Upstart - Q1 2023
May 9, 2023
Transcript
Operator (participant)
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.
Jason Schmidt (VP and Head of Investor Relations)
Good afternoon, 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 market close 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 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 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 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 & FinTech Forum on May 17th and the Bank of America Global Technology Conference June 7th. Now I'd like to turn it over to Dave Girouard, CEO of Upstart.
Dave Girouard (CEO)
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 will 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. 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. 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 launched publicly in March in the form of the Upstart Macro Index, or UMI, suggests that the financial health of the mainstream American consumer deteriorated rapidly through the first nine or so months of 2022, but has since stabilized, if not improved, for the last several months. The personal savings rate, which may be the most relevant predictor of UMI, bottomed out mid last year at 2.7% and has increased to 5.1% since then. Since late 2022, loans on our platform have been priced conservatively relative to UMI, so our bank and credit union partners can feel confident that recent vintages are today performing at or above expectations.
While banks are certainly treading carefully in the current environment, many lenders and institutional investors appreciate the combination of high yield and short duration that Upstart-powered loans offer. Irrespective of the environment, I push our team very hard to make sure Upstart improves constantly in four critical dimensions. First, best rates for all. We founded Upstart to improve access to credit, so delivering the best rates possible to all consumers will always be our true north. Given the breadth and diversity of competition, we'll never 100% achieve this goal. In a fierce effort to do so, we can become the market leader in a vitally important segment of our economy. Better rates are unlocked first and foremost by a more accurate and predictive credit model, one that excels at separating good risk from bad, and AI is the key to this.
Our models are today trained on more than 100 billion cells of performance data. Now, with an average of 90,000 new loan repayments due each day across all our bank partners, the system is learning and adjusting in near real time to actual loan performance. We pushed 23 new and improved versions of our AI models into production during the first quarter alone, about one every three days. We're confident that our AI has never been as sophisticated or as accurate as it is today. In order to deliver the best rates for all, we also need a diversity of bank and credit union partners, each with different priorities, business objectives, and balance sheet issues to solve. Today, we have almost 100 such partners, an order of magnitude more than the 10 we had when we went public in December 2020.
We additionally need a strong presence and reputation in institutional and capital markets because the limited risk appetite of bank balance sheets will never serve the needs of the entire U.S. credit market. This quarter, we expanded our roster of institutional partners in ways that should help us deliver quality offers to consumers through all parts of the cycle. Second, more efficient borrowing and lending. Every quarter, we aim to make our platform more efficient for consumers and bank partners. This improvement comes from better AI, which enables more sophisticated risk models, which in turn enable a faster and more efficient experience for consumers and lenders. In the first quarter, we achieved a record level of automation with 84% of Upstart-powered loans fully automated across all our bank partners.
By this, I mean the loans were approved and verified instantly with zero human intervention from rate requests through loan funding. We know of no other lending marketplace with this level of automation. This instant and automated process, which by the way, 70% of consumers access via a mobile phone, creates an unparalleled wow moment for the borrower, who is often surprised, if not shocked, to realize that there are no more steps in the approval process. Because consumers rightfully value their time, this delightful moment is often more impactful than the specific rate our bank partners offer. Efficiency is obviously important for the lender as well. Our bank partners' Upstart-powered lending programs are open for business 24 hours a day, seven days a week.
In addition to providing the modern all-digital experience their customers expect, banks can tailor their Upstart lending programs to precisely target their business objectives, risk appetite, and balance sheet needs. When it comes to routine transactions like offering a loan, branch hours are inconvenient, human intervention is costly, and consumers just want what they want when they want it. Third, more resilience. After all we've experienced in the last year, I'm keenly aware that we need to build more resilience into Upstart's business. Lending is inherently cyclical, but we aim to build a platform that largely mitigates that cyclicality, ensuring that credit continues to be available and flowing when it's needed, albeit accurately priced to prevailing conditions. Central to this resilience is securing a baseline supply of long-term capital that we can depend on through the market's ups and downs.
As I mentioned earlier, we've completed agreements with multiple strategic partners as of today and will continue to explore additional partnerships. Our primary goal is to have loan funding capital committed at a level that allows us to remain cash flow positive through typical market cycles. Resilience also comes from a flexible business model with lower fixed costs, proven pricing power, and durable unit economics. We've always been a capital-efficient business, raising and spending a fraction of what peer companies spend, but there are always more ways to drive efficiency. Between Q4 and Q1, we took the necessary steps to reduce Upstart headcount by almost 30%. While clearly a gut-wrenching decision, it will allow us to return to profitability at a significantly lower loan volume and has led us to be more focused and nimble in delivering our product roadmap.
We also identified opportunities to reduce our technical infrastructure costs by as much as $10 million annually and sublet some unnecessary office space, both of which will go directly to the bottom line. On the revenue side, we flexed up our take rates, delivering a record contribution margin of 58% in Q1. Our prior record contribution margin was 54% in Q3 of 2020. Our strong and flexible unit economics are a by-product of the competitive advantage provided by AI. All these together position us well to navigate whatever twists and turns lie ahead while strengthening our position for the inevitable sunnier markets to come. The last important lever on resiliency is our product offering itself, which I'll speak to now. Fourth, a broader range of products. Moving beyond our core personal loan product is critically important to reaching our potential as a business.
Offering a wider range of solutions makes us more relevant to more consumers and also more valuable to our bank and credit union partners. Product and borrower diversification can also provide greater resilience through future market cycles. We continue to make progress in our second big bet, the auto lending market. This market has had what may be the most tumultuous three years in its 100 plus years history. Despite this, we've made rapid progress with our products and couldn't be more excited about our potential. Since our last earnings call, we announced that both Acura and Mercedes-Benz approved Upstart as a digital retail provider, becoming our eighth and ninth OEM partners. We recently launched a new and improved AI model for our auto retail lending product that builds off our existing auto refinance model. We now consider both of these models calibrated and performing on target.
Our footprint of dealers piloting our lending product expanded to 39 since last I updated you. We expect this rollout to continue throughout the year. We also signed our first external funding agreement for auto retail, which is an important milestone for us. Lastly, we're making rapid improvements to our servicing and collections of auto loans, which accrues directly to model performance. I'm also pleased to let you know that we expect to launch a home equity product later this year. This is a great fit for Upstart for a few reasons. First, 95% of HELOCs are financed by banks and credit unions. It's an asset our lending partners know and value. Second, HELOCs naturally serve a very prime consumer, namely homeowners. We expect Upstart's HELOCs to have annual loss rates less than 1%. Third, home equity products tend to be counter-cyclical to refinance products.
We know this because in Q4 2022, HELOC volumes grew 32% year-on-year, even while mortgage refinances plummeted. Importantly, there's a lot of opportunity to improve the process of originating HELOCs. The average HELOC today takes 36 days to fund, while we're aiming for online approval in 10 minutes and funding within five days. Lastly, I have to mention the incredible progress made by our small dollar loan team. By way of context, banks feel pressure from regulators to eradicate overdraft fees and instead to provide affordable relief loans to consumers who have short-term cash needs. They've struggled for years to do this both meaningfully and profitably. Short-term loans of a few hundred dollars to existing customers or even to random walk-up consumers at rates within the APR limits for nationally chartered banks has seemed beyond the reach of the banking industry.
Well, we're building it for them, and we believe it has the potential to eradicate more than 70% of payday loans in the next five years. Our small dollar product already has 90% automation rates, far beyond even our core personal loan product. In Q1 we launched a new AI model for this product that delivered the largest single accuracy improvement measured in our history. We've also expanded the offering to include loan terms as short as three months, which show over 37% increase in approval rates. I'm not sure we've ever delivered a product with as much impact and as much alignment with our mission as we're seeing from the small dollar team. To wrap things up, I want to acknowledge that the financial industry is not out of the woods yet.
Even in this challenging economy, I believe Upstart is in position to grow reasonably through our typical run rate of model and technology improvements. When the banking and credit markets eventually normalize, as surely they will, the true strength of our platform will become clear to all. Upstart's success will continue to be built on excellence and leadership in AI. By this, I mean the speed with which we can develop, deploy, and calibrate new and more accurate AI models. Together with the amazing quality of our team, it is this that makes me optimistic about Upstart's future. Thank you, and I'd like now to turn it over to Sanjay, our Chief Financial Officer, to walk through our Q1 2023 financial results and guidance. Sanjay.
Sanjay Datta (CFO)
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 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 borrower 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 turbulence has also contributed to wider market spreads on high yield debt after a brief period of moderation in January and February, which is in turn causing institutional investors who rely on functioning ABS markets to be increasingly cautious in their deployment of capital. We have managed to more than offset these headwinds by securing multiple longer-term funding agreements, which we expect to deliver more than $2 billion in capital over the coming 12 months. We believe that these deals, as well as others in the pipeline, will provide us with a stronger and more resilient capital supply over the coming quarters.
With these items as context, here are some financial highlights from the first quarter of 2023. Revenue from fees was $117 million in Q1, coming in above our guided expectation as a result of some increased funding secured through our longer term capital arrangements, as well as ongoing take rate optimization. Net interest income was slightly below guidance at negative $14 million, largely a result of unrealized fair value adjustments informed by the economics of a balance sheet transaction that was expected to close after the end of the quarter. Taken together, net revenue for Q1 came in at $103 million, slightly above guidance and representing a 67% contraction year-over-year. The volume of loan transactions across our platform in Q1 was approximately 84,000 loans, down 82% year-over-year and representing over 53,000 new borrowers.
Average loan size of $12,000 was up 22% versus the same period last year. 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 58% in Q1, up from 47% last year and three percentage points above our guided expectation for the quarter. We continued expanding our margins in Q1 through higher rates of automation, which attained a peak of 84%, improved marketing efficiency and increased take rates.
Operating expenses were $235 million in Q1, down 15% year-over-year, up 14% sequentially due to one-time restructuring costs incurred as part of our reduction in force, as well as a one-time non-cash charge resulting from the cancellation of a single executive performance-based equity award, which accounted for approximately $40 million of the overall expense base in this past quarter. The majority of the year-over-year reduction was achieved through sales and marketing, which declined by 76% following the trend in volume. We continue to limit hiring to only a handful of key strategic positions. Altogether, Q1 GAAP net loss was $129 million and adjusted EBITDA was negative $31.1 million, both comfortably above our guided numbers.
Adjusted earnings per share was -$0.47 based on the diluted weighted average share count of 81.9 million. We ended the quarter with loans on our balance sheet at $982 million, down sequentially from $1.01 billion the prior quarter. Of that total, loans made for the purposes of R&D, principally within the auto segment, represented $493 million of that total. Our corporate liquidity position remains strong, with $452 million of total cash on the balance sheet and approximately $632 million in net loan equity at fair value. In our remarks of last quarter, we expressed optimism that the consumer trends impacting credit appeared positive to us and that the worst was likely behind us. This is indeed what we have perceived over the last 90 days.
Consumers reducing expenditures indicates to us that they are overspending less relative to income. Decreasing numbers of job openings in the economy indicates to us that Americans are returning to work. While both of these dynamics could be interpreted as a prelude to economic slowdown, it is clear to us that both have been beneficial for credit. This continues to be our perspective as we look to Q2. We also expressed confidence last quarter that through a combination of margin expansion, workforce reduction, and expenditure control, we could create a path to return to EBITDA breakeven at our current lower scale. Indeed, we now anticipate achieving this in the second quarter.
While painful, the workforce reduction was carried out with minimal impact to the velocity at which we are developing our newest round of bets in auto lending, small dollar loans, and HELOCs, all areas in which we look forward to sharing more updates in the coming quarters. With these specifics in mind, for Q2 of 2023, we expect total revenues of approximately $135 million, consisting of revenue from fees of $130 million and net interest income of approximately $5 million. Contribution margin of approximately 60%. Net income of approximately negative $40 million. Adjusted net income of approximately negative $7 million. Adjusted EBITDA of approximately zero, and a diluted weighted average share count of approximately 83.1 million shares. We are happy to be signaling a return to sequential growth and cash profitability in the current market environment.
Our improving guidance is clearly not deriving from obvious improvements to the macroeconomy just yet. It is flowing from a combination of tenacious execution, operating discipline, margin expansion, and deal making. As always, a huge note of gratitude to the various Upstart teams who have been heads down and laser focused on getting us through the storm and who have remained resolute over the past year in the face of such challenging external circumstances. While there may yet be a few more twists and turns along the way, we are optimistic that we have weathered the worst of it and barring any reversal in consumer trends that we are back on an ascending flight path. With that, Dave and I are happy to open up the call to any questions. Operator.
Operator (participant)
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. Our first question comes from the line of Simon Clinch with Atlantic Equities. Please go ahead.
Simon Clinch (Research Analyst)
Hi, Dave. Hi, Sanjay. Thanks for taking my question, and congrats on, you know, 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 it's focused on or anything like that we need to know about? Thanks.
Sanjay Datta (CFO)
Yeah. Thanks, Simon. This is Sanjay. Let's see. I mean, I guess I would say, upfront, you know, each agreement is a bit bespoke, so it's hard to sort of broadly generalize. 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 be expansive with our margins and to improve our take rates. 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, you know, a take rate co-investment or modest discounting and risk-sharing.
You know, all investors have a slightly different set of preferences and objectives, so it tends to be a bit different by 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. Apart from some, you know, preferential economics that essentially flow from our, you know, enhanced, you know, unit economics, they tend to look very similar to what we would normally do through the capital markets.
Simon Clinch (Research Analyst)
Great. That's really helpful. Thank you. Maybe a follow-up question to that. Just on, you know, on your comments around take rate and I guess, you know, 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? Then, you know, what does that mean in terms of, I suppose, those funding commitments become less important in that regard. Just like to think about how all that ties together.
Sanjay Datta (CFO)
Sure, yeah. I mean, I guess the punchline is 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, you know, the loan demand on the borrower side. Currently, as an example, inelasticity is quite high. You know, credit is in demand on the borrower side. You know, that creates, you know, sort of pricing ability on our side.
Maybe the more important thing is, you know, when we're sort of solving for the near-term P&L, we are optimizing take rates as much as possible against that inelasticity, and we are managing our marketing programs to deliver, you know, loans that are profitable in the near term. As the economy evolves and certainly as it improves, what you would see is, on the one hand, a declining inelasticity, so there'll be more sort of provision of credit on the supply side, and so borrowers will have more choice. The other factor would be, you know, in our case, we would then start to rebalance how we trade off the short term for the long term.
By reducing take rates and by growing marketing campaigns, we can generate more volume, harvest more lifetime value of the customer, harvest more, you know, gains on the model learning side, things that won't necessarily show up in this quarter's P&L but may provide value over time. When you put all of that together, you know, you get an improving economy. I think you'd probably see take rates that may not go back to where they were before but would probably moderate with the economy improving.
Simon Clinch (Research Analyst)
Thanks. That's really helpful. Thank you.
Sanjay Datta (CFO)
Okay.
Operator (participant)
Our next question comes from the line of Ramsey El-Assal with Barclays. Please go ahead.
Ramsey El-Assal (Managing Director and Senior Equity Research Analyst)
Hi, this is John Coffey on for Ramsey. I had a question for you on your slide 18, really regarding your conversion rates. 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 this sometimes that potential borrowers are hitting that ceiling for interest rates or they're deciding to defer some kind of purchases till later on when they're maybe in a little bit more of a stable economic condition?
Sanjay Datta (CFO)
Yeah. Hey, John. Yeah, 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 investor materials. That basically reflects the fact that, you know, apples to apples, the same consumer is defaulting at a rate that is, you know, maybe sort of two to three times higher than they were in mid 2021. Because of that, you know, consumer repayment pattern change, we're pricing loans very differently, right? We're including much higher default premiums in the loans. Compounding that, of course, is the higher base interest rates, which are requiring investors to demand higher sort of returns.
When you add those two up, our like-for-like price for a loan has gone up, you know, quite dramatically, and in some cases, you know, 1,500 to 2,000 basis points. Because of that change in pricing,two things are happening. One is a lot less borrowers are getting approved. Right. You know, a lot of them are being pushed above the 36% APR threshold. Even for those who are still getting approved, their prices are a lot higher and they're maybe less predisposed to taking the loan. Those two things combined have resulted in the contracting conversion rate.
Ramsey El-Assal (Managing Director and Senior Equity Research Analyst)
All right, great. Thank you. Just, for a very short follow-up, I noticed that your loans on 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 watermark, or is that still too early to say?
Sanjay Datta (CFO)
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, you know, there's a certain number we won't go above, and that's probably roughly where we were last quarter. We also sort of said in our remarks that there is a, you know, a transaction that did not complete in Q1, but we expect it to complete in Q2. That will bring our balance sheet, you know, down next quarter. Now, from there, we may sort of continue to use the balance sheet as a, as a platform tool.
I think that you'll probably see us remain, sort of in a, in a volume where we are sort of, you know, peaking at the billion-dollar range, and then, you know, ebbing or flowing from there based on whether we're transacting or accumulating.
Ramsey El-Assal (Managing Director and Senior Equity Research Analyst)
Great. Thank you.
Sanjay Datta (CFO)
Okay. Thanks.
Operator (participant)
Our next question comes from the line of Peter Christiansen with .
Peter Christiansen (Director of Digital Assets and Fintech Services Equity Research)
Good afternoon. Thanks for the question. I just wanted to dig a little bit into the secured funding, the $2 billion. I just wanna understand, 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, to the existing run rate, I guess of business that you have.
Sanjay Datta (CFO)
Sure. Thanks, Peter. This is Sanjay. 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, you know, in exchange for a longer-term agreement. 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 both the, you know, the improving guide that we have in our Q2 numbers as well as its sort of more general optimism we're signaling qualitatively.
Peter Christiansen (Director of Digital Assets and Fintech Services Equity Research)
That's helpful. Then I guess in the past, you know, Upstart has made a number of model changes to the AI platform and you've seen subsequent results change as well. I guess assuming the status quo environment, like how do you think these model changes will influence results in the coming quarters? Thank you.
Dave Girouard (CEO)
Hey, Peter, this is Dave. I mean, generally speaking on the margin, the upgrades to the AI tend to improve automation or improve accuracy of the models, and those tend to be in aggregate positive to growth. As I was kinda saying toward the end of my remarks, you know, we believe we can grow without the economy improving, but it will certainly, you know, be doing it against what is currently a pretty challenging economy with respect to funding markets, you know, base credit, rates, interest rates, et cetera. But we do believe, I mean, the reason we've been able to grow and over time is predominantly 'cause the technology and the models get better, and those tend to lead to growth.
Sanjay Datta (CFO)
Even in a difficult environment as we have today, that is still true.
Peter Christiansen (Director of Digital Assets and Fintech Services Equity Research)
Okay. Thank you. Thank you both.
Sanjay Datta (CFO)
Thanks, Peter.
Operator (participant)
Our next question comes from the line of Giuliano Bologna with Compass Point. Please go ahead.
Giuliano Bologna (Managing Director)
I was curious in looking at kind of the mix of bank versus non-bank, and the, you know, 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.
Sanjay Datta (CFO)
hey, Giuliano. you're asking about the sort of mix of banks versus institutional investors?
Giuliano Bologna (Managing Director)
That's right, yes.
Sanjay Datta (CFO)
I mean, I guess, look, at a, at a headline level, I would say that obviously the events that we went through in March that particularly impacted the banking sector, definitely had an impact. The dynamic there is, you know, we continue to bring new sort of lending partner, bank credit union partners aboard, but existing ones are obviously becoming a little bit more conservative. I think that impacted the capital markets less 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.
I think depending on, you know, what that banking, what that sector experiences over the coming quarters, you know, you'll probably see that reflected in their ability to or their appetite to lend and to take more balance sheet risk.
Giuliano Bologna (Managing Director)
That makes sense. Kind of looking through some of the past disclosures, you know, you kind of have two banks that seem to be the primary enablers of the loan sales or kind of the marketplace side of the platform. 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 to the institutional investors and retained by Upstart. It could imply that, you know, one or two of those banks accounts for, you know, 50+ or getting close to 60% of all of your kind of bank funding side of the platform.
I'm curious, you know, what level of concentration there is on the bank side of the funding platform, kind of if you've seen any of those partners pull back in their buying activity recently?
Dave Girouard (CEO)
Yeah. There's, there are really three banks on our platform that serve as conduits where they originate loans. In some cases, they hold some of them. In other cases, they end up selling them to institutional partners. 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. That sort of creates with the structure that you're seeing there. It's not really, you know, in a true sense a revenue concentration.
These are, again, many institutional buyers behind those banks. We do have multiple, what we would call marketplace lending partners on the platform.
Giuliano Bologna (Managing Director)
Got it. I'm curious, you know, when you think about, you know, funding concentration with any partners, are there any partners that are kind of, you know, 10% or more of your overall funding or 15% or more of your overall funding, or is it more diversified than that?
Sanjay Datta (CFO)
Giuliano. I think what you'll see in our revenue concentration disclosures, when the financials come out, is that those concentrations are going down. I think in terms of, you know, source capital dependency, I don't think anything is far greater than, you know, the ballpark that you just mentioned.
Giuliano Bologna (Managing Director)
Got it. Thank you very much. I'll jump back in the queue.
Sanjay Datta (CFO)
Thank you.
Dave Girouard (CEO)
Thank you.
Operator (participant)
Our next question comes from the line of James Faucette with Morgan Stanley. Please go ahead.
James Faucette (Managing Director)
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? It sounds like you're planning to add more to that, firstly. Secondly, how much should we expect that you may have to harmonize at least some of those terms into other sources of capital?
Dave Girouard (CEO)
Hey, James. This is Dave. Good question. I would say, first of all, one of the comments I had made in my remarks earlier was that we would like to have in any particular month, capital committed such that we can be cash flow positive as a business. Sort of a baseline of capital that we feel very, you know, good about being solid will be there. That would be a pretty dramatic reduction in cyclicality. That's, I think, what we would try to do.
I generally think, you know, 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, you know, commitment to us. I think that's a structure that we would expect to have for the long haul. I think it makes sense that if they're gonna commit to you're gonna make some special commitment to them. There can 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.
I do think we want a significant fraction of the funding to be more long term committed and getting a little bit of a preference for doing that. 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 or 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, you know, lenders lean toward even in more difficult times.
That's how we're thinking about it. I think there will always be kind of, We'll hopefully harmonize these types of agreements into a consistent structure. Sanjay said they're starting off a little bespoke by, you know, probably not hard to imagine that that would happen. Over time, I think we would really like to almost programatize it so it's a little more structured. I do believe there'll be sort of longer term partners, and there'll be at will partners coexisting in our platform.
James Faucette (Managing Director)
Yep. Yep. I appreciate all that, Dave. 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 know, you're expecting to roughly be adjusted EBITDA break even now that those programs have been fully implemented. You know, should we take that to mean that you're at the right cost base and that the kind of the first quarter would have been roughly the bottom from a revenue generation perspective, and that you can grow at least for, you know, the remainder of this calendar year on a sequential basis? Are there incremental actions that may need to be taken?
Just trying to think through, kind of how you're seeing the business and its evolution from this point.
Sanjay Datta (CFO)
Hey, James. This is Sanjay. Yeah, I think we're in very good shape. I think 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. You know, barring any dramatic reversal in the business and the economy, I think we will sort of grow from here. 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, you know, we're large consumers of, you know, compute. You know, our machine learning models require a lot of sort of training resources and we wanna get more efficient at that.
Our engineering footprint, you know, the resources we consume, you know, can get more efficient as well. I think that, you know, this will be an ongoing set of initiatives. I think by and large, your 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, you know, we're sort of indicating that we think there's a nice path for growth from here on out. You know, as we did, as we dfemonstrated before, our cost base is gonna scale very efficiently with the top line, and it'll sort of provide nice margin materialization as we grow.
Dave Girouard (CEO)
That's great. Thank you for that, Sanjay.
Sanjay Datta (CFO)
Thank you.
Operator (participant)
Our next question comes from the line of Reggie Smith with J.P. Morgan.
Reggie Smith (Executive Director of Equity Research)
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, you know, becoming a bank and not wanting to do that, which I can totally appreciate. My question for you and I guess it kinda relates back to the funding as well, would you consider, like, a warehouse type of funding mechanism? Does any of your $2 billion, is any of it structured in that kinda way, where you pay a fixed rate and you hold more loans on balance sheet?
Sanjay Datta (CFO)
Is it all-?
Reggie Smith (Executive Director of Equity Research)
Is all of that $2 billion that you talked about purely, you know, arm's length outside, off-balance sheet, financing?
Dave Girouard (CEO)
Yeah. Reggie, yeah. That's generally what we would term forward flow commitment, so loans that are purchased monthly, by a third party, an outside third party. That's what that is. It's not on our balance sheet. There's no warehousing on our side. They can be using, you know, they could be leveraging on their side if they chose to, but that's separate from anything going on with us. let me see. What was the other part of the question?
Reggie Smith (Executive Director of Equity Research)
Would you consider warehouse? Is that also something that you would not pursue?
Dave Girouard (CEO)
Yeah. We've had modest warehouse capacity for many years. When the loans are on our balance sheet to some extent, we have, those are financed and it's more efficient use of our equity capital, but that's still, you know, that's under that umbrella of the loan total Sanjay said we aim 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. We do use that for capital efficiency, but it's not a primary funding mechanism, just as our balance sheet ultimately is not a primary funding mechanism.
Reggie Smith (Executive Director of Equity Research)
Got it. No, I appreciate it.
Sanjay Datta (CFO)
Yeah. Just to be clear, Reggie, the loans on our balance sheet, when we say we have $1 billion of assets on the balance sheet that, you know, less than half of that is the actual loan equity of ours. The rest is financed. 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, you know, and they can finance as suits them.
Reggie Smith (Executive Director of Equity Research)
Yeah, 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 $1 billion, and that's kinda where you wanna remain at least for the foreseeable future. My second question, guidance. Very strong numbers. In particular, I guess the net interest and kinda 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.
Sanjay Datta (CFO)
Yeah, sure, Reggie. This is Sanjay. As far as the guidance, I would say that, you know, Q1 was the anomaly in a sense, which is, you know, 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. When interest rates are going up, which has happened with a lot in the last year, it's taken a, you know, 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. It was not a balance sheet transaction that completed in Q1, so that's why it's unrealized.
Because it was a balance sheet transaction that we were anticipating, we were expecting, and we expect it to close, you know, early in Q2, we sort of reflected the economics of that transaction in Q1, and that will be in our disclosures. 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. Therefore, I think what you're seeing now, in our guidance for interest income just sort of reflects ongoing normality. It does, you know, it's sort of like interest rate stability, no large transactions, and some modest, you know, some modest income from our remaining balance sheet.
Reggie Smith (Executive Director of Equity Research)
Got it.
Sanjay Datta (CFO)
-that's how I would think about the guidance. As for performance, I think the best way to think about it is in our investor materials, we generally display, you know, 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.
Dave Girouard (CEO)
The simple summary is, you know, vintages that are on our balance sheet from back in 2021, or 2022 are likely gonna underdeliver, as they are across the broader platform. I think anything as of certainly Q4 forward, so anything from the last six to nine months are well on track to overdeliver, in our opinion. If, you know, the performance of our balance sheet will just reflect the underlying vintages that you see on the broader platform.
Reggie Smith (Executive Director of Equity Research)
Got it. If I could sneak one more in. On the take rate, you talked about, I guess, stronger economics. Curious, is there a way to kinda parse the impact that of stronger pricing or origination fees that are paid by borrowers versus maybe what your partners are paying you? Was any change there when you talk about better pricing?
Dave Girouard (CEO)
I don't think there's anything necessarily more to parse there other than fees primarily borne by borrowers that are getting loans, you know, funded through institutions tend to flex up at times like this. That's really what you're seeing. I mean, base, you know, 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. We would really be happy to see all that reverse itself over the next year if we're so fortunate.
Reggie Smith (Executive Director of Equity Research)
No, I got it. That wasn't clear to me. I'm sorry. I've got a couple calls going on, so I didn't catch that part, that it was primarily on a borrow fees. Okay. Thank you.
Dave Girouard (CEO)
No worries.
Operator (participant)
Our last question comes from the line of Simon Clinch with Atlantic Equities.
Simon Clinch (Research Analyst)
Hi, guys. I've got to jump back in the 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, you know, pretty staggering. You know, 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 I guess, how to think about that in terms of the benefit going forwards. 'Cause, you know, previously we haven't needed that many rollouts to create significant benefits for you guys.
Dave Girouard (CEO)
Yeah. 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. 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. You know, all across the... I don't know exactly how many AI models and distinctive AI models we have, but it's quite a few, and those teams are working in parallel. This isn't the same model being updated or retrained every three days. It's less than that.
There's a lot of them, and each one of them, you know, generally are making some part of our product line, that much better. That's a pace which, you know, a couple years ago we were probably maybe doing, you know, one a month or so it's quite a difference.
Simon Clinch (Research Analyst)
All right. That sounds a lot more sensible. Thank you.
Dave Girouard (CEO)
Thanks, Simon.
Operator (participant)
This concludes today's question and answer session. I will turn the call back for any additional or closing remarks.
Dave Girouard (CEO)
Just wanna thank everybody for listening today. As we've said, we're happy with what we've achieved in the first quarter. We're actually pretty optimistic about 2023. Thanks for sticking with us.
Operator (participant)
This concludes today's call. Thank you for your participation, and you may disconnect.