Upstart Holdings Inc
NASDAQ:UPST
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Upstart Holdings Inc
Earnings Call Analysis
Q4-2023 Analysis
Upstart Holdings Inc
For the first quarter (Q1) of 2024, a mixed financial picture emerges. The company expects total revenues around $125 million, with fee revenues driving most of the positives at $133 million, contrasted by a negative net interest income of approximately $8 million. The contribution margin stands at an estimated 61%, while the bottom line appears challenged with projected net income at negative $75 million, slightly improved figures when adjusted for net income and EBITDA, approximately negative $33 million and negative $25 million, respectively. Investors should note the diluted weighted average share count of 87 million shares in their valuation calculations.
An important shift in the risk profile has been identified; delinquencies are on the rise within more affluent borrower segments, prompting the company to enhance the prudence in their loan pricing to mitigate credit risks. This trend deviates from previously improving delinquency rates among lower prime borrowers. The company maintains an optimistic outlook, anticipating that these prime borrower segments will follow a cycle of normalization similar to their less affluent counterparts, eventually enabling the company to capitalize on a stabilized environment.
The company operates in a funding-constrained environment, reflecting in high loan pricing and relatively low approval rates. This condition signals a delicate balance where neither an excess of funding nor borrowers exists, a situation that can impact funding availability and loan origination growth.
A $300 million balance sheet deal was a notable event post the quarter end, and it played a role in the company's strategy of increasing loan aggregation more than usual in the previous quarter. This action points to a proactive approach the company takes in managing its balance sheet in anticipation of significant transactions.
The company has highlighted that loss rates differ by funding channel, such as bank or credit union partnerships, affecting the traditional understanding of the borrower mix. For the coming quarter, two factors are influencing the guidance: the expected seasonal decline in borrower demand due to tax refund season and tightening credit further in response to rising defaults among more affluent borrowers. This blend has shaped the company's outlook for Q1 and may see a continuation of these trends in the near term.
As the company looks ahead, there is an active search for more committed capital deals to replace the need for balance sheet funding. This shift will improve liquidity management and potentially reduce balance sheet exposure, aligning with long-term financial health and strategic flexibility.
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You are currently holding for the Upstart fourth quarter 2023 earnings call. We are still gathering participants, and we'll be starting shortly.
Good day, and welcome to the Upstart Fourth Quarter 2023 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jason Schmidt, Head of Investor Relations. Please go ahead, sir.
Good afternoon, and thank you for joining us on today's conference call to discuss Upstart's fourth quarter and full year 2023 financial results. With us on today's call are David Girouard, start's Chief Executive Officer; and Sanjay Datta, our Chief Financial Officer. Before we begin, I want to remind you that shortly after the market closed today, Upstart issued a press release announcing its fourth quarter and full year 2023 financial results and published at Investor Relations presentation. Both are available on our Investor Relations website, ir.upstart.com.
During today's call, we will make forward-looking statements, such as guidance for the first quarter of 2024 related to our business and our plans to expand our platform in the future. These statements are based on our current expectations and information available as of today and are subject to a variety of risks, uncertainties and assumptions. Actual results may differ materially as a result of various risk factors that have been described in our filings with the SEC. As a result, we caution you against placing undue reliance on these forward-looking statements. We assume no obligation to update any forward-looking statements as a result of new information or future events, except as required by law.
In addition to 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 address as many analyst questions as possible during the call, we request that you limit yourself to one initial question and one follow-up.
Later this quarter, upstart will be participating in Citi's 2024 13th Annual Fintech Conference on February 27, the Morgan Stanley Technology Media and Telecom Conference on March 4 and and the Citizens JMP Technology Conference on March 5. Now we'd like to turn it over to Dave Girouard, CEO of Upstart.
Good afternoon, everyone. I'm Dave Girouard, Co-Founder and CEO of Upstart.
Thanks for joining us on our earnings call covering our fourth quarter and full year 2023 results. Despite the difficult lending environment, we delivered solid results to end the year. with revenue up 4% sequentially and our third consecutive quarter of positive adjusted EBITDA. Without question, 2023 was a challenging year for both Upstart and the lending industry, and we're glad to be done with it. With interest rates at their highest in decades, elevated consumer risk throughout multiple bank failures leading to extreme caution and conservatism among lenders and a significant dislocation in capital markets the environment presented one hurdle after another. Considering the challenges 2023 presented, I'm happy with the decisions we took and the progress we made for the long-term success of Upstart.
Looking ahead, we remain cautious about the near-term outlook for our business, and we'll continue to operate responsibly in this environment. But I'm hopeful that you'll begin to see the benefits of our work as the economy continues to normalize in 2024. The numbers will show that we actually become far more efficient. And even while becoming more efficient, we've laid the groundwork to become a more resilient and diversified company that can thrive through a wide range of economic conditions.
With regard to efficiency, in Q4, we increased our contribution margin, both percentage-wise and absolute dollars versus the year ago quarter. We also finished 2023 with 26% fewer head count than at the end of 2022. Despite this, we hired almost 200 new Upstarters in 2023 and as we continue to strengthen our teams and reinforce our priorities. Improved efficiency sets us up well for a return to profitable growth in the future. But 2023 was not all about efficiency, we also focused intensely on building a stronger Upstart for the future. Let me share six areas where we've made significant progress recently and why I believe they'll lead us to a bigger and brighter future.
Number one, managing the macro. In the last 2 years, we experienced an economy unlike any in recent history. In fact, if you look even further to the past, you would be hard-pressed to find an economic cycle similar in form to what we've experienced since the beginning of the pandemic. While most of our innovation historically has been focused on selecting the right borrower at the right price, we learned that disruptions to the macro economy can reduce bank's desire to lend all together, particularly in unsecured credit where risk is naturally greater.
In 2023, we took on this challenge by releasing the upstart macro index, a tool that provides lenders with a clearer picture of the current state of the economy and enables them to make more refined decisions about their lending programs. We also developed parallel timing curve calibration, which helps calibrate new versions of risk models faster than what was previously possible.
While we believe predicting the economy's future is unrealistic, we do think lenders can be far more data-driven and nuanced in their decision-making. UMI and PTCC represent a giant first step toward offering a proprietary set of macroeconomic management tools that we expect banks and credit unions will demand for all their lending programs. Such a tool set is vital to Upstart's mission. Because it has the potential to make appropriately priced credit readily available to more Americans in all parts of the cycle.
Number two, extreme automation. Because so much attention goes to our risk models related to credit decisioning, it's often less well created, how much progress we've made in building a highly automated and efficient credit origination process. automation and efficiency are a winning combination in any economic climate.
In Q4, we once again achieved an all-time high with 89% of our unsecured loans proved through an instant and fully automated process. So we expect this number to vary quarter-to-quarter. The long-term trend has been clear, and it's a big win for us. We believe process automation is a durable advantage for upstart that creates an obviously better user experience. who wouldn't want to be approved instantly for a loan rather than having to upload documents, schedule phone calls or wait hours or days for a response from a credit analyst.
We believe a fast, automated approval is essential to winning over borrowers who have lots of choices and little patients or time, and these tend to be the best borrowers. And it's not just a better user experience. In Q4, 92% of automatically approved applications converted to a funded loan while only 27% of those involving manual steps converted. That's an astounding difference, more than 3x the conversion rate. Improved conversion from automation mechanically reduces up-funnel costs associated with customer acquisition and data associated with generating the rate offer.
Of course, automated loans cost upstart far less to process in the verification step contributing directly to our efficiency and allowing us to pass the savings along to our lending partners. We recently began to brand and market our automated approval process to applicants as fast track. Just by planning the benefits of fast track to applicants, we've increased our funnel conversion by more than 2%.
Number three, strengthen. We've also focused on strengthening our core personal loan product for periods of higher interest rates and elevated risk, such as we've been experiencing in recent quarters. In the coming months, we expect to release an optional feature that allows borrowers to provide collateral to support their personal loan application. This option will help borrowers access credit at lower rates than would otherwise be possible particularly at a time when rates and risks are elevated.
We've also identified a somewhat different opportunity to assist our lending partners in periods of reduced liquidity. When banks tend to prioritize retaining existing customers over acquiring new ones. We're hard at work at developing tools and techniques to help our bank and credit union partners do just that, strengthening their relationships by better serving existing customers. We expect to share more about this later in 2024.
As I mentioned last quarter, we've also upgraded our investment in servicing and collections and are hopeful we'll see dividends from this investment in 2024 and for years to come. The product team working on our servicing platform grew by more than 60% in Q4. Much of the effort is focused on simply making it easier for borrowers to pay and for servicing agents to handle borrowers issues quickly and efficiently. But we're increasingly excited about applying our machine learning expertise to this aspect of our product as well to maximize repayment and optimize handling of bars who may go or have already gone delinquent. We've begun programmatically gathering the data that will unlock the type of efficiency and efficacy gain in servicing that we've long seen on the origination side.
Number four, upgrading the money supply. In our first 12 years, the lion's share of our innovation has been focused on [indiscernible] enabled credit origination. In parallel, we've also developed capabilities related to efficient customer acquisition that are serving us well. But we've directed far less innovation towards the supply side of our business, i.e., the money, and this needs to change.
Today and in the coming years, we are increasing our innovation on the money supply and have a healthy head start in this area. Success in this domain means our funding across products will be more scalable, more reliable and more competitive with respect to cost. We believe this innovation can be unlocked by long-term partnerships that combine novel risk sharing and returns moving structures with direct and proprietary access to our credit origination engine.
After the quarter end, we closed an agreement with [ Ares ], a leading global alternative investment manager for them to acquire $300 million of personal loans. Additionally, we signed an agreement with a lending partner that we expect will originate approximately $500 million in loans over the next 12 months.
Number five, products for all environments. We're building a set of upstart offerings that are countercyclical to each other with the goal of developing a more balanced portfolio of credit products with less volatility in overall volume. We're particularly excited about rapid progress in our first home lending product, a HELOC. This product is popular in high rate environments when consumers are reluctant to sell their home or refinance their mortgage.
We recently crossed our first $5 million in cumulative HELOC originations, and our month-to-month growth is quite encouraging. We've now expanded to 11 states plus Washington, D.C. and expect to add a few more states in the coming weeks.
In Q4, our average HELOC time to close was down to 9 days. This is amazing progress against our long-term goal of a 5-day close and already dramatically better than the industry average of more than 5 weeks.
In Q4, we also launched our first instant approvals for the HELOC product. This means we're now often able to instantly verify identity, income and home value without any tedious document upload or waiting. We're hopeful this will become a meaningful percentage of our originations this quarter. We expect to drive this instant approval percentage up for HELOC, just as we've done successfully with unsecured personal loans.
Lastly, we successfully integrated our HELOC within our personal loan application. This means personal loan applicants who are homeowners may be offered a home equity option in addition to an unsecured loan. This is an area ripe with opportunity, and we expect to refine and expand this product integration over time.
In contrast, high interest rates made 2023 a difficult year for auto lenders. Regardless, we continue to make progress with our auto offering. We used the time to grow and strengthen our relationships with auto dealers, rounding out our retail software with key features most requested by dealers. We also expanded our finance offering with 88 dealerships now offering Upstart auto lending, up from [ 27 ] a year ago. And we recently announced that we're expanding our AI-powered financing capability nationwide. Expecting to reach 90% of U.S. consumers by the end of this quarter. We're confident that steady focus on the auto vertical will be rewarded once interest rates begin to decline.
Number six, extending upstarts AI leadership. While the last couple of years have been challenging, I believe they've ultimately extended our leadership in the application of AI to lending. Our models learned more than at any time in our history. We've navigated extreme changes in macro conditions and build tools and capabilities to manage through such changes in the future. Our small dollar product, which I consider to be at the frontier of AI-enabled lending, we've tripled approval rates since August, and this product now represents about 15% of first-time borrowers on the platform.
This type of rapid improvement, along with increasing automation and efficiency, gives me confidence that our forward progress in this domain is unparalleled.
To wrap things up, I'm pleased to share that in January, we brought Upstarters together in Austin, Texas. To kick off 2024 with our largest upstart gathering ever. We spent significant time talking about why our mission is so vitally important, and we left with a greater sense of purpose of our work. Upstarters across the country are confident and undeterred by the challenges involved in pioneering AI lending. Because they appreciate the size of the opportunity before us and the impact that access to affordable credit can have on the lives of all Americans.
While many fintechs and even banks retreat from the lending business, we remain strongly committed to it. Americans will always need access to affordable credit. And by continuing to serve borrowers through this difficult time of extending our advantage in training data, model calibration, [ prox ] and process. Once the economy inevitably normalizes and lending becomes fashionable again, I believe it will be difficult for others to catch up with us. We're excited for the new year and optimistic for what it holds for upstart. Thank you. And I'd now like to turn it over to Sanjay, our Chief Financial Officer, to walk through our Q4 and full year 2023 financial results and guidance. Sanjay?
Thanks, Dave, and thanks to all of you for joining us today. The hallmark of our economy in the second half of 2023 has been the remarkable unrelenting growth in personal consumption, which continued unabated through the balance of the year. This trend stands in contrast to the flagging level of disposable income, which on a real per capita basis peaked before last summer and has since languished.
These contrasting portions of consumption and income over the back half of last year have left personal fiscal health and as precarious a state as they've been since the great financial crisis with personal savings rates hovering close to all-time lows. With respect to the corresponding impact on unsecured credit performance, we continue to see clear signs that the rising default rates of lesser prime lower FICO borrowers that has played out over the past 2 years, is now stable and showing signs of imminent recovery.
However, the same pattern of rising defaults is now in the progress of working its way through higher cycle, higher prime borrower segments as well as primary and more secured products. According to our recent report released by the New York Fed, auto loans and credit cards have now spiked to their highest delinquency rates since the great financial crisis and continue to rise. Within unsecured lending, our view is that the near-term risk in credit has shifted to the primary customer segments. And as a result, we are becoming increasingly conservative in our underwriting of these higher cycle borrowers.
The funding markets continue to be oversaturated with assets on offer in the secondary markets. largely coming from banks who continue to reduce the size of their balance sheet through asset sales. Despite these ongoing distractions, institutional loan buyers appear increasingly comfortable with the prospect of a soft economic lending or perhaps even that no lending will be required. And there is an increasing anticipation of rate cuts at some point later in 2024.
The general outlook on the macro economy seems increasingly consistent with our own long-held view that inflation is on the wane and that significant unemployed risk in this labor market is unlikely. We are optimistic that our ongoing partnership efforts with the institutional funding markets will become increasingly constructive over the course of the coming year, should these macro trends fold. The examples of the partnerships that Dave announced earlier that have closed since the end of last year are hopefully indicators of more good things to come in 2024.
With this environment as context, here are financial highlights from the fourth quarter of 2023. Revenue from fees was $153 million in Q4, slightly above our guidance of $150 million and up from $147 million last year. Net interest income was negative $13 million in Q4. With continued R&D portfolio charge-offs in line with expectations and a downward revision to the outlook of our risk capital co-investments, reflecting the deterioration in the prime borrower loan performance.
Taken together, net revenue for Q4 came in at $140 million, above our guidance and up 4% from the prior quarter. The volume of loan transactions across our platform in Q4 was approximately 129,000 loans up 12% sequentially and representing over 82,000 new borrowers. Average loan size of $10,000 was flat versus the same period last year and down 9% sequentially.
Our contribution margin, a non-GAAP metric, which we define as revenue from fees, minus variable costs for borrower acquisition, verification and sourcing as a percentage of revenue from fees came in at 63% in Q4, just ahead of guidance and up 10 percentage points from last year. As Dave highlighted, we continue to benefit from high levels of loan processing automation and fraud modeling efficiency. Achieving another new high in percentage of loans fully automated at 89%.
Operating expenses were $188 million in Q4, down 9% year-over-year but up 5% sequentially. As increasing sales and marketing spend somewhat offset efficiencies in automation and servicing costs. Altogether, Q4 GAAP net loss was $42 million, while adjusted EBITDA was positive $1 million, both just ahead of guidance. Adjusted earnings per share was negative $0.11 based on a diluted weighted average share count of $85.6 million.
We completed the full year with net revenue of $514 million down 39% from 2022, a contribution margin of 63%, up 14 percentage points from the prior year and adjusted EBITDA of negative $17 million representing a negative 3% adjusted EBITDA margin versus 4% a year earlier. We ended the year with loans on our balance sheet of $977 million before the consolidation of securitized loans down from $1.01 billion the prior year.
Of that balance, loans made for the purpose of R&D, principally auto loans, was $411 million. In addition to loans held directly, we have consolidated $179 million of loans from an ABS transaction in the third quarter, from which we retained a total net equity exposure of $38 million. We ended the year with $368 million of unrestricted cash on the balance sheet and approximately $590 million in net loan equity at fair value. Some amount of the core personnel to our balance sheet in Q4 were aggregated in anticipation of a secondary loan sale that was completed following the close of the quarter totaling $300 million.
Despite the promising [ EMIC ] indicators around inflation and employment, we believe we are not yet completely out of the woods from a macro perspective. The excess money in our collective savings accounts plentiful during the stimulus years, has been spent after accounting for the effects of inflation. And with historically low savings rates, the cash account balances in the economy continue to contract.
As noted, we believe rising delinquencies are now making their way over to the primary and more affluent segments of the borrower base, which is causing us to increase the conservatism in our loan pricing for those borrowers. Confirming the lingering credit risk. And keeping in mind traditional seasonal softness in the first quarter of the year. For Q1 of 2024, we expect full revenues of approximately $125 million, consisting of revenue from fees of $133 million and net interest income of approximately negative $8 million. Contribution margin of approximately 61%, net income of approximately negative $75 million, adjusted net income of approximately negative $33 million, adjusted EBITDA of approximately negative $25 million and a diluted weighted average share count of approximately 87.0 million shares.
Having observed the stabilization and recovery of delinquency trends from lower prime borrowers, we believe to have cost for optimism coming into the new year. And so it has been disappointing to see how the primary borrower segments are now quickly following suit and extending the strain of the current environment. We will, as always, continue to act in the best interest of the credit by quickly reacting to raise prices and lower conversions in these segments. Confident in the belief that this will always lead to the best long-term outcome for our business. If the earlier arc of the less affluent borrowers is any indication, the same cycle amongst primary borrowers will soon normalize. And when it does, we continue to have conviction that we will be very well positioned to capitalize.
Continuing thanks to all of the Upstarters who are persevering through this right. With that, Dave and I are happy to open the call to any questions. Operator?
[Operator Instructions] And our first question is going to come from Kyle Peterson from Needham.
Just wanted to start off on funding and what the kind of constraint of growth right now, is the constraint right now on funding, whether it be committed capital or other buyers or this kind of a borrower demand and getting people below that 36% threshold? Just to see what the different gating factors are right now?
Kyle, this is Dave. I think that there's not an obvious excess of funding or borrowers. It does tend to bounce back a little bit back and forth, because the pricing of loans is so high, the approval rate is relatively low compared to our history. But it's still a funding constrained environment. So it's not definitively leaning one way or the other right now.
Got it. That's helpful. And then just a follow-up on core personal loans, health and balance sheet at the -- we sequentially it ticked up quite a bit. I guess, adjusting for that, the loan sale looks like it did continue to glide down. But I guess, excluding some noise in the loan sales and some of the timing issues. Should we expect the core personal loans on the balance sheet to continue to run down at least outside of the committed capital and risk sharing agreements? Or could that bounce around a bit?
Kyle, this is Sanjay. Yes. I think one of the things we referenced is that one of the reasons we aggregated a bit more than usual in the prior quarter on our balance sheet was in anticipation of the balance sheet deal that we had that closed subsequent to the end of the quarter, we've disclosed it as a subsequent event, but it's a transaction that Dave referenced. That was a $300 transaction.
Our next question is going to come from David Scharf from Citizens JMP Securities.
Sanjay or Dave, I'm wondering, in light of your commentary about sort of delinquencies stabilizing more among kind of the lower-tier borrowers and kind of seeing more deterioration among prime. Can you remind us sort of what the borrower FICO mix is that you're targeting? I mean I know from securitization docs very often had sort of an average FICO and sort of that -- I'm sorry, [ $6.70 to $6.90 ] range. But can you define to us a little better sort of how you're viewing the core target borrower base right now, sort of how you're defining near prime.
David, it's Sanjay here. So I think that historically, we've said and I think we continue to believe that FICO is not necessarily a great metric with which to understand our portfolio because it tends to be pretty broadly distributed across our grade mix.
Now I think if you think about borrowers in general, let's call it, less affluent borrowers have become riskier over the last 18 months, we've certainly in increasing their loss estimates, kicked a lot of them out of the approval box, and so there's a less -- so much lower incidence of them as there have been historically. And those borrowers are beginning to recover in the repayment trends and now it's the more affluent borrowers that I think we're describing as starting to maybe follow suit. And so I think that's a dynamic that you'll see. As we react to those trends through pricing, you'll see those mix shifts happen in our portfolio. But I think it's a bit hard to take a broad sort of fighter aggregate of our platform because: A, they're pretty broadly distributed across grades; and B, there -- the loss rates themselves are pretty different by funding channel, whether it's a bank or a credit union. Those are -- that's collateral that does not tend to show up in the securitization data, whereas if you're looking at the institutional world, it tends to be sort of higher loss rate and higher returns. So think all of that makes it hard to describe our platform through a traditional lens, but hopefully, if you just think about just sort of high-level loss rates, you'll see higher loss rate borrowers begin to recover from prior trends and lower loss rate borrowers begin to deteriorate.
Got it. It's helpful color. Maybe just as a follow-up, focusing more near term on the Q1 guide. Would you characterize the origination outlook in the fee revenue guidance is sort of the normal seasonality that we typically see in Q1 tax refund season with non-prime borrowers usually being down balances? Or is there any kind of further tightening of credit that we should read into that?
Sure. Yes, David. I think there's probably two components to call out, and one of them certainly is what you're describing, which is I think, usually in Q1, you run into a bit of a slump in borrower demand as you get into tax refund season. and we're certainly anticipating that. I think that you could probably assume is what we've seen on average in prior years.
And then the second one is what we described which is that, in fact, we are reacting to rising loss or sort of default trends in the primer borrower base by increasing loss estimates and reducing conversions a bit. But those two things combined probably made the gap or the bridge to our Q1 guidance.
Our next question is going to come from Ramsey El-Assal from Barclays.
I was wondering if you could comment on the on-balance sheet loans and that amount and whether we should -- given more committed capital that you're securing whether we should expect that maybe next year to come down from the levels that we're seeing now or whether this is sort of where it's going to live for a while.
Ramsey, it's Sanjay, again. Yes, I think there's maybe sort of two factors to call out with respect to our loan balance at the end of the year. One, which is true the prior quarter as well is that we have -- we've consolidated a recent ABS deal as a deal from 2023. And that sort of sits as an additional component of our balance sheet. It's not really anything we have economic basis in -- or I guess we have a much smaller economic basis than the full amount of the consolidation, one ongoing factor. The other one, which we just alluded to, is that we've announced that prior -- or sort of after the end of the quarter, subsequent to the end of the quarter, we've completed a balance sheet transaction with an institutional funding partner that was on the order of $300 million, and during Q4, we were aggregating loans in anticipation of that deal closing. And so a lot of those loans are now off of our balance sheet.
As far as how to think about the go forward, I think you're right, as we as we hopefully have more to announce with respect to committed capital deals, those will obviously supplant our balance sheet and take on more of the of the volume. And then separately, we're always interested in finding sources of liquidity for our existing balance sheet. That's just really just a function of where pricing and returns are in the market. And so those -- I think two things combined will determine to what extent we are able to reduce our balance sheet over the coming quarters.
Got it. Okay. And a follow-up for me. I wanted to ask about auto loans. On Slide 23, it looks like the number there declined pretty significantly again quarter-over-quarter. I guess two questions are, when do you expect that to maybe bottom out and begin growing again? And then secondarily, is there a business risk that you're auto customers get turned off because your approval rates are quite a bit lower than they were. Is there any kind of ancillary business risk of managing the credit side of the business at this point as you're trying to build the business?
Sure. Good question. Let's just say, obviously, rates have been very high in the auto lending world, both because interest rates are high and because the price of cars is very high. So I think that's really contributed to an environment where the volume is down. We are very careful working with a fairly tight group of dealers that we work on lending with. And we're very aware that we need a certain throughput with each of these dealers. So it's something we do manage carefully.
We've done a lot with our software beyond lending. So I think there's a lot of value we are delivering to these dealerships irrespective of the loan volume going through our part of the platform, managing their online parts of their business as well as the in-store process of selling cars. So there's a lot more to what we do for dealers than just the loans. So we feel pretty good about that.
And our next question is going to come from Peter Christiansen from Citi.
Dave, I just want to follow up on Ramsey's comments, I think is important. As we think about our forward flow agreements and the innovation that you're looking to unlock there does having an equity stake in some of these forward flow agreements, is that -- should we think of that as par for the course? Is that going to be a regular feature going forward? Or is it the opposite of that over time, you just really want to reduce that balance sheet exposure altogether.
Good question. I think we generally think that we're headed in the direction of having a number of large long-term relationships where there is risk sharing and alignment structured into the process. And we think this is both necessary and important to having that type of relationship and having the capital committed over long periods of time. So we are exploring different structures to those and some participation in those. But I think this is the nature of what we believe will be important and necessary to have long-term funding partnerships with types of partners that can really help us rescale this business and get to where we were and far beyond.
I appreciate that color. And then just a follow-up, maybe this is for Sanjay. How should -- obviously, there's a lot of forecasts out there, some of them predicting bed cuts this year, that kind of level. How should we think about the conversion ratio conversion number kind of being impacted, should we start seeing 25 basis points, 50 basis points, those kind of chunk type of cuts. Is there any way that we -- rule of thumb that we should think about, should that happen later this year?
Pete, I mean interest rate reductions would obviously be helpful to conversion. And I think the extent to which it improves conversion is a bit depending let's call it, the premise of the borrower. I think maybe a rough rule of thumb in aggregate could be for a 100 basis point reduction, something on the order 10% to 15% relative conversion boost, but that will vary by borrower type. .
Our next question is going to come from Rob Wildhack from Autonomous Research.
I wanted to ask about the $300 million loan sale to Ares. Could you comment on the terms associated with that sale? What was the execution price? And if there's any risk or loss sharing associated with that?
Yes, Rob. Yes, we don't have anything, I think, right to announce on the terms other than I think we're very excited about that partnership and where we can take it. I think it was a good deal for both sides. I think it's kind of a structure in which we will sort of have an ongoing relationship in terms of the performance of the collateral. And hopefully, over time, we can convert that into -- this is a first step into a much broader relationship.
Okay. And then, Sanjay, maybe one for you or another one for you. unrestricted cash, it was almost $400 million at the end of the period, but also finished I think as low as it's been since March 2021. So how do you think about the cash needed for "run the business" purposes? And then how should we think about cash generation going forward in the context of the new outlook for negative adjusted EBITDA and earnings in the first quarter.
Sure. Yes. Thanks for the question, Rob. I guess First of all, just in thinking about our balance of cash, again, I think it was probably a little bit low and loans on our balance sheet were a little bit high compared to normal as a result of this transaction. And subsequent to the close of the year, we executed the transaction and loans on our balance sheet are now lower and cash is higher. And I think we're in a pretty good range right now. with respect to the cash we have on hand. With respect to the operating sort of future of the business, we have guided a negative EBITDA for Q1.
I think some of that, consistent with the guide itself, some of that is seasonal. We are in the seasonal trough of the year. So we expect some of that to rebound. Beyond that, there's also -- the fair value is the one part of our EBITDA that is noncash, but it does impact EBITDA. And so I think some of our some of our guide for Q1 is impacted by the, let's call it, the delinquency trends we referred to in the primary segment of the borrower base which is affecting our fair value marks. And so some of the EBITDA is seasonal, some of it is noncash. And I guess I'd say more generally, I think we've always demonstrated a history of being bottom line focused and running the business responsibly, and our intention is to get back to EBITDA breakeven positive as quickly as possible. So I think if we can accomplish that, then certainly the cash balance we have on hand certainly, post the transaction that we announced with Ares are comfortable.
Our next question is going to come from Simon Clinch with Redburn Atlantic. Please go ahead.
I wanted to follow up on the question about committed capital actually. And just if we take a step back and think about the announcements you've made, the relationships you've built, how should we think about the current and the potential I guess, quarterly cadence of committed capital that you can build. Because I think the original case was that you were looking to build enough committed capital on a sort of run rate basis, on a regular basis to allow you to be breakeven whatever the cycle. So I was just wondering, could you just update on that with some figures around it, please?
Sure. Simon, this is Sanjay. So yes, I think -- I'll reiterate what we said in prior cycles, which is I think a rough rule of thumb for run rate, if half of our origination volume was supported by committed capital, we think that's a good start. And I think that's roughly where we are right now, obviously, our levels of originations over the past couple of quarters and guiding into next have not grown substantially, so that the capital we have on hand is sufficient to create that sort of foundation.
Obviously, as we rescale the business as we would hope to this year, we're going to have to scale the committed capital base in accordance. And I think that we're pretty optimistic we'll be able to do that. I think that just in terms of the shape and texture of the deals, as Dave said, I'll just reiterate, I think we view this as having a relatively small number of large sort of committed bilateral relationships that we can grow into and grow with as the business grows.
And I think the kinds of names we've talked about with respect to the deals and transactions we've done, are the kinds of partners we can grow into over time as the models prove out and as the partnerships mature. So I think some of this is doing additional deals, but some of this will be growing the size of those deals as long-term partnerships over time as the business sort of regains it's prior scale.
That's great. And just as a follow-up question. I was wondering, is there scope and interest in developing or leveraging your technology expertise and capabilities to develop new lines of business that are more recurring in nature and less transactional. And is there -- how big could something like that gets for [indiscernible].
It's a good question, Simon. We're certainly aware that having a volatile sort of source of revenue has its downside for sure. And so we are keenly interested in having more predictable revenue. And in fact, some of it not based on sort of lending volume per se. I mean the first step, of course, is to have products that will tend to be countercyclical to each other. And that's definitely something as we mentioned. We're very excited about our HELOC product has been one that is actually very popular in high-rate environments like we have today.
So it's just a product mix question there. And then there's also -- we do believe there's opportunities where there's more straightforward fees for technology such as we do make modest fees that we charge to car dealerships today. And we will certainly explore other ways to monetize our technology. And I think the broader it gets with more products that covers, et cetera, that's certainly possible.
And I would just also highlight, we've shown, I think, some pretty amazing ability to automate credit origination entirely separate from whose credit model is being used. And that itself has a lot of value to it. So as we've done that in personal lending, we're beginning to do that both in auto and HELOC. Those sort of automation capabilities, I do think, at least have the potential to be unbundled and available because they create a much, much better user experience regardless of whose pricing models or risk models are being used elsewhere.
And our next call is going to be John Hecht from Jefferies.
First one is -- I guess, just sort of accounting. I mean the securitization that you're consolidating on the balance sheet, do you guys just from an asset liability perspective show kind of the net residual value in the assets? Or how do we think about it from an asset liability perspective on an accounting basis. And then does the interest income and interest expense flow through the P&L related to that securitization as well?
John, this is Sanjay. So on the balance sheet, the securitization is not shown on a net basis. It's shown on a gross basis. So the full amount of the assets of the securitization are in our asset line and the full amount of the liabilities are in our liability line. With respect to the P&L, I think ultimately, it is the net impact that shows up because you're getting interest revenue and interest expense, both hitting net interest income. And so on the face of the P&L, you're just going to see the net of that in the net interest income line. I think if you were to look in the note of net -- for net interest income and look at the civic revenue and expense line items within interest income, you would see the gross numbers, but they're not on the face of the P&L.
And then, Dave, I think you mentioned starting to get collateral in the installment loans I'm wondering from a contractual and then just a physical basis, if you can give us some more information about how that might look.
Yes. Generally, scheme, one of the things we're moving towards is really a single application for credit where the resulting loan that might be the best one for the borrower could be an unsecured loan. It could be one secured by some asset, maybe in auto or something else, it could also be a home equity loan. And depending on who the person is, the use case, how much cash they're looking for. But doing that through one product, I think, is really helpful because it allows borrowers to kind of see different choices.
Also collateralized loans, generally speaking, you're going to get lower rates. So there's a trade-off there. You might have a better product at a better rate or be able to borrow more if a sense for a home renovation or something like that. So I think that's pretty unique. Most of what we see in the market are products that you apply individually for different types of loans. And this is really aimed at being able to give the best product to the person with all the right trade-offs in one really fast efficient experience.
So you would be -- in other words, you'd be getting collateral and then you could make a loan of a different type, just having that collateral as a backstop?
It's really -- yes, the application process would be somewhat neutral to what type of loan you may get, and then you may get two or even three different offers an unsecured loan or loans secured by your car, maybe a home equity loan, of course, secured by your home. So the -- so there may be some trade-offs and choices between those and that would be presented hopefully, as clearly as possible to the applicant. And that just means we think we can make our funnel conversion higher having better choices available through one simple process.
And that's something we're just starting down the road of -- we mentioned in the remarks earlier that our HELOC product is now being surfaced within what we thought of as our personal loan application. And that's kind of the sort of direction we're headed is being kind of borrower centric in terms of their choices and trade-offs as opposed to being product-centric. And we think there is just a lot of opportunity for improvement in that area.
And our next question is going to come from Arvind Ramnani from Piper Sandler.
First question really is kind of relative to sort of like what you're expecting towards the end of last year towards versus how things are shaping out for the beginning of the year. Did I hear correctly on the call, you said that kind of things have kind of deteriorated or kind of in line with how you've been thinking about things?
Arvind, this is Dave. I think things have gone to a large extent, the way we kind of suggested even a year ago, and that was that less prime, lower-income folks were being hit earlier. And then during 2023 really began to improve and reemerge. And there was a belief that people at higher incomes, higher FICOs were going to be affected later. And that's really what we've seen more recently.
So in the grand scheme of things, it's really gone the way we expected, and I think we communicated our expectations there. And you can see that in the Fed numbers that were released, I think, just last week. So it is an unusual situation to have default rates of credit cards and auto loans at their highest since the great financial crisis, yet unemployment remains quite low. So it's not a typical scenario that anybody has seen out there. But having said that, our models are doing the right things. They're tightening and recalibrating constantly. And we're very hopeful that this will be the year where this will get put behind us. And I think there's good reason to believe it's a faster trip to a correction for primary borrowers who are employed, et cetera. And all that to us looks pretty solid.
Great. And then as you look out for the rest of the year. I mean you said you hope that the year gets behind you. Is it -- are you talking about '24 or '23 .
I'm sure we were referring to 2023. I think we're up -- I think despite the near-term noise, I think we're all very optimistic about 2024 as a year.
Okay. Yes. Yes. That's what I thought. I just wanted to clarify. And then when do you think you'll be in a better position to kind of reinstate like annual guidance or you'd kind of -- you just -- you're not in a position to really talk about that?
I think when there's a lot of things that are outside our hands, the Fed's move interests and whether inflation is, in fact, tamed or is going to reemerge, et cetera, the sort of precarious situation, we think a lot of American consumers are in financially where they're still spending more than the probably should, given their income. So there's a bunch of things out there that we don't control and they're pretty important to our business as it exists today. We're certainly working towards being less dependent on those. But the reality of today is those matter a lot to us. And so we would really want to be in a more of a steady state place economically, and we're just not there yet.
Our next question is going to come from James Faucette from Morgan Stanley.
I wanted to just touch really quickly on OpEx levels. it sounds like you feel that the environment and the potential quick rebound in more prime or type borrowers, could rebound pretty quickly. And so as of now, it doesn't sound like you're anticipating any OpEx trimming. I just want to make sure I understand that correctly. And when you talk about getting back to EBITDA breakeven et cetera. Is that something that you're, as a result of anticipating should happen this year roughly? Or are we thinking more into next year once we've had the ability for stabilizing environment to really take hold?
James, it's Sanjay. Yes. Thanks for the question. I think -- as I said, I think there's maybe a couple of factors weighing on our Q1 EBITDA guide. One of them is the seasonality itself which is just -- it's a headwind to volumes for a quarter or so. One of them is the fact that there is this fair value component to EBITDA, which is noncash, but that in turn is impacted by some of the default trends we're seeing out there, in particular on the primary side. So hopefully, those things are transitory. I guess the answer to your broader question is we would absolutely hope to make our way back to EBITDA breakeven this year. It's an important priority for [indiscernible] have said there are certain things out of our control, but as long as some of these things subside and we can see a clear path to recovering from them, then I think that will provide a clear path back to breakeven.
Got it. Got it. And then in terms of like the -- particularly on the primer and how you guys have reacted. I think the comments on the seasonality are clear. But can you give us a sense of how recently you started to make your adjustments on what you're doing from a primary perspective and the way that it's impacted. Is that recent here in maybe February? Or did this really start even at the end of last year?
James, I would say that in rough terms, I think we noticed this starting to happen at the end of last year. And by this year early, they were sort of persistent enough that we reacted.
So it was early on in the quarter, not just something in the last couple of weeks, I guess.
I mean we're only 6 weeks into the quarter. So yes, it was not -- it wasn't January 1 coming off the New Year's Eve party, but I think we've been watching this last year. And I think it takes a few weeks for it to bake and for us to react to it.
Our next question is going to come from Michael Ng from Goldman Sachs.
I had a follow-up to some of the questions about the outlook for the rest of the year. But perhaps you could just talk a little bit about the visibility that you might have in origination volume and recovery throughout the rest of 2024. Should 1Q be the low watermark because of the seasonality piece. And is there anything that you saw as it relates to the stabilization and the lower prime borrowers that might be a helpful framework to think about when we should see more stabilization and potential recovery on the primary side?
Mike, I think it's a good question. I would just say the pandemic -- the strange pandemic effects of stimulus and subsequent stimulus we're fairly profound, and they hit first and hardest to lesser prime, lower-income people. And we did see that improve. So that sort of suggests there's a bit of mania or some form of mania maybe when someone has too much cash and inability to spend it that they develop some habits that don't make sense long term. And and then they recover from them. But the effect was just delayed on higher income, higher FICO goal, and I would think there's reason to believe it just won't last as long or be as destructive as it can be for lower income people.
So we do believe there has to be a time where things begin to revert to the mean just in terms of consumer behavior, savings rates, things of that nature. And we're full about 2024 the year that will begin to happen. Also, of course, inflation waning. It doesn't just -- just even if we have great inflation prints, things are still a lot more expensive today than they were in 2019, regardless. So that still just takes a bit of time for people's incomes to catch up with their expenses. And I think that kind of what's going on right now.
Our next question is going to come from Regi Smith from JPMorgan.
Most of mine have been hit. But I did, I guess, I have a question about -- you talked about, I guess, high income and prime consumers feeling it and kind of tightening the credit box there. And the question is like who are you approving these days? What's the profile of a successful applicant today?
Well, Regi, we're not sort of like radically changing who's approved as any loss assumptions go up than certain people that might have been approved before wouldn't be. But when we say that the credit box is tightening, which it has for primary people in recent times, that's really just saying, on average, they're probably going to have a bit higher rate than they would have otherwise. It doesn't necessarily mean they're not approved. And that does affect conversion. So for the primary people, it means a bit higher rates, maybe the loan size their proof for it might not be exactly what they ask for. But generally, they're still going to get approved for something when it happens at the less prime end, a lot of them fall -- end up going above -- effectively going up above the 36% rate. And for that reason or declined. That's the dynamic that plays out whenever rates go up or when the credit models tighten.
Understood. That's helpful. Thinking about -- no, it's real quick, I'm sorry. There was, I guess, a slide towards the back of your presentation and I think you recalibrated I guess, the returns. Maybe can you talk a little bit about what that is, the upstart long performance chart, Page 36 in the back, whether that -- a little bit about like kind of what's going on there and I guess, it doesn't sound like it impacted your cash flows, but what would you tell people that kind of question the ability to kind of underwrite and the thoroughness of your models with a mistake like this?
Yes, sure. Thanks, Regi. It's Sanjay. So yes, this chart, I'll say, so a bit of a specific artifact. The point of this chart was really to try and aggregate loan performance across our entire platform of funding channels, which obviously no single investor or lender is. But really, it's just meant to show the impact of the macro conditions on the overall business and how we've reacted to them.
The specific thing we're calling out on this chart is that in updating the forecast methodology of this chart we realized we were making a calculation error in the old way that we've been using that resulted in us overestimating the forecast of the expected returns on this chart.
So first of all, importantly, this is just an error that's isolated to this particular PowerPoint slide. It's got nothing to do with underwriting. It does not impact in any way any of the numbers we report or present. It really doesn't impact our conversations with individual parties because those are on a specific basis, not platform-wide. And I don't really think it even necessarily changes the shape of the trends that we've been describing, which is that at a high level, we've historically overperformed prior to COVID, we were impacted by macro trends, which peaked in our case, sometime in early 2022. And we've since been reconverging the target.
And so I think in updating the methodology, we've refined that and I think we're just calling out maybe some of the differences in the fine print, but that's what we're trying to lay out for you here.
And that's all the time we have for questions. At this time, I would like to turn the conference over back to you for additional or closing remarks.
All right. To wrap up, 2023 was a pivotal year for upstart. We made strides in personal lending and in our auto business. We launched a home equity product and released two tools that are proving to be invaluable for improving model calibration. And we accomplished these goals while running an operationally and fiscally tight ship. That focus will continue in 2024, regardless of when the economy normalizes and the advantages of our leadership in AI lending become clear to all. So thanks all for participating today. We look forward to speaking with you again next quarter.
And this concludes today's call. Thank you for your participation. You may now disconnect.