Upstart(UPST)2024-08-06 22:16Loan Distribution and Funding - 57% of the total principal of loans transacted on the marketplace during the six months ended June 30, 2024 were purchased by institutional investors, 27% were retained by lending partners, and 16% were held on the balance sheet[221] - The company secured multiple committed capital and co-investment arrangements with institutional investors and third-parties beginning in 2023 to improve loan funding capacity[222][235] - 57% of the total principal of loan originations facilitated on the marketplace during the six months ended June 30, 2024, were purchased by institutional investors[352] - 27% of the total principal of loan originations facilitated on the marketplace during the six months ended June 30, 2024, were retained by lending partners[366] - 16% of total loan originations facilitated during the six months ended June 30, 2024 were held on Upstart's balance sheet, excluding consolidated securitization[378] - The company plans to sell loans held on its balance sheet to institutional investors over time through secondary sales or securitizations[312] Financial Performance and Metrics - Transaction Volume, Dollars decreased by 6% to $1.11 billion in Q2 2024 compared to $1.18 billion in Q2 2023, while increasing by 3% to $2.24 billion in the first six months of 2024 compared to $2.17 billion in the same period of 2023[245] - Transaction Volume, Number of Loans increased by 31% to 143,900 in Q2 2024 and by 36% to 263,280 in the first six months of 2024 compared to the same periods in 2023[245] - Conversion Rate improved significantly to 15.2% in Q2 2024 and 14.6% in the first six months of 2024, up from 9.4% and 8.8% in the same periods of 2023, driven by marketing efforts and new product initiatives[247] - Percentage of Loans Fully Automated increased to 91% in Q2 2024 and 90% in the first six months of 2024, up from 87% and 86% in the same periods of 2023, due to improved model accuracy and process automation[248] - Contribution Profit decreased to $76.1 million in Q2 2024 and $157.3 million in the first six months of 2024, compared to $95.9 million and $163.5 million in the same periods of 2023[250] - Contribution Margin declined to 58% in Q2 2024 and 59% in the first six months of 2024, down from 67% and 63% in the same periods of 2023[250] - Adjusted EBITDA turned negative at $(9.3) million in Q2 2024 and $(29.6) million in the first six months of 2024, compared to $11.0 million and $(20.1) million in the same periods of 2023[244] - Adjusted Net Income (Loss) worsened to $(15.3) million in Q2 2024 and $(42.4) million in the first six months of 2024, compared to $5.4 million and $(33.3) million in the same periods of 2023[244] - Net loss widened to $54.5 million in Q2 2024, compared to $28.2 million in Q2 2023[264] - Total operating expenses increased to $183.1 million in Q2 2024, up from $169.1 million in Q2 2023[264] - Upstart incurred a net loss of $119.1 million for the six months ended June 30, 2024[375] - Contribution Profit and Contribution Margin are used by the company to assess performance and communicate financial results, though they are non-GAAP measures with limitations[289] - Contribution Margin for the three months ended June 30, 2024 was 67%, compared to 58% for the same period in 2023[291] - Operating Margin worsened to (43)% for the three months ended June 30, 2024, compared to (23)% in 2023[292] - Adjusted EBITDA was negative $9.3 million for the three months ended June 30, 2024, compared to positive $11.0 million in 2023[297] - Adjusted EBITDA Margin was (7)% for the three months ended June 30, 2024, compared to 8% in 2023[297] - Net Loss Margin deteriorated to (43)% for the three months ended June 30, 2024, compared to (21)% in 2023[297] Revenue and Fees - The company's revenue is primarily earned through platform and referral services provided to lending partners, with fees that can be fixed or variable depending on contractual arrangements[224] - Revenue from fees, net decreased by 9% to $130.5 million in Q2 2024, down from $143.7 million in Q2 2023, primarily due to a 6% decline in transaction volume[267] - Platform and referral fees, net decreased by 7% to $98.6 million in Q2 2024, compared to $105.8 million in Q2 2023[267] - Servicing and other fees, net declined by 16% to $31.9 million in Q2 2024, down from $37.9 million in Q2 2023[267] - Revenue from fees, net decreased to $130.5 million for the three months ended June 30, 2024, down from $143.7 million in 2023[292] - 85% of the company's total revenue in the six months ended June 30, 2024, was generated from platform, referral, and servicing fees from lending partners[366] - 26% of the company's revenue in the six months ended June 30, 2024 was generated from loan servicing fees[411] - The company charges a fixed percentage servicing fee based on the outstanding balance of loans serviced[414] Costs and Expenses - Borrower acquisition costs increased to $23.2 million in Q2 2024 and $48.0 million in the first six months of 2024, up from $19.0 million and $38.8 million in the same periods of 2023[250] - Borrower verification and servicing costs rose to $31.2 million in Q2 2024 and $63.3 million in the first six months of 2024, compared to $28.7 million and $58.5 million in the same periods of 2023[250] - Engineering and product development expenses increased to $58.5 million in Q2 2024, up from $57.9 million in Q2 2023, reflecting investments in AI model improvements and new product development[264] - General, administrative, and other expenses rose to $53.0 million in Q2 2024, compared to $50.4 million in Q2 2023, driven by business growth support[264] - Borrower acquisition costs increased to $23.2 million for the three months ended June 30, 2024, up from $19.0 million in 2023[291] - Borrower verification and servicing costs rose to $31.2 million for the three months ended June 30, 2024, compared to $28.7 million in 2023[291] - Sales and marketing expenses increased by $9.1 million (38%) in Q2 2024, with payroll and personnel-related costs rising by $4.8 million and advertising costs by $4.2 million[274] - Sales and marketing expenses increased by $12.8 million (23%) in H1 2024, primarily due to a $9.3 million rise in advertising costs and a $3.6 million increase in payroll expenses[275] - Customer operations expenses increased by $1.9 million (5%) in Q2 2024, driven by a $3.7 million rise in servicing expenses, partially offset by a $2.1 million decrease in payroll costs[276] - Engineering and product development expenses decreased by $46.5 million (28%) in H1 2024, mainly due to a $43.8 million reduction in payroll costs related to PRSU cancellations[279] - General, administrative, and other expenses increased by $2.6 million (5%) in Q2 2024, with legal and compliance costs rising by $2.3 million and professional fees by $1.0 million[280] - Other income, net decreased by $4.2 million (80%) in Q2 2024, primarily due to a $2.4 million drop in miscellaneous income and a $1.7 million decline in dividend income[283] AI Models and Risk Management - The company's AI models benefit from a flywheel effect, where accumulation of repayment data leads to improved accuracy of risk and fraud predictions, resulting in higher approval rates and lower interest rates[230] - The company's credit decisioning process incorporates macroeconomic conditions data, such as unemployment levels and personal savings rates, to respond to changes in the macroeconomic environment[236] - The company's AI models have not been extensively tested during economic downturns or recessions, which could lead to greater than expected losses if the models fail to accurately predict loan performance[360] - The fair value of loans on the company's balance sheet has declined and may continue to decline due to underperformance of loans originated using AI models[360] - The company's AI models may underperform if they fail to accurately reflect economic conditions on borrowers' credit risk[342] - The Upstart Macro Index (UMI) is in early R&D stage and remains unproven, with potential risks to the company's reputation and credibility[372] - UMI values have been revised to remove seasonal patterns, and further changes may occur in the future[372] - The UMI (Underlying Macroeconomic Index) was measured at approximately 1.49 as of June 30, 2024, indicating a 49% incremental risk to loan repayment performance compared to the baseline[236] Loan Products and Market Expansion - The company introduced a new offering of personal loans for small dollar loans in 2022, launched the HELOC product in Q3 2023, and launched auto secured personal loans in Q2 2024[242] - R&D Loans, primarily auto refinance and auto retail loan products, are held on the balance sheet for testing and evaluating AI models, with initial target returns generally lower than market benchmarks[221][229] - The vast majority of loan originations facilitated through the company's marketplace are unsecured personal loans[417] - Auto loans issued through the company's lending marketplace are secured by collateral, but repossession begins after 60 days of delinquency[415] - Expansion into new markets and new loan products may subject the company to additional regulatory requirements and scrutiny[406] Macroeconomic and Interest Rate Risks - The company expects economic conditions and interest rate changes to adversely affect loan demand and borrower repayment ability[329] - Higher interest rates may lead to increased delinquencies, defaults, and charge-offs, negatively impacting loan performance[329] - Interest rate risk exposure on warehouse credit facilities was $387.4 million as of December 31, 2023, and $258.2 million as of June 30, 2024[330] - The company has interest rate cap agreements with an aggregate notional amount of $268.8 million to mitigate interest rate risk[330] - A hypothetical 100 basis point increase in the discount rate would result in an $8.7 million decrease in the fair value of loans as of June 30, 2024[317] - A hypothetical 10% increase in credit risk would result in an $8.4 million decrease in the fair value of loans as of June 30, 2024[323] - The company held $135.1 million of loans in consolidated securitization as of June 30, 2024, with a hypothetical 100 basis point increase in credit risk resulting in a $2.2 million decrease in fair value[324] - Beneficial interest assets totaled $97.8 million as of June 30, 2024, with a hypothetical 10% increase in credit risk resulting in a $22.6 million decrease in fair value[325] Regulatory and Compliance Risks - Regulatory scrutiny on AI in lending, including potential impacts from the CFPB's final rule requiring public reporting of consumer protection violations[402] - The company completed fair lending reviews by Relman Colfax LLC, with potential reputational and regulatory risks if findings are viewed negatively[401] - The company is exposed to risks from changes in laws or enforcement actions related to consumer loans and AI lending practices[398] - The company's reputation is critical, with risks from negative perceptions of AI, loan performance, and regulatory actions[396] - The company's loan servicing activities are highly manual and regulated, with potential risks of errors or non-compliance affecting business and reputation[414] Lending Partner Dependence and Risks - The company's top three lending partners account for a significant portion of loan originations and revenue[343] - The top three lending partners accounted for 80% of the Transaction Volume and 72% of total revenue in the six months ended June 30, 2024[394] - The company's reliance on a small number of lending partners for significant revenue and loan originations poses a business risk[394] - The company's lending partners may suspend, limit, or cease their participation in the marketplace, which could decrease the number of loans facilitated and adversely affect revenue[367] - The company's agreements with lending partners are non-exclusive and may contain minimum fee amounts, posing risks to maintaining or growing lending partnerships[368] Loan Performance and Credit Risk - The company held $820.6 million of loans on its balance sheet as of June 30, 2024, including $396.3 million for R&D purposes and $289.2 million of core personal loans[312] - Upstart held $685.5 million of loans on its balance sheet as of June 30, 2024, excluding consolidated securitization[378] - Upstart's R&D loans, which make up a substantial portion of loans held on its balance sheet, have higher default rates and charge-offs than expected[378] - The company's ability to collect on loans is largely dependent on the borrower's financial stability, which can be affected by factors like unemployment, divorce, and economic conditions[411] - The company partners with third-party collection agencies, and any failure in their performance could harm the company's brand and reputation[412] - The company began conducting first-party collection activities for lending partners in Q4 2022, with no prior experience in such activities[412] Cash Flow and Liquidity - The company had unrestricted cash of $374.8 million as of June 30, 2024[300] - The company's aggregate maximum exposure to losses was approximately $260 million as of June 30, 2024[304] - Net cash provided by operating activities was $117.9 million for the six months ended June 30, 2024, with non-cash adjustments of $185.1 million and a net loss of $119.1 million[309] - Net cash used in investing activities was $113.6 million for the six months ended June 30, 2024, primarily due to $110.9 million in loan purchases and originations[310] - Net cash provided by financing activities was $88.6 million for the six months ended June 30, 2024, driven by $247.5 million in proceeds from borrowings[311] - The company held $560.6 million in cash and restricted cash as of June 30, 2024, with exposure to credit risk from financial institutions[327] Future Outlook and Risks - The company expects an equal investment in all vintages of Upstart-powered core personal loans from Q1 2018 to Q1 2024 to deliver returns in line with a blended target of 9.3%[227] - The company reduced its workforce by approximately 20% in January 2023 and by an additional 10% in the three months ended June 30, 2024 to decrease operating costs and streamline operations[234] - The company faces risks related to maintaining diverse and resilient loan funding from institutional investors, attracting new lending partners, and adapting to changing macroeconomic conditions[370] - Upstart's revenue growth rate and financial performance in the past may not be indicative of future performance due to macroeconomic conditions and other factors[379] - Upstart's AI models and automation of loan processes have driven past growth, but future improvements may not yield the same level of growth[380] - Upstart's quarterly results are likely to fluctuate due to economic conditions, interest rate changes, and other factors, potentially affecting its stock price[382] - Upstart's loan funding arrangements, including securitizations and warehouse credit facilities, expose the company to risks that could reduce loan funding capital[384] - The company has incurred net losses and may not achieve profitability in the future[342] - The company's success depends on the continued growth of the unsecured personal loan market, which could be impacted by macroeconomic conditions and regulatory developments[417] - The company's revenue is highly susceptible to fluctuations in the unsecured personal loan market, as it is the primary source of income[417]