Upstart Holdings, Inc. (NASDAQ:UPST) Q1 2024 Earnings Call Transcript

Upstart Holdings, Inc. (NASDAQ:UPST) Q1 2024 Earnings Call Transcript May 7, 2024

Upstart Holdings, Inc.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Upstart First Quarter 2024 Earnings. Today’s conference is being recorded. At this time, I would like to turn the conference over to Jason Schmidt. Please go ahead.

Jason Schmidt: Good afternoon and thank you for joining us on today’s conference call to discuss Upstart’s first quarter 2024 financial results. With us on today’s call are Dave Girouard, Upstart’s Chief Executive Officer, and Sanjay Datta, our Chief Financial Officer. Before we begin, I want to remind you that shortly after the market closed today, Upstart issued a press release announcing its first quarter 2024 financial results and published an Investor Relations presentation. Both are available on our Investor Relations website, ir.Upstart.com. During the call, we will make forward-looking statements, such as guidance for the second quarter of 2024 and the second half of 2024 relating to our business and our plans to expand our platform in the future.

These statements are based on our current expectations and information available as of today and are subject to a variety of risks, uncertainties and assumptions. Actual results may differ materially as a result of various risk factors that have been described in our filings with the SEC. As a result, we caution you against placing undue reliance on these forward-looking statements. We assume no obligation to update any forward-looking statements as a result of new information or future events, except as required by law. In addition, during today’s call, unless otherwise stated, references to our results are provided as a non-GAAP financial measure and are reconciled to our GAAP results, which can be found in the earnings release and supplemental tables.

To ensure that we can address as many analyst questions as possible during the call, we request that you limit yourself to one initial question and one follow-up. Later this quarter, Upstart will be participating in the Needham Technology Media and Consumer Conference, May 14th; RPG Emergent Payments and Fintech Forum, May 15; B Riley’s Securities Institutional Investor Conference, May 22nd, and Mizuho Technology Conference, June 12, as well we will host our Annual Shareholder Meeting on May 29. Now, we’d like to turn it over to Dave Girouard, CEO of Upstart.

Dave Girouard: Good afternoon, everyone. I’m Dave Girouard, Co-Founder and CEO of Upstart. Thanks for joining us on our earnings call, covering our first quarter 2024 results. I’d like to start by saying I’m quite proud of the work of Upstarters around the country continue to do to build the world’s leader in AI-enabled lending. With credit availability as constrained as it’s been in more than a decade, we’ve never felt the urgency of our mission more than we do today. We’re off to a solid start this year and have made significant progress with our products and with funding. There are many reasons to believe our business will return to growth soon, but we’re also prepared for the current macroeconomic conditions to persist. So we continue to focus on improving our efficiency and financial performance.

We’re investing responsibly for the long term. In pursuit of efficiency, we minimize hiring, reduced the size of some teams, flatten org structures, and reallocated resources to our highest priorities. Since the beginning of 2024, we’ve cut fixed expenses from headcount by approximately $20 million on an annual basis. Our headcount today is as low as it’s been since Q3 of 2021. We’ve also improved the efficiency of our cloud infrastructure and reduced our model training and development costs. Year-over-year, our compute and storage costs have been reduced by 23%, and we expect to generate additional savings in this area. We believe these actions set up Upstart to return to profitability sooner and to rebound more quickly through the company we know we can be.

I’m happy to report that the funding situation on our platform is beginning to improve for banks and credit unions, as well as for credit investors. We’re hopeful this trend will continue through 2024. Unfortunately, consumer risk and interest remain at or near all-time highs, conspiring to constrain the volume of transactions on our platform. Given this combination, and assuming rates on Upstart remain at or near their current high levels, we expect to reduce the use of our balance sheet to fund loans that are not R&D purposes. This will allow us to make better use of those funds elsewhere, so we will continue to be flexible and responsive in using our balance sheets to do the right thing for the business. We continue our work to make Upstart a platform that can thrive in any macroenvironment.

This work comes in the form of improvements to our core personal loan product, as well as progress in the newer products in our portfolio. Last quarter, I mentioned an initiative to allow applicants to provide collateral to support their personal loan application, with the goal of helping borrowers access credit at lower rates than would otherwise be possible. Today, I’m happy to report that we’ve successfully launched our auto-secured personal loan as a pilot in seven states. Our approach allows qualified applicants to make an informed choice between an unsecured or an auto-secured personal loan, which commonly offers a lower APR. Thus far, ASPL rates are an average 20% less than the rate on an unsecured loan. The ASPL also helps many applicants qualify for a loan who would otherwise be declined.

Last quarter, I also shared that we were developing tools to help our lending partners strengthen relationships with their existing customers, which is often their priority in periods of reduced liquidity. To that end, two weeks ago, we announced Recognized Customer Personalization, or RCP. With this new feature, lenders can identify when an existing customer is actively shopping for a loan on Upstart.com, and strengthen their relationship by making a compelling offer of credit. This is a capability many banks and credit unions have long requested, and we’re pleased with the initial response. 30 of our bank and credit union partners have signed up for RCP already. In Q1, 90% of unsecured loans on the Upstart platform were fully automated, an all-time high for us.

For the borrower, this means no documents to upload, no phone call required, and a final approval in just seconds. For Upstart and our lending partners, it means there’s no human in the loop whatsoever to process and complete the loan application. Automation is a hallmark of AI-enabled lending, and Upstart aims to be the best at it. We continue to make progress in our auto business, with 103 dealer rooftops now live with Upstart-powered lending versus 39 a year ago. In keeping with the times, we’ve tasked our auto team to move more quickly toward profitability. This means doubling down on credit quality, making improvements to our in-store platform, and focusing on overall dealership success, along with the goal of improving the unit economics of each dealership.

We’ve somewhat reduced our go-to-market investment in auto retail for now, and believe a more focused effort today will allow us to scale more quickly in the future. We’re making fast progress with our home equity product, which continues to exceed our expectations. We knew it would be an attractive product in a high interest rate environment, and the team’s progress thus far has been impressive. Less than a year after launch, we’re offering an Upstart HELOC in 19 states plus Washington D.C., covering 33% of the U.S. population. This is up from 11 states last quarter, and now includes Florida, our largest state to date. I mentioned last time that we were beginning to automate verification of borrower information, and I’m happy to report that we’re now able to instantly verify 36% of HELOC borrowers.

This includes instant verification of identity and income, without any tedious documents to upload. In another sign of progress, when we offer applicants a HELOC as an alternative to a personal loan, we see a list in the percentage of applicants taking one of our offers. This validates our approach to integrating our personal loan and HELOC applications, creating a single unified funding form for multiple products. Lastly, but perhaps most importantly, we signed our first funding deal for the Upstart HELOC and expect to begin selling loans on a forward flow basis to this partner in the next few weeks. I’m excited to see this product scale through 2024 and beyond. Our small dollar loan product continues to expand rapidly, with Q1 originations up 80% quarter-to-quarter.

Consumers love these small relief loans because they’re fast and simple and so much more affordable than the more expensive flavors of credit normally available for them. Today, about 60% of applicants can come to us for a small dollar loan and initially qualify to actually get the loan, which is a super strong conversion rate at this stage. From a what’s in this Upstart perspective, I’ll say first that this product is core to our mission. For meaningfully expanding for the percent of Americans, we invite into the world a bank quality credit with a small but important first step. The beauty of this relief loan is that it’s primarily offered to those who don’t today qualify for our personal loan. So instead of declining them entirely, we give them the opportunity to perform on a small loan and start them on a better financial path.

And of course, our risk models are learning rapidly by extending credit to someone who would otherwise be turned away. These small loans are rapidly expanding the frontier of understanding of our models and represent a long-term opportunity to serve Americans with fairly priced credit. We continue to invest in our ability to service Upstart loans and help those borrowers who become delinquent return to financial health. For example, we made it simpler and easier for borrowers to adopt auto pay, a key leading determinant of credit performance. These efforts have led to an increasing number of borrowers enrolled in auto pay for 24 straight weeks. In another example, we launched a new channel for contacting delinquent borrowers. Just in its initial deployment, this channel is projected to reduce gross losses of more than 3%.

This is just the beginning. We see a wealth of opportunities to reduce loan rates, improve recoveries, all while helping borrowers get themselves on a better financial footing. As I mentioned earlier, we’re seeing improvements in the funding side of our business. These improvements are both in the bank and credit union segments, as well as on the institutional and credit fund side. The liquidity challenges many banks and credit unions experienced in 2023 seem to be waning. Many lenders now, once again, facing a shortage of assets. This new challenge is compounded by the fact that the cost of funding for many regional and community banks has risen and are now paying more for deposits. We are still cautious about the direction of the economy; many lenders are now looking for ways to generate healthy and appropriately risk-adjusted yield from their balance sheet.

We saw eight new lenders join our platform in Q1, and a number of existing lenders increase their funding. The number of new lenders and the total available funding on Upstart from lending partners are both at their highest since prior to the 2023 bank failures a year ago. We also continue to make progress with institutional capital, working to renew and extend existing partnerships and to bring investor partners who paused in the past back to the platform. And as mentioned previously, we signed the first partnership to fund Upstart’s home equity product. As a result of this product, we expect to be borrower-constrained as long as the rates on Upstart platforms remain as elevated as they are currently. Altogether, we are hopeful that we are headed into a period of stable funding in excess of our needs.

We expect this will allow us to reduce the use of our own balance sheet and redeploy that capital to other important goals. To wrap things up, our lean organization is making rapid progress on building a product portfolio and a platform that will accelerate the financial industry’s migration to AI-enabled lending. With the interest in AI soaring, just last week we launched a first of its kind AI certification program to help bank executives prepare for this brave new world. Just in the first couple days, several hundred individuals registered for the course, reflecting the broad demand to upscale in this area. Some of you on today’s call also may find the course to be of interest. I want to thank our starters for their resilience and perseverance through a clearly challenging period.

We find strength and durability in our focus on the mission and the satisfaction we find in pursuing it together. I approach every day confident that the Upstart team is unmatched in both its capacity to execute as well as its unity of purpose. Thanks. I’d like now to turn it over to Sanjay, our Chief Financial Officer, who walked through our Q1 2024 financial results and guidance. Sanjay?

Sanjay Datta: Thanks, Dave, and thanks to all of you for joining us today. As was the case in 2023, the dominant influence on our business so far this year remains the macroenvironment, and the trends we highlighted last quarter have remained consistent. Real personal consumption in our economy continues to surge, more recently powered by the gathering momentum of the services economy, and now increasingly compounded by the rapidly growing outflow of interest payments. Despite healthily growth in wages, overall disposable income has in fact languished over the past year due to the combined headwinds of falling government transfer payments, sagging asset income, and as of the new year, a significantly higher personal tax burden compared to 2023.

The consequence of continuing consumption growth against flat disposable income has been a downward trend in the personal savings rates, which have fallen back towards the 3% level after peaking almost one year ago, and matched by a continuously falling balance of real savings deposits. In an economy with strong headline growth numbers and low unemployment, the anemic savings rates and declining real savings balances are the clear problem statement. Regarding credit performance, we spoke last quarter about the trend of deterioration at the primer end of the borrower base, which has continued. Our models have reacted to this trend over the past quarter with higher loss estimates and correspondingly higher ATRs for more affluent borrowers in order to maintain the returns investors expect, which has further reduced loan volume on our platform.

This had a partial adverse impact on our Q1 results, and its full impact is being felt in Q2. On the funding side of the platform, liquidity amongst banks and credit unions is beginning to improve. We are seeing encouraging signals of funding capacity increases from existing lenders, as well as new lenders joining the platform, including our first forward flow buyer of HELOCs. In the institutional markets, we are in the process of extending and rolling over all of the committed capital relationships that are coming up on their one year mark, as well as in some cases working on meaningful upsizing, which we are pleased to interpret as a positive endorsement of our program. We currently expect that these efforts will result in approximately $2.7 billion of funding through committed capital and other co-investment arrangements over the next 12 months, with additional opportunities in the pipeline.

Separately, we are starting to see more signs of formerly active investors once again reengaging with the platform. With this environment as context, here are some financial highlights from the first quarter of 2024. Revenue from fees was $138 million in Q1, up 18% from the prior year but down 10% sequentially, and in line with the decreased origination volumes, resulting from the increased pricing of prime loans. Net interest income was negative $10 million, reflecting the impact of prime loan performance on our risk-sharing positions, as well as some realized fair value impact taken as part of a secondary sale transaction. Taken together, net revenue for Q1 came in at $128 million, above our guidance, an up 24% year-over-year. The volume of loan transactions across our platform in Q1 was approximately 119,000 loans, up 42% from the prior year but down 8% sequentially, and representing over 68,000 new borrowers.

Average loan size of $9,500 was down from $12,200 in the same period last year, driven by robust growth in small dollar loans. Our contribution margin, a non-GAAP metric which we define as revenue from fees minus variable costs for borrower acquisition, verification, and servicing as a percentage of revenue from fees, came in at 59% in Q1, down four percentage points sequentially, primarily reflecting increased investments in servicing and collections capabilities. We continue to benefit from very high levels of loan processing automation, achieving another high in the percentage of loans fully automated at 90%, and our seventh sequential quarterly improvement. Operating expenses were $195 million in Q1, down 17% year-over-year, but up 4% sequentially as our payroll coming into the new year gets reset with a new benefits cost basis and bonus accruals.

As Dave mentioned, since the beginning of 2024, we’ve restructured some teams and reduced headcount in order to quicken our path back to profitability. Altogether, Q1 GAAP net loss was $65 million and adjusted EBITDA was negative $20 million, both ahead of guidance. Adjusted earnings per share was negative $0.31 based on a diluted weighted average share count of $87 million. We ended the first quarter with loans on our balance sheet of $924 million before the consolidation of securitized loans, down from $982 million in the same quarter of the prior year. Of that balance, loans made for the purposes of R&D, principally auto loans, was $316 million. In addition to loans held directly, we have consolidated $157 million of loans from an ABS transaction in Q3 of 2023, from which we retained a total net equity exposure of $28 million.

We ended the quarter with $301 million of unrestricted cash on the balance sheet and approximately $572 million in net loan equity at fair value. With our models having largely adjusted to the increased delinquency rates of prime loans and the near-prime universe of borrowers now toggling between stabilization and recovery, we believe that the wave of elevated defaults propagating from the abrupt stimulus and de-stimulus of the economy in 2021 is now at or very close to its peak. Assuming no new credit shocks lurking on the horizon, we are anticipating a return to sequential growth in the second half of this year and a return to positive EBITDA by the end of this year. With that in mind, for Q2 of 2024, we expect total revenues of approximately $125 million, consisting of revenue from fees of $135 million, and net interest income of approximately negative $10 million, contribution margin of approximately 56%, net income of approximately negative $75 million, adjusted net income of approximately negative $36 million, adjusted EBITDA of approximately negative $25 million, and a diluted weighted average share count of approximately 88.4 million shares.

For the second half of 2024, we expect revenue from fees of approximately $300 million and positive EBITDA in Q4. Thanks once again to all for joining us today. And with that, Dave and I are happy to open up the call to any questions. Operator?

See also 30 Countries with Carbon Tax in the World and 19 Best Alternatives to Discord in 2024.

Q&A Session

Operator: [Operator Instructions] And our first question will come from Ramsey El-Assal with Barclays.

John Coffey: Hi, thank you very much. This is John Coffey on for Ramsey. I just wanted to ask you, Sanjay, about your second half of 2024 outlook with the revenue from fees of approximately $300 million. Could you just give me a little bit of a better idea what some of the underlying mechanics of this are that are going to drive it to that level? Is it just that you’ll be able to make more attractive loans to consumers? Is it just trying to think of what the different factors are that makes you a little bit more optimistic here?

Sanjay Datta: Hey, John. Great question. Thanks. Some context on the second half of 2024, I would say, first of all, our assumptions on the macro are neutral. And in that environment, really, a lot of this growth is down to how we kind of historically grown, which is a roadmap of product execution resulting in model improvements and accuracy gains. And so maybe one of the important contextual points is the main macro effect that we’ve been sort of contending with over the last two years really is a propagation of what came from the stimulus and the de-stimulus to the economy. And as we said in our remarks, we really think that’s now in the process of fully running its course. And so we’re really back to our old model of improving technology and accuracy and driving conversion gains from that. And we think that’s going to be the story in the back half of this year.

Operator: And our next question will come from Kyle Peterson with Needham.

Kyle Peterson: Great. Good afternoon. Thanks for taking the questions, guys. I wanted to start off on expenses, assuming that we’re kind of in a little bit muted environment macro-wise, so at least for a little while. Are you guys comfortable with the expense structure where it is now on a cash basis, or do you think there’s more wood to chop or more action to potentially take if volumes don’t snap back?

Sanjay Datta: Yes. Hey, Kyle. As we said in our remarks, we have been doing a lot of that work. And since the end of the quarter, we’ve announced some more cost reductions. And I think as of where we are at the end of that series of cost reductions, we feel like we’re in a good place for our current scale and for the plan we have for the rest of this year. I mean, obviously, if there’s another downturn in the macro that affects the credit environment, we’ll have to react further. That’s all is through a possibility, but as of where we are, we think we’ve taken the appropriate actions.

Kyle Peterson: Okay. That’s helpful. And then just a follow-up on credit. I know you guys kind of mentioned some of the credit concerns with the affluent borrowers that you guys mentioned last quarter is kind of still in the same, I guess are the loss assumptions still the same? And if so, like are you guys comfortable with some of the pricing and origination or underwriting changes you guys have made that the newer vintages in that cohort can be profitable and attractive for investors?

Dave Girouard: Hey, Kyle, this is Dave. Yes, we are comfortable that our models are caught up and the current product is performing and is calibrated. As we said, we see signs of recovery in the less prime, less affluent parts of the world, and the more affluent primer part is what has deteriorated more recently, but we’re hopeful also that we are kind of reaching toward the end of that. So it has been a cycle that we’ve been observing for a while. We did, I think, accurately state that it was going to affect less affluent people first and then probably more affluent primer people later, which is exactly what’s happened. And now, as Sanjay kind of alluded to, we’re hopeful we’re nearing the end of this. And then for us, it’s just kind of back to business of improving model accuracy, funnel throughput, et cetera. And that’s what gives us some confidence in the rest of this year.

Operator: And our next question will come from Peter Christiansen with Citigroup.

Peter Christiansen: Thank you. Good afternoon. Thanks for the question. Dave, Sanjay, I wonder if we could dig a little bit into the growth in the small dollar loan product there. What impact that’s had on the conversion rate, perhaps, maybe? How should we think about the conversion rate and standard personal loan levels? And then a second question, I’m just curious, on the auto side, it looks like you kind of run rating around five loans per rooftop per quarter. Just curious, what’s the opportunity to increase that share within each rooftop and maybe some of the steps that you’re taking there to improve that? Thank you.

Dave Girouard: Sorry, Pete. This is Dave. On the small dollar loan product, there’s definitely a heavy focus on automation there. I don’t know if we have the numbers to separate rates of automation for the small dollar going from the personal loan, but they certainly contribute to that 90% that we put up. In auto, I think we definitely believe there is a lot of room for increasing market share on loans per dealership. That’s actually one of the very central focus of ours is how we do that. And part of that is the model getting smarter, better separation, which means we compete better, and also just the process of originating those loans in the dealership. And so those are, as I kind of highlighted earlier, very central to our focus, and we’re a little less worried about exactly how many dealers are lending.

We want to make sure the volume going through a dealer and the unit economics of a dealer are where we want them to be, and that’s been a lot of focus bars for the recent months.

Peter Christiansen: Thanks, but I guess the question on the small dollar loans is really more on how that impacts the conversion ratio, which went to 14% this quarter. Just curious how typical, the typical personal loan product is doing from a conversion ratio factor, if you can piece it out. Thank you.

Sanjay Datta: Yes, I think the answer to that is, I don’t think it’s a huge impact, but it’s probably marginally positive. As you could think of, like, with just the personal loan product, there’s a certain approval rate, and then people who are outside of that approval box can usually get approved for a smaller loan, like a small dollar loan. So for a given marketing sort of send size, we will have additional approvals due to that product, but I don’t think it’s really big enough to move the dial in a significant way at this point.

Operator: And our next question will come from Dan Dolev with Mizuho.