Good day, and welcome to the Upstart First Quarter 2023 Earnings. Today’s conference is being recorded. At this time, I would like to turn the conference over to Jason Schmidt, Head of Investor Relations. Please go ahead.

Good afternoon, and thank you for joining us on today’s conference call to discuss Upstart’s first quarter 2023 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 2023 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 2023 related to our business and 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 the result of new information or future events, except as required by law. In addition, during today’s call, unless otherwise stated, references to our results are provided as non-GAAP financial measures and are reconciled to our GAAP results, which can be found in the earnings release and supplemental tables. To ensure that we can address as many analyst’s questions as possible during the call, we request that you please limit yourself to one initial question and one follow-up. Later this quarter, Upstart will be participating in the Barclays Emerging Payments and FinTech Forum on May 17 and the Bank of America Global Technology Conference, June 7. Now, I’d like to turn it over to Dave Girouard, CEO of Upstart.

Good afternoon, everyone. Thank you for joining us on our earnings call covering our first quarter 2023 results. I’m Dave Girouard, Co-Founder and CEO of Upstart. Despite the headwinds facing our industry in early 2023, I’m pleased with the progress we made against the objectives that I set out for you previously. I’m hopeful that as we move through the year, you’ll come to see Q1 as a transitional quarter for Upstart. While the economic environment remains turbulent, there are many reasons to be optimistic about our future. I assure you we aren’t waiting around for the economy to improve. First, our development teams made giant leaps forward in each of our main product areas. Innovation in AI is the primary source of Upstart’s competitive advantage, and we continue to break new ground in this area. I’ll share more about these wins shortly. Second, we accomplished this while taking significant fixed costs out of our business. Last quarter, I told you that I’m committed to running an operationally and fiscally tight ship. Given our concerted efforts in Q1 to reduce both payroll and operational expenses, I’m confident that Upstart is now a more streamlined and efficient company setting us up to return to profitable growth soon. I’ll share more about our cost reduction efforts later. And finally, I’m pleased to tell you that we secured multiple long-term funding agreements together expected to deliver more than $2 billion to the Upstart platform over the next 12 months. This is a critical first step toward building resiliency and predictability into our business. Together, I believe these efforts put us in a stronger position regardless of which direction the economy turns. Our own analysis, which we launch publicly in March in the form of the Upstart Macro Index, or UMI suggests that the…

Thanks, Dave, and thanks to all of you for joining us today. At a headline level, over the past quarter, we’ve observed continuing stability in consumer repayment trends on the borrower side of our platform, counterbalanced by heightened volatility in the banking and institutional funding markets. In U.S. consumer personal finance, a couple of virtuous trends continue to unfold in the aggregate statistics. The percent of adults participating in the workforce continues to climb steadily as our population returns to work and the average personal tax burden for each individual has fallen considerably since last year, together, leading to a rising level of real disposable income per adult. On the expenditure side, real consumption per capita continues to moderate and creep back into line with disposable income. Rising disposable income and moderating consumption expenditures are resulting in a personal savings rate that has now risen in each of the past six months, since bottoming out last September. This particular indicator has demonstrated a strong correlation to borrow repayment health since the pandemic, and we are seeing this reflected in our Upstart Macro Index, which peaked last October and is showing signs of early recovery. The ongoing improvement in the consumer fiscal condition together with the recalibration of our own underwriting models is resulting in loan performance that as of our Q4 vintages, we believe is on track to deliver unlevered gross returns of approximately 11% as a blended average across the banks, credit unions and institutional buyers on our platform. Conversely, the funding side of the ecosystem remains challenging in the current climate. Increased conservatism among existing lending partners in the wake of the recent bank failures has enhanced our headwinds, even as we have brought additional volume onto the platform through implementation of new bank partnerships. The banking sector…

Thank you. [Operator Instructions] Our first question comes from the line of Simon Clinch with Atlantic Equities. Please go ahead.

Hi, Dave. Hi, Sanjay. Thanks for taking my question and congrats on a pretty good quarter here. I was wondering just -- could you give us a little bit more detail around the long-term funding commitments perhaps and how we should think about how that might be applied or flow through for the remainder of the year? Are there any constraints product categories that’s focused on or anything like that that we need to know about? Thanks.

Yes. Thanks, Simon. This is Sanjay. Let’s see. I mean, I guess I would say Upfront each agreement is a bit bespoke, so it’s hard to sort of broadly generalize. But maybe a couple of headline thoughts. First of all, I would say these agreements, they more or less flow from the ability we’ve demonstrated over the past couple of quarters to the extensive with our margins and to improve our take rates. And because we have expanded margins, really the way to think about these agreements are we’re able to sort of share some modest preferential economics with long-term committed investors. Those preferential economics could take the form of sort of return premiums or a take rate co-investment or modest discounting and risk sharing. All investors have a slightly different set of preferences and objectives, so it tends to be a bit different by a counterparty. They’re all currently focused on personal loans, so they’re sort of restricted to our core business. Beyond that, they tend to mirror our broader institutional programs. So apart from some preferential economics that essentially flow from our enhanced, unit economics, they tend to look very similar to what we would normally do through the capital markets.

Great. That’s really helpful, thank you. And maybe a follow-up question to that. Just on your comments around take rate and I guess, the very impressive contribution margins that you generated this quarter and anticipate to generate in the next quarter. How should we think about the sustainability of that as you go through perhaps an economic recovery and loan acceleration at some point? Should we expect those contribution margins to decline and then what does that mean in terms of – I suppose those funding commitments become less important in that regard, but just like to think about how all that ties together.

Sure, yes. I mean, I guess the punchline is they’re – I think they’re probably sustainable for as long as we want them to be. There’s really two underlying factors I would point to. One is the extent to which we are sort of investing for the short-term versus the long-term, and the other is the general elasticity of the loan demand on the borrower side. So currently as an example in elasticity is quite high, credit is in demand on the borrower side. And so that creates sort of pricing ability on our side. But maybe the more important thing is, when we’re sort of solving for the near term P&L, we are optimizing take rates as much as possible against that in elasticity, and we are managing our marketing programs to deliver loans that are profitable in the near-term. I think that as the economy evolves and certainly as it improves, what you would see is, on the one hand, a declining in elasticity. So there’ll be more sort of provision of credit on the supply side, and so borrowers will have more choice. But the other factor would be, in our case, we would then start to rebalance how we trade off the short-term for the long-term. And so by reducing take rates and by growing marketing campaigns, we can generate more volume, harvest more lifetime value of the customer, harvest more gains on the model learning side, things that won’t necessarily show up in this quarter’s P&L, but make, provide value over time. And so when you put all of that, you get an improving economy, I think you’d probably see take rates that that may not go back to where they were before, but would probably moderate with the economy improving.

Thanks, that’s really helpful. Thank you.

Our next question comes from the line of Ramsey El-Assal with Barclays. Please go ahead.

Hi, this is John Coffey on for Ramsey. I had a question for you on your Slide 18 really regarding your conversion rates. So it looks like your conversion rates had declined from about 21% last year to 8%. I was just trying to understand the drivers of this a little bit better. Is most of it just the supply of credit or is it sometimes that potential borrowers are hitting that, that ceiling for interest rates or they’re deciding to defer some kind of purchases to later on when they’re maybe a little bit more of a stable economic condition?

Yes. Hey, John. Yes, it’s got – it doesn’t have much at all to do with the supply side. I think maybe the single most explanatory variable would be what we call our Upstart Macro Index or UMI, which is also in our nester materials. And that basically reflects the fact that, apples-to-apples, the same consumer is defaulting at a rate that is maybe sort of 2 to 3 times higher than they were in mid-2021. And because of that, consumer repayment pattern change, we are pricing loans very differently, right? We’re including much higher default premiums in the loans. And then compounding that, of course, there’s the higher base interest rates, which are requiring investors to demand higher sort of returns. And when you add those two up, our, like-for-like price for a loan has gone up quite dramatically. And in some cases 1,500 basis points to 2,000 basis points. And because of that change in pricing, two things are happening. One is a lot less borrowers are getting approved, right? So a lot of them are being pushed above the 36% APR threshold. And then even for those who are still getting approved, their prices are a lot higher and they’re maybe less predisposed to taking the loan. So those two things combined have resulted in the contracting conversion rate.

All right. Great. Thank you. And just for a very short follow-up, I noticed that your loans and your balance sheet actually declined a little bit quarter-over-quarter. Should we think of last quarter, the fourth quarter as a bit of a high water mark, or is that still too early to say?

Good question, John. I mean, I think that we – I think continue to think of the balance sheet along the lines of the parameters we’ve expressed to the market, which is there’s a certain number we won’t go above and that’s probably roughly where we were last quarter. We also sort of set in our remarks that there is a transaction that did not complete in Q1, but we expect it to complete in Q2. And that will bring our balance sheet down next quarter. Now from there we may sort of continue to use the balance sheet as a platform tool. But I think that you’ll probably see us remain sort of in a volume where we are sort of peaking at the billion dollar range and then ebbing or flowing from there based on whether we’re transacting or accumulating.

Great. Thank you.

Okay. Thanks.

Our next question comes from the line of Peter Christiansen with Citi.

Good afternoon. Thanks for the question. I just wanted to dig a little bit into the secured funding, the $2 billion. I just want to understand, is this – are these funds like securing minimums from existing partners, or is it incremental from new funding partners, if you could just provide a little bit more color on that and how it is compares to the existing run rate, I guess, of business that you have.

Sure. Yes. Thanks, Pete. This is Sanjay. Yes, I think a lot of it is coming from partners that are new to the platform that we’ve never worked with before. Some of it is coming from existing partners who had either sort of stepped away from funding during the sort of turbulence the past few quarters and are coming back to the platform or they’re re-upping in significant size and committing forward in exchange for the longer-term agreement. So I think in almost every case, you can view it as sort of being additive to what we’ve been doing recently and sort of underpins the – both the improving guide that we have in our Q2 numbers as well as its sort of more general optimism we’re signaling qualitatively.

That’s helpful. And then I guess in the past, Upstart has made a number of model changes to the AI platform and you’ve seen subsequent results change as well. I guess in the current – I guess assuming the status quo environment, like how do you think these model changes will influence results in the coming quarters? Thank you.

Hey, Pete, this is Dave. I mean, generally speaking on the margin that upgrades to the AI tend to improve automation or improve accuracy of the models, and those tend to be an aggregate positive to growth. So I was – as I was kind of saying toward the end of my remarks, we believe we can grow without the economy improving. But it’ll certainly be doing it against what it’s currently a pretty challenging economy with respect to funding markets, base credit rates, interest rates, et cetera. So but we do believe, I mean, the reason we’ve been able to grow and over time is predominantly because the technology and the models get better and those tend to lead to growth and even in a difficult environment as we have today that still is still true.

Okay. Thank you. Thank you, both.

Thanks, Pete.

Our next question comes from the line of [indiscernible] with Compass Point. Please go ahead.

I was curious in looking at kind of the mix of bank versus non-bank and the – our institutional investors on the platform. I’d be curious if there’s a sense of like where that mix may have shifted this quarter where that might go going forward.

Hey, Juliana, you’re asking about the sort of mix of banks versus institutional investors.

That’s right, yes.

Yes. I mean, I guess look at a headline level, I would say obviously the events that we went through in March that particularly impacted the banking sector definitely had an impact. And so the dynamic there is we continue to bring new sort of lending partner bank, credit union partners aboard, but existing one, they’re obviously becoming a little bit more conservative. I think that impacted the capital markets less so. So you may have seen a bit of a shift towards the institutional dollars. How that plays out forward is a bit hard to tell. I mean, the banking sector is obviously right now in a bit of turbulence and that may increase or it may moderate and I think depending on what that banking, what that sector experiences over the coming quarters [indiscernible] price reflected it – that reflected in their ability to or their appetite to lend and to take more balance sheet risk.

That makes sense. And then kind of looking through some of the past disclosures, you kind have two banks that seem to be the primary enablers of the loan sales or kind of the marketplace side of the platform. But if you add up the volumes of those two banks, it seems to imply that they’re actually much more than the loans that are being sold the institutional investors and retained by Upstart. And it could imply that one or two of those banks accounts for 50% plus or even close to 60% of all of your kind of bank funding side of the platforms. I’m curious what level of concentration there is on the bank side of the funding platform, and have you’ve seen any of those partners pull back in their buying activity recently?

Yes. There are really three banks on our platform that serve as conduits where they originate loans. In some cases they hold some of them, and in other cases, they end up selling them to institutional partners. So there are three of those banks on our platform, and it’s quite possible to move volumes between them. It’s quite purposeful that we can do that. Generally speaking, the fees and the profits on the loans that end up in the institutional side are higher than they are on the bank, on the – what tend to be the primer loans that banks are originating and holding on their balance sheet. So that sort of creates what the structure that you’re seeing there, but it’s not really in a true sense of revenue concentration. These are again many, many institutional buyers behind those banks. But we do have multiple what we call marketplace lending partners on the platform.

Got it. And I’m curious, when you think about flooding concentration with any partners, are there any partners that are kind of 10% or more of your overall funding or 15% or more of your overall funding? Or is it more diversified than that?

Hey, Juliana, yes, it’s – I think what you’ll see in our revenue concentration disclosures when the financials come out is that those concentrations are going down. And I think in terms of source capital dependency, I don’t think anything is far greater than the ballpark that you just mentioned.

Got it. Thank you very much. And I’ll jump back into queue.

Thank you.

Your next question comes to the line of James Faucette with Morgan Stanley. Please go ahead.

Hey, thank you very much and thanks for the details today. Wanted to go back on the secured funding, and I think you made the comment that there were some preferential terms that you were able to offer to them. I guess a couple questions associated with that going forward, what would be the right level of mix or targeted mix for that group? And it sounds like you’re planning to add more to that, firstly, and secondly, how much should we expect that you may have to harmonize at least some of those terms into other sources of capital?

Hey James, this is Dave. Good question. So I would say first of all, one of the comments I had made in my remarks earlier with that we would like to have in any particular month, capital committed such that we can be cash flow positive as a business. So sort of a baseline of capital that we feel very good about being solid will be there and that would be a pretty dramatic reduction in cyclicality. So that’s I think what we would try to do. I generally think we are benefiting from the fact that we have very strong margins in that we can share a bit of them with the preferred partner and a preferred partner is one that is making a longer-term commitment to us. So I think that’s a structure that we would expect to have for the long haul. And I think it makes sense that if they’re going to commit to you, you’re going to make some special commitment to them. And there can all of course also continue to be plenty of sort of at will participants in the marketplace month in, month out. And we don’t expect that to go away. We think it’s a good thing, but I do think we want a significant fraction of the funding to be more long-term committed in getting a little bit of a preference for doing that. And lastly, as we’ve said, I think we feel comfortable given our margin structure that we can afford to do that. The other thing I’ll add is this is all as Sanjay said earlier, entirely related to personal loans today, I think we will push for this kind of structure on other products as well. I kind of believe that secured products are ones that are much primer like the HELOC product will have probably, I would just say less of a need for it because they will just tend to be more normal familiar products and ones that lenders lean toward even in more difficult times. So that’s how we’re thinking about it. I don’t know if they’re – I think there will always be kind of will hopefully harmonize these types of agreements into a consistent structure. Sanjay said they’re starting off a little bespoke by probably not hard to imagine that would happen, but over time I think we would really like to almost programatize it though it’s a little more structured. But I do believe there’ll be sort of longer-term partners and they’ll be at will partners coexisting in our platform.

Yes. Yes. And then on – I appreciate all that, David. And then how are you feeling about the state of your cost base now on a run rate basis? I know that here in the June quarter, you’re expecting to roughly be adjusted EBITDA breakeven now that those programs have been fully implemented. But should we take that to mean that you’re – you feel like you’re at the right cost base and that the kind of the first quarter would’ve been roughly the bottom from a revenue generation perspective and that you can grow at least for the remainder of this calendar year on a sequential basis, or are there incremental actions that mandate be need to be taken? Just trying to think through kind of how you’re seeing the business and its evolution from this point.

Hey James, this is Sanjay. Yes, I think we’re in very good shape. I think on a personnel – from a personnel perspective, I think we did what we needed to do in Q1 and we’re past it. I think our workforce numbers are in very good shape now and borrowing any dramatic reversal in the business and the economy. I think we’ll sort of grow from here. There – look, there’s still more work to be done on the OpEx side. As Dave mentioned, there’s sort of programs to sort of reduce – we’re large consumers of compute our machine learning models require a lot of sort of training resources and we want to get more efficient at that our engineering footprint, the resources we consume can get more efficient as well. So I think that this will be an ongoing set of initiatives, but I think by and large, you’re sort of – your model is right, which is I think we’re at a good place. We can tighten up a little bit more, but I – we’re sort of indicating that we think there’s a nice path for growth from year on out and as we did – as we demonstrated before, our cost base is going to scale very efficiently with the top line, and it’ll sort of provide a – provide nice margin materialization as we grow.

That’s great. Thank you for that, Sanjay.

Thank you.

Our next question comes from the line of Reggie Smith with JPMorgan.

Good evening, gentlemen. Congrats on the quarter and on securing the $2 billion in funding. My question, I know in the past, you’ve been asked about becoming a bank and not wanting to do that, which I can totally appreciate. My question for you, and I guess it kind of relates back to the funding as well. Would you consider like a warehouse type funding mechanism? And does any of your $2 billion is any of it structured in that kind of way where you pay a fixed rate, you hold more loans on balance sheet? Or is it all – is all that $2 billion that you talked about purely arms length outside of balance sheet financing?

Yes. Reggie, yes, that, that, that’s generally what we would term forward flow commitment. So loans that are purchased monthly by a third-party and outside third-party. So that’s what that is. It’s not on our balance sheet. There’s no warehousing on our side. They can be using – they could be leveraging on their side if they chose to but that’s separate from anything going on with us. So let me see. What was the other part of the question?

Would – so would you consider warehouse is that also something that you would not pursue?

Yes. We’ve had modest warehouse capacity for many years. So when the loans are on our balance sheet to some extent, we have – those are financing and it’s more efficient use of our equity capital. But that’s still that’s under that umbrella of the total as Sanjay said, we – and to stay at no more than $1 billion on our balance sheet, and those tend to be warehoused or at least some of them are. So we do use that for a capital efficiency, but it’s not a primary funding mechanism just as our balance sheet ultimately is not a primary funding mechanism.

The loans on our balance sheet, when we say we have $1 billion of assets in the balance sheet, that, less than half of that is the actual loan equity of ours. The rest is finance, but we still consider that to be our balance sheet. It’s really what we’re interested in with the long-term arrangements is third parties as the risk engine and they can finance as suits them.

Yes. No, I appreciate that. The – I guess the crux of the question was would you consider being more, I guess, balance sheet intensive? But it sounds like you’re comfortable with the billion and that’s kind of where you want to remain links for the foreseeable future. My second question, guidance very strong numbers. In particular, I guess the interest – net interest and kind of fair value, I guess that implies a pretty sharp sequential improvement there. Was curious what was driving that, and if you could talk a little bit about the performance you’re seeing of your loans that are held on balance sheet loss rates and things of that nature.

Yes, sure. Reggie, this is Sanjay. So as far as the guidance I would say that Q1 was the anomaly in a sense which is normally you’d expect your balance sheet to have some modest positive income. We tend to hold our loans at fair value, so we mark-to-market, we don’t use CECL accounting. And so when interest rates are going up, which has happened with a lot in the last year, it’s taken a toll on the valuations. Q1 in particular didn’t necessarily have adverse sort of interest rate movements, but what it did have is, we booked unrealized fair value marks that reflected a balance sheet transaction. Now it was not a balance sheet transaction that completed in Q1, so that’s why it’s unrealized. But because it was a balance sheet transaction that we were anticipating, we were expecting and we expected to close early in Q2. We sort of reflected the economics of that transaction in Q1 and that will be in our disclosures. So I think you could think of that as of Q2 going forward, we’re not really anticipating any large significant transactions beyond the one we’ve already accounted for. And therefore, I think what you’re seeing now in our guidance for interest income just sort of reflects ongoing normality. It does – it sort of like income rate or sorry, interest rate stability, no large transactions and some modest income from our remaining balance sheet. So that, that’s how I would think about the guidance. As for performance, but I think the best way to think about it is in our investor materials, we generally display what we’re intending to do as a blended average across our platform with respect to gross return delivery and how we think each vintage is trending. And that the simple summary is, vintages that are on our balance sheet from back in 2021 or 2022 are likely going to under deliver as they are across the broader platform. I think anything as of certainly Q4 forward. So anything from the last six months to nine months are well on track to over deliver in our opinion. And so if the performance of our balance sheet will just reflect the underlying vintages that, that you see on the broader platform.

Got it. And if I could sneak one more in, on the take rate you talked about I guess stronger economics. Curious is there a way to kind of parse the impact that of stronger pricing or origination fees that are paid by borrowers versus maybe what your partners are paying you? Was there any change there when you talk about better pricing?

I don’t think there’s anything necessarily more to parse there other than fees, primarily borne by borrowers that are getting loans, funded through institutions, tend to flex up at times like this. So that’s really what you’re seeing. I mean, based yield requirements are going up, loss expectations are going up, and also the fees going up, all of which we certainly don’t love, but it’s the reality of the economy we’re sitting in that we have to play in. And we would really be happy to see all that reverse itself over the next year if we’re so fortunate.

No, I got it. That was in clear. I’m sorry. I’ve got a couple calls going on, so I didn’t catch that part that it was – that was primarily borrowed with fees. Okay. Thank you.

No worries.

Our last question comes from the line of Simon Clinch with Atlantic Equities.

Hi guys, I’ve got to jump back into queue. Thanks for taking my question again. I was just curious going back to your – the pace of your new model rollouts or updates through the quarter was pretty staggering. And I’ll just as someone who doesn’t really know about these things, I was wondering if you could talk us through perhaps the risks and/or challenges of that kind of pace of rollout and what to – I guess how to think about that in terms of the benefit going forward, because previously we hadn’t needed that many rollouts to create significant benefits for you guys.

Yes. Simon, it’s a good question. It’s important I would just say to state that we have different models in production for each product that we have. So there’s four products, two auto products, a personal loan product, small dollar product, each of whom have related, but different models that push to production. There’s also models that are more focused on automation than the pricing. So things that deal with fraud and those kind of things. So all across the – I don’t know exactly how many AI models in distinctive AI models we have, but it’s quite a few. And those teams are working in parallel. So this isn’t the same model being updated or retrained every three days. It’s less than that. But there’s a lot of them in each one of them generally are making some part of our product line that much better. So that’s a pace which a couple years ago we were probably maybe doing one a month or so. So it’s quite a difference.

That that sounds a lot more sensible. Thank you.

Thanks, Simon.

This concludes today’s question-and-answer session. I will turn the call back for any additional or closing remarks.

Just want to thanks everybody for listening today. And as we’ve said, we’re happy with what we’ve achieved in the first quarter. We’re actually pretty optimistic about 2023, so thanks for sticking with us.

This concludes today’s call. Thank you for your participation and you may now disconnect.