Upstart Holdings, Inc. quarterly report, Q3 FY2022

Upstart Holdings, Inc. — Q3 2022 Form 10-Q

Business context and reporting period. Upstart operates an AI-based lending marketplace, partnering with banks to originate and service consumer loans, principally unsecured personal loans, and expanding into auto, small-dollar and small-business lending. This unaudited quarterly report covers the three and nine months ended September 30, 2022; comparisons below are with the corresponding 2021 periods unless stated otherwise.

Key financial results

Metric	Q3 2022	Q3 2021	Nine months 2022	Nine months 2021
Total revenue	$157.2 million	$228.5 million	$695.5 million	$543.7 million
Revenue from fees, net	$179.3 million	$210.4 million	$751.7 million	$513.9 million
Operating income (loss)	$(58.1) million	$28.6 million	$(55.4) million	$80.5 million
Net income (loss)	$(56.2) million	$29.1 million	$(53.4) million	$76.5 million
Adjusted EBITDA (non-GAAP)	$(14.4) million	$59.1 million	$53.7 million	$140.9 million
Adjusted EBITDA margin (non-GAAP)	(9)%	26%	8%	26%

• Q3 diluted loss per share was $0.69, compared with diluted earnings per share of $0.30 a year earlier. Nine-month diluted loss per share was $0.64, versus earnings of $0.81.
• Q3 revenue from fees fell 15%. Platform and referral fees declined 30% to $134.8 million, while servicing and other fees rose 135% to $44.6 million.
• Q3 interest income and fair value adjustments, net, were $(22.1) million, compared with positive $18.0 million. Management attributed the adverse change primarily to fair-value losses and realized losses on loan sales, amid rising rates and higher delinquencies.
• Q3 operating expenses were $215.3 million, up from $199.9 million. Engineering and product development rose 78% to $66.2 million; customer operations rose 29% to $45.0 million. Sales and marketing fell 40% to $56.4 million.
• Contribution profit, a non-GAAP measure, was $96.0 million in Q3, broadly unchanged year over year; contribution margin increased to 54% from 46%. The company cautions that these measures are not substitutes for GAAP profitability.

Operating performance and material changes

• Q3 transaction volume was $1.85 billion, down 41% year over year; the number of loans facilitated fell 48% to 188,519. Management also reported dollar volume was down 44% from Q2 2022.
• Conversion rate declined to 9.7% from 23.0%. The percentage of loans fully automated increased to 75% from 67%.
• For the first nine months, transaction volume was $9.66 billion and loan count was 975,194, up 26% and 19%, respectively. Revenue increased 28% over that period, but the company moved from net income to net loss.
• Nine-month funding mix: originating banks retained 28% of platform loans, institutional investors purchased 65%, and Upstart funded 7% through its balance sheet. Funding constraints led the company to retain more loans, including loans held for research and development.
• Loans on the balance sheet at fair value increased to $700.5 million from $252.5 million at year-end 2021. At September 30, $248.8 million related to R&D loans and $451.7 million to core personal loans otherwise expected to be purchased by investors.

Cash, debt and liquidity

• At September 30, 2022, cash was $684.0 million and restricted cash was $146.0 million, totaling $829.9 million. Total assets were $1.92 billion; stockholders’ equity was $718.6 million.
• Borrowings had a $918.9 million carrying value, including $661.3 million principal of 0.25% convertible senior notes due 2026 and warehouse borrowings. Aggregate principal payments due were $931.0 million. Warehouse borrowings were $269.7 million and carry floating rates.
• For the nine months, operating cash flow was $(421.8) million, investing cash flow $(29.0) million and financing cash flow positive $89.5 million. Cash and restricted cash declined $361.3 million. Operating cash use reflected loan purchases, partly offset by loan repayments and sales.
• The company repurchased 4.4 million shares for $150.1 million during the nine months, at an average $33.84 per share; $249.9 million remained under the $400 million authorization at September 30.
• Management said cash on hand and operating cash flow should be sufficient for liquidity needs for at least the next 12 months, while noting future requirements depend on loan funding, growth and other factors. The filing does not provide quarterly or full-year earnings guidance.

Outlook, risks and unusual items

• Management described institutional investor funding as constrained since Q2 and said some bank partners had paused or reduced originations. Upstart expects to use its balance sheet to meet some near-term funding needs while pursuing more committed third-party capital; timing and availability are uncertain.
• Management reported that institutional-investor loan vintages from 2021 and early 2022 were underperforming target returns. It also cited higher interest rates, inflation, increased delinquencies, lower borrower acceptance and reduced investor risk appetite as pressures on volume and loan economics.
• Fair-value measurement relies on significant unobservable assumptions. Q3 and nine-month results included material negative fair-value adjustments and loan-sale losses. A 100-basis-point increase in discount rates would reduce the September 30 loan portfolio’s fair value by an estimated $8.5 million; a 10% adverse change in expected credit losses would reduce it by $8.7 million.
• Revenue and loan funding are concentrated: two bank partners accounted for 45% and 26% of Q3 revenue, and Cross River Bank and another partner originated 52% and 36% of nine-month loan count, respectively. The company identifies funding concentration and partner retention as material risks.
• Regulatory risks include evolving oversight of AI-based lending and bank-fintech relationships. Upstart requested termination of its CFPB no-action letter in June 2022. The filing also discusses possible fair-lending, licensing, true-lender, usury and consumer-protection challenges.
• Several securities and derivative lawsuits alleged misleading statements concerning the company’s business and prospects. The company said it intends to defend the claims; it recorded no loss contingency and could not estimate a reasonably possible loss range. These matters are distinct from the company’s statement that other ordinary-course litigation was not expected to have a material adverse effect.
• Q3 stock-based compensation expense was $36.7 million; nine-month expense was $92.0 million. This recurring non-cash cost is excluded from certain company-reported non-GAAP measures.
• Warehouse facilities were reported covenant-compliant at September 30. Disclosure controls were assessed as effective, with no material change to internal control over financial reporting during the quarter.

Investor verification priorities

1. Check subsequent loan performance, especially 2021 and early-2022 vintages, delinquency trends and how actual returns compare with origination targets.
2. Track whether bank and institutional funding capacity recovers, the share of loans retained on Upstart’s balance sheet, and the terms and availability of committed capital.
3. Review future fair-value marks and loan-sale results, including the effects of discount-rate, credit-loss and prepayment assumptions.
4. Monitor cash use, warehouse facility maturities and covenants, the 2026 convertible notes, and the amount of capital allocated to loan purchases and repurchases.
5. Follow bank-partner concentration, CFPB and other regulatory developments, and the status and potential financial impact of the pending litigation.