Aug. 8, 2023
Editor’s note: Upstart Co-Founder and CEO Dave Girouard shared thoughts on second quarter 2023 results during the company’s quarterly earnings call. To read more about Upstart’s Q2 2023 earnings, visit here.
Good afternoon, everyone. Thank you for joining us on our earnings call, covering our second quarter 2023 results. I’m Dave Girouard, co-founder and CEO of Upstart.
I told you last quarter that I was hopeful Q1 was a transitional one for Upstart and I continue to believe that’s the case. I’m pleased we delivered quarter on quarter growth in Q2 for the first time in more than a year. And more importantly, we achieved record-high contribution margin and positive cash flow, a result of our efforts over the past year to improve efficiency and operating leverage in our business. This is despite an environment where banks continue to be super cautious about lending, interest rates are as high as they’ve been in decades, and capital markets remain challenged. A close look at our financials in Q2 suggests that Upstart has the opportunity to grow quickly and profitably when we return to a normalized economy.
I’m also pleased to see clear signs that inflation is ebbing, despite a continued strong labor market. Our lens on inflation is different from that of others – from our point of view, wage growth in excess of goods inflation is a new and positive development, particularly for the less affluent segments of the US that we tend to serve.
The market is increasingly optimistic that the Fed can achieve their 2% inflation target without a serious recession. While a recession remains a possibility, our view is it’s likely to be a shallow white-collar recession – one less likely to result in significant unemployment for less affluent Americans. And unlike 18 months ago, the Fed now has readily available tools to handle a significant slowing of the economy – they can lower rates to spur growth once again.
We continue to be confident that our core personal loan risk models are properly calibrated and have been so since November of 2022. Thus we expect these recent vintages to deliver at or above target returns.
Funding markets remain cautious and risk averse. Banks and credit unions are generally focused on deposits and liquidity, while capital markets are beginning to show signs of normalization. We added another committed capital partner in July and are in conversations with several more interested parties. We also completed a securitization after the close of Q2 with significantly tighter spreads than our prior deal earlier in the year.
Meanwhile, we continue to manage Upstart cautiously but optimistically in a funding constrained environment. Every week, I remind the Upstart team to focus maniacally on improving every aspect of our business, strengthening our company for a time when the markets will inevitably return to center. As I said to you last quarter, I focus our team’s energy on improving Upstart in four key dimensions:
Best rates for all
The core thesis of Upstart is that superior AI-enabled risk models will improve access to credit for all. And the company that can build superior risk models faster than anyone else stands to benefit from this dramatic transformation of the lending industry. In this light, I want to share an exciting breakthrough – something we call parallel timing curve calibration. This is a technique aimed at accelerating the pace of model calibration and thus model development.
The challenge with launching a new model in lending is that you have to wait many months to see how it performs in the real world. If you’re originating three-year loans, then you need to originate some loans and then watch them perform for 36 months to have clear feedback on model calibration across the timing curve.
But with parallel timing curve calibration, the new model can be used to re-underwrite all in-process loans from the past, generating new predictions for how they will perform in their remaining months. This is not a backtest – the new model is used to predict how all outstanding loans in the platform will perform in coming months, not how they performed to date. In this way, within a few months, you can have a clear signal as to calibration across ALL months in the timing curve. This results in a dramatically faster calibration process for new models. From the point of view of our lending partners and credit investors, this is a giant win because it means we provide a tighter and faster feedback loop regarding model performance. We’re very excited about its potential to extend our leadership in AI lending and are in the process of patenting this technique.
More efficient borrowing and lending
Last quarter, we reached an all-time high of 88% of unsecured loans fully automated. That means instant and automated approval with no waiting, no documents to upload, and no phone calls. This matters a lot, because even the most accurate loan pricing model is useless if applying for a loan is too time consuming or laborious.
The notion of building an entirely software-driven credit origination process – one that can run 24/7 in a fully lights-out environment – has been with me since Upstart’s founding and was inspired by my years at Google.
Please bear with me as I share a short story: In 2003, I was interviewing for a role at Google. The company was still private at the time, so the world knew little about the financial colossus that was growing in Mountain View. At one point in the process, the external recruiter said that I couldn’t interview that week at Google because the entire company was skiing at Lake Tahoe. I thought to myself “that’s a great company.”
Then she said “but get this – the company is still making $7 or $8 million a day in revenue.” I thought to myself “no that’s an AMAZING company”. And the idea has stuck with me since.
So how have we done? In 2016 we began to pursue the goal of fully automated loans. Zero human involvement from rate request through transfer of loan funds. Approved in a matter of seconds. Lights out.
By Q2 2017, 29% of our unsecured loans were fully automated, in Q2 2019 it was 64%, in Q2, 2021 it was 69%, and in Q2 2023, this past quarter, it was 88%.
Automation doesn’t just allow us to scale originations faster than headcount, it creates a “wow” moment for consumers who have never experienced such a fast and effortless loan application process. Recently, we began to brand this “fast track” – something we probably should have done years ago. This breakthrough experience is a signature of Upstart and the lenders we serve.
In addition to ongoing initiatives to strengthen the funding side of our marketplace, we continue to optimize our fixed costs. This increases the leverage in our business, so that Upstart can thrive across future economic cycles. In Q2, we identified another $7M in annual technical infrastructure costs that we can eliminate, bringing our total annual cost savings in tech expenses to nearly $17M. We continue to hire very modestly and only in strategic situations.
We also achieved a contribution margin of 67%, our best ever by a long shot. This is a sure sign that our focus on efficiency is bearing fruit. A principal driver of this record contribution margin was our efforts to build a stronger relationship with existing customers. As a result of these efforts, 38% of our originations in Q2 came from repeat borrowers, also a record for us. And as a consequence of that, we also saw record low acquisition cost per loan in Q2.
Expanding our footprint
We continue to make progress in our newer products and are excited to see the progress we’ll make through the rest of 2023.
In the second quarter, we made significant strides in our auto retail lending business. We expanded our footprint from 39 rooftops with Upstart lending implemented last quarter to 61 rooftops today. We also added 12 additional states we now support, covering more than 65% of the US population. We launched new risk models for both our auto refinance and retail lending products, delivering as much accuracy improvement as we’ve seen in the last year from our personal loan models. We continued to improve our auto recovery performance, reducing delays in the recovery cycle by 75%. On the features side, we launched a new device agnostic in-store application that expands access to desktops, laptops, and tablet browsers. We also brought on our second, and third lending partners for auto retail – no easy feat given the current market environment.
We’re also making rapid progress on our small dollar “relief” loans. These loans start at just a few hundred dollars and are currently offered only to Upstart applicants who don’t qualify for our mainstream personal loans. For this reason, they’re entirely incremental to both our approval rates and our model training set. Our first vintages have now reached full maturity and our model is now fully calibrated, with observed losses in line with expectations for our most recent model version. In a first for Upstart, we began using cash flow data as part of the risk model for small dollar loans. This incremental data has led to increased approval rates and will eventually become available for all our loan products. Our fully automated rate in Q2 for small dollar loans was 90% – an incredible achievement that demonstrates the power and impact of AI in lending. In Q3, we’ll move beyond offering this product exclusively to those declined for personal loans and will finally enable direct consumer applications.
Last but not least, I’m happy to let you know that our home equity product is officially off the ground with a pilot program in the state of Colorado. We expect a fast follow with the state of Michigan, and also hope to be in a handful of additional states by the end of Q3. This is the first Upstart product specifically designed for prime borrowers, where a superior process enabled by automation is a richer source of differentiation than loan pricing itself. As a reminder, I mentioned last quarter that we’re targeting online approval in less than ten minutes and a closing process of less than 5 days for an Upstart-powered HELOC, against an industry average closing time of more than a month.
To wrap up, we’re not yet certain the economy is headed to a better place. So we continue to be cautious while investing for the long-term. And you’re now beginning to see the benefits of our disciplined approach. Regardless of the economy’s direction in the coming months, I’m confident that we’re building a better, stronger enterprise for the future.
We’re in the pole position to lead the industry to an AI-enabled future – one that represents a giant leap forward for both borrowers and lenders. And we do this not because of fascination with AI, but because of what brought us here – the potential to dramatically improve access to credit for tens or even hundreds of millions of Americans.
There are many dimensions along which you can weigh our efforts to make Upstart stronger – speed of model development, strength of unit economics, low fixed costs, demonstrable leverage in our business, improved funding supply, and growing product diversity.
But the dimension that gives me confidence more than any of these is talent density – at both the executive and individual contributor level. For those excited about AI and passionate about its potential to improve lives, we know of no better place than Upstart to build a career. And while we’re hiring strategically and with extreme caution, our digital first approach is enabling us to hire top talent across the country. More than 90% of job candidates have accepted our offers in recent months, an incredible success rate. While much of the world is debating how to return to the office full-time, we’re very happy with the results of our digital-first approach. I will close with a huge thank you to all Upstarters as well as the family and friends that support them. We’re on an incredible mission together and it wouldn’t be possible without each of you.
This transcript contains forward-looking statements, including but not limited to, statements regarding economic uncertainty, our long-term success, and our future growth. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate”, “estimate”, “expect”, “project”, “plan”, “intend”, “target”, “aim”, “believe”, “may”, “will”, “should”, “becoming”, “look forward”, “could”, “can have”, “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. Forward-looking statements give our current expectations and projections relating to our financial condition; macroeconomic factors; plans; objectives; product development; growth opportunities; assumptions; risks; future performance; business; investments; and results of operations, including revenue, contribution margin, net income (loss), non-GAAP adjusted net income (loss), adjusted EBITDA, adjusted EBITDA margin, basic weighted-average share count and diluted weighted-average share count. Neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. The forward-looking statements included in this transcript and on the related teleconference call relate only to events as of the date hereof. Upstart undertakes no obligation to update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.
All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected. More information about factors that could affect our results of operations and risks and uncertainties are provided in our public filings with the Securities and Exchange Commission, copies of which may be obtained by visiting our investor relations website at www.upstart.com or the SEC’s website at www.sec.gov. These risks and uncertainties include, but are not limited to, our ability to sustain our growth rates from recent years; our ability to manage the adverse effects of macroeconomic conditions and disruptions in the credit markets, including inflation and related monetary policy changes, such as increasing interest rates; our ability to access sufficient loan funding, including in the securitization and whole loan sale markets; the effectiveness of our credit decisioning models and risk management efforts; geopolitical events, such as the Russia-Ukraine conflict; disruptions in the credit markets; our ability to retain existing, and attract new, bank partners and lenders; and our ability to operate successfully in a highly-regulated industry.