November 08, 2022
Editor’s note: Upstart Co-Founder and CEO Dave Girouard shared thoughts on third-quarter 2022 results during the company’s quarterly earnings call. To read more about Upstart’s Q3’22 earnings, visit here.
Good afternoon, everyone. Thank you for joining us on our earnings call, covering our third-quarter 2022 results. I’m Dave Girouard, Co-Founder and CEO of Upstart.
Our results in Q3 were certainly not what we wanted them to be. But I also believe they reflect the Upstart team making the right decisions in a very challenging economic environment for the long-term success of the company.
Our revenue is down primarily because loan volume on our platform is down and, secondarily, because credit markets are extremely cautious and even dislocated. Higher interest rates and significantly elevated risk in the economy means we’re approving about 40% fewer applicants than we would have a year ago. And those approved today are seeing offers about 800 basis points higher than they would have a year ago. This accounts for the vast majority of the reduction in volume. Many of our lending partners have reduced their originations, raised their rates, or both. This is generally out of an abundance of caution with respect to the economy and despite the fact that their Upstart-powered loan portfolios have met or exceeded expectations since the program began in 2018.
But I want to be clear: Contraction in lending volume in a time of rising rates and elevated consumer risk is a feature of our platform, not a bug. In fact, it’s required in order to generate the returns lenders and investors expect. Whether due to an increase in expected loss rates, caution on the part of lenders, or higher yield demanded by credit investors, higher interest rates and reduced volumes means that, as unhappy as we are with the numbers, the system is working as intended.
We’re eyes wide open to the challenges of the current macro economy and determined to make the decisions that will optimize for the long-term success of Upstart. At the simplest level, we’re improving our operational efficiency in the near term so that we can continue to maximize investment in our AI platform for the long term.
First and foremost, we’re continually calibrating our risk models to the market. Performance of our credit is and always will be our highest priority. While we don’t make predictions about the future, we’ve chosen to take a conservative position with respect to the direction of the economy in the coming quarters. In other words, we assume the worst is in front of us. We’ll be pleasantly surprised if this turns out not to be the case.
Second, we’re strengthening our unit economics both by increasing our revenue per loan as well as reducing marketing spend in our most expensive acquisition channels.
And third, we’re carefully managing our operational and fiscal plans to ensure that we’re on a strong corporate footing for as long as this cycle lasts. In recognition of the reduction in loan volume on our platform, we unfortunately eliminated approximately 140 hourly positions within our loan-operations team, representing about 7% of our workforce. This was disappointing for sure, but necessary to keep our operational capacity in line with the current environment. No other teams at Upstart were affected. We’re also limiting hiring in other functions to a small number of positions that are strategic to our business.
With a healthy balance sheet, robust unit economics, and strong pricing power, we believe we’re well positioned to navigate an extended period of economic uncertainty while continuing to invest strategically in future growth.
Despite these challenges, I’m very optimistic about Upstart’s future. There’s broad recognition among technology leaders and industry pundits that AI is perhaps the most transformational technology of our time, and risk-based industries such as lending are at the forefront of this incredible opportunity. As the leader in AI-enabled lending, we are well positioned to capitalize on these growing trends, and believe that market volatility will only strengthen our position and differentiation over time. While we dislike a weakened economy as much as you do, the increase in default rates that accompany this weakness serves to train our AI models faster. While other platforms continue to retreat to serving super-prime consumers, Upstart is rapidly learning how to price and serve mainstream Americans in all market conditions.
Beyond my conviction in AI and the impact it can have in lending, my optimism also stems from seeing the rapid progress made by each of our product and machine-learning teams. Some of the areas where we’re making fast progress include:
First, model accuracy—Our AI models have never been more accurate relative to a traditional FICO-based model, and our pace of model development has increased significantly. To be more specific, the increase in Upstart’s model accuracy in the last four months is as much as we saw in the prior two years.
Second, macro reporting and responsiveness—An important goal for Upstart is to help lenders understand the direction our economy is trending in order to make more informed decisions about their lending programs.
To support this goal, we’ve developed and are beginning to productize the Upstart Macro Index, or UMI. This index is a monthly indication of the state of the economy, specifically with regard to consumer financial health and credit performance. At the simplest level, UMI is designed to estimate the level of default to expect in a time period, holding underwriting models and borrowers constant.
What’s even more interesting is that we’ve determined that a handful of common economic variables present in the Dodd-Frank stress tests can estimate UMI with a high degree of accuracy. We continue to iterate our methodology with the intention of translating widely available forecasts of macro indicators into an expectation for future level of defaults. We believe this is the first time that commonly understood and broadly forecasted economic indicators can predict credit performance, and are looking forward to sharing more with you as we refine this tool.
Our goal is to be the fastest platform to respond to macro changes and to provide the most relevant and up-to-date information to our lenders, and UMI is a big step in that direction.
Third, automation—In the third quarter we saw a record 75% of loans fully automated. This came from a variety of efforts, including an experiment to help applicants enter information more accurately that led to an absolute 1.8% lift in instant approvals.
Fourth, auto refinance—This quarter saw three significant improvements to our auto refi product: We launched a new model to more accurately identify loan payoff amounts, we fine-tuned our income verification models, and, finally, we improved the process of reviewing registration cards. These upgrades collectively led to a 20% improvement to our auto refi conversion funnel.
Fifth, auto retail—In Q3, we shipped our largest software release of the year, including a new “build & price” feature which allows consumers to build, configure, and price autos that the dealer doesn’t yet have on the lot. Our software is in more than 700 dealers now. We’ve also turned on retail lending with three more dealer groups and are now in four states, representing 25% of the US auto market by population. And more than one in three auto loan applications were automatically verified, about double the prior quarter.
Sixth, small-dollar loans—This team shipped too many improvements to name, but in Q3 we saw more than 9,000 small-dollar loans on our platform, almost 4X the prior quarter. And all of these loans were to borrowers whom we otherwise would have declined. Smaller and shorter-term loans are critical to reach more consumers and help our AI models learn as quickly as possible, so we’re very excited about this progress.
And seventh, small business loans—I told you last quarter that we had reached our first $1M in SMB loans. Well now we’re close to $10M in loans originated and the team is rapidly shipping improvements as we look to refine that product.
While the financial impact of these upgrades to our products is muted in the current environment, we’re confident they’ll set us up for a giant leap forward once the economy and credit markets normalize.
Finally, while there’s no shortage of caution among banks and credit unions, I’m also happy to report that we deployed a record 17 new lenders onto our platform in Q3, including Alliant Credit Union, which is a top 10 credit union by asset size. This compares to 17 lenders launched in all of 2021. While these lenders are starting off cautiously, it’s encouraging that we’re planting seeds for funding capacity in our future. As of today, we have 83 lenders under contract on the Upstart platform.
Before I wrap up, I want to say again: We’re not pleased with the results we shared with you today. But when interest rates are rising and the economy is in flux, lenders and credit investors naturally become cautious. Despite this caution, our lenders will tell you that the performance of their Upstart-powered credit has met or exceeded expectations over time.
We don’t like volatility any more than you do, but we won’t allow it to set us off course from our long-term goal to reinvent how credit works. Our goal is to become the destination with the best rates and the best process for all forms of credit for everyone. This can’t and won’t be done by a single bank, but it can be done by a vast network of banks, credit unions, and credit investors powered by a modern cloud-based AI platform.
Great companies separate themselves from merely good ones during the hardest of times. They are clear-eyed about how the environment has changed. They make smart and fast decisions in order to ride out the turbulence. But they also retain an optimistic focus on the horizon as they continue to invest in the future. You have my full commitment to ensure Upstart is exactly that type of company.
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.