections capabilities. We continue to benefit from very high levels of loan processing automation, achieving another high in the percentage of loans fully automated at 90%, and our seventh sequential quarterly improvement.Operating expenses were $195 million in Q1, down 17% year-over-year, but up 4% sequentially as our payroll coming into the new year gets reset with a new benefits cost basis and bonus accruals. As Dave mentioned, since the beginning of 2024, we've restructured some teams and reduced headcount in order to quicken our path back to profitability.Altogether, Q1 GAAP net loss was $65 million and adjusted EBITDA was negative $20 million, both ahead of guidance. Adjusted earnings per share was negative $0.31 based on a diluted weighted average share count of $87 million.We ended the first quarter with loans on our balance sheet of $924 million before the consolidation of securitized loans, down from $982 million in the same quarter of the prior year. Of that balance, loans made for the purposes of R&D, principally auto loans, was $316 million. In addition to loans held directly, we have consolidated $157 million of loans from an ABS transaction in Q3 of 2023, from which we retained a total net equity exposure of $28 million. We ended the quarter with $301 million of unrestricted cash on the balance sheet and approximately $572 million in net loan equity at fair value.With our models having largely adjusted to the increased delinquency rates of prime loans and the near-prime universe of borrowers now toggling between stabilization and recovery, we believe that the wave of elevated defaults propagating from the abrupt stimulus and de-stimulus of the economy in 2021 is now at or very close to its peak. Assuming no new credit shocks lurking on the horizon, we are anticipating a return to sequential growth in the second half of this year and a return to positive EBITDA by the end of this year. With that in mind, for Q2 of 2024, we expect total revenues of approximately $125 million, consisting of revenue from fees of $135 million, and net interest income of approximately negative $10 million, contribution margin of approximately 56%, net income of approximately negative $75 million, adjusted net income of approximately negative $36 million, adjusted EBITDA of approximately negative $25 million, and a diluted weighted average share count of approximately 88.4 million shares. For the second half of 2024, we expect revenue from fees of approximately $300 million and positive EBITDA in Q4.Thanks once again to all for joining us today. And with that, Dave and I are happy to open up the call to any questions. Operator?
[Operator Instructions] And our first question will come from Ramsey El-Assal with Barclays.
This is John Coffey on for Ramsey. I just wanted to ask you, Sanjay, about your second half of 2024 outlook with the revenue from fees of approximately $300 million. Could you just give me a little bit of a better idea what some of the underlying mechanics of this are that are going to drive it to that level? Is it just that you'll be able to make more attractive loans to consumers? Is it just trying to think of what the different factors are that makes you a little bit more optimistic here?
John, great question. Some context on the second half of 2024, I would say, first of all, our assumptions on the macro are neutral. And in that environment, really, a lot of this growth is down to how we kind of historically grown, which is a road map of product execution resulting in model improvements and accuracy gains. And so, maybe one of the important contextual points is, the main macro effect that we've been sort of contending with over the last 2 years really is a propagation of what came from the stimulus and the de-stimulus to the economy. And as we said in our remarks, we really think that's now in the process of fully running its course. And so, we're really back to our old model of improving technology and accuracy and driving conversion gains from that. And we think that's the -- that's going to be the story in the back half of this year.
And our next question will come from Kyle Peterson with Needham.
I wanted to start off on expenses, assuming that we're kind of in a little bit muted environment macro-wise, so at least for a little while. Are you guys comfortable with the expense structure where it is now on a cash basis? Or do you think there's more wood to chop or more action to potentially take if volumes don't snap back?
Yes, Kyle. As we said in our remarks, we have been doing a lot of that work. And since the end of the quarter, we've announced some more cost reductions. And I think as of where we are at the end of that series of cost reductions, we feel like we're in a good place for our current scale and for the plan we have for the rest of this year. I mean, obviously, if there's another downturn in the macro that affects the credit environment, we'll have to react further. That's always a possibility, but as of where we are, we think we've taken the appropriate actions.
Okay. That's helpful. And then just a follow-up on credit. I know you guys kind of mentioned it seems like some of the credit concerns with the affluent borrowers that you guys mentioned last quarter is kind of still in the same -- I guess, like are the loss assumptions still the same. And if so, like are you guys comfortable with some of the pricing and origination or underwriting changes you guys have made that you guys -- that the newer vintages in that cohort can be profitable and attractive for investors?
Kyle, this is Dave. Yes, we are comfortable that our models are caught up and the current product is performing and is calibrated. As we said, the -- we see signs of recovery in the less prime, less affluent parts of the world, and the more affluent primer part is what has deteriorated more recently, but we're hopeful also that we are kind of reaching toward the end of that. So it has been a cycle that we've been observing for a while. We did, I think, accurately state that it was going to affect less affluent people first and then probably more affluent primer people later, which is exactly what's happened. And now, as Sanjay kind of alluded to, we're hopeful we're nearing the end of this. And then for us, it's just kind of back to business of improving model accuracy, funnel throughput, etc. And that's what gives us some confidence in the rest of this year.
And our next question will come from Peter Christiansen with Citigroup.
Dave, Sanjay, I wonder if we could dig a little bit into the small -- growth in the small dollar loan product there. What impact that's had on the conversion rate, perhaps maybe how should we think about the conversion rate and standard personal loan levels?And then a second question, I'm just curious, on the auto side, it looks like you kind of run rating around 5 loans per rooftop per quarter. Just curious, what's the opportunity to increase that share within each rooftop and maybe some of the steps that you're taking there to improve that.
Sorry, Pete. This is Dave. On the small dollar loan product, there's definitely a heavy focus on automation there. I don't know if we have the numbers to separate rates of automation for the small dollar going from the personal loan, but they certainly -- they contribute to that 90% that we put up.In auto, I think we definitely believe there is a lot of room for increasing market share on loans per dealership. That's actually one of the very central focus of ours is how we do that. And part of that is the models getting smarter, better separation, which means we compete better, and also just the process of originating those loans in dealership. And so, those are, as I kind of highlighted earlier, very central to our focus, and we're a little less worried about exactly how many dealers are lending. We want to make sure the volume going through a dealer and the unit economics of a dealer are where we want them to be, and that's been a lot of focus of our for the recent months.
But, I guess, the question on the small dollar loans is really more on how that impacts the conversion ratio, which went to 14% this quarter. Just curious how typical -- the typical personal loan product is doing from a conversion ratio factor, if you can piece that out?
Yes, I think the answer to that is, I don't think it's a huge impact, but it's probably marginally positive. As you could think of, like, with just the personal loan product, there's a certain approval rate, and then people who are outside of that approval box can usually get approved for a smaller loan, like a small dollar loan. So for a given marketing sort of [ cent ] size, we will have additional approvals due to that product, but I don't think it's really big enough to move the dial in a significant way at this point.
And our next question will come from Dan Dolev with Mizuho.
Actually, really pretty good results. I mean, I'm a little surprised by the initial kind of knee jerk stock reaction. Do you think -- is this -- I mean, if you had to guess, is this -- if you look at 2Q versus what people were expecting, is something kind of changed was -- do you think there has been a bit of a mis-modeling that just kind of a little bit of a misunderstanding in terms of 2Q? Because if I look at trends overall, they seem to be more optimistic than pessimistic, especially if I look at the UMI, which is continuing to trend down, and your loan performance, which is in line with the expectation. I'm trying to sort of connect the dots here.
Yes, Dan. Basically, the Q2 guidance is as it is because rates have moved up during the first quarter, and that's the tightening due to observation of deterioration, and as we've mentioned previously in the primer segment, so that's fully felt in the second quarter. We do have hope that these rates are as high as they'll be and they'll come off these rates. But in any case, we feel like this sort of pandemic and post-pandemic stimulus effect is really running its course. So that gives us some comfort that we're kind of back to the world that we know, which is we can make improvements to the funnel and to the models and grow on a month-to-month basis really just based on advancement of the technology. That -- you're not seeing that really in the Q2 guidance because we're just fully getting to this place where we think the models are reflecting the risk out there. But we think there's -- we feel pretty comfortable with the second half of the year.
Got it. Yes. Because if I look at the UMI, it seems to be going down, which is a positive signal, correct?
Yes, UMI just very recently took a dip, which, of course, is something we like to see. But it's really important to say that it moves a lot week-to-week. We do update the site every week and you'll see it jump around a bit. It has taken a nice turn and we would love to see that become a trend, but we don't bank on that by any stretch. There's certainly a lot of noise in that UMI number on a week-to-week basis.
And we'll take a question from David Scharf with Citizens JMP.
Sanjay, kind of wondering, you had mentioned, I think, in the update about $2.7 billion of committed capital inflow deals over the next 12 months. As you think of notwithstanding, obviously, consumer demand and some of the macro uncertainties you still can't predict, but as you think about your overall volume expectations, should we think about that as pretty much funding entirely new origination activity? Or is your guess 12 months from now, we're going to see less balance sheet exposure to the core personal loan product, meaning is some of that $2.7 billion going to be focused on perhaps whole loan sales on the existing retention?
David, sure. Yes, that figure, I would say, is the number that we believe we have pretty direct line of sight to as of right now and the majority of it is forward funding. I would say that as the platform scales and certainly as the credit environment and markets become more constructive, and we said that we have some signals or some reasons to believe that, that's currently happening. We would hope to increase that number along with the scaling of the platform. So there continue to be more opportunities beyond that $2.7 billion in the pipeline. And I think we said before, we want to keep it at some reasonable ratio of the overall platform size. So, I guess, the implication of all of that is that, as the platform grows, if we're doing our job right on the capital market side, we should be reducing balance sheet exposure to whole loans.
Got it. And then just as a follow-up, and maybe on the thing, on those whole loans, on the credit side. I guess, the roughly $51 million of net fair value adjustment and earnings, I guess, it's fair value accounting that's principally current period losses plus any mark-to-market. Is that $51 million comprised entirely of charge-offs? Or did you take any kind of net write-ups or write-downs on the fair value of the loans you've retained?
So, yes, certainly a large part of it are the ongoing sort of charge-offs from the whole loans that are on our balance sheet. But I think if you look into some of the materials in the deck, you'll see that some amount of that was some writing down of our risk positions in some of these co-investment structures largely flowing from what we've been talking about, which is this sort of degradation at the prime end of the borrower spectrum now. You're starting to see that reflected in some of the markdowns.
And our next question is from Rob Wildhack with Autonomous Research.
Just wanted to clarify something you've said earlier. Are you -- do you intend to reduce the absolute number of loans on the balance sheet or just the core personal loans on the balance sheet, or just the R&D loans on the balance sheet?
Rob, I mean, I think our intention would certainly be to reduce exposure to the core personal loan business. That, of course, is pending both the scaling of the platform, but also the level of engagement that we're getting from the capital markets. I think it's probably fair to say that compared to the amount of R&D loans we have on the balance sheet today, which is principally comprised of auto, we could imagine in a perfect world that being reduced as well. But both of those, I think, intentions are contingent on certain external things.
Okay. Got it. Can you give some color on just how low you'd like to go from the $530 million in core personal or the $1 billion cap that you've discussed in the past? And then, I'm curious why make this change right now. You've spoken in the past about the attractive return profile of the loans, and I think today you sound pretty positive on the macro outlook or the return profile going forward. So why the decision to hold fewer loans now?
This is Dave. Let me just maybe take a first crack at that. I mean, basically, holding whole loans on a balance sheet isn't super efficient. So while we do, we are creating structures with long-term partners to be invested alongside them. Holding whole loans on the balance sheet, even if they're warehoused or leveraged, isn't particularly efficient. So that's not something we necessarily want to do more than necessary. For some of the R&D processes, as we've told, that's exactly what we have to do. In the personal loan product, we would certainly rather have anything on our balance sheet be in some form of risk sharing or partnership with a long-term capital provider as opposed to just holding loans on. So our goal would be is to have ultimately no personal loans other than those for some reason in an R&D structure or some kind of risk sharing agreement we have with a long -term partner.
I'll just add to that briefly, Rob. So Dave spoke to sort of the more -- the long-term intention or strategy for how we wanted to play our balance sheet. In the shorter-term, to your question of why we are signaling or aspiring to a reduction on whole loans in the balance sheet? Really has to do with what we expressed as some positive signals from the institutional markets and the capital markets in their demand of loans. And, of course, if that third-party capital has healthy demand for loans, we would always prefer to deliver it to them than to hold it on our own balance sheet just because that's more central to how our business model works.
And we'll take a question from John Hecht with Jefferies.
First question is, it looks like about $70 million of incremental -- little north of $70 million incremental capital co-invested in the quarter. I know you guys didn't deal with Ares in the quarter. I'm just wondering, can you tell us how much of that co-investment was tied to that deal versus, I guess, upping some of the flow agreements that you've already announced prior to this quarter?
John, we don't have an exact breakdown, but Ares was certainly a meaningful portion of the overall amount. I mean, if I had to ballpark it, I think something around the order of half was probably in the ballpark, but we don't have a specific breakdown for you.
Okay. That's helpful in any case. And then the second half -- well, the second half, the growth in the second half, you mentioned the HELOC. And I think you mentioned HELOC, a flow agreement on HELOC, maybe I misheard that. But how do we think about the contribution of some of the newer products to the enhanced growth in the second half versus the first half versus the more traditional products?
Yes, John. So you heard it right. We've got our first sort of forward flow capital partner in HELOC and hoping to bring some more on shortly. I would say, look, we're very excited for some of the newer products, particularly, I mean, HELOC is a great product in this environment. We talked about how fast small dollar loans were growing, and I think there is showing the kind of conversion strength where we believe we might be able to start to extract some good economics there. But I think in the relatively near-term, i.e., for the rest of this year, I think that our economics and our guide really do depend on the core business. I don't think the new products are quite yet going to move the dial in a meaningful way. But we're very excited for them for 2025.
And our next question will come from Nate Richam with Bank of America.
I understand you're being conservative on the underwriting, but can you talk a little bit about the demand environment for the loans you're producing? Like I know you said like the partner banks are kind of like offset some of this deposit pressure with the higher yields. I'm just curious if the demand has kind of increased with this higher rate for a longer environment.
By demand, you're referring to the lending partners, which we think of the supply, but that having been said, yes, I think the banking credit union sector has changed from what we would have told you 3 or 6 months ago. There were definitely liquidity challenges. Nobody was really wanting to do all that much lending and focused only on their own customers, et cetera. That situation has definitely begun to move the other direction. So liquidity seems to be a problem that's kind of going away, and bank executives generally feeling better about their balance sheet and their position, but they're suddenly -- their ratios aren't right in terms of having sufficient assets. So there seems to be an increasing appetite for loans, the right types of loans, et cetera, for banks and credit unions. And that's been something we're seeing. So we're now at a place where in that part of our lending, we definitely have excess capital and because rates still are super high and that constrains demand from borrowers. But having said that, the demand from loans as a group from banks and credit unions has definitely strengthened.
And then just curious if there's anything to call out from a tax refund season. I mean, we heard a few conflicting things about how seasonal trends played out in the quarter. And I'm just curious, like for the loans that you were servicing, do you see anything like just different from a repayment or delinquency standpoint? Or maybe also [ on-demand side ], is there anything different to call out?
Yes, seasonality in our business is fairly consistent. We did exactly what we would have expected this year where the sort of loan demand troughs and also credit performance improves a lot during the season when people are receiving tax refunds from the government. And that has played out every year and we saw it again this year. So that's -- we were sort of planning on that. We've begun to model that into our credit, et cetera, and expect it. And so, it seems to have gone the usual path.
And our next question will come from Giuliano Bologna with Compass Point.
One thing I'd be curious about and kind of picking right about -- and I realize you had some commentary about some model improvements. But it seems like a lot of your loans were being priced above 36%. I'm curious if there's any incremental sense of what portion of the funnel you think you could push below 36% over the next few months and quarters. And how that could flow into incremental origination volumes?
Yes, Giuliano, it's a good question. Yes, because we have a limit, there's no loans above 36% on our platform. That means when underlying rates or return demands go up, as well as when loss assumptions go up, a lot of people will no longer be approved. And that's one of the fundamental challenges of having that limit at 36%. Having said that, it also works the opposite way. So as rates come down and/or risk comes down, which we measure as UMI, a lot of those people will come back into the approval fold. So it's one of the things we deal with. We've also mentioned several initiatives to actually bring more people into the approval bucket, things like the auto-secured personal loan, things like the small dollar loan. So we're tackling it on many fronts because we'd like to stay in that sort of 36% envelope because it sort of reflects where nationally chartered banks can go, and so it feels like a good place for us to be.
That's helpful. And then I realize you provided some commentary about the co-investments. It looks like the fair value is down $10 million linked quarter. When we think about the kind of bucket of loans that's associated with -- there's obviously multiple vintages there. I'm curious what vintages are driving that kind of the deterioration in the pool. Is it coming from, yes, 4 quarter old vintages, 3 quarter old. Just kind of curious what vintages are driving that. And if you're seeing any changes in the trends across the vintages that are covered by co-investment?
Giuliano, this is Sanjay. Yes, I would say this is -- the dynamic here really is more about a move or maybe we'd call it a deterioration at the prime end of the borrower base, and it has happened pretty consistently across vintages. I mean, the more seasoned the vintages, the less loss it has left in its life, so the less impactful it is. But I would say all else equal, prime borrowers, whether they took out their loan a year ago or a month ago, have all performed a little bit worse this year than they were performing 6 months ago, and that's the thing that's being reflected in the lower volume guide that we have for Q2, as well as some of the fair value changes that have really been reflected in our risk sharing positions. So I wouldn't call it a vintage-specific thing.
And we'll take a question from Simon Clinch with Redburn Atlantic.
I wanted to follow up on the questions around the second half. I mean, it's the first time for a while we've had you give that kind of visibility. And I was wondering if you could perhaps give a little bit more color around what you're actually anticipating in terms of the conversion rate as the borrower constraints ease and what you're probably assuming in that guidance?And then to that last point about the primer and the primer end of the market, are you assuming continued deterioration in that part following the current trends within that work as well for the second half?
Simon, well, I'll take crack at the first part of your question, which is really the second half of this year. And again, let me just kind of reiterate some points, because as you mentioned, we are going back to longer-term perspective somewhat here. And it's important to remember, the reason we went away from that over the recent past is because we were grappling with a very specific thing in the macro. And that thing, as we said is that, when the economy received a large influx of cash in the form of stimulus, that then abruptly stopped. It created -- it propagated a massive wave of elevated defaults. And that thing worked its way through the borrower base, starting with the sub-primer folks and working its way to the more and more affluent folks. The folks who were impacted earliest, the borrowers that were at the sub-primer end of the spectrum are now well on their way to recovery.The [ primest ] end of that spectrum, I think we've said, is sort of like more recently crested in terms of their default patterns. And because we've now seen that essentially play itself out, we're now back in the environment where there's just sort of, in our view, regular macro risk and execution against the product road map in order to create model gains. So I believe we are, in some sense, back in the environment we were in before the stimulus and, frankly the pandemic. And in that world, most of our growth was directly reflected in conversion gain. And most of that conversion gain came directly from improved model accuracy. So I think you can roughly intuit that sequential growth that we're telegraphing for the back half of this year. We expect most of that, if not all of it, to show up directly in the form of conversion.Now, in that long explanation, I've forgotten what the second part of your question was. Would you mind repeating it?
No, the second part of that question was just around the primer, and if you're actually assuming that to deteriorate, but you've said you're -- it's crested and sounds like you're assuming just go back at a normal level, is that fair?
Well, to be clear, we're not -- defaults now are very high. We're not expecting them or assuming that they'll go back down. We will just assume that they won't further deteriorate, right? I think we're sort of assuming a constant macro to today, not an improving one. An improving one would, we believe, be a tailwind to what we're working against.
Okay, great. And just as a follow-up, on the $2.7 billion of capital that you have visibility in for the next 12 months, could you give us a sense of what level of upscaling you've seen to -- that gives you that number? And I think you said as well that most of that is actually forward flow rather than that kind of long-term committed capital. So just clarify some of those things.
Yes, that is correct. I would say that the $2.7 billion number really is an expression or a result of the sort of continuation or elongation of existing relationships, as well as some new ones. It doesn't really contemplate any significant upsizing in the existing relationships. Although, as we mentioned, I do think some of that is in play and we're working on it, but we're not including that in the numbers that we currently have line of sight to.
And we'll take a question from Reggie Smith with JPMorgan.
I wanted to follow-up on the last question or might have been 2 questions ago where you were talking about, I guess, your prime exposure. And in the last quarter you talked about prime kind of deteriorating. And it sounds like -- and I just want to make sure I'm hearing you right, when you speak of prime, you're not talking about prime in the traditional sense, but you're talking about more, like primer, but still net primer, maybe because you frame who is the prime customer you're talking about, and I know you don't use FICO scores, but like how would that customer translate to FICO? Just so that we're all speaking the same language, then I have a few follow-ups.
As you know, there's a lot of different dimensions or ways to define prime, but for the sake of being reductive, I think you could think of the current stress as being somewhere north of 700 FICO score. And I think if you're well below sort of 60, you're probably currently on the path to improvement.
Understood. And then, I guess, so thinking about that prime customer. Is there a way to articulate, or how should we think about what the, I guess, current life of loan loss rate is for that borrower? Maybe how that has changed in the last, call it, 6 months as you've seen, that kind of deteriorate? Just kind of curious, like what are you talking about there?And then thinking about that 36% cap, I think last quarter you talked about being able to raise prices. So, I'm assuming that they're not that high, that there's room to kind of price it. Maybe talk about the dynamics there, like how much you've been able to raise APRs versus what the loss increase has kind of been there?
Let's see, I mean, I think you're asking a little bit about the sort of nature of loss rates in the primer end. Obviously, they're much lower. I think that you could probably think of them in the sort of low- to mid-single digits as an expected loss target. And they're probably coming in high to the tune of, I don't know, 50% plus or so. So that adds a couple of hundred basis points to the APR. It certainly does not push them out of or even anywhere near the 36% approval box. But when you get higher APRs, you get lower acceptance rates just due to elasticity. And so, conversions are down, volumes are down, et cetera.
Understood. Okay. And then I wanted to ask about -- so appreciate the guidance of the back half of the year. And, I guess, when you do a simple average, you get to about $150 million on average in fees. And that's about flat to what you did in the fourth quarter of '23. My guess is that there's probably some cadence there and that you probably won't be running it flat as you get to the fourth quarter and there may be some growth there. Can you talk a little bit about if there's anything you can provide in terms of how 3Q and 4Q, should we assume kind of flat or is it more 4Q loaded? Yes.
Sure, yes. I mean, I would say that I don't -- I think it's safe to assume they won't be flat. I mean, we're going to have to regrow into that level by getting some conversion gains over time. So I think you could think of that as hopefully a steady-ish stream of conversion gain that will regrow us into that scale consistently.
And we'll take a question from James Faucette with Morgan Stanley.
Just a few quick follow-ups for me. In the assumption of flat macro, does that assume then, if we continue to see a bit of the deterioration in primer borrowers that you've seen that, that would be a headwind? Or are you expecting to be a loss that was max? I guess, that was my first question.
James, no, I think that I would maybe say sort of flat in aggregate. So if you see mild deterioration at the primer end and mild recovery at maybe the less prime end, that would sort of result in a relatively aggregate neutral macro under which we could sort of achieve, I think, the numbers that we have described.
Yes. Got it. And then just a quick couple of clarifications is that, as you're looking to renew some of your long-term capital agreements that were entered into about a year ago, how should we be anticipating change in terms there? And then I'll just tag [Technical Difficulty] as you're adjusting your OpEx space, is there a level at which you're thinking that you should be breakeven or you keep OpEx relatively flat from there or can you? Or how do we think about, how you're thinking -- how you're feeling about OpEx if you -- if and as you get back to breakeven on profitability?
Sure. Let's see. I'll just take the second question first on OpEx. So as we sort of said in our remarks, we've taken some cost actions since the end of the quarter, and those will get factored in to the back half of the year. I think that's 1 component of our return to EBITDA breakeven. It won't get us there alone. So we are expecting some growth as well. If that growth doesn't materialize and it leaves us short of our EBITDA target, then we will sort of reconsider it at that time.And I think your first -- your initial question -- or your -- the first part of your question was about the renewal of the committed agreement and to what extent terms are changing? Look, any time you -- these are sort of renewals of existing relationships. I think that any time you spend something like a year in an initial relationship, you have learnings on both sides of what works well and what doesn't. And so, it's natural to sort of revisit some of that when you re-up. But I think that in the large -- in the grand scheme of things, I don't think those are -- they're not major changes. I think you can largely think of these as surviving sort of persistent relationships with some fine-tuning around the edge. I don't think there's anything that will dramatically change the economic picture for our business model.
Thank you. And that does conclude the question-and-answer session. I'll now turn the conference back over to you for any additional or closing remarks.
All right. Well, thanks to all of you for joining us today. To close, I just want to assure you that we are taking the necessary steps to return to growth and get back to EBITDA profitability, all while continuing to invest in our future with a very fast pace of innovation. We look forward to showing you our progress through 2024 and beyond. Thanks for joining today.
Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.