Upstart Holdings Inc
NASDAQ:UPST
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Upstart Holdings Inc
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Good day, and welcome to the Upstart Fourth Quarter 2022 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 2022 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 2022 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 2023 related to our business and our plans to expand our platform in the future. These statements are based on our current expectations and information available as of today and are subject to a variety of risks, uncertainties and assumptions. Actual results may vary 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 the result of new information or future events, except as required by law. In addition, during today's call, unless otherwise stated, references to our results are provided as non-GAAP financial measures and are reconciled to our GAAP results, which can be found in the earnings release and supplemental tables. To ensure that we can address as many analyst’s questions as possible during the call, we request that you please limit yourself to one additional question and one follow-up.
Later this quarter, Upstart will be participating in the JMP Securities Technology Conference on March 6 and the Loop Capital Markets Investor Conference on March 13.
Now I'd like to turn it over to Dave Girouard, CEO of Upstart.
Good afternoon, everyone. Thank you for joining us on our earnings call covering our fourth quarter and full year 2022 results. I'm Dave Girouard, Co-Founder and CEO of Upstart. Obviously, 2022 was a challenging year for Upstart, and we're not happy with the results we're sharing today. In many ways, last year was the perfect storm for our business model. The withdrawal of federal stimulus disproportionately harmed our borrowers, akin to a simulated recession for millions of mainstream Americans suddenly lost what had become their primary source of income.
The Fed's interest rate hikes the fastest in several decades left both lenders and capital markets cautious and concerned about what might come next in our economy. Out of an abundance of caution with respect to the economy, many lenders cut back or paused their originations, despite the fact that their Upstart-powered loan portfolios have met or exceeded expectations since the program began in 2018.
Having said that, we're not into excuses. The best companies take advantage of the opportunities presented in the most difficult times. 2022 was in some ways a gift because it laid there some parts of our business that we needed to improve. We've made great progress in many of these areas, and I'll share a few of them with you shortly.
But first, I want to make it clear that we're committed to running an operationally and fiscally tight ship and always have been. We've been profitable for most of the time that we've been public. It is our intention to return to profitability as soon as possible.
Given the reduction in lending volume, two weeks ago, we took the unfortunate but necessary step of reducing the size of our workforce by 365 team members, representing about 20% of our staff. I'm deeply grateful for the immeasurable contributions these Upstarters made to our mission over the years, and I'm profoundly sorry that their time at Upstart came to such an abrupt end.
With this reduction in staffing, we also decided to pause development of our small business lending product. This was a necessary step to ensure we can adequately resource the rest of the roadmap. We look forward to the day when we can resume our pursuit of the world's best AI-powered business loan. Yet we haven't just focused on reducing expenses, we grabbed the opportunity that 2022 presented to make important improvements across Upstart in ways that have made us a stronger company for the future.
Let me share a few examples. First, we've traditionally viewed our business model in the simplest terms as a marketplace for loans based on price discovery and participation for consumers and lenders. And while this is true, it's also useful to think of the funding on our platform as a strategic supply chain that needs to be scaled and strengthened continually.
In our earnings call in August, I told you that we would begin to investigate partnerships that could provide more reliable and persistent funding to the Upstart platform. I'm happy to report that we're in late-stage discussions with multiple potential partners in support of this goal. Second, we also took advantage of the volatile economy to significantly upgrade our model's ability to understand and react to macroeconomic conditions.
Last quarter, I announced our plan to productize the Upstart Macro Index, or UMI. This new metric measures how changing economic conditions, like inflation and unemployment, are impacting credit performance. We continue to make breakthroughs in our methodology for calculating UMI, and we expect to launch this monthly metric to the public later this quarter.
This is an exciting development from our machine learning team. In an industry first, Upstart will provide lenders with near real-time insight into the financial health of the American consumer, allowing them to adjust their lending programs accordingly. This is a big step toward providing banks and credit unions with lending infrastructure that autonomously, continuously and rapidly adapt to changes in the economy. You'll be hearing more about this soon.
Third, 2022 confirmed that we have both strong unit economics and considerable pricing power even in the most challenging environment. Despite the fact that our lending volume in 2022 was down 14% versus the prior year, our contribution profit was actually up 13% year-on-year. Optimizing our pricing represents a large surface area of opportunity, which we've only just begun to explore.
In addition to these major improvements, we've also continued to innovate across our platform in support of future growth. In fact, I believe we made more progress with our technology in 2022 than in any year in our history. And as capital markets and the overall economy normalizes, I expect this will become obvious to all of you. Some important areas of progress from last year include model accuracy. Our AI models continue to separate risk significantly better than a traditional FICO-based model, and we continue to increase our pace of model development. The increase in our model accuracy in the last seven months is more than what we delivered in the prior 2.5 years.
Automation. In the fourth quarter, we saw a record 82% of personal loans fully automated. By automated, I mean there was no human intervention anywhere in the process of originating the loan. This boost came primarily from eliminating or automating processes that our loan operations team has traditionally done manually.
Auto Retail. We finished the year with 778 total dealerships under contract, a 90% increase from a year ago. As automobile inventories are replenished and prices normalize, our ability to modernize the car buying experience for our dealer partners will only become more important. We're piloting our AI-powered auto loan in 27 of our dealerships, helping them approve more applicants with less friction. As of now, when borrowers are presented with an Upstart-powered loan in these dealerships, they choose us 42% of the time. Also in Q4, about one in every three Upstart-powered auto retail loans were fully automated, an increase of 25% from the prior quarter.
Small dollar loans. We launched this innovative product in June of 2022. Today, our Small dollar product includes loans from $200 to $2,500 with tenors from three months to 18 months. To date, we've originated more than 24,000 small dollar loans to individuals who otherwise would not have been approved for our personal loans.
More than 12,000 of these loans were originated in Q4 alone. This expansion of borrower coverage means we are dramatically increasing the pace at which our machine learning models are improving. And just as importantly, in Q4, 88% of small dollar loans were fully automated.
Lending partners. In our earnings call a year ago, I told you we had 42 lenders on the Upstart platform. Today, that number is 92, representing growth of 130%. Despite the hostile 2022 environment, banks and credit unions recognize and appreciate a fundamental secular change in technology when they see it. These partners are starting cautiously with us, but they represent a significant expansion of potential lending capacity on the Upstart platform once there's a bit more clarity on the direction of the economy.
Now I'd like to turn your attention to 2023 and our priorities for this year. Our first priority is to continue to assure proper model calibration and model accuracy for all our products regardless of which way the economy turns. This is the foundation on which all other success is based. This implies as much as anything taking a conservative position relative to the UMI trends we observed today, and there, our next stop is to return to profitability as soon as possible. While we can't make promises given the unknowns in the economy, we are intensely focused on generating operating cash and positive GAAP net income once again.
And with some modest cooperation from the economy, we expect to return to our pattern of quarter-on-quarter growth this year. While the expansion of both bank and capital market funding are foundational to this effort, growth is also gated by the approval rates and interest rates that the prevailing risk in the world dictates. This risk is conveniently captured on a monthly basis by UMI. This year, it's also a priority of ours to reduce the volatility in transaction volume on our platform in the future. This is the primary motive of the committed capital initiative I mentioned earlier.
It also means improving our ability to serve primary borrowers more competitively, which is in the interest of Upstart as well as our bank and credit union partners. And lastly, we can reduce future volatility by continuing our expansion into secured products such as auto loans and home loans, which are generally preferred by lenders in times of uncertainty. Through all of this, we're focused on using our balance sheet efficiently and wisely. We have been a model of capital efficiency since our earliest days, and I expect to continue on this path in 2023 and beyond.
Before I turn it over to Sanjay, I want to share why I'm as optimistic as ever about Upstart's future. The core thesis of our business that AI can unlock smarter credit decisions than a 30-year-old credit score can is now obvious. The recent launches of products powered by generative AI has opened our eyes to the unlimited potential of artificial intelligence and machine learning.
A couple of weeks ago, a warden school NDA Professor admitted that ChatGPT had successfully passed his final exam. So it's not gently to believe that AI can lead to more accurate credit decisions. Indeed, we are proving this every day. It's clear that Upstart is an established market leader in the application of AI to lending. Despite the economic challenges of 2022, we are a much better company than we were a year ago with more advanced technology, accelerated model development and dramatically more training data, and our founder-led leadership team is stronger than ever.
As I've said before, the price of credit is the price of the American dream. We chose this path of reinventing credit so that it works for everyone, not because it's easy, but because it's important. We chose it because no one else was doing it and it needed to be done. I can think of no better journey to improve the financial health of mainstream Americans than the one we're on, and we certainly won't let a little economic turbulence get in our way.
Thank you. And now I'd like to turn it over to Sanjay, our Chief Financial Officer, to walk through our Q4 and full year 2022 financial results and guidance. Sanjay?
Thanks, Dave, and thanks to all for taking a break from your Valentine's Day to listen in.
Reflecting back over the past year and on our outlook of a year ago, it's safe to say that the macro has exceeded our most wildly bearish expectations. One year ago on our earnings call, we've begun to sound the alarm on encroaching consumer delinquencies and the potentially adverse impact of the disappearing government stimulus at a time when the broader markets were still quite sanguine about the economy.
Over the course of the ensuing year, the impact of change in income and consumption patterns on consumer delinquency proved greater than we could have predicted and the resulting contraction in the funding markets was sharp. Indeed, as we exit 2022 and enter a new year, consumer delinquencies remain elevated and the funding markets remain limited in their appetite for risk.
Despite this, we are starting to see some encouraging signs that the worst of the macro may be behind us. The personal savings rate, which we watch closely as an aggregate barometer of consumer fiscal health, has now lunched upwards for three consecutive months, reaching in December its highest level since the prior spring.
Underpinning this trend is a relatively recent reversal in the growth of real personal consumption coupled with a nascent recovery in workforce participation rates over the same period, prompting income and consumption to begin drifting back towards their historically closer alignment. The ongoing recovery of workforce participation rates and real hourly wages, both of which still language below pre-pandemic levels, suggests to us ample runway for continuing improvement to personal savings rates over the coming quarters.
Reflecting this improving consumer fiscal health, UMI, our internal measure of the macro impact on consumer defaults of Upstart-powered loans, matched upwards from Q3 to Q4, but at a much slower rate than in prior quarters and has shown encouraging signs of stabilization in the early weeks of 2023.
As UMI stabilizes, we are seeing a corresponding reconvergence of longer-term performance to target for our more recent vintages as they continue to season. On the funding side, spreads for senior securities in the securitization markets have also shown some initial signs of tightening in 2023 after a very challenging Q4. Concurrent with and perhaps related to these encouraging trends, as David alluded to, we are engaged with multiple prospective partners who are actively exploring long-term capital relationships with us, some of which we qualify as being at an advanced stage, including formal expressions of interest. While we do not yet have anything definitive to report, we hope to have more concrete news on this front soon.
With these data points as back truck, here are some financial highlights from the fourth quarter. On the top line, revenue from fees of $156 million was largely in line with our expectations. Net interest income came in above forecast, largely a result of choosing to retain more loans on our balance sheet than anticipated given the market conditions in Q4. Taken together, net revenue in Q4 was $147 million, ahead of our guidance by representing a 7% contraction sequentially and a 52% contraction year-over-year.
The volume of loan transactions across our platform in Q4 was approximately 154,000 loans, down 69% year-over-year and representing over 106,000 new borrowers. Average loan size was up 22% versus last year. Our contribution region, 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 53% in Q4, up from 52% last year. We continue to expand our margins in Q4 through higher take rates and more efficient marketing spend.
Operating expenses were $205 million in Q4, down 16% year-over-year and 5% sequentially. The majority of the reduction was achieved through reduced sales and marketing, which was down by 56% year-over-year following the trends in volume. Over the last quarter, we have largely limited hiring to only a few key strategic positions in operations, engineering and G&A, all of which were nominally down sequentially in overall spend.
Taken together, these components resulted in a Q4 GAAP net loss of $55.3 million. Adjusted EBITDA was negative $16.6 million, well ahead of our guided number of negative $35 million. And adjusted earnings per share was negative $0.25 based on a diluted weighted average share count of $82.2 million.
We ended the full year with net revenue of $842 million, down 1% from 2021. A contribution margin of 49%, roughly flat from the prior year and adjusted EBITDA of $37 million, representing a 4% adjusted EBITDA margin versus 27% a year earlier.
During Q4, we made the decision to sell fewer loans from our balance sheet than we originally contemplated in our guidance. Liquidity in the secondary markets remained thin during the quarter, and in our view, the market prices for personal credit do not ultimately reflect the extent to which our models have recalibrated to the new trends of consumer default. So we chose to retain loans on our balance sheet and harvest the interest income.
We plan to continue testing the market as pricing normalizes and selling becomes a more attractive strategic option. In the meantime, the balance of loans on our balance sheet rose in Q4 to $1.01 billion, up $310 million from last quarter. Of that total, loans made for the purposes of R&D principally within the auto segment represented $492 million of that total. We are now roughly at the maximum size of balance sheet that we are planning to maintain, and we will, therefore, largely limit new additions to the balance sheet until we can find suitable sources of liquidity for existing loans.
Despite this, we remain in a comfortable position of corporate liquidity with $532 million of total cash on the balance sheet and approximately $674 million in net loan equity at fair value.
Looking to Q1, the near-term outlook continues to be tied to the macro economy, and despite some of the encouraging trends previously mentioned, we continue to price loans with a conservative assumption of further degradation in the macro environment, and consequently, in our Upstart Macro Index.
More specifically, our topline guidance for Q1 reflects a higher forward assumption for UMI in our loan pricing, traditional Q1 seasonal headwinds, some further tightening from our funding partners that we have experienced coming into the year and the withdrawal of our own balance sheet as a funding source for new loans.
On the expense side of the ledger, they refer to the workforce reduction, which we announced two weeks ago. As a result of this reduction, we expect to realize cash savings of approximately $57 million in operating expenses over the next 12 months, primarily related to employee cash compensation and benefits, in addition to $42 million of savings from reduced stock-based compensation expense over the next three years.
Also related to this event, we anticipate incurring $15 million in restructuring charges in the first quarter, which we have excluded from our non-GAAP guidance. With these specifics in mind, for Q1 of 2023, we expect total revenues of approximately $100 million, consisting of revenue from the fees of $110 million and net interest income of approximately negative $10 million. A contribution margin of approximately 55%, net income of approximately negative $145 million, adjusted net income of approximately negative $70 million, adjusted EBITDA of approximately negative $45 million and a diluted weighted average share count of approximately 81.9 million shares.
Before wrapping up, we would just like to take a moment to acknowledge the group of Upstarters that were affected by the reduction in force that we recently went through. The time you spent with us and the contributions you made will always be a part of the Upstart journey, and we will do our best to honor them and to take your work forward in a way that would make you proud. We look forward to seeing what amazing things you will do in the next chapter.
Thank you. And with that, Dave and I are now happy to open the call to any questions. Operator, back to you.
[Operator Instructions] Our first question comes from Ramsey El-Assal with Barclays.
Hi. This is John [indiscernible] on for Ramsey. I had a question for you on pricing power. I believe a couple of quarters ago, you commented that on the -- given the tighter environment, you had a little bit more pricing power, and I think you also mentioned something like this in your prepared comments. So I was wondering, can you say whether or not any of the revenue declines you saw this quarter were partially offset by higher pricing?
John, this is Sanjay. I would say that our take rates were very similar to the prior quarter, maybe up a little bit. So we did -- we were sort of able to offset them marginally, but I don't think the impact was significant enough obviously to change the trajectory.
Okay. Great, thank you.
Our next question comes from Pete Christiansen with Citi. Please go ahead.
Thank you. Good afternoon. Dave, I was wondering if you could talk -- you talked to a great extent about on the supply side funding. I was just wondering if you can dive a little bit into the demand side. I recognize that you pulled back from marketing quite a bit, but your sense for overall loan demand for the category of borrower that you serve, that would be helpful.
And then as a follow-up, just wondering if you can give us a sense of the allocation levels that you have with your existing bank partners, have you seen any changes in that dynamic?
Sure. Thanks, Pete. This is Dave. I would say, I don't know if there's an absolute measure of demand for loans in the environment, but I would -- I think we can safely say, demand is very strong. Consumer demand for credit in a time when people are -- the personal savings rate has been down. It's up recently, but just given where the American consumer has been, I think it's normal to expect that demand for credit is quite strong. We're headed into a seasonal time when it usually actually weakened due to tax returns and that kind of thing, so we'll see. Sometimes that's overwhelmed by something else. But for now, I think we can safely say that consumer demand for credit continues to be very strong.
Great. And...
Sorry, the other question. No worries.
Yes. Just wondering, I know at some banks, for instance, have like a 10% cap of Upstart loans or something like that. Have you seen like those allocation levels that some of your bank partners typically take? Have you seen them alter at all in the last few months?
Well, for sure, every bank partner has kind of a capacity each month, and they can change it at will as they go. And that a lot depends on whatever else is going on in their business, the state of the balance sheet, et cetera. So it's very common that banks would increase or decrease. Generally speaking, without question over the last year, banks have been tightening and reducing lending as they've just had concern about the economy. They're watching the same CNBC. Everyone else's have had concerns, and that's probably been one of the most impactful and challenging parts to our business in the last year is really just banks get very conservative naturally and cautious when they're unsure about what's next in the economy.
Great. Thank you.
Our next question comes from David Scharf with JMP Securities.
Hi, good afternoon. Thanks for taking my questions. First one, maybe just following up on kind of loan demand and specifically, the kind of the Q1 outlook. Your commentary on both kind of credit trends and consumer demand seem very consistent with the other kind of nonprime personal lenders we've heard from this quarter. As we think about kind of the step down in revenue, does that primarily setting aside tax refund seasonality. David, is that more a function of tightening the credit box further? Or is it just kind of the limitations imposed by your balance sheet at this point?
Thanks, Dave, for the question. Generally speaking, we are kind of a supply and demand balanced business model. So sometimes we have excess borrowers and not enough funding. Out of the times, it can be the opposite. Today, actually, most of the decline in our business is because rates approvals are way down and rates are way up, and that's largely due to higher levels of risk in the environment.
Now at the same time, actually, as I had said earlier -- a question from Pete, lenders have pulled back as well. So in a strange way, we're relatively balanced, but at a much, much higher -- much lower approvability, much higher interest rate and that's what's driving lower volumes. And over the years, as we look into 2023, of course, it's hard to say which way it will go, but we're always essentially trying to maintain balance between supply and demand. But right now, most of the decline in volume in our platform, the most fundamental reason really is because the rates are much, much higher. The approval rates are much lower. And that's this thing we call UMI, it's just a function of the risk that's out there in the environment.
Got it. Got it. Helpful. And maybe as a follow-up, just turning to the expense side. I realize -- so it's dangerous doing just simple math, but if I just kind of divide the annualized cost savings and one-third of the stock comp into the number of employees downsized, it averages about $200,000 per employee, and -- which is not insignificant. I'm just wondering, is there any color you can provide on perhaps the type of disciplines that were rationalized. I don't know if this was primarily engineering, product development or in other areas, but is there anything in kind of the downsizing that kind of alters a longer-term sort of new product and technology initiative outlook?
David, this is Sanjay. Let's see. In terms of the sort of the, let's call it, the allocation of the reduction in force, it's pretty evenly spread across the company and some functions took a bit of a different absorption than others. But overall, almost all teams were affected as you'd expect when you have a workforce reduction on the order of 20%, which is what it was.
With respect to the product roadmap, I think the main thing that we communicate to the market is that this will, at least for the time being, put our efforts in small business lending on pause. We do have every intention of getting back to them when the time is right, but I think that's sort of the main call out. There's a couple of other things on the margins that maybe weren't quite as understood in public, but I think that's maybe the sort of the big impact to the, call it, the near to medium-term road map.
Got it. Great. Thank you.
Our next question comes from Simon Clinch with Atlantic Equities. Please go ahead.
Hi, guys. Thanks for taking my questions. Lots of really useful information in today's report. Thanks very much. I guess I just wanted to get a sort of a bigger picture perspective on the business model here. Because when I think back to the performance and the market share gains you had coming out of the pandemic, I was wondering what -- I guess what are the differences in the market structure today in the business model and the institutional funding channels that might mean the share gains that you're -- the advancements you've made with your AI models might perhaps not live up to the standards that we saw coming out of that very unusual period in pandemic.
I'm just wondering sort of how to think about the pace of those share gains and what might be working or what might work against it coming out of this particular environment.
Sure. So I think our technology has only gotten better, and the environment, of course, changed pretty dramatically. And as I kind of acknowledged in my remarks at the beginning, it definitely showed us some things we needed to know kind of that an at-will model where funding can come and go or lending and/or investing in those can come and go month to month is -- well, it might be sort of beautiful on a whiteboard and from a pure economist point of view, it makes a lot of sense. But in reality, we need to have volume more locked in and secured, which is an important initiative for us.
So the issues we've had really to date are almost entirely related to the funding side. Some of it is macroeconomic and some of it, frankly, is on us and things we need to fix. None of it, in my view, is on our technology. I think it continues to be extraordinary and differentiated, if not more so today than it has been.
All the improvements I kind of talked about in my remarks earlier are, in some sense, masked because if the funding markets aren't operating properly and if lenders aren't deciding if it makes sense to lend, there's only so much we can do. So we are pursuing some initiatives, as we've said, to sort of make sure we don't make the same mistake twice. And so having secured funding, committed funding over longer periods of time to us is very fundamental.
Also, this effort we're doing with what we call UMI is really to be really transparent with lenders, in particular, with banks and credit unions of what's going on in the economy. So they can make very informed decisions, which might be to tighten standards and slow down volumes at times, but it hopefully won't be as dramatic as it has been in the past where maybe they didn't have as much insight as they needed to what's going on out there. So these are all efforts on our side to fix what we think needed to be fixed in our business. But none of them, at least in my view, are really related to the core AI and its predictiveness, et cetera, which we feel very confident in.
And maybe just touching then as a follow-up on the UMI Index. Is this something that will potentially prove a really useful tool at accelerating the pace of bank partners coming on to the platform and also keeping it -- keeping the relationships even stickier than they have been in the past?
Well, we certainly hope so. I mean I think the idea of having a very quantified in near real time, meaning just you're getting information about the month that has just finished indication of the health of the consumer that you lend to and with different sort of slices and dices available for a lender is really powerful because it's not something a lender's done in the past. If they have either over performance or underperformance in their credit programs.
It's really hard to attribute that item to something about how you set your system up and the rules you have in your system or maybe the economy is deteriorating in some way, you don't have visibility. This is a really powerful way to say, no, we can actually isolate the performance of credit model from the impact of the macro economy. And that itself, I think, is going to be a very powerful new tool and one
we think that lenders of all flavors will get excited about.
Thanks so much.
Our next question comes from Rob Wildhack with Autonomous Research. Please go ahead.
Hi, guys. I wanted to ask about your more committed funding sources. Wondering if you could give some more detail there. What type of partners you might be in discussions with? What kind of arrangements you're working out with them? Any additional color on the timeline, too, would be really helpful.
Rob, this is Sanjay. Let's see on sort of the more committed capital style relationships. I guess I would say, first of all, I think we've always been pretty cautious in saying that this is sort of a transition over time for us. It's not something that would necessarily happen in the near term. I think these are large -- very strategic relationships.
That said, I think we sounded a note of optimism in our prepared remarks. And just to sort of reiterate the points there, I don't think we have anything definitive to call out right now, but we are in a number of conversations with multiple partners that, I guess, I would qualify as sort of advanced stage. We sort of mentioned that we had some indications of interest.
So again, hopefully, we'll have something more definitive to announce soon. But I think in the meantime, we're sounding some sort of notes of optimism, if you will. And I think they're related to some of the optimistic trends we're seeing in the broader environment, some of the things that we took through.
And then your question really is like what are the sort of the nature of these arrangements. At the simplest form, on the one hand, they would sort of on the partner side be more committed -- forward commitments at scale of capital. And then in exchange, you would imagine some kind of sort of premium in the economics and that could take a couple of different forms. And I think we're discussing different structures with different partners as we speak. So it's a bit hard to sort of be too precise, but that's sort of the most general sort of description of how these partnerships will work.
Got it. That's very helpful. And then on your current funding partners, how do your conversations would then vary by type? I'm wondering if the conversations would say, a larger bank might be different than that with a credit union or with a credit founder, your ABS partners. Any additional color you could add there would be really helpful.
Sure. This is Dave. Well, I would just say, maybe on the bank and credit union side, I mean they do vary a bit. Credit unions were really flush with deposits a year ago. That is much less the case today. So where -- credit unions are really starved for loans because they were, again, very flushed with deposits. I think that's a little reverted to normal, and so that just changes their appetite.
And banks, not much so. I mean I think banks, there's a lot of interesting competition for borrowers going on out there with regard to deposits. So I think it's one of the more interesting dynamics. It's really saying, some of the new guys in the market really pushing the APY, pay for deposits up. So there's just a lot going on out there that I think is changing pretty quickly, but we don't fundamentally see any overwhelming change in dynamic other than, as usual, you can hear it from the CEOs of the largest banks. I mean just caution about the economy, they're all kind of caging. Would this be an in and out small recession, will it not be a recession, hard landing soft landing. So I think that's just sort of the cautiousness that's out there.
But a year ago, I would say, generally, there was -- on all sides, there's definitely swimming in deposits and in need of credit as a result, and that's definitely much lesser today.
Thanks.
Our next question comes from Mike Ng with Goldman Sachs. Please go ahead.
Hey good afternoon. Thanks for the question. I just have two. They're both on the 1Q '23 guidance. And it was helpful to get a lot of color around what was driving some of the sequential decline in revenue, which sounds like it was mostly a funding constraint. So first, I was just wondering if you could talk about whether that sequential decline in revenue was solely due to a tougher funding environment? Or are you actually expecting lower levels of rate requests and conversion? Thank you.
Mike, this is Sanjay. I would say, I think that the sort of the constraints that are conditioning our guidance for Q1 are happening on both sides of the ecosystem. On the, let's call it, the borrower side, approvability is constructed on a couple of fronts. One, we did sort of mention that the assumptions around sort of macro forecast and their impact on loan performance are becoming more conservative as we go from Q4 to Q1. Some of that is not necessarily a reflection of what we're actually seeing, it's a reflection of conservatism because the most important thing we need to do in our business is to get the loan performance. And so we sort of doubled down on that as we exited Q4 and that will spill into Q1.
And then, of course, there's the seasonality impact that Dave referred to, which is the fact that traditionally, in Q1, as you get sort of course of the tax season, you do see a 10% to 15% trough, depending on the year.
And then on the funding side, as we said, yes, there's some continuing pullback on funding sources, particularly those who are more reliant on leverage and liquidity, those who were relying the ABS markets. Q4 was turned out to be a tough quarter for ABS issuance. And so I think that sort of affected some of what we had coming into Q1. And then, of course, we mentioned sort of the loss of our own balance sheet as a funding source, which was not the majority of our funding source, but it plays a factor as well.
So I think when you add all of those things together, you sort of have something on the borrower, the approvability side, some things on the funding side and they sort of add up to where we guided.
Great. And then just the last question -- the second question. What's a good way to think about the rest of the year? Appreciating your comments about 1Q likely being the trough. Should we expect to grow off of that $110 million of fee revenue throughout the year, assuming that the funding environment and the UMI environment doesn't necessarily change? Or can it be significantly better than that? Thanks.
Sure. Yes. I mean, I guess, at the highest level, I think the mechanics that we most focus on and the way I think this will play out. So, two things that are very closely related. The first one and the most important one really is expressed by that metric, what we call UMI.
Essentially, as that stabilizes and starts to come back down, it means that risk in of as the macro is sort of contributing to more risk and borrower delinquency, that is exciting. And as that happens, we believe what you will see is a re-convergence to target for loan performance, which some of those material there in our investor slides.
And that performance will go back to target and in fact, back to exceeding target as it has historically. And as those two things happen, the approvability side on the borrower side of the ecosystem becomes accretive to the business. So, the approvals go up, risk goes down. And typically, the funding markets will follow that when they start to see signals of subsiding risk and signals of sort of loan target performance and overperformance. Typically, that's accompanied by easier ABS markets, and certainly, if we get a couple of deals in place along with -- in the style of committed capital, that will provide the fuel on the funding side to go back to our prior levels.
Our next question comes from James Faucette with Morgan Stanley. Please go ahead.
Thank you. This is Sandy Beatty on for James. I have a question on the loan performance trends. So, the ABS data that we track has shown a pretty meaningful deterioration just looking at annualized losses, delinquencies of the majority of the public deals over the last, call it, three or five months or so.
So, I just wanted to make sure, are we interpreting that correctly? How is your team thinking about that? And then just contextualizing with the UMI and then the general comments on the consumer.
Yes. Sure. Sandy, this is Sanjay. So, I guess there's a couple of -- if you're looking at sort of broader ABS issuance right now, I said that there's a couple of phase delays I would call out. The first one is just the time it takes from the issuance or the origination of a loan for it to get sort of issued into season in an ABS deal. And so that's sort of, I think, a bit of a lagging indicator in that sense.
And so, to sort of speak in the language of vintage, and this is, I think, reflected in what you see us sort of produce with respect to the loan performance to target chart that we have in our investor materials. I think the trough or the low point of loan performance or maybe the high point of excess delinquency, if you will, happened in our view in sort of late 2021, maybe towards the end of 2021, if you will.
And then there's a second phase delay, which I think is probably relevant to what you're looking at, if you're looking at broader issuance, which is in our view, it's pretty clear that from a phasing perspective, it's the lower-income borrowers that became impaired first. And then now it's sort of the primer borrowers that are coming under stress.
And of course, I think in our sort of issuance and in our collateral, you'll typically see the former more reflected because we tend to work with lower-income borrowers. And if you're looking at broader issuance, it does probably towards the side of higher prime borrowers or certainly, if you're looking at other digital players.
And so, I guess, in my view, the way I describe it is, I think the lower income borrowers probably hit their trough at the end of 2021. The primer borrower is probably sort of troughing somewhere in mid-2022, and all of that takes a quarter or two to actually flush through the ABS sort of numbers. And so that's how I maybe describe the system from our perspective.
Got it. That's very helpful. One that's more general in nature and really on the back of the January restructuring plan. I know we've talked about 1Q and the forecast in terms of cost cutting, I just wanted to ask, generally, how you're thinking about timing with respect to the path to profitability. Obviously, a focus of the market this year, given rates, et cetera. But has that been a conversation? Is there a general target? And what's the thought process at a high level?
Sure, James. This is Dave. I would say, generally, when we took the action we took a few weeks back, we definitely thought we need to put ourselves in a position where fixed expenses make sense in the environment as it exists not in the environment as we wish it will be later this year.
So, we've largely set ourselves up to be fairly neutral or, if you will, on fixed expenses and then not making any large assumptions about the economy improving, et cetera. And that's just how we think about it. We're in a very stable position, and in our view, the business -- the market we serve is not like we going to deteriorate this year. It could stay where it is for a while and not something you can live with, but that was the nature of it is.
Let's get ourselves -- forget about how many people we had last month or whatever, let's get ourselves to a fixed expense position that we feel like makes sense in the environment we're dealing with right now. And it will not only give us more confidence in our future from a financial perspective, we'll, in fact, be able to emerge out of us at some point with a lot of leverage and a lot of sort of profit potential in our business because we have slim down fixed expenses.
We've also gotten really good about marginal spending on marketing. Our contribution margins are way up. Our acquisition costs on pre-loan basis are way down. So, we're just set up, I think, really well for the future. But again, we're not making any assumptions about a dramatic improvement in the macro.
Okay, thank you for taking my question.
Our next question comes from John Hecht with Jefferies. Please go ahead.
Thanks very much. I guess thinking about what you guys did about $1.5 billion of volume this quarter or Q4. It looks like you're doing somewhere between -- closer to one in Q1. You're not balance sheeting it. I'm wondering kind of can you characterize over that six-month period, who are the buyers -- kind of the main channels of buyers or investors? And kind of what's the transfer pricing within each of those channels?
John, this is Sanjay. So, the channels are largely similar to what we've described in the past. There's a channel that's sort of balance sheet. I would say, that the primary end of the spectrum, and they tend to be banks and credit unions. And then, of course, in the capital markets, there's sort of maybe a bifurcation between, let's call it, folks who rely on the ABS markets and folks and funds who do not.
I think most of the remaining funds that are working are the ones that do not rely on the ABS markets, just given the volatility of the ABS markets. And when you think about the pricing of loans, well, the banks who are using our technology to put loans on their own balance sheet through their own origination channel are pretty much setting their own prices with respect to what the borrower is paying, and we charge a pretty standard fee.
So, there's no real transfer the loan in that regard. They use our technology and the loan is originated for their own use, for their own balance sheet. With respect to the capital markets, we've always originated and transferred at par. There's been some minor exceptions to that for folks who have committed volumes forward. In exchange for that and in exchange for scale, we provide a bit of a discount, but it's something that's, I would say, very close to par.
Okay. And then can you -- we know you've raised pricing over the past year. You mentioned the loan sizes are a little bit larger on average. Can you give us like what -- maybe what's the kind of goal post duration and rate and kind of size of loans just for us to think about the portfolio -- what the portfolio -- originating portfolio looks like at this point.
Well, let's see. So, with respect to duration and loan size, we don't necessarily have a proactive view on what we're trying to achieve. We present the options for the borrower, and the market will sort of -- the marketplace will do its thing. I think in the way that the marketplace has trended because we've restricted approvals so much and because we've raised rates so much, the remaining of the resulting collateral is primer than it was, call it, six, nine months ago, and primer loans tend to be bigger loans.
And so, the fact that many of the -- sort of the lower-grade loans have been removed from the approval box has opted to increase loan size. So that's maybe a bit of a mix effect. With respect to -- I think when you say rates, are you -- you're sort of describing take rates or are you talking about interest rates?
Well, I mean, I guess I'd be interested -- yes, in the fee -- the average fee per dollar of origination. And then what are the yields that you're passing on? Like-for-like, whether it's a prime cohort or nonprime, what's the yield differential now versus a year ago?
Sure. Well, on the take rate side, I guess, in a general sense, you'll see that the take rates, if you look at our sort of fee revenue as a percentage of originations, they've gone up. And they've gone up really as a reflection of -- I think Dave answered a question earlier about underlying loan demand right now. Fundamental demand is very high. Approvability is low.
But when demand is high, there's a lot of inelasticity. And we've said in the past that we can use that as a way to improve our unit economics in times where volume is contracting. So, as you've seen volume contract over the course of the year, our take rates have gone up. And that's despite the fact that the banks and the prime loans are increasingly a larger fraction of the mix, right, because they are less impacted by the changes that kick loans out of the approval box.
So, you've seen an improving take rate even despite the fact that the percentage of loans and the percentage of bank capital has gone up.
And with respect to yield, again, there's that bifurcation where banks typically originating lower loss rate sort of primary loans, if you will, are setting their own rates, and they're sending them as a function of what they see in the economy and what that in cost of capital is. They've obviously not had as direct an impact on their own cost of capital as for state capital markets.
So, I would say that their yields have gone up on average somewhat, but it's a little bit bank by bank. It's a bit of a different case. In the capital markets where we have one essentially monolithical program, you can sort of certainly in the investor materials, we sort of laid out what our gross loan targets are after loss.
And just in rough terms, if a year ago, they were around the sort of seven, eight ballpark, they're now sort of near 11. So, they've gone up -- roughly commensurate with what has happened to treasury rates sort of at the two-year duration.
Our next question comes from Hal Goetsch with Loop Capital. Please go ahead.
Thanks for taking my question. Let me asked about your automotive business, and I just want to make sure I understand what you said. You the AI-powered platform is in only 27 of some 178 dealerships, is that right?
You're making the lives in 27.
In those 27, it's taken nearly 42% share of the loans on those dealer managements. Is that the best way to think about that?
That's right. So that was exactly when our loan offer has shown to show to somebody.
Okay. And is the loan like shown? Is it participating every time and being given an opportunity? Because this is the point of sale part of your business. The other part of your business is kind of refinancing other expenditure. This is a pretty cool part of your business is point of sale essentially for very large ticket.
I just kind of want to know how many extra deals may be your system is helping the dealership complete on an average week because those are very profitable transactions for incredible. Could you just share with us what you can about that?
Yes. I think -- I mean, I don't have a specific number for you, but for sure, we have -- one of our very primary values for dealerships is that we can make on offers with to borrowers that aren't getting them elsewhere, and -- or sometimes just better rates than they will see elsewhere.
And also, the close rate because it's a very automated process is significantly faster and better for the dealer. That's the kind of primary value proposition. I think if you wanted to just look at kind of wallet share, which is a different sort of cut on things and you take out the captives, meaning the OEMs doing lending programs themselves outside of the captive, I think we have about in those 27 dealers, about 20% wallet share outside of the capital loans.
Okay. So, 20% outside of capital. Okay. Great. And one cut on the overall market for the side of the platform for supply -- the supply for loans, the buyers, how much of this recent issue is that those buyers have so many more places to go now that rates have moved up. How would you characterize -- is that a fair characterization of what's going on? Is this two or three years ago, trying to find some yield in 6%, 7%, 8%, 9% is hard. Now it's a little bit easier.
That's definitely been a dynamic over the past couple of quarters. Let's call it hedge funds that previously needed to sort of buy and lever up in order to get high single-digit returns can now buy senior bonds returning 7% in some cases.
And so, they can sort of meet their hurdles with different alternatives as compared to before. So, there's been a lot more competition for yield, and I think that's been an environment that has been a little bit anomalous. And I think that we're starting to see signs, certainly of the senior instruments out there starting to revert a little bit and tighten up in terms of how they're pricing. But yes, there's been some substitution.
Okay. Let me ask one last question. On your 92 lenders now, is there generally like kind of same-store sales growth? Or is it -- are we still in a period now where the macro is still causing even the 42 that were originally on there to lend less because you really don't have that view yet because the macro has changed even on the original 42 you started with.
Yes, for sure. The macro affects everybody, meaning all of our partners generally to one degree or another are feeling the impact of the macro. So that can mean they're slowing down or they're pausing. Sometimes they're signing with us and implementations are taking longer because they're not as -- they're just more cautious. So, they know this is a direction they're going in, but they're moving a little cautiously in the beginning of 2023 or the end of 2022.
So, for us, we are adding them at a good clip, and if you sort of see the pace of additional lenders on the platform, we're really happy with that. But they're not converting into large quotes, monthly quotas very as quickly as they would have in the past and that's a function of the economy. But having said that, I think we feel happy that we're adding future capacity right now, and when the clouds part a little bit and there's a little more clarity, I think we'll have a much larger number of lenders on the platform that are ready to go, and perhaps, have been lending at a very small level for a while out of caution. But we -- presumably, we'd be ready to go to larger bonds when they have confidence.
Great. Okay. Thank you so much.
Our next question comes from Arvind Ramnani with Piper Sandler. Please go ahead.
Yes, I just wanted to ask about the lenders -- lending partners that you onboard. How much of that is like kind of like a sales process where you have a sales team going out there looking to kind of sign up new lenders and then onboard them? And then once they're on boarded, to kind of show them loans or kind of syndicate loans with those particular lenders.
I understand like kind of the loan process. You have like 80% above kind of a processing rate, but in terms of lenders, if you can just kind of walk through that process a little bit, that will be helpful.
Sure, Arvind. This is Dave. I think it's easy to compare it to kind of an enterprise selling process, right? We're selling technology to banks to help them lend along the flow of borrowers, but the process really looks like what you might expect out of seeing somebody selling, I don't know, SaaS software for this or that.
So, you have to win the business side. There's a lot of effort to get through committees and such because they have risk committees and credit committees and such. We know the drill now. So, we've done it a lot of times, but it is an enterprise selling process and then an onboarding process, which you could think of as the customer success team, et cetera, helping somebody walk through a process of getting live and originating loans.
And then after the fact, there's just -- we're almost constantly in touch with them, and they're thinking about what they want to be next and where volumes are, what we're seeing. So, there's a lot of a fairly heavy amount of account management. That's why there's 90-plus lenders on the platform today, and we're imagining a day when there's 500 or more. And so, we want them to better do as much as they can themselves, but we're certainly handling them very carefully one by one today.
Okay. That's great. And so, like to throw a number out there, whether it's 500 or number bigger or greater, will that solve kind of this problem of kind of a constrained lending environment? Like I mean that we may be too late to kind of solve the problem kind of right now, and we're potentially even getting out of it.
But like, let's say, few years from now, we go through another kind of tough economic cycle and then you are sitting with the base of maybe 500 or more like lenders, will that kind of make this situation a lot easier?
I would say, it's one of several things that we would like to put in place before the next cycle, if you want to put it that way. Having a lot more lenders on the platform is great, but if they all act and behave the same, then it doesn't help all that much. But in reality, the lenders that are on the platform today, they will look back at this time and say, well, it turns out the Upstart loans performed all the way through that.
So, we are today building a proof point for a lot of the credit unions and smaller banks on our platform who have not seen credit deteriorate. They've actually performed really well, get out of an abundance of caution, and because this is the first cycle inventor with us, they do pull back and they do sometimes pause.
So, I think, first of all, having another proof point or having a very large proof point, if you want to call that, over the last 12 months, it will serve us well in the future because the loans for these banks and credit means have really performed well. We'll also be in different categories. So, if they started with us in personal lending, it may be in auto lending or home lending, et cetera, and that, of course, I think, has a lot of opportunity to sort of cement the relationship further.
So, the lenders definitely have a lot of potential for us to fill out a large part, the primary end of what is originated to our platform. The other things we can do and we are doing. So, the next time around, there'll always be some volatility in our business given the nature of what we do, but we certainly hope it will look like it has in the last year, and we are working very hard at that.
Perfect. And just kind of last question. I mean you certainly provided guidance, which was helpful and kind of provided some guardrails on what you'll need to do to kind of made those numbers. But if you kind of think of like what scenario would kind of drive like either upside or downside to kind of the estimates you provided. What Kind of -- what needs to happen kind of with the broader macro for like kind of the range of outcomes would change as the year progresses?
Yes. Arvind, this is Sanjay. It's relatively straightforward, and there's sort of an answer both on the borrower and on the lending side, but upside would look a lot like what I described earlier. UMI comes down. Mechanically, loan performance will achieve target/overperform. And then I think as a consequence of that funding will sort of return to the platform or we will create some partnerships that will create some scale.
That would create upside certainly sort of a trajectory back to where we were previously and downside would be the opposite. I mean if the world degrades or devolves further if personal savings rates do a U-turn and sort of go back down low levels and/or the funding markets get even more skittish versus where they are today that I guess its theoretically to create some downside as well.
Perfect. And just last one, if I could. This AI and ChatGPT and bunch of these things that have kind of made kind of more mainstream press. Has kind of -- as some of your kind of conversations with some of your partners become a lot easier, right? Like I mean, I could imagine like two years back when you were talking about AI, people -- there may have been a cohort of folks expressing some level of skepticism that this AI thing is kind of not very tangible, but now with it becoming more kind of broadly kind of well-known or publicized.
It convinced to use the word ChatGPT. Have some of those conversations changed where people are like, okay, fine, you're using AI. I can actually kind of wrap my hands around now that I've touched it.
I think arguing some sense ChatGPT and this kind of generative AI as it's known. There's obviously a different class of AI trying to do something very differently, but in some sense, it's free marketing for us because the category of AI is getting credence. And when you see what ChatGPT guys, can sort of stunning to just try it if you haven't tried it. And it sorts of says, well, if it can do that, certainly, it can build a better credit model and can make smarter lending decisions. What we're trying to do actually seems much more straightforward in many ways.
So, it's an advertisement for the power of AI and for the fact that AI is going to be very central in our economy for the decades to come. So, if you're a bank executive, you really want to think about how that fits in the future, how you start to get awareness of it and it just makes Upstart, I think, a more attractive partner.
Great. Thank you very much.
The next question comes from Dan Dolev with Mizuho. Please go ahead.
Guys. I only have one question. I'm going to make it easy for you guys. So just really quick. It looks like the subprime and even the near prime is kind of beyond their [indiscernible]. Does that mean that you can like reopen the credit box in Q1?
Dan, sorry, I didn't quite -- you said that the sub sort of the lower prime borrowers are beyond there.
Yes. It looks like based on what you said is that the near prime and subprime is kind of beyond the trough in terms of their credit risk. Does that mean that you can actually reopen the credit box in the first quarter? And that was my other question. Thank you.
I think we would look to -- well, we're open to -- we would look to sort of increase approvals as they started to trend back down. And I don't think we've quite reached the point where we're willing to call that. I think they've been at a very stable level now for multiple months, but we need to see evidence of them. Or let me maybe talk about it in macro terms.
We need to see further evidence of personal savings rates rebounding. We need to see further evidence of income coming back in line with consumption. And the model will adjust as it sorts of detects the patterns in repayment, which will result from that. So, it's not necessarily a thing we need to sort of take a decision on. The model will react to improving trends as they begin to play out in the data.
Our final question comes from Vincent Caintic with Stephens. Please go ahead.
Hi. thanks for taking my question. So, a two-part question, both related to the funding side. So first, on the balance sheet, if you could discuss how much capacity you do have for increasing the amount of loans that you have on balance sheet. And if there's maybe other ways to increase that capacity. So Fintech’s, for example -- have banks, as an example.
And then the second part of the question is, I saw that you recently had an upside securitization to the 2023. Just wondering if you could talk about that, the appetite there and any learnings you can have like if there's potentially more opportunity there? Thank you.
Sure. Thanks, Vincent. Let's see. On the first one, well, let me start by saying, I don't think we have a desire to substantially increase our balance sheet capacity certainly in terms of its percentage of the overall platform and what it represents. I don't think a sustainable strategy would be to create bigger and bigger balance sheet capacity in the way that some peers have pursued through bank charter.
I just don't think that's the model for us for a lot of reasons, which we've covered in the past. I mean we could effectively scale up our capacity as the platform scales up. And you can imagine when we're doing many different products and running different R&D projects with maybe one of their capacity, but I think we're at our local maximum now, and I think it's suitable to the size and the scale of the platform. We would want the recovery of the platform to be driven by the funding markets, not by increasing balance sheet capacity. So that's, I think, a fairly deliberate strategic choice.
With respect to the ABS markets, we did close and price a deal in January. And yes, like I said, I guess I would characterize it at a high level. I would say that the -- if you think about basically the senior and the subordinate parts of securitization, the senior instruments seem to have a lot of rebound in demand and their spreads have tightened a lot.
So, I think they priced significantly better than they did in Q4. We're still not at the point where there is a real market for subordinate risk. That has not improved versus Q4, but typically, that's the way things get sequenced. The senior -- the sort of less risky instruments come back first, and then you sort of eventually will see a rebound in the subordinate parts as well. So, I think we're sort of maybe -- hopefully, nothing does U-turn or sort of midway through that that transition hopefully.
Thank you. And this does conclude today's call. Thank you for your participation, and you may now disconnect.