Good day, ladies and gentlemen, and welcome to the Upstart Q1 Fiscal Year 2022 earnings call. Today's call is being recorded. At this time, I would like to turn the call over to Jason Schmidt, Vice President, Investor Relations. Please go ahead, sir.
Good afternoon, and thank you for joining us on today's conference call to discuss Upstart's Q1 2022 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'd like to remind you that shortly after the market closed today, Upstart issued a press release announcing its Q1 2022 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 Q2 and full year 2022 related to our business and our 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 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 Barclays Emerging Payments and Fintech Forum , May 16, Citi Beyond the Basics Conference, May 24, BofA Securities Global Technology Conference, June 8, and Morgan Stanley Technology, Media and Telecom Conference, June 14. We will also be holding our annual stockholders' meeting on May 17. 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 2022 results. I'm Dave Girouard, co-founder and CEO of Upstart. I'm pleased to say we're off to a great start in 2022. The Upstart team just delivered our seventh consecutive profitable quarter and our fourth straight quarter with triple digit year-over-year revenue growth.
As a recognized innovator in AI lending, we continue to expand our leadership position in personal lending and are now off and running in our auto lending product as well. Despite the macro headwinds that appeared over the first quarter, we saw loan transactions of more than $4.5 billion, a record for the Upstart platform and perhaps for the industry as a whole. At the same time, we added a huge number of lenders and car dealerships during Q1.
Today, we have more than 500 dealerships on Upstart, as well as 57 banks and credit unions, which is up from 42 when I last updated you in February. At this point, we're adding about a lender per week. This is real progress considering we had just 10 lenders on the platform when Upstart IPO'd in December 2020. Additionally, we now have 11 lenders with no minimum FICO score in their credit policies, up from 7 the last time we spoke.
I'm confident that our momentum and pipeline for both dealerships and lenders has never been stronger. We continue to make rapid progress with our auto refinance product as well. In the first quarter, we transacted more than 11,000 auto refi loans on our platform, almost twice as many as we did in all of 2021.
We also launched our first AI model for auto refi that is partially trained by our own auto lending performance data. This kicks off the process of building and deploying increasingly accurate versions of our model, which is our primary source of competitive advantage in the market. In Q1, we also more than doubled the rate of instant approvals for auto refi applicants, another major step toward increasing funnel throughput and delivering a differentiated product experience.
Of course, in the recent weeks and months, it's become apparent that 2022 is shaping up to be a challenging one for the economy and for the financial services industry in particular. In my remarks in our February earnings call, I mentioned that the Omicron variant, the clear signs of inflation and the Fed's plans to counter it, and the market rotation out of high growth technology.
Since then, it's become clearer just how aggressive the Fed will be with interest rates in order to combat a level of inflation that we haven't seen in decades. The two-year treasury note, which is the most relevant industry benchmark for our business, has risen more than 200 basis points since October. Of course, the war in the Ukraine and the zero COVID policy in China have only increased the risks and uncertainties facing the global economy.
As I said in February, lending is a cyclical industry and always will be. We expect volume and pricing on our platform to vary accordingly. As a result of the increased risk in the economy, as well as the corresponding higher returns demanded by banks and credit investors, the average loan pricing on our platform has increased more than 300 basis points since October.
In addition to increasing rates for approved borrowers, this also has the effect of lowering approval rates for applicants on the margin. Given the hawkish signals from the Fed, we anticipate prices will move even higher later this year, which will have the effect of reducing our transaction volume, all else being equal.
If you've been following Upstart for a while, you know that we've been through several disruptions in our industry over the years, and each time Upstart gained market share and emerged a stronger company.
When the economy gets turbulent and nimbleness is at a premium, the advantages of a founder-led company with a closely knit and tenured leadership team become apparent. That's what you have in Upstart. Three founders involved in the business day in and day out, and a proven leadership team, half of which have been with Upstart almost since inception.
I'm proud of how Upstart performed in the last 2 years, particularly during an economic cycle with no precedent. In the worst year of the pandemic, 2020, Upstart grew revenue 42% and generated a modest profit. Of course, our growth rate and our profits since then have been extraordinary by any measure.
Even in this challenging environment of 2022, our guidance for full year revenue implies a growth rate of 47% over 2021, and we expect to be cash flow positive. With respect to credit performance, we're pleased how our models performed on behalf of our lenders during this tumultuous period. While not perfect, our models significantly outperformed traditional FICO-based risk models and learned quickly while doing so.
For Upstart loans originated and funded by our banks and credit union partners, we saw significant overperformance since the beginning of COVID, which has normalized to on target performance in recent months. There has been no meaningful underperformance of returns with any of our more than 50 lending partners since the program's ex-inception in 2018, despite significant periods of economic disruption.
For loans funded by institutions and capital markets, we've observed more volatility, which is natural given their broader risk aperture. The unprecedented level of government stimulus caused the majority of these post-COVID vintages to overperform significantly. The abrupt termination of these stimulus programs has caused some of the more recent vintages to underperform. We're confident that our models are currently well-calibrated to the latest consumer credit conditions, performing in line with expectations and are more accurate than at any time in our history.
Let's turn now to our new product efforts. One of our most important initiatives for 2022 is the accelerated rollout of our auto retail product. Since acquiring Prodigy in April 2021, we expanded our dealership footprint from about 100 rooftops at the time of the acquisition to more than 500 today, making Upstart one of the fastest growing auto retail software in the industry.
Upstart's active dealership footprint over the last 90 days spans 35 different OEMs, including Toyota, Subaru, and VW. At this point, we're also well into phase two, which is the introduction of Upstart-powered loans into our auto retail software. This represents the next critical step in modernizing the car buying experience. Without question, our early progress in delivering loans through our retail software has exceeded our most optimistic expectations.
While lending is enabled in just a handful of dealerships in California, the uptake and win rate for the loan product, technically termed a retail installment contract, has been far better than anticipated. Our auto teams are working quickly to smooth some of the product's edges, filling in a few missing features, and completing integrations with various legacy dealer systems, all in the interest of moving toward a broad-based rollout.
Our goal is to enable lending in a few dozen dealerships in four states this quarter, representing about 25% of the U.S. population, followed by a full nationwide rollout in Q3. Based on what we now know, we expect the auto retail lending business to contribute meaningfully to Upstart's monthly transaction volumes by the end of the year, setting us up for a significant ramp in 2023.
As I've said before, auto retail is perhaps the largest of all buy now, pay later markets, so this is one of the most exciting developments in Upstart's history. You should feel confident that we have a lot of executive attention on getting it right. I'm also pleased to share that we began publicly testing our small dollar loan product in the past few weeks. I first mentioned this to you in our earnings call last November.
It's designed to help consumers with unexpected and immediate cash needs. Think a few hundred dollars repaid in just a few months. But it's also important to remember that we're building a bank-ready product at bank-friendly APRs, always operating within the 36% rate cap prescribed to nationally chartered banks and to those who serve U.S. military service members.
This is a strategic initiative to our mission to improve access to credit, and we believe it will accelerate the pace at which we can bring more and more marginalized Americans into the mainstream banking system. When I told you in November that we aim to launch the small dollar loan before the end of 2022, our small dollar team set an aggressive goal to launch the product by the end of Q1, and I'm pleased to report that they achieved this ambitious goal.
Of course, we still have lots of work to do to realize the opportunity in small dollar lending, but the team's ambition is inspiring. Additionally, I'm happy to share that our small business lending team is likewise making impressive progress and is aiming to have their product in the market within a few months.
The first version of our SMB pricing model will include more than 500 variables about both the applicant and the business. It will also feature our loan month modeling framework, which is one of the most impactful innovations added to our personal loan product a few years back.
Our initial testing suggests that version 1 of our SMB model will deliver higher accuracy as measured by area under the curve, or AUC, than peer models that have been in the market for years. We'll begin to cautiously test this new product in the second half of the year. I'm excited about our SMB product for 2 reasons. First, business lending is central to far more banks than is consumer lending, so our bank partners are ready and waiting for this.
Second, despite the interest banks have in business lending, the FDIC data suggests that 77% of large banks and almost 90% of small banks have no online application process whatsoever. We're also hard at work on some fundamental upgrades to the infrastructure that underpins our AI models and how we develop them. It's important to realize that the surface area over which we're implementing AI has expanded dramatically.
First, we're now working on 7 or 8 unique models that target different aspects of credit targeting and origination, and we're implementing these different models across 5 different credit products as of now. Second, the amount and types of data used to train our models has grown exponentially and will continue to do so. As such, the time and processing power required to retrain our models has similarly increased.
Naturally, the opportunity to improve the infrastructure we use to build, train, and deploy AI models is enormous. In an effort broadly referred to internally as Machine Learning to Heaven, or ML2H, we're working to dramatically upgrade this infrastructure. Our goals with ML2H are to allow hundreds of research scientists to seamlessly and securely build new models and add data to existing models, train and test them in an automated fashion, and deploy them across the entire model ecosystem simultaneously.
The system we're working toward will provide maximum leverage to our research scientists, productizing and automating how new models are trained, tested, and deployed. Another important area we're investigating is the means by which our AI models include assumptions about the macro economy.
While our models have long considered the current macro context at the time a loan is priced, we've consistently said that we aren't and don't aim to be macro forecasters. Yet, macro events will always have some degree of impact on the performance of Upstart-powered loans.
Given our product is designed to target a particular return to lending partners, that implies there's always some view of the macro future inherent in our models. Given this reality, we intend for our product to explicitly share the macro adjustments that are embedded in the models, and furthermore, to allow our partners to input their own macro assumptions. This will provide significantly more transparency to our lending partners and will also put our focus squarely on risk ranking, which is the heart of what makes Upstart's models unique. A few weeks back, we celebrated Upstart's tenth anniversary.
It was a wonderful opportunity to remember all we've been through, to stop for a moment to reflect on how we got where we are today, and to show the gratitude that I feel for all those who have been part of that journey, our employees, past and present, our investors and partners, and of course, our friends and families that made this all possible.
Some of the old-timers, the OG Upstarters, if you will, shared some of their favorite moments in Upstart history. We talked about the street curb we sat on for lunch each day in our Palo Alto office because we had no better place to gather. When I had the chance to speak to the team, I told them that I'm not particularly adept at celebrating the past. It's just not me.
I'm far too excited about and paranoid about the future to spend too much time toasting to our success in the past. As we shifted toward talking about the future, I told our team we need to act with urgency today with a healthy dose of paranoia. We're a company grounded in reality with our eyes wide open as to the evolving risks we see in the industry and in the world.
At the same time, we have to pair this urgency about the present with optimism and absolute determination about the future. Fortunately, most of our leadership team has been here, so we know the drill and are confident that we can navigate whatever 2022 and beyond might hold. We know we can blend that urgency for today with the optimistic eye on the horizon.
Because although we serve a cyclical industry, we represent a secular change that the financial services industry desperately needs. Artificial intelligence will reshape the economics of lending in ways that will reverberate for decades. We're today pursuing opportunities that represent more than $6 trillion in annual origination. There's little question about the scale of the addressable market.
We see a clear path to building a company with more than $10 billion in revenue in the coming years, and are maniacally focused on achieving that goal. Thank you. Now I'd like to turn it over to Sanjay, our Chief Financial Officer, to walk through our Q1 financial results and guidance. Sanjay?
Thank you, Dave, and thanks to everyone for being with us today. Just to quickly call out the key financial trends before diving into the more detailed numbers. On the top line, origination volumes and revenue from fees were both slightly up from last quarter, which was encouraging given the seasonal drop we typically see in Q1. Profitability was ahead of guidance, but as anticipated, down sequentially from last quarter, partly due to the ramp of auto lending.
We've continued to deploy our balance sheet assertively in the service of R&D in both auto lending and new segments of personal lending, as well as using it to smooth fluctuations in funding of core personal loans. As Dave outlined, the macro environment has become an increasing headwind to growth this past quarter, with both rising interest rates and rising consumer delinquencies putting downward pressure on conversion.
With these dynamics in mind, here now is a summary of our numbers. Net revenues in Q1 came in at $310 million, up 156% year-over-year. Revenue from fees constituted $314 million of that amount, representing 101% of overall revenue and up 9% sequentially from last quarter.
Net interest income was a negative component of net revenue this quarter as the loan assets on our balance sheet, which we mark to market each quarter, sustained declines in valuation due to the rising interest rate environment. The volume of loan transactions across our platform in Q1 was approximately 465,000 loans, up 174% year-over-year and representing over 350,000 new borrowers.
Average loan size was up 18% over last quarter, an indication for us that fundamental loan demand from borrowers is back on the rise after being suppressed for more than a year due to government stimulus. Our contribution margin, a non-GAAP metric which we define as revenue from fees minus variable costs for borrower acquisition, verification, and servicing, declined from 52% in Q4 to 47% in Q1, a level which was nonetheless 100 basis points above guidance.
Our declining contribution margin was almost entirely a function of the expected ramp in auto lending, which remains contribution negative at this early stage. Without the effect of auto loans, our contribution margin for personal lending would have clocked in at a robust 51%. Operating expenses were $275 million in Q1, growing 13% sequentially over Q4.
Sales and marketing and customer operations spend, both typically viewed as variable costs, each outgrew revenue this quarter at 16% and 18% QoQ respectively, due to the additional onus of acquiring and onboarding auto loans. Engineering and product development grew 8% sequentially due to slower hiring than targeted and remains our priority area of investment.
Growth in general and administrative spend grew 3% sequentially. Taken together, these components resulted in Q1 GAAP net income of $32.7 million, up 224% year-over-year and above our guidance, but down 44% sequentially from Q4. Similarly, Adjusted EBITDA exceeded guidance at $62.6 million and grew 198% year-over-year, but slid 31% quarter-over-quarter.
Adjusted earnings per share for Q1 was $0.61 based on a diluted weighted average share count of 95.5 million. We ended the quarter with $1 billion in restricted and unrestricted cash, down from $1.2 billion at the end of last year as more of our capital base flowed into loan assets in support of R&D programs, primarily in auto refi and some newer segments of personal loans.
Additionally, we have started to selectively use our capital as a funding buffer for core personal loans in periods of interest rate fluctuation where the market clearing price is in flux. Our balance of loans, notes, and residuals at the end of the quarter was consequently up to $604 million from $261 million in Q4.
Since our prior earnings release, the level of uncertainty in the macro environment has continued to grow. After remaining at historically low levels for the past eighteen months, loan default rates rose quite abruptly towards the end of last year and are now back to, or in some cases above pre-pandemic levels.
This is a dynamic we have observed consistently across the full breadth of our portfolio, although one which appears to be disproportionately impacting higher risk tiers, which are generally composed of borrowers who one might assume have a greater exposure to loss of government stimulus.
As a way to keep investors abreast of such credit trends, we have introduced new information in our investor materials which shows, in aggregate for all historical vintages, the in-period loan defaults compared to the aggregate defaults that were predicted across those vintages at the time of their origination.
The drop and subsequent reversal in default trend that is shown on the chart are, in our view, a function of the injection and subsequent waning of the government stimulus. As a consequence, virtually all of our pre-2021 vintages will substantially outperform their return targets, while the 2 or 3 vintages most adjacent to the reversal in trend at the end of 2021 are set to underperform.
Separately, interest rates have continued to climb in response to inflation signals and Fed tightening. The combination of inflation and monetary tightening imply the non-trivial risk of a recession potentially later this year. Given the general macro uncertainties and the emerging prospect of a recession later this year, we have deemed it prudent to reflect a higher degree of conservatism in our forward expectations.
With this as context, for Q2 of 2022, we are expecting revenues of $295 million-$305 million, representing year-over-year growth rate of 55% at the midpoint. Contribution margin of approximately 45%. Net income of -$4 million to $0. Adjusted net income of $28 million-$30 million. Adjusted EBITDA of $34 million. A diluted weighted average share count of approximately 96.2 million shares.
For the full year 2022, we now expect revenue of approximately $1.25 billion, representing a growth rate of approximately 47% from the prior year, down from $1.4 billion guided last quarter. Contribution margin of approximately 48%. Adjusted EBITDA of approximately 15%. Our thanks once again to everyone at Upstart who is working hard to move our mission forward. With that, Dave and I are now happy to open the call to any questions. Operator, back to you.
Thank you. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We take our first question from Ramsey El-Assal with Barclays. Your line is open. Please go ahead.
Hi. Thanks for taking my question this evening. My first question is on the conversion rate. It came in a little lower than our model. Sanjay, I know you mentioned that, some higher delinquency rates might be putting some pressure there. I guess first in quarter, maybe talk about the sort of puts and takes with the conversion rate, and then also what should we be expecting as we move forward throughout the year?
Hey, Ramsey El-Assal, this is Sanjay Datta. Yeah, thanks for the question. I think it's related to what we just described, which is two things that the interest rates in the economy go up and consequently risk hurdles for banks and for institutional buyers go up. Similarly, as we've talked about between roughly November and February, delinquencies in the economy reverted as well.
They had been unnaturally low for about 18 months. With the waning of the government stimulus, in our view, those trends have reversed. Those two things result in higher interest rates quoted to consumers, and that results in lower conversion. I think that's the totality of the story.
How that plays out for the rest of the year, I think is a function of those two things. We view the reversal in the delinquency trends to be stable now and has been stable for about 60 days in our view. You know, as I said, there's the prospect of higher rate hikes or I guess higher interest rates.
You know, at the end of the year there is a risk of you know, something like a recession as inflation plays out and as the Fed continues to tighten. You know, those two things could present further risk to the conversion rates. I guess it would sort of depend on your view of how the macro environment will evolve for the rest of the year.
Fair enough. I also wanna ask you about the ABS side of your business. You mentioned that you'd seen some dislocation that sort of worked its way, you know, back to something more normal. I guess talk about the demand environment for your loans as, you know, as we stand today.
Then also maybe clarify whether you foresee needing to incur any kind of residual liabilities or any other kind of handholding measures in order to get those transactions kinda consummated or whether you think the environment's not really gonna demand that as we move forward.
Yeah, sure. I guess the broader picture on loan demand, so as you know, there's a variety of different channels by which the loans get funded. I think that the loans that are getting funded through bank balance sheets or credit union balance sheets, I would say, is among the more resilient, because they have a cost of funds from their deposits that tends to be a little bit insulated from, you know, the way that the yield curves are moving the economy.
We have buyers that are a part of the institutional world that are buying and holding on balance sheet. I would say those are a little bit more exposed to interest rate movements in the economy, but still somewhat resilient.
Then there's the amount of the loans that are getting, you know, from those buyers sent to the ABS markets. That's a fraction that has changed historically as a result of how constructive the ABS markets have been. Obviously the ABS markets in 2021 were historically constructive, so you could make a very healthy gain by purchasing a loan and selling it into the ABS world.
A lot of that activity happened. You know, that opportunity as rates have tightened and as cost of funding has gone up is far less today. The amount of product getting sent to the ABS markets is a lot less in 2022 than it was in 2021.
I don't think that really changes our equation with respect to how we participate in the ABS markets. We've always been a little bit at arm's length in the sense that it's not our balance sheet that's contributing meaningfully to those ABS deals. It is you know, loan buyers and investors and other institutions that are making the decision to contribute or not. We don't really retain any residual risk in those deals, and it's not our plan to do so going forward.
Perfect. Thank you very much for your answers.
Thank you, Ramsey.
We take our next question from Pete Christiansen with Citi.
Good evening. Thanks for the question. Dave, Sanjay, I was just hoping you can elaborate a little bit on that last comment Sanjay made about, I guess, credit trends seem to be stable the last 60 days. If you look at some of the rollovers on delinquencies, I guess there's some concern that you could trigger some of the ABS, CNL thresholds.
Just wondering if there's a concern there at some point, and could this impact your ability to attract funding? Then just my second question, Sanjay, you mentioned you've upped the balance sheet risk here a little bit. How far are you willing to go in terms of supporting new loans and putting warehouse liabilities on the balance sheet?
Yeah. Hey, Pete, thanks for the question. This is Sanjay. Let's see. Your first question is about the pattern of delinquencies and ABS triggers. The delinquencies just sort of in absolute level, as I said, sort of they renormalized to pre-pandemic levels fairly abruptly starting in October, November. I think that pattern stabilized in sort of roughly February through March and April were very stable months.
You know, the question of triggers on ABS deals, so it's a somewhat technical thing, but what will breach triggers on an ABS deal aren't the sort of in-period delinquencies, but it's the charge-offs from delinquencies of prior months. You know, we've done some modeling on that. I think that with respect to our large ABS deals, I don't think there's much concern of breaching triggers.
We do some smaller monthly sort of pass-through issuance, and there is a possibility that those triggers will be breached. That's a somewhat technical thing. It basically means that the residual holders, you know, are locked out of cash flows for, you know, a couple of months while the bondholders get, you know, replenished, and then the cash flows begin to flow again. It would impact their returns.
It's not something that rises to the level of seriousness of us, you know, worrying about ability to transact those deals. I think it's sort of a temporary technical thing that will cause some interruption of cash flows between bondholders and residual holders. Then your second question is how we plan to use our balance sheet.
As I said, I mean, historically, our balance sheet has been almost exclusively for the purpose of R&D. We have used our balance sheet in the last quarter to do what I call sort of a market clearing mechanism. By that what I mean is when interest rates in the economy change quite quickly, I think it would be fair to say that our platform, its ability to react to the new market clearing price is probably not as nimble as we would like. It's somewhat manual. It requires a bunch of conversations and phone calls.
When interest rates move and investors are sort of each deciding what their new return hurdles are, there can be a gap or a delay in responding to the funding and that's a situation where we've chosen to sort of step in with our balance sheet and almost sort of bridge to the new market clearing price. As that is happening often and abruptly, we've been sort of playing that role with our balance sheet. I don't view that to be a long-term or necessarily sizable activity for us.
I think that, you know, developing the mechanisms to respond more nimbly to new price discovery as rates change is something that's on our roadmap, and it's something that we wanna start to invest in, so that it can happen in a much more automated way. You know, at the end of the day, we view our platform as being a platform that responds to risk and rates in the environment.
And so the faster we can do that, the faster we'll be able to sort of deliver the new returns in any given scenario to the investors and not have to bridge it with our own balance sheet. I would view it through that lens. Thank you, Sanjay.
Thanks, Pete.
Next question from Simon Clinch with Atlantic Equities.
Hi, Sanjay. Hi, David. In terms of your guidance for the year, you're explicitly, I believe, building in a recession scenario later in the year. I was wondering if you could help us just sort of bridge the gap to sort of what's changed in terms of the mix of your loans. You talked about before having embedded $1.5 billion of auto loans for the year. You know, what's changed there? What's changed on the personal loan side? And then I have a follow-up just probably on the last point you were just making. Okay.
Sure. This is Dave. I might as well jump in at least once here. Yeah, I mean, I think it's actually fairly simple. We expect less volume than we would have a few months ago based on pricing in the marketplace being higher. And that's a function of both underlying base rates, you know, being higher, as well as the risk in the environment and the risk premium that either lenders or investors are demanding. You put that all together and it's been an increase in, you know, sort of average rate to the consumer of several hundred basis points.
I think I've always said, we're not in some sense a terribly interest rate sensitive thing, and we've kind of said, you know, interest rate changes of 50 or 100 basis points are something that could well be offset by improvements to our platform. In this case, it's much more significant than that.
Of course, in the last few months we've seen and it is probably 300 basis points or higher. That's what's giving us, you know, our guidance for the rest of the year. We're not in no way predicting a recession or anything like that. It's not really our job to try to do that. We're just reflecting the prevailing rates in the marketplace and the loan transactions that that typically translates to, and that's what you're seeing there.
Okay. Just to follow on the last point, I'm kind of surprised to hear that, you know, you're using your balance sheet to put some loans on there which aren't just for R&D purposes. Yeah, it strikes me as it's just not a normal course of business for you given your platform business for banks. I was just wondering what kind of message that might send to your bank partners or to others in the system. Just curious about that. Thanks.
Look, I think it's Sanjay kind of explained this. Generally, we view ourselves as a marketplace where ultimately price discovery happens and loans are funded or not funded when they make sense by our bank partners, or by, you know, capital markets, institutional investors, et cetera.
Some of this works very fluidly, particularly on the bank and the credit union side, where they have very direct controls to change their return hurdles, et cetera. We don't have those mechanisms in place as well on the other side. It's more of a manual process. When something changes as quickly as it did and interest rates and the risk premiums in the market changed very rapidly, then we stepped in to sort of bridge that, but it's sort of a temporary thing.
As Sanjay said, it is an intention of ours to make the system more automated and more fluid, so we don't have any need to do that. It's not part of our business to hold loans and generate net interest income from loans on our balance sheet, but we certainly wanna make sure there's fluidity in the system. We're definitely gonna do some more work so we can do that without any of our, you know, balance sheet participation in that.
Simon, just to maybe put the numbers into context. I think the amount of the total platform loans that ended up on our balance sheet this quarter was still a single-digit percentage. Of that amount, probably close to three quarters of it was still R&D style spending on predominantly auto loans and other new products and segments. It was still a relative minority, relatively small percentage. It is just sort of an important new thing that we haven't been doing in prior quarters just because of the fluidity of the environment.
Understood. Okay. Thank you.
We take our next question from Andrew Boone with JMP Securities.
Hi, thanks for taking the questions. As we think about rising interest rates that you're offering, can you just help us understand the spread between what consumers are replacing, right? So if I think about credit card rates going up and other credit card products also rising, are you guys implying that the spread between what is being refinanced is just broadening out and widening?
Can you help me understand that? Secondly, as we think about auto refinancing, there are clearly some headwinds going on there with auto prices coming down, rates coming higher. How are you thinking about the auto refi business for 2022? Can you just double click on that? Thanks so much.
Sure. Thanks, Andrew. On the first question, I mean, it's actually fairly straightforward, and it's not even. You don't have to think as deep as, like, what a person might be refinancing through an Upstart-powered loan. It's really as simple as when the consumer rates go up, that means on the margin, a whole bunch of people that would have been approved are no longer approved.
So there's a whole bunch of just loans that never happen at all. And there's a bunch of people that are still approved, but the interest rate is a few percentage points higher, and a certain fraction of them are gonna just decide that's not the product that they want. They don't need it.
It's in many cases, it's a discretionary loan where they're buying something or paying off something that they don't necessarily have to. There's a fair degree of price sensitivity and just put those together. When average rates go up, you're gonna see less volume. When average rates go down, you're gonna see more volume.
There's a lot of things we're of course doing in the midst of that to make the funnel more efficient and more performant. All else being equal, of course, if rates go up, those are the effects that you're seeing there. On auto refi, I would just say there's a lot in flux because it is a new product and because it's also a re-refi product, meaning it has interest rate sensitivity to it.
A little hard to judge how those things will balance over the course of the year. That's kind of, you know, it's a new product for us. We don't have as much history as we do in personal lending. Certainly, you know, again, it's an interest rate sensitive product, so that works against us.
We're also making some pretty rapid progress in terms of automating people refinancing loans, getting much more focused on digital signatures away from wet signatures, et cetera. There's been some really good progress there, but how those will trade off over the course of the year is just a little hard to predict right now.
Thank you.
We take our next question from Vincent Caintic with Stephens.
Hey, thanks for taking my questions. I appreciate all the products you're rolling out and the talk about the adjustable market. I guess, you know, the biggest investor worry is on the funding side and, you know, not having the funding to fuel your origination volume. Two parts of questions.
First on that balance sheet, $600 million. Understanding it's not supposed to be a long-term thing, but if you can maybe size what your appetite is. I guess my understanding was that only loans that were approved by the funding partners were to be originated. I'm just wondering what's different there. Then secondly, if you can talk about kind of the funding partnership. You know, how is interest?
I saw that you had 50 new bank partners this quarter, so if you could talk about that. Then the forward flow agreements, if you could talk about, you know, your conversations with your institutional investors. Thank you.
Yeah, sure. Maybe I'll start off on the institutional side. I don't think we have a specific target or number in mind with respect to how we're managing our balance sheet. I mean, it's sort of an ongoing trade-off between you know, wanting to spend those dollars on R&D and new products to sort of incubate new models and calibrate new models versus buffering the core business through interest rate you know,
Interest rate shocks while we're waiting or sort of investing, making the platform sort of more nimble to reacting to finding those market clearing rates. How we balance the two is I would say a bit of a fluid equation. I don't think we have an easy heuristic on how we would sort of prioritize the two.
Certainly in Q1 with all the volatility we saw, even though I would say that the majority of our balance sheet spending was still of the R&D flavor, just making sure that the core business was stable, you know, continued to be an important component for us. I don't know, Dave, do you wanna talk a little bit about the lending partners side?
Yeah. We actually had a phenomenal quarter, significantly our best ever in terms of signing up new lending partners and deploying them as well. Doing exceptionally well, particularly with credit unions. I think both in terms of what we signed up and deployed onto the platform as well as what our current pipeline looks like has never been stronger.
We're extremely pleased with the progress we made. We're adding about one lender every week, and I think there's certainly an opportunity to accelerate from there. You know, lender adoption has certainly been a highlight.
Okay. Thank you. Just a follow-up question on the guidance. The revenue adjustment to your guide is that all transaction volume or is there any change to assumptions to your take rate? If you wouldn't mind, if you do kinda have an assumption for your transaction volume, that'd be helpful. Thank you.
Volume. I think I would say the entire difference is transaction revenue related. We don't have any explicit assumptions on the on-sheet or any of that nature.
Okay, thank you.
We move to Mike Ng with Goldman Sachs.
Hey, good afternoon. Thanks for the question. I just had a follow-up on the revenue outlook change. It sounds like it was mostly driven by a lower origination outlook due to lower demand from rising rates. I just wanted to see if you're seeing any change in the, you know, lending parameters or shrinking of the credit box due to what's happening on the funding side?
Hi, Mike. This is Dave. No, I don't think there's any significant change in that regard. I would say generally. On the banks and credit union side, there's been very little movement in any direction. I would say, you know, in some cases they've raised target returns a bit, but I think it's just at the margin.
Largely that side of the house has not changed significantly. It's really on the other side where expectations of investors and et cetera has gone up in terms of return targets. No, it's not really any real change with respect to the, you know, credit box of the various lenders.
Okay. Great. Thanks, Dave. I just wanted to follow up on some of the discussion around the loans on the balance sheet. You know, what's your assumption for where that goes for the rest of the year? Do you plan to simply allow those to mature? Are you gonna kinda sell them into the market when you have the opportunity? Just any thoughts there would be great. Thank you.
I would say, yeah, those are being held as, you know, held for sale loans. Obviously, it'll be a function of, you know, what that secondary market looks like, and we will, you know, we'll make an economic decision on them, but I think the preference would be to get liquidity and get cash back on the balance sheet rather than to hold the loans and earn interest income.
Okay. Great. Thank you, Dave. Thanks, Sanjay.
Thank you.
We take our next question from David Chiaverini with Wedbush Securities.
Hi. Thanks for taking the questions. I wanted to ask about the recent change to your loan modification policy in which you made it easier for Upstart borrowers to obtain forbearance, and these delinquent borrowers would be considered current on their loans. Can you discuss why you made this change? Are delinquent borrowers automatically entered into the forbearance program, or do they have to opt into it?
Yeah, thanks. This is Sanjay. On loan modifications, I guess the simple way to describe it is, and even independent of the macro environment, we had certainly through the early days of COVID when unemployment shot up and there was a lot of requests for forbearance, we have a lot of data that led us to conclude that you're always or you're generally better off creating flexibility in times of, call it macro stress, creating flexibility for borrowers and helping them work through those periods of turbulence.
I think in rough terms, if you charge off a loan, you're probably getting something in the order of 10-12 cents a dollar on the recovery. If you run an effective forbearance program, you can sort of get sort of on the order of 30-40 cents on the dollar. We had plans anyways to sort of begin to optimize the way we managed modifications and forbearance.
I would say that this macro environment accelerated those plans because it's made it that much more you know valuable to the borrowers. It's not an automatic enrollment thing. It still does require an application and a review. I would say we loosened our standards to make it a program that was sort of more widely applicable.
Great. Thanks for that. My follow-up question relates to the fair value adjustment. It looks like in 2018 when interest rates were rising, the fair value adjustment was about a $40 million headwind to revenue.
Then when interest rates fell, the fair value adjustment was about a $30 million tailwind in 2021, which probably would fall right to, you know, the bottom line of EBITDA. Could you discuss how we should think about that line item this year and how it impacts your EBITDA forecast given the rising rate environment?
Yeah, sure. I guess that's always been, I would say a small component of volatility on the P&L. As you know, it's sort of deprioritizing our business model. The reason for the magnitude for it in 2018 was a bit of a technical one. In the early days of our securitization program, we were doing risk retention ourselves because, you know, we were a relatively new entrant into the market.
We couldn't convince anyone to do it for us. We had to consolidate a lot of those securitizations onto our balance sheet. As a result, there's sort of big positives and big negatives. We didn't actually have any economic exposure to those deals. Some of that is a bit optical.
I would say in 2020 and 2021, you can see our balance sheet reduced quite meaningfully. Some of that is just the deconsolidation of those ABS deals. The way I would think about it going forward is it's sort of a function of the scale of our balance sheet and what's going on in the economy.
For right now, you know, the scale of our balance sheet is a little bit bigger than it was last year. Obviously, when you put loans on the balance sheet, there's two different accounting treatments.
Our particular accounting treatment is we mark our loans to market every quarter. When interest rates, you know, you're holding a loan and the interest rates are going up, you'll take a fair value hit.
That's what's happening right now. I guess the answer to your question depends a little bit on what happens to interest rates, obviously. If they continue to go up, and in particular, as Dave mentioned, the one that's particularly relevant to us is the two-year treasury. It's about 250 basis points higher than it was, you know, late last year.
If that's topped out and it's stable, we shouldn't see any, you know, further fair value devaluations. But if we're holding loans on our balance sheet and that number continues to go up, there will be further devaluations.
I guess in the grand scheme, I kind of view this as it, you know, it's gonna create some positive and some negative volatility from year to year. I think in the long term sort of framework of the business, we don't really view it as meaningful to, you know, the business opportunity we're trying to execute against.
Thanks very much.
We move to Arvind Ramnani with Piper Sandler.
Hi. Thanks for taking my question. Yeah, I just wanted to ask about, you know, some of the topics you've talked about, you know, you're putting loans on your balance sheet. I know, Sanjay, you clarified most of it is more for R&D, but there is some, you know, kind of some portion.
I don't know if you're able to sort of quantify what's R&D versus kind of just taking on, like, you know, regular risk. Then the second part of the question is, you know, under what circumstances should we see that number go from the single digits to the double digits? Is that possibility on the table, you know, as we look out for the rest of the year?
Sure. Yeah. I guess the answer to the first question, Arvind, is, I think in Q1, probably about three-quarters of our loans were R&D. The majority of what we balance sheeted was still in the auto segment, which we consider to still be sort of the R&D phase. You know, what are the potential future scenarios?
Yeah.
It's a good question. To some extent, it depends on you know it's a function of the level of dislocation in the economy and the progress we've made in I would say automating our platform's ability to react to new market clearing rates.
So you know in a world where our platform exists as it does today and there's you know further sharp shocks to the interest rate, and what's happening is you know the prices on our platform are not reacting in real time to the return requirements of the investors as they're changing. You know that's the situation in which our balance sheet has sort of stepped in to create stability.
I, you know, I would hope that on the one hand, we're creating more of an automated mechanism in our platform's ability to react to those changes in the economy. They would happen, you know, in real time. Investors maybe at the limit could just set their own rates as they change.
You know, it sort of depends also to some extent on the stability of the rates and the economy. Those are a bit hard to judge. You know, it's sort of a real-time equation for us as the environment changes.
Great. Just to follow up on auto, you know, and remember when we had met in New York, maybe it's been a couple of months now. One of the topics we discussed was, you know, auto, kind of you'll kind of look to kind of, you know, take the large proportion of the auto loan, you know, to kind of work with the banking partners. Is there like a timeline change just given, you know, circumstances have changed quite a bit in the last couple of months? You still feel like you can stick to the original sort of time frame?
I don't think that's changed. I mean, we've kinda thought of this year for the refi product, we are bringing
Lenders on, I think we have 12 signed up now. Our first priority is bringing lenders onto that platform, and we'll do that through the second half of this year. The auto retail product is different and much earlier. I would view that as something where we'll move toward bringing lenders toward the beginning of next year. There are different time frames, but I don't think our expectations for either of those products have changed.
Terrific. Thank you.
Moving forward to Shebly Seyrafi with FBN Securities.
Yes, thank you very much. I was impressed by your 18% sequential growth in your average loan amount. It hit $9,700, but you were at $13,000 at the beginning of 2020. Do you think you can approach that number anytime soon?
Shebly,
Uh, w- I w-
Oh, go ahead, Dave.
Oh, no. Oh, well. Why don't I start? You know, we don't expect that. Well, I would not expect it to go back to 13,000. I think basically our, you know, as our systems get better, approving more people at the margins, you're gonna trend towards smaller loan sizes.
There's a lot of good things about having better support for smaller loan sizes in terms of what people need. We're now launching the small dollar product, which is, of course, even smaller. I don't see a dynamic other than maybe a short-term thing here and there that would drive loan size up significantly.
It can be just driven up, you know, by demand and we may get some high quality, very prime, bank lenders on the platform, which would typically have larger average loan sizes. It can be some puts and takes like that. If you looked across the whole platform, and you look across a significant period of time, it's actually kinda hard to imagine, you know, loan sizes going back to where they would've been back then.
Okay. My follow-up is that the loan amount on your balance sheet's about $600 million. Can we or can you say at least that was a high watermark for the year or that's gonna be the high watermark for the year? Or do you think it can grow meaningfully over the next couple of quarters?
Yeah, I don't know that we could say that that's the high watermark. I mean, our you know plans to continue with R&D programs. You know, demand there is growing. As we get out of the auto refi sort of balance sheet program, we're gonna start to shift some of those dollars to auto retail as they become more significant later in the year.
As Dave said, we think we'll be in market with small business lending. These are all programs that, you know, investment markets and banks are gonna want to see, you know, some amount of curves and history before they start investing significant dollars so that they, in our view, will require some incubation. You know, the other side of the equation is the economy does remain very fluid right now.
If we do need to step in with our balance sheet to sort of stabilize the core business, I think that's an important tool for us. You know, I don't think we would ever do it in any way that started to exhaust our capacity or even come close to it. You know, it is a tool that although it's not you know it's not our objective, it's an important stabilizer of the business as when the you know the waters are choppy, so to speak. Okay. Thank you.
Next question from James Faucette with Morgan Stanley.
Hi, this is Sandy Beatty on for James Faucette. Can you remind us how the usury limits impact what your platform can do, particularly for those lower end consumers? I guess are there scenarios where you run into issues here just in terms of capping what would otherwise be approved as APR offers move higher? How does it impact your market share trajectory?
Sure. Basically there's, you know, 50-plus lenders on the platform. They each have their own sort of statutory arrangement they operate under. Could be state chartered, could be nationally chartered. They have different rate caps that they observe themselves, and we have no say in that whatsoever.
If you look across the entire platform, we have made a decision a long time ago that we don't support any lender originating loans above 36%. That's the statute that all sort of nationally chartered banks are under. We just kind of made the decision a long time ago. That's where we wanna put the limit for the platform overall. We can control that.
The bottom line is, when there were a lot of people that three months ago might have been approved close to 36%, that today would not be approved at all. For sure, when rates go up and return hurdles go up, it has the effect of pushing people out of the approval band and into the decline band.
That's just, you know, the nature of the business. When the model gets a little smarter, it will approve some of them, and it will disapprove others that it might have approved before. That also is, you know, the nature of the business, the nature of the product, getting better. That's the bottom line.
We don't per se have any say in what a bank or a credit union's maximum APR is. That's a function of both their own business model and their own regulatory regime that they operate under.
Got it. Thank you. Just as a quick follow-up, take rates in a tighter funding environment, with downward pressure on conversion, is there a scenario where we could see changes to unit economics, just within that funding backdrop? Just wanted to make sure I asked.
Yeah. Hey, Sandy. It's Sanjay. I guess the short answer is yes. You know, as macro environment becomes more challenging, you might see us become more conservative in how we're managing the business, and that could result in higher take rates or, you know, bigger, larger unit economics from, you know, lower marketing operations costs.
Got it. Thank you.
We take our final question from Nat Schindler with Bank of America.
Yes. Hi, guys. You mentioned that you outperformed heavily during the pandemic because of stimulus. It makes sense. Now your loans are showing signs of underperformance, particularly in the worst, the lowest quality loans, so the lowest FICO score loans, I'm guessing.
You did though, the bulk of your low FICO before FICO score lending really started, late last year. What does that mean for the performance of your entire portfolio of loans that have been 2022 or later? Are we looking or maybe even Q4 2021 originations and later, are those gonna be even significantly worse than you're suggesting because they're weighted towards those lower quality loans?
Matt, a couple things of clarity because the statements you're making aren't entirely accurate. First of all, most of the effect we saw from the decline from the sort of retraction in stimulus was across the board, all flavors of loans. I mean, there was some marginal difference between the highest risk loans and the lowest risk loans.
Largely it was an effect that we saw that was universal. For us it's a very clear sign that it's a macro effect. That's one important thing to say. Another important thing to say is it actually has nothing to do with FICO whatsoever. It's really by our own risk grades that we look at these things.
FICO, you can actually see this in some information we put into the investor deck. Our risk separation was dramatically more than FICO, so it's not really related to FICO scores whatsoever. You know, there you have it. I mean, I think that we're very happy with how the model is performing now. It has been stable, as Sanjay said, for the last 60 days.
I think the bottom line is when you go through a period where the government, you know, essentially pays everybody's salaries for most of a year and then suddenly stops, it's a pretty damn difficult thing to calibrate exactly right.
I don't think we're exactly right, but our risk ranking's been exceptional. The product is stable today. None of our banks and credit union partners have seen any underperformance. Overall, we're actually feeling quite good.
What's the risk looking like?
Yeah, Matt, let me.
Oh, sorry.
Sorry, Nat, just gonna maybe again describe. I know you're sort of the direction you're heading in, but the effect was broad, as Dave Girouard said. It was maybe slightly more on high-risk loans than low-risk loans. The real relationship to cohort performance is on timing.
By that, what I mean is if you're an investor buying happily or a bank sort of originating happily across the past couple of years, what you'd see is probably 12 vintage quarters of overperformance. The ones that were timed right around the injection of the stimulus, so call it late 2019 to sort of early 2021, those will overperform dramatically. Maybe kind of like 2x the return target.
The sort of two or three vintages that were right around the time of what we call the reversal of the loss trend, and you could see this in our investor deck. It was sort of like, you know, the Q2 and the Q3 2021 will marginally underperform to the tune of, we'll call it, you know, 20%.
Really the underperformance we're talking about, it's tempting to kind of wanna relate it to the change in mix we've had over the last year. Really what it is it lines up almost exactly with the injection and the sort of evaporation of the government stimulus. As Dave said, there's marginal differences between the low and the high end of risk. I think that's the secondary story. It's not the main driving effect here.
Would then it be reasonable to assume, if student loan forbearance ends as expected, that it would have a compounding effect on this? It would be the opposite of stimulus?
If forbearance ends, meaning if they start demanding the repayment of student loans or if they.
Yeah
Forgive student loans?
If they start demanding repayment again, as expected.
Yeah, I think.
I mean, it's still unknown what they're gonna do, but it keeps getting delayed, so.
Yeah, I think that would be another example of reversal of stimulus, right? They've sort of allowed forbearance for a long time, and so I think it would just maybe be a continuation of the trend I'm describing.
I think, you know, the majority of the excess balance sheet in our economy has been unwound, if you could see like the personal savings rates, they shot up in a couple of different instances over the course of 2020 and early 2021, and those savings rates are right back down to where they were before.
There may be some, you know, maybe not all of the stimulus has been drained out of the economy. You could sort of describe it that way, but we think a lot of it, if not the majority of it, has. There may be a bit more to go. As I said, we've seen stable trends now for a couple of months.
Okay. Is there any, though, demographic kind of? Are you more demographically targeted towards younger people who are likely to be, you know, to have student loans, or are you more broad? Or are you targeted somewhere else? Just wondering how big of an impact that could be on your borrowers.
I would say in the past, we definitely like the inception of our company largely was around thin file borrowers, but I don't think that's the case anymore. I think we have a pretty broad, broadly distributed portfolio across the risk grades and the demographics now.
You know, I don't know. I think it's the biggest, you know, platform in this space will probably be. I think you could imagine trends will be roughly proportional to the general population on our platform at this point.
Okay. That makes sense.
Thank you. It appears there are no further questions at this time. I'd like to turn the call back to Dave Girouard for any additional or closing remarks.
Just wanna say thanks to everybody. We are actually quite pleased and quite happy with the results. Definitely appreciating also that 2022 is a complicated year in the economy and a lot of open questions. We are exceptionally confident in the strength of the business and as optimistic about our future as we have been. Thanks to everybody for joining us today.
That concludes today's call. Thank you for your participation. You may now disconnect.