Upstart Holdings, Inc.

Good day and welcome to the Upstart Third Quarter 2024 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over

to

Alice Berry. Please

go ahead. Good afternoon and thank

you for joining us on today's conference call to discuss Upstart Third Quarter 2024 financial results. With us on today's call are Dave Girard, Upstart's Chief Executive Officer, and Sanjay Dutta, our Chief Financial Officer. Before we begin, I want to remind you that shortly after the market closed today, Upstart issued a press release announcing its Third Quarter 2024 financial results and published an investor relations presentation. Both are available on our investor relations website, .upstart.com. During the call, we will make forward-looking statements such as guidance for the fourth quarter of 2024 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, uncertainty, 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 our earnings release and supplemental tables. To ensure that we can address as many analyst questions as possible during the call, we request that you limit yourself to one initial question and one follow-up. On November 22, Upstart will be participating at the WebBush Disruptive Finance Virtual Conference. Now, we'd like to turn it over to Dave Gerard, CEO of Upstart.

Good afternoon, everyone. I'm Dave Gerard, co-founder and CEO of Upstart. Thanks for joining us on our earnings call covering our third quarter, 2024, results. We know there's a lot going on this week, and we appreciate you making the time to be with us. I'm happy to report that we continue to strengthen Upstart's position as the fintech leader in artificial intelligence. With our Q3 results, it's clear that our team's efforts are driving improved financial performance today, as well as a stronger foundation for the quarters and years to come. With 43% sequential growth in lending volume and a return to positive, adjusted EBITDA sooner than expected, we're pleased that Upstart's comeback story continues to play out as we anticipated. When I look across Upstart, I see improvements in so many areas that are important to our future. Our core product is growing quickly, has exceptional economics, and is delivering increasingly competitive rates across the credit spectrum. Our newer products are gaining traction with both our auto and home lending products expanding nicely quarter to quarter. And our funding supply has never been more durable, with more committed capital than ever, powered by truly innovative partnership structures. Overall, credit performance continues to strengthen and gives us confidence that we're well calibrated to the macro. And finally, our velocity at delivering AI wins has never been better. Consistent with last quarter, these improvements weren't primarily driven by improvements to the macro economy. While the 50 basis point reduction in the Fed rate provided a modest boost to platform volume at the end of September, rates overall continue to be quite elevated. And the Upstart macro index, while stable, continues to be well above the historical average. This is all to say that we believe any substantial macroeconomic wins remain in our future. Today, I'd like to share some details about the third quarter and the progress that we made. In our core personal loan product, we continue to iterate on our ability to rapidly launch increasingly sophisticated models. Model 18, which I described in some depth last quarter, drove large conversion improvements in Q3, which translated to much of the growth we're reporting today. We also continue to solve ML infrastructure and scaling challenges related to training frequency, process automation, and inference speed. We've set aggressive goals regarding data freshness for our machine learning team, which is critical to proper calibration in a volatile macro environment. We're also working hard to reduce model latency, even in the face of deploying more technically sophisticated models. In Q3 alone, we reduced model inference latency by 13 percent. I believe that our model training and deployment represent the state of the art in an industry that, for the most part, has yet to discover the power of predictive AI. Q3 was Upstart's largest quarter of personal loan origination volume in two years, despite the significantly elevated rates I mentioned earlier. Our goal is to offer the best rates and best process to all Americans, and we're making significant strides in this direction. This means not just having the best models and highest levels of automation, but feeding them with the most efficient fuel, the capital, so that the end product, the loan, is consistently the best available. While this is a goal we can never 100 percent achieve, a constant, urgent, and determined effort to offer the best rate and the best process to everybody will make Upstart a formidable brand and a sustainable leader in the industry. Our T-PRIME program, which we announced just a couple of weeks ago, takes a giant leap toward this goal by expanding our reach to the super-prime end of the credit spectrum. By working closely with our lending partners, we're creating offers of credit that shine in comparison to anything in the market and bring us closer to a brand that can resonate with all Americans. Originations of Upstart auto loans increased 46 percent sequentially to $26.5 million. On the retail side, we signed our 11th Certified Digital Retailing OEM Agreement in October. This agreement increases Upstart's franchise dealer market opportunity by 14 percent. In October, we also began the rollout of a complete redesign of Upstart's in-store software product that improves usability and information access as we continue to modernize the technology stack used by dealerships across the country. On the refinance side, we recently upgraded the loan application experience, reducing the average time to fund from 19 days to nine. Car owners who refinance with Upstart now save an average of $800 per year, and we're optimistic that we can increase the amount saved by our borrowers in the months ahead. Our home equity business continues to scale like you'd expect from a fast-growing startup, with originations more than doubling on a sequential basis. And I'm also happy to report that with more than 600 HELOCs originated to date, we still have zero defaults. Growth in the HELOC product was driven predominantly by conversion rate improvements, a common theme if you've followed Upstart for long. Better targeting and higher qualification rates combined with a 50 percent increase in close rates of those offered loans led to these strong results. We exited Q3 with an instant approval rate for HELOC applicants of 49 percent, up from 42 percent in Q2. This means we're able to instantly verify applicants' income and identity without the need for tedious document uploads. We're now live in 34 states and Washington, D.C., covering 55 percent of the U.S. population. We expect to expand to more states with our HELOC product this quarter. We continue to invest heavily in servicing and collections. And as I've said before, we're particularly focused on leveraging machine learning to customize the borrower experience and improve repayment rates. And this effort is beginning to pay off. I'm increasingly confident that loan servicing and collections will become another area where we have unique and sizable competitive advantage over time. In Q3, we launched multiple personalization efforts, including optimizing the time of data call and the time of data send emails. We don't have concrete results for these initiatives yet, but they're part of our broader push to use machine learning and data to create a materially differentiated loan servicing experience. We also expanded support coverage to include Sundays without adding headcounts to the team. And finally, we began exploring the use of large language models to reduce our spend even further. Our work to improve operational efficiency combined with machine learning means we believe we can continue to improve roll rates, even while reducing the cost of servicing each loan. Last quarter, we continued to see strong loan performance, with roll rates from one day delinquent to charge off down 13 percent year over year. Even more compelling is that 30 day delinquency rates have trended down sequentially through Q3, despite the fact that the third quarter has traditionally been a seasonally worse quarter for loan servicing. We're confident that there are many more wins in this part of our business in the coming quarters. On the funding supply of our business, we continue to strengthen our position quarter to quarter. A few weeks back, we announced a partnership with Blue Owl, whereby their Adelaide affiliate will purchase up to $2 billion in loans from the Upstart platform over 18 months. Similar to last quarter, I'm happy to report that in Q3, well over half of our loan funding was in the form of longer term committed partnerships. Today, I want to call the incredible work done by our capital markets team, who have risen to the challenge of developing important and innovative partnerships with several of the market leaders in private credit. Innovation on the funding side of our business is a trend I expect to continue throughout 2025. Banks and credit unions continue to increase their funding on the Upstart platform as their liquidity improves and they ramp up their lending. This year, we signed 24 new lenders, which is already more new lenders and new capital than was added in all of 2023. In addition, more of our existing bank and credit union partners are expanding their lending programs with us, bringing more low cost capital with more attractive rates to Upstart borrowers. The T-Prime program I mentioned earlier is one important way they're doing this. I'm also pleased that loan funding has kept pace nicely with our regrowth of originations. The volume of loans on Upstart's balance sheet continues to trend down, even while loan originations have accelerated. We're also in a stronger cash position as a result. Keeping supply and demand in balance while we regrow our core business will continue to be a challenge, but we're in a strong position to manage this important dynamic. Last quarter, I told you that Upstart was turning a corner. Now we can say that we're clearly gaining momentum. Even without a significant boost from the macro economy, we're in growth mode and our credit is performing well. Our core business is expanding again and our newer businesses are making fast progress. We're hopeful that we'll see macroeconomic wins in the quarters to come, but we're not waiting around for them. Upstart's mission is simply to improve access to credit. Our strategy to accomplish this goal is to provide the best rates and best process to everybody. This isn't AI for AI's sake. It's because more than a decade ago, we recognized that it's the right tool to accomplish this ambitious goal. We believe that success in this regard will result in a generational company with immeasurable impact on American families and the U.S. economy. We're making rapid progress against this goal and as a brilliant leader in our industry once said, it's day one here at Upstart. Thank you and now I'd like to turn it over to Sanjay, our Chief Financial Officer, to walk through our Q3 2024 financial results and guidance. Sanjay?

Thanks, Dave, and thanks to all of you who are joining us today on what I'm sure has been a distracting week for everyone here in the U.S. The macro environment continues to be an influential factor in our business, though with respect to consumer credit, it has in our view remained relatively stable since our last report a quarter ago. As anticipated, this has allowed our risk models the freedom to continue improving borrower selection and driving conversion gains. Our belief is that inflation is largely behind us, a remnant trace from an historically large increase in the money supply that occurred between 2020 and 2021. The enduring strength of our labor market also continues to astonish, and in our view, the U.S. economy now suffers from a structural shortage of workers, making the odds of significant near-term unemployment in our estimation remote in any scenario short of an economic meltdown. Consumers in the U.S. have continued their remarkable spending spree, perhaps even a little too remarkably for our taste, but Americans did enjoy a surge of disposable income entering 2024 that provided some support for the ongoing spend levels, as well as some welcome breathing room and savings rates. Consequently, consumer defaults on unsecured credit have stabilized over the course of the year, easing down from their peak to a lower but still elevated level of stress as reflected in our upstart macro index. Taken as a whole, the macro currents around us have become much less choppy and in their current state no longer appear to represent a direct headwind to our business. With all of this as context, here are some financial highlights from Q3 of 2024. Revenue from fees was $168 million in Q3, of 28% sequentially from the prior quarter and 8% ahead of guidance, as various model accuracy enhancements continue to produce improved conversion. Net interest income was negative $5 million, less than half of the net interest income loss be experienced in the same quarter a year ago. Taken together, net revenue for Q3 came in at $162 million, $12 million above our guidance, and up 20% year on year. The volume of loan transactions across our platform in Q3 was approximately 188,000 loans, up 64% from the prior year and up 31% sequentially, and representing over 118,000 new borrowers. Average loan size of $8,400 was up from $7,700 in the prior quarter, driven higher by the model wins, which allowed more borrowers to qualify for full personal loans at the expense of the smaller relief loans that they otherwise would have been presented with. Our contribution margin, a non-GAP metric, which we define as revenue from fees minus variable costs for borrower acquisition, verification, and servicing as a percentage of revenue from fees, came in at 61% in Q3, up 3 percentage points sequentially, and 4 percentage points above our guidance for the quarter. Our margins benefited from higher conversion rates on personal loans, as well as improved automation and efficiency in the borrower onboarding process. Operating expenses were $207 million in Q3, up 13% sequentially from Q2. Expenses that are considered variable, relating to borrower acquisition, verification, and servicing, were up 20% sequentially, less than the growth of the corresponding fee revenue base. Fixed expenses were up 12%, as the improved trajectory of the business triggered some catch-up accruals for expenses that were not being incurred earlier in the year at our lower volumes, some of which will be temporary in nature. We continue to pursue tight expense management as a core principle, and have implemented some further streamlining of operational headcounts since the end of the quarter. Altogether, Q3 gap net loss was $7 million, significantly ahead of guidance, and due in large part to gains made on the refinancing of some of our outstanding convertible debt. Adjusted EBITDA was positive $1 million, also comfortably ahead of guidance, and accomplishing our goal of breaking through to positive adjusted EBITDA one quarter ahead of schedule. Adjusted Earnings Per Share was negative six cents, based on a diluted weighted average share count of $90.1 million. We ended the third quarter with loans on our balance sheet of $537 million before the consolidation of securitized loans, down from $686 million in the prior quarter, continuing the progress we've made over the past year in reducing the size of the balance sheet and establishing strong relationships with a handful of strategic capital partners. Of that loan balance, loans made for the purposes of R&D, principally auto loans, stood at $399 million. In addition to loans held directly, we continue to consolidate $119 million of loans from an ABS transaction completed in 2023, from which we retained a total net equity exposure of $18 million. We ended the quarter with $445 million of unrestricted cash on the balance sheet, up almost $70 million from the prior quarter. In Q3, we also completed the refinancing of roughly half of our outstanding convertible debt with a new issuance that pushes the maturities on this tranche out to 2029. On the funding side of our platform, we see encouraging signs that the markets are becoming increasingly constructive. Liquidity in the banking and credit union sectors continues to improve, and increasing numbers of lenders are dropping their required rates of return on our platform. On the institutional side, the large amounts of money that have been raised under the banner of private credit, initially earmarked mainly for corporate lending, are now increasingly finding their way over to consumer assets. In our return to the ABS markets this past month, we saw high levels of oversubscription and significant tightening of spreads for each class of bonds. These are the signs that the capital markets are returning to their core function and once again embracing risk in the pursuit of yield. As we look ahead to Q4, we continue to presume a roughly stable macro environment, with minimal change to credit trends in either direction. We expect the September 50 basis point rate cut from the Fed to work its way into our marketplace pricing over the course of this quarter, providing some modest lift to volumes. Beyond that, much of the growth we are anticipating this quarter will be driven by continuing improvements to our models and marketing campaigns, which we expect will generate higher application volumes and borrow approval rates. Expanded availability of funding is not perceived to be a driver of growth in this quarter, but we are assuming that it will also not constrain it. On the expense side, we will continue to pursue optimized margins and frugal fixed expense management. With this as context, our guidance for Q4 is total revenues of approximately $180 million, consisting of revenue from fees of $185 million and net interest income of approximately $5 million. Contribution margin of approximately 59%, net income of approximately negative $35 million, adjusted net income of approximately negative $5 million, adjusted EBITDA of approximately positive $5 million, and a diluted weighted average share count of approximately 91.7 million shares. Thanks to all once again for joining us on this call. And now, Dave and I will be happy to open up the lines for any questions. Operator?

Thank you. And if you would like to ask a question, please signal by pressing star 1 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 your equipment. Again, you can press star 1 to ask a question, and we'll pause for just a moment to allow everyone an opportunity to signal for questions.

Our first question is coming from

the line of Peter Christensen with Citi.

Good evening. Thanks for the question here. Dave Sanjay, I was just curious if you could talk about underlying use cases on the personal loan side. If you've seen any changes there, is this notion that a debt consolidation wave could help you on the volume side quite a bit, certainly on the demand side? Just curious if you're seeing any mixed changes in use cases for personal loans. Thank you.

Hey Pete, this is Dave. I don't think there's any radical change. Personal loans have always been a fairly generic tool that consumers can use in a lot of different ways, paying for weddings, paying off debt, paying for a large purchase, etc. I think that utility continues to be there, but I don't think we've observed any dramatic change in the use cases.

Appreciate that. Thank you.

Our next question is coming from Ramsey

Ellisall with Barclay's.

Hi, great. Thank you very much. This is John Coffey on the call for Ramsey. I just had two questions for you. I think Sanjay, in the past couple earnings calls, you spoke quite a bit about some of the slower recovery in your prime customer. So I was wondering if you could tell me what that recovery looks like again in your prime base. Are we close to the middle, the beginning, or the end? And then I guess my second question is just on the trajectory of EBITDA. I know we have a positive number this quarter where you're expecting another one next quarter. Should that be a pretty smooth runway in future years just generally speaking, or are there any one-offs we should keep in mind?

Hey John, this is Sanjay. Hope you're well.

On the second question with respect to EBITDA, as you've seen, we've broke through to break even slash positive EBITDA this quarter. We're guiding up next quarter. And as long as we are successful in continuing to improve our models, improve conversion, and grow,

we

would

expect that EBITDA would follow suit. And sorry John, can you remind

me of your first question?

Yeah, the status of the prime customer, I know you said they were sort of later to weekend, but they're also coming back. But you said some of that return to the prime customer as opposed to the subprime was a little delayed. I think you spoke about it quite a bit, I think the last call or two.

Yeah, thanks for refreshing. On the trend of consumer repayments and defaults and the various segments within that, we did call out the fact that there was a bit of a phasing difference between lower prime and higher prime consumers in that the lower prime consumers were impacted sooner than the primer consumers maybe back in late 2021. And by the time they had stabilized and started improving again, even as of a quarter or two ago, the prime borrowers still had not quite stabilized. I think we see that all sort of reconverging to a place of stability across the spectrum right now. And so if you take our macro index as a high level indicator of where the aggregate numbers are on consumer repayments, we don't perceive there to be any real remaining segment differences. And that's why you may have heard in another announcement we sort of announced that we're leaning in more confidently into the prime segment with the T-Prime program.

Great, thank you very much.

Thank you, John.

Our

next question is coming from Arvind Ramini with Piper Sandler.

Hi, thanks for taking my question. You know, I just kind of, Dave, I just want to go back to some of the comments you made on the kind of the opening remarks. Like, you know, some of your performance you said, or a lot of this performance is, you know, kind of driven by inherent improvements in your own kind of model and not as much with kind of these lower interest rate cuts. And I'd love to see you can kind of expand on that a little bit more and provide some metrics. And also if you can kind of give us an idea of how these lower interest rates will sort of add to some of the tailwinds that you're seeing.

Sure, Arvind. You know, we got a little bit of help from interest rates that say, you know, the Fed rates changed and maybe, you know, a modest amount of support from that in September. So not all that meaningful over the course of the quarter. Going forward, we certainly hope to get more boost. But really the growth in the third quarter was really due to model upgrades that, you know, we're upgrading our AI models constantly, but sometimes we get, you know, just small modest wins and other times we get very large wins. And model 18, which I first mentioned in the call three months ago, was probably one of the bigger launches and upgrades to the system than we've had in quite some time. And what that really means is much more, you know, increased separation of risk. And that very commonly leads to higher conversion. You can think of it as basically, you know, it's identifying riskier people and eliminating them from the borrower pool and the net net is you can lower the rates and approve more other people. And also the level of automation is at our all time high, you know, over 90% of the loans are fully automated. Both of those contribute to growth and to just getting more people through the funnel, which is very, you know, fundamental to those numbers that we put up there.

Terrific. And then, you know, I think that if I heard you right, you said, you know, roughly kind of half of your loan volume now is through, you know, committed capital. And if that's the case, you know, you know, as we look forward the next couple of years, we get into like a more like normalized rate environment. When you think of committed capital versus like oppositionistic capital, how do you think that thing will balance? Because I know kind of, you know, before we went into this like tough environment, you almost did not have like a lot of committed capital, but now you're at about like half of that. How do you think that will trend over the next couple of years?

Sure, Arvind. Well, we'll say this. We certainly love having a significant portion of the capital being committed today. It may even be more than we would like historically to went back a couple of years. The funding on the platform was entirely at will month to month by design. And then as you know, we decided a couple of years ago, we wanted to start to have much more committed capital. Think of it, you know, more like a supply chain of capital than a little less like just a pure marketplace. And that's really helped. And that's what's really supplying a lot of the fuel for growth today is that well over half of it is committed capital. Having said that, I think there is a place for kind of a spot market, if you will, where capital can come and go. There are those capital that will come in and will ultimately take loans to securitization when the ABS markets are functioning. So I don't think we ever want 100% committed capital because there's this kind of market creation happens with at will capital as well. So a healthy balance will be good. But certainly we like today having a lot of committed capital, a lot of long-term partners that we can create a lot of value for and they can create value for us as well.

Perfect. That's really helpful. Thank

you very much. I'll help thank you. Thank

you. Our next question is coming from James Fossett with Morgan Stanley.

Hi everyone. It's Michael and Fontaine for James. Thanks for taking our question. I just wanted to ask on the small dollar loans, obviously reaching breakeven economics here, like how should we be thinking about incremental variable cost reduction there and sort of the impact on approval rates broadly?

Sure, Michael. This is Dave.

You know, the small dollar product essentially is really kind of a way to get somebody into the system who wouldn't be approved for a larger loan, generally speaking. And it is generating positive economics. It's actually not a drain in us whatsoever. They're very short-term loans. They turn over, capital turns over super quickly. So I don't think we see that as any kind of drain on the system. They are, as I said, positive economics. It's really expanding the boundary of who we can approve. A lot of those small dollar borrowers will come back later and get personal loans or maybe refinance an auto loan, etc. So for us, it's really helpful. It's also helping train our AI models on a lot of borrowers that it would not have otherwise seen. So it kind of keeps pushing the boundaries of what we can improve. I don't know, Sandre, if you want to add

anything to that. No, I think that's a pretty good description.

Okay, great. And maybe just one sort of question on impact of a change in administration broadly. I know it's obviously tough to prognosticate about direction of the overall unemployment rate. But if we are in this world in which unemployment rate is lower, credit is generally better, how are you thinking about sort of like run rate origination trajectory that we should be cognizant over over the next call it? You know, 12 to 18 months.

Well, with respect to the administration, I mean, I think the market, as you can see in the last day or so, kind of likes a business friendly Republican administration historically. So that's maybe not a surprise. But having said that, our business has grown up through four different administrations and had very engaged relationships with regulators under each of them. So we don't really see, you know, which parties empower in DC as a central factor in our business. So very happy. And we've made a ton of progress working with regulators, particularly around the use of AI and fairness and lending and those kind of issues. So we feel very good about that. Generally speaking, you know, our growth as a company has almost always come internally, not externally, meaning improvements in the models and, you know, getting more and more funding, improving models, being able to prove more people. These new products that are coming out appealing to a different set of people. The T prime program is now has more competitive offers for much more prime borrowers. So all these are the kind of things that we just keep. I think we can grow on and certainly as the consumer risk drops, you know, the upstart macro index, as that goes down, that is certainly a tailwind to us, as is, you know, fed rates, the benchmark rates going down. So those are all good things. But as I kind of said in the remarks, we aren't waiting around for, you know, fed rates to drop or for UMI itself to drop. We really believe we can drive consistent growth really through just the kind of improvements we make for our models quarter in and quarter out.

That's a great call. Appreciate it. Thank

you. Our next question is

coming from Rob Wildhack with Autonomous Research.

Hi, guys. I wanted to ask about T prime and your expansion into super prime. Can you just fill us in on how you get paid in that business? Is it any different? And then how do the take rates and contribution margins compare to the core business?

Sure, Rob. That's a good question. We essentially, we don't like doing any loans that there aren't positive unit economic funds. We aren't. We never do this in a way that we would intentionally lose money on the loan. So they are positive, but certainly across the spectrum, the more prime you are, the more you're at that end of the spectrum, the thinner margins are because you have just a more heavily competed consumer. And what we were really able to do with our lending partners is find something that works for them in terms of very low, relatively low loss rate product, which is very good for our credit union and bank partners. It has a nice field and we make less on it, but we have a very positive contribution margin. If you look at our business today, contribution margins are super high compared to where they were historically, you know, in the like, in the range of 60 percent. Whereas, you know, in the middle of 2021, they were in the mid 40s, I believe. So we expect our contribution margins to come back down to earth as our volumes expand. And we don't think T prime is going to upset that in any dramatic way. But this is essentially also important to say these are this is sort of a part of the market we have just not participated in historically. So regardless of the percent contribution margin, these are contribution dollars that we would not otherwise have. And that's how we would think about it.

OK, thanks. And then somewhat relatedly, just wanted to get your thoughts on the broader competitive landscape. You're going into super prime with T prime. You have someone like SoFi who's doing their own loan platform business that seems to be targeted more towards your main demographic. What do you guys think about all of that? How do you how intense do you feel the competition is today? And then how do you manage around that competition to make sure you're protecting or protecting your targeted cash flows going forward?

Yeah, I mean, we've always operated in a very competitive environment, you know, in some sense from a consumer perspective, a loan is a loan. And for us, having proprietary underwriting that we think is creating separation is always been the center of our thesis. We can improve more people at lower rates. We can avoid the people you don't want to lend to. And increasingly with what we talked about with T prime is we can compete across the credit spectrum. So certainly there'll always be a lot of competition, but we like our model. It can be a loan can be originated and held by a credit union or a bank at a very modest yield and a very low risk. We also have relationships with the private credit market, very successful in ABS. So there's just, you know, I think a platform that can move really quickly. And I think controlling all parts of this from the data that's collected, that the model is trained on servicing these loans, et cetera, means it's a very healthy approach. We have a lot of competition has very different models out there, whether they be banks or other types of syntax. But we like our play in it. But it's a vast market and there's there's room for multiple players for sure.

Very helpful. Thank you. Thank you.

Our next question is coming from Cal

Peterson with Needham.

Hey, good afternoon, guys. Thanks for taking the questions. I want to start off on the rate cut commentary. You just mentioned in your prepared remarks that the September cut is expected to work its way through into the fourth quarter. You know, if there's further easing and we had to cut today, should we think about these as being potential tailwinds at like a one to two quarter lag or or is there another way to to kind of incorporate that

into our own assumptions? I'll take that one.

Yeah, the I think I think that's roughly right. You know, a rate cut by the Fed first requires warehouses and other financing mechanisms to adjust. And then, you know, thereafter, we'll we'll begin to reflect that in our core pricing. And so I think a lag of, you know, one to three months is probably reasonable.

OK, that's helpful. And then maybe switching gears, I know you guys mentioned, you know, the average loan size was a little bigger and part of that's due to model improvements. You know, maybe any thoughts about, you know, does that impact some of the progress or initiatives you guys had had been making on the small dollar product or does that now get shifted to a different consumer? If some of those guys that were taking the smaller loans can now qualify for longer ones, just how that fits into the near term growth algorithm would

be very helpful.

Yeah, I guess in the

grand scheme of things, when either risk is lower or required returns are lower and more people can qualify for larger loans, it does mean that less of them are taking what the otherwise would have been offered, which is maybe a smaller dollar loan. I think that overall is good for the ecosystem and for the borrower. It may have obviously impacts on average metrics like loan size, etc., but I think overall we would view that as a positive in the environment.

Got it. That's helpful. Thank you.

Our next question is coming from David Schwartz with CitizensJMP.

Hi, good afternoon. Thanks for taking my questions. Most have been answered, but just two quick follow ups. First, on the expense side, Sanjay, I think you said there were some catch-up accruals in the third quarter and I'm wondering if you could quantify how much of Q3 expense levels might be non-recurring and how much specifically in the fourth quarter we should think of for marketing.

Yeah, I think, on the back of a cocktail napkin, I think you could think of that as sort of like five million-ish in excess expense that maybe otherwise would have been sort of captured earlier in the year and was sort of captured as a one-time catch-up this quarter.

Okay. In a Q4 marketing spend, just given the...

...you know, as we

think about CAC, similar to

third

quarter levels?

Yeah.

I don't perceive there to be any large changes coming.

Okay. And then just lastly, on the funding side, I think earlier in the year...correct me if I'm wrong, I think the Castle Lake arrangement included some form of risk sharing or mandated risk retention. Is that the case with Adelaide recent deals or are these just kind of strict flow arrangements?

Yeah, the Adelaide deal has a version of co-investment where we're investing alongside them.

Okay. Got it. Great. Thank you. Thanks, David.

Our next question is coming from Assignment Clinch with Redburn Atlantic.

Hi, everyone. Hi. Thanks for taking my question. I was wondering, David or Sandeep, could you talk a bit about the conversion rates and how we should think about that progressing as Model 18 really starts to drive through? I'm not asking this because while you delivered some great upside to numbers this quarter, I thought the conversion rate would have been higher to deliver that and it only went up, well, 180 points or so. So I'm just curious as to how to think about that going forward.

Sure. I mean conversion

rate getting higher is a good thing. It sort of contributes directly to growth. It's not the only thing that contributes to growth. So depending on how acquisitions working, et cetera. But you should expect when we make model improvements, when we increase automation, things of that nature, it will drive conversion rate up. But there's always this like sort of trade-off where suddenly it makes sense to spend more on marketing or some other type of expense and it can drive it back down. So conversion rate doesn't grow to the sky, if you will, because there will always be an interest from our side in, in effect, investing more once conversion rate reaches a certain point.

Right. And if I go back in time, I remember in the earlier days, I think we used to talk about a conversion rate of 22% being sort of optimal. So has that changed?

Hey, Simon.

This is Sanjay. So maybe one additional consideration that's signer in this multi-product world than, you know, in the old days when we were really largely a single product is that, for example, we were converting some people into small-dollar loans. And as the model accuracy improves, more of those are being converted into full personal loans. And so that's not an improvement to conversion per se, because each one of those is counted as a convert. It's just a much more lucrative conversion. So I think maybe what we can try to do over the next couple of quarters is give you guys more insight into, you know, product level conversion where it'll be more meaningful to the economics.

That'd be great. Appreciate it. Thank you so much. Thank you, Simon.

And it looks like our last question is coming from Giuliano Bellono with Compass Point.

Well, congratulations. Great to see you. You know, the continued progress securing, you know, committed funding arrangements. I guess, you know, on that topic, it looks like the, you know, the total invested capital or the assessed value is up about $100 million in quarter. I'm curious about, you know, when you think about the go-forward basis, is there a rough sense of how fast that should be growing, you know, quarter over quarter, especially as volumes continue to improve from here? And also, you know, is there an upper bound to where you'd want that to be relative to capital or cash? And, you know, hopefully not compounded the question, but then I'd be curious roughly where the percentages are, what kind of car is outstanding relative to that co-invest as of the third quarter?

Yeah. Hey, Giuliano. This is Sanjay.

Hope you're well. So I think the rough framework or the rough model you can use to think about this, and we've sort of signaled this in the past, is that in these particular deals, we expect to be somewhere in the mid to high single digits as a co-investment. And I think that's generally true, and it continues to be true. Now, I think in quarters where we sign big deals, such as the Blue Owl slash Ataliah deal, and very often those deals are accompanied by large backbook transactions as well in order to seed the relationship and sort of, you know, seed the utilization of the financing facilities. Then there can be a bigger one-time sort of jump in the committed capital dollars level, and that's true of this quarter as a result of the Blue Owl deal. Those are more a function of deal signings than ongoing forward flow investment. But I think writ large, I think a mid to high single digit percentage of the flow which is committed, and as Dave said, that's sort of somewhere over half of our total volume right now is the right amount for us to scale on. And you know, the total amount that we're comfortable with, I think, is really a function of the size and scale of our platform because obviously as it gets bigger and as our business is throwing off more money, we're able to put more of it in dollar terms into these arrangements. But I think that overall, as a percentage of the total volume we're doing, it should be some single digit percentage.

That was helpful. And I guess, you know, from an exposure perspective, should we just think about, you know, somewhere in the mid to high single digits is what that 334 represents? Or is there any kind of like ballpark of what the principal exposure looks like at this point?

Yeah, that 334 million is a mid single digit percentage of the total amount of origination dollars that

it

was used

to generate.

That's very helpful. And then I'd be curious, do you have any sense of where the take rate move this quarter? I realize we'll get the data from the 10-Cube. I'm curious. When we think about kind of the gross take rate movement, you know, I'm assuming it's drifting a little bit lower as you add a little bit more prime. Hopefully that's a good way of thinking of it. And I'm curious if you can give a rough sense of, you know, are some of the higher prime loans coming on with, you know, a low single digit take rate or a mid single digit take rate or, you know, a rough sense of where that,

you know,

some of the high prime loans might be coming on.

Yeah, sure, Giuliano. I think the take rate

is in roughly the same ballpark as in prior quarters. I think in this particular quarter, it may be very slightly down. Some of it has to do with the mix between, you know, institutional funding and LP funding. Some of it is maybe a function of this T prime program that we're scaling, which, as Dave said, has, you know, smaller but still positive margins. And some of it is frankly experimentation. As we scale, we're always trying to find the, you know, the optimum elasticity or the optimum price given elasticity in different segments. And that, you know, allows us to experiment a little bit with some percentage of our traffic. And I think the combination of those three create a bit of push and pull with take rates. But net-net, I think they're in the same ballpark, maybe marginally lower than last quarter.

That's very helpful. I appreciate the time and I'll jump back in the queue. Thanks, Giuliano.

And

there are no further questions at this time. I will now turn the conference back to Dave Gerard for any additional or closing remarks.

I just want to say thanks to all for joining us today. We're excited about our position and our velocity toward the future. We think our business is really beginning to hit on all cylinders again. We appreciate you joining us, especially during this super busy week. And we look forward to talking to you again in the new year. Thanks

for joining.

This concludes today's call. Goodbye. Thank you for your participation. You may now disconnect.