UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
| (Mark One) | |||||
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the fiscal year ended | |||||
| OR | |||||
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the transition period from_________to ________
Commission File Number: 001-39797
(Exact name of registrant as specified in its charter)
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(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
| Upstart Holdings, Inc. | ||||||||||||||
| (Address of principal executive offices, including zip code) | ||||||||||||||
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| (Registrant’s telephone number, including area code) | ||||||||||||||
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Securities registered pursuant to Section 12(b) of the Act:
| Title of each class: | Trading Symbol: | Name of each exchange on which registered: | ||||||
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| ☒ | Accelerated filer | ☐ | |||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | |||||||||
| Emerging growth company | |||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrants as of June 30, 2023, the last business day of the registrant’s most recently completed second fiscal quarter, was $2,594,276,077 , based on the closing price reported for such date on the NASDAQ. Shares of the registrant’s common stock held by each executive officer, director and holder of 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose.
As of February 8, 2024 there were 86,430,264 shares of the registrant’s common stock outstanding.
Documents Incorporated by Reference
Portions of the registrant’s Definitive Proxy Statement relating to the 2024 Annual Meeting of Stockholders are incorporated by reference into Part II and III of this Annual Report on Form 10-K to the extent stated herein. Such Definitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the registrant’s fiscal year ended December 31, 2023.
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| PART I. | ||||||||
Item 1C. | ||||||||
| PART II. | ||||||||
Other Information | ||||||||
| PART III. | ||||||||
| PART IV. | ||||||||
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws about us and our industry, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “seek,” “could,” “intend,” “target,” “aim,” “project,” “contemplate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Forward-looking statements contained in this Annual Report on Form 10-K include statements about:
•our future financial performance, including our expectations regarding our revenue, our operating expenses, our ability to determine reserves and our ability to achieve and maintain profitability;
•our ability to improve the effectiveness and predictiveness of our AI models and our expectations that improvements in our AI models can lead to higher approval rates and lower interest rates;
•our ability to increase the volume of loans facilitated through our AI lending marketplace;
•our ability to successfully maintain a diversified and resilient loan funding strategy, including lending partnerships, whole loan sales, committed capital arrangements and securitization transactions;
•our capital allocation plans, including expectations regarding funding loans through our balance sheet and allocations of cash and timing for any share repurchases and other investments;
•our ability to maintain competitive interest rates offered to borrowers on our platform, while enabling our lending partners and institutional investors to achieve an adequate return over their cost of funding;
•our ability to successfully build our brand and protect our reputation from negative publicity;
•our ability to increase the effectiveness of our marketing strategies, including our direct consumer marketing initiatives;
•our expectations regarding macroeconomic events, including rising interest and inflation rates and monetary policy changes;
•our expectations regarding the credit performance of Upstart-powered loans;
•the impact of recent bank failures, including disruption in the banking industry, and any associated effects on our business and industry;
•our expectations and management of future growth, including expanding the number of potential borrowers;
•our ability to successfully adjust our proprietary AI models, products and services, and provide up-to-date information to our lending partners, in a timely manner in response to changing macroeconomic conditions and fluctuations in the credit market;
•our compliance with applicable local, state and federal laws;
•our ability to comply with and successfully adapt to complex and evolving regulatory environments, including regulation of artificial intelligence and machine learning technology;
•our expectations regarding regulatory support of our approach to AI-based lending;
•our expectations regarding the success of our strategic investments and acquisitions, including the integration of acquired operations, products, technology, internal controls and personnel;
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•our expectations regarding new and evolving markets and our ability to enter into new markets and introduce new products and services;
•our expectations concerning relationships with third parties;
•our ability to protect against increasingly sophisticated fraudulent borrowing and online theft;
•our ability to service our loans and pursue collection of delinquent and defaulted loans;
•our ability to successfully compete with companies that are currently in, or may in the future enter, the markets in which we operate;
•our ability to effectively secure and maintain the confidentiality of the information received, accessed, stored, provided and used across our systems;
•our ability to successfully obtain and maintain corporate funding and liquidity to support continued growth and for general corporate purposes;
•our ability to attract, integrate and retain qualified employees;
•our ability to maintain an effective system of disclosure controls and internal control over financial reporting and operations;
•our ability to effectively manage and expand the capabilities of our operations teams, outsourcing relationships and other business operations;
•our ability to maintain, protect and enhance our intellectual property;
•our expectations regarding outstanding litigation and regulatory investigations; and
•our ability to manage the increased expenses associated with being a public company.
We caution you that the foregoing list may not contain all of the forward-looking statements made in this report.
Forward-looking statements should not be relied upon as predictions of future events. We have based the forward-looking statements contained in this report primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors, including those described in the section titled “Risk Factors” and elsewhere in this report. Readers are urged to carefully review and consider the various disclosures made in this report and in other documents we file from time to time with the Securities and Exchange Commission that disclose risks and uncertainties that may affect our business. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this report. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.
Neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. Moreover, the forward-looking statements made in this report relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this report to reflect events or circumstances after the date of this report or to reflect new information or the occurrence of unanticipated events, except as required by law. Undue reliance should not be placed on our forward-looking statements as we may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.
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In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this report, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely upon these statements.
Each of the terms the “Company,” “we,” “our,” “us” and similar terms used herein refer collectively to Upstart Holdings, Inc., a Delaware corporation, and its consolidated subsidiaries, unless otherwise stated.
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PART I
ITEM 1. BUSINESS
Overview
Upstart is the leading artificial intelligence (“AI”) lending marketplace, connecting millions of consumers to more than 100 banks and credit unions that leverage Upstart’s AI models and cloud applications to deliver superior credit products. Founded in 2012, Upstart’s platform includes personal loans, automotive retail and refinance loans, home equity lines of credit (“HELOCs”), and small dollar loans.
We’re dedicated to improving access to credit for all. Money is a fundamental ingredient of life, and unless you are in the few percent of Americans with significant wealth, the price of borrowing affects you every day. Throughout history, affordable credit has been central to unlocking mobility and opportunity. The FICO score was invented in 1989 and remains the standard for determining who is approved for credit and at what interest rate. While FICO is rarely the only input in a lending decision, most lenders use simple rules-based systems that consider only a limited number of variables. Unfortunately, because these legacy credit systems fail to accurately identify and quantify risk, millions of creditworthy individuals are left out of the system, and millions more pay too much to borrow money.
Upstart AI remakes the lending process. We leverage AI to more accurately quantify the true risk of a loan. Our AI models have been continuously upgraded, trained and refined for more than ten years. We apply AI models to income and identity fraud, acquisition targeting, loan stacking, time-delimited default and prepayment prediction, and servicing. Powered by more than 1,600 variables1, our models are trained on more than 58 million repayment events, adding an average of 83,000 new repayments each business day.
We believe the flywheel effects generated by our constantly improving AI models provide a significant competitive advantage. More training data generally leads to higher approval rates and lower interest rates with better returns to our bank and credit union partners, collectively our “lending partners.” Our AI also enables our lending partners to deliver an exceptional digital-first experience. They can respond instantly to a customer’s loan request 24/7 with no human intervention. In 2023, more than 87%2 of our loans were fully automated where borrowers were approved instantly, with zero documentation to upload.
Our AI marketplace connects consumers with our lending partners. Consumers can access Upstart-powered loans via Upstart.com, through a lender-branded product on our lending partners’ own websites, and through auto dealerships that use our Upstart Auto Retail software.
Loans issued through our marketplace are retained by our lending partners, purchased by our network of institutional investors, or funded by Upstart’s balance sheet. Investors may also invest in securities collateralized by Upstart-powered loans through our pass-through and securitization programs.
As of December 31, 2023, out of the total principal of loan originations facilitated on our marketplace in 2023, 48% were purchased by institutional investors, 32% were retained by our lending partners, 16% were held on our balance sheet, and the remaining 4% were contributed as collateral to the securitization transaction completed in July 2023, which we have consolidated in our financial statements. In the year ended December 31, 2023, our top three lending partners originated 80% of the loans facilitated through our marketplace and fees received from these
1 “Variables” refers to raw variables and combined variables considered in our AI models. A “raw” variable is a non-combined, conceptually distinct unit of data, such as “applicant-reported savings.” A “combined” variable is data that has been transformed, combined, or otherwise engineered from a raw variable or set of raw variables, such as “applicant-reported savings” divided by “loan amount.”
2 Percentage of Loans Fully Automated is defined as the total number of loans in a given period originated end-to-end (from initial rate request to final funding for personal loans and small dollar loans, and from initial rate request to signing of the loan agreement for auto loans) with no human involvement required divided by the Transaction Volume, Number of Loans in the same period.
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lending partners accounted for 63% of our total revenue. Our goal is to continue expanding our lending partnerships to new participants and deepen our relationships with existing lending partners.
Institutional investors play an important role in our lending marketplace by providing capital for higher risk loans that may not be economically feasible for traditional banks and credit unions to hold. We enter into nonexclusive agreements with our institutional investors who purchase whole loans, the trust entities in our pass-through programs and the grantor trust entities in our asset-backed securitizations. To improve the loan funding capacity for our marketplace across business and macroeconomic cycles, we secured multiple committed capital arrangements with institutional investors in 2023, which delivered a significant amount of loan funding to the Upstart marketplace. We continue our work on further developing and securing committed capital arrangements for our marketplace.
Our revenue is primarily comprised of fees paid by lending partners and institutional investors. We charge our lending partners platform and referral fees at origination and the agreements with our lending partners may contain minimum fee amounts. We also earn loan servicing revenue from contracts with lending partners and institutional investors. As a usage-based platform, we target positive unit economics on each transaction, leading to a cash efficient business model with high margins. We believe these are the key components to achieve both high growth rates and profitability over time.
Our AI Lending Models
Our AI models are central to our value proposition and unique position in the industry. They are central to the efficacy of the Upstart marketplace experience we provide to consumers and the value we deliver to lending partners and institutional investors. The key aspects of our AI models include:
Variables and Training Data
Variables and Training Data
Variables in our AI models have increased from 23 in 2014 to more than 1,600 as of December 31, 2023. These include factors related to credit experience, employment, educational history, bank account transactions, cost of living and loan application interactions. As of December 31, 2023, our models have been trained on more than 58 million repayment events, adding an average of 83,000 new repayment events each business day. Upstart's models benefit from an exponentially growing dataset of repayment observations, allowing them to detect subtle patterns that drive loan-level default and prepayment risk.
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These elements of our model are co-dependent; the use of hundreds or thousands of variables is impractical without sophisticated machine learning algorithms to tease out the interactions between them, and sophisticated machine learning depends on large volumes of training data. Over time, we have been able to deploy and blend more sophisticated modeling techniques, leading to a more accurate system. This co-dependency presents a challenge to others who may aim to short-circuit the development of a competitive model. While incumbent lenders may have vast quantities of historical repayment data, their training data lacks the hundreds of non-traditional variables that power our model.
Modeling Techniques
Modeling Techniques
Growth in our training data has enabled the development of increasingly sophisticated modeling techniques. For example, while earlier versions of our models were centered on logistic regression and Monte Carlo simulations, our more recent models incorporate neural networks, Bayesian hyperparameter optimization, and gradient boosting. We expect that our data science investments and continued growth of training data will unlock even more powerful techniques over time.
Model Applications
Model Applications
While our first model focused on predicting the likelihood of loan default, we have since applied models throughout the process of credit origination. These models quantify and reduce risk in various ways, while also increasing automation and funnel conversion.
The currently active AI models within the Upstart platform—shared by and available to all Upstart’s lending partners—include:
•Acquisition targeting—identifies consumers likely to qualify for and have need for a loan;
•Loan stacking—identifies consumers likely to take out multiple loans in a short period of time;
•Time-delimited prepayment prediction—quantifies the likelihood that a consumer will fully prepay a loan earlier than originally scheduled;
•Income fraud—quantifies the risk of potential misrepresentation of borrower income;
•Identity fraud—quantifies the risk that an applicant is misrepresenting their identity;
•Time-delimited default prediction—quantifies the likelihood of default for each period of the loan term; and
•Servicing—identifies borrowers to prioritize for servicing outreach, allowing for customized intervention and improved servicing efficiency.
Despite their sophistication, our AI models are delivered to lending partners in the form of a simple cloud application that shields borrowers from the underlying complexity. Additionally, our platform allows lending partners to tailor lending applications based on their policies and business needs. Within the construct of each lender’s self-defined lending program, our platform enables the origination of conforming and compliant loans at a low per-loan cost.
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Our Ecosystem
Our ecosystem includes consumers, banks, credit unions, auto dealers and institutional investors who purchase Upstart-powered loans directly or invest in securities issued by our pass-through and securitization programs. This broad ecosystem allows participants to access and benefit from our products in a variety of ways, which leads to broader adoption of our AI lending solutions.
Consumers
Consumers
On the consumer side, we have built a mobile-responsive web application to aggregate demand on Upstart.com, where consumers are presented with lender-backed offers from our lending partners. Consumers can quickly and easily inquire about a rate, evaluate and choose a loan offer, provide necessary information for verification and review required disclosures before final acceptance of the loan. A similar experience is also offered as a branded product on lending partners’ websites. We have also made significant investments in Upstart Auto Retail, a front-end software-as-a-service application that modernizes the auto sales process for both the consumer and the dealer. Similar to Upstart.com, we expect Upstart Auto Retail to become an important aggregator of consumer demand.
Consumers on our platform are generally offered unsecured personal and secured auto loans ranging from $1,000 to $100,000 in size, at APRs typically ranging from approximately 7.8% to 35.99%, with terms typically ranging from three months to seven years, with a monthly repayment schedule and no prepayment penalty.
Value Proposition to Consumers
•Higher approval rates and lower interest rates—An internal study, conducted and published in 2023, compared our personal loan AI model to that of a traditional underwriting credit score based model. The study demonstrated the ability of our AI model to expand credit access to borrowers. Results from the study showed that our AI model approves 44% more borrowers and yields 36% lower average APR for approved loans.
•Superior digital experience—Whether consumers apply for a loan through Upstart.com or directly through a lending partner’s website, the application experience is streamlined into a single application process and the loan offers provided are firm. In the year ended December 31, 2023, 87% of Upstart-powered loans were fully automated, an increase from 75% in 2022. Automation improvements were due in large part to product, engineering and machine learning enhancements such as eliminating previously manual processes, increasing the accuracy of our verification and fraud detection models, and removing inefficient or unnecessary processes and procedures.
Lending Partners and Institutional Investors
On the loan funding side, we target a wide range of small, medium, and large lending partners with an appetite to invest in improved underwriting and digital originations. Because AI is a new and disruptive technology, and lending is a traditionally conservative industry, we have brought our technology to the market in a way that allows us to grow responsibly and improve our AI models, while allowing lenders to take a prudent approach to assessing and adopting our platform. As of December 31, 2023, we had more than 100 lending partners. Our lending partners retain loans that align with their business and risk objectives. Because lenders vary with respect to program objectives, risk tolerance and funding capacity, program parameters can vary significantly across different lenders. Lending partners have access to an administrative interface for reporting and program management. We also perform fairness testing on our models to help satisfy lending partners’ regulatory obligations.
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Loan volumes exceeding lending partners’ funding capacity or risk tolerance can be flowed through our marketplace and sold to our network of institutional investors, which have a broader and more diverse appetite for risk. As a result, we can develop our business and our AI models faster than if we relied only on the funding capacity of our lending partners. The combination of lending partner and institutional investor funding provides our lending marketplace with competitive and diverse capital.
Our network of institutional investors includes investors that buy whole loans originated via Upstart’s platform, as well as investors that buy securities, such as pass-through certificates. We are typically retained by participating institutional investors to service the loans we help originate. In the case of whole loan purchasers, we typically enter into loan purchase agreements and loan servicing agreements with such purchasers. Institutional investors may also purchase interests in loans originated via Upstart’s platform in the form of pass-through certificates. We have pass-through certificate programs sponsored by certain financial institutions under which institutional investors can purchase securities collateralized by Upstart-powered loans from an issuer trust.
While there are minimal differences between whole loan sales and sales of pass-through certificates from Upstart’s perspective, both programs are offered to provide flexibility to institutional investors in our marketplace. Some institutional investors may prefer pass-through certificates, which may be more liquid and require less operational complexity, while other institutional investors may prefer whole loan purchases, which are generally more cost effective. Whole loans purchased after origination may later be included in our asset-backed securitization transactions whereby interests in these Upstart-powered loans are sold to other institutional investors.
For our asset-backed securitizations, we engage with investment banks to structure transactions under which we and/or certain of the purchasers of whole loans or pass-through certificates described in the preceding paragraphs sell pools of whole loans to a bankruptcy-remote special purpose entity. The special purpose entities, through one or more intermediate transfers and entities, create and sell tranched asset-backed notes and subordinated certificates, in each case, backed by the collective pools of Upstart-powered loans sold into the investment structure.
Value Proposition to Lending Partners and Institutional Investors
•Competitive digital lending experience—We provide banks and credit unions with a cost effective way to compete with the technology budgets of their competitors.
•Expanded customer base—We refer customers that apply for loans through Upstart.com to our lending partners, helping them grow both loan volumes and number of customers.
•Upstart referral network—Once we aggregate consumer demand on our website, we pass those customers to our lending partners
•Branded product—Lending partners can serve customers with a branded Upstart application on their own website or mobile application.
•Flexible configurations—We built a configurable lending solution designed to meet the needs of our lending partners. Because our lending partners have complete authority and control over their lending programs, they predetermine many aspects of their loan offering, including interest rate and loan size ranges, target returns for various risk profiles, minimum credit score, maximum debt-to-income ratio, fee structures and disclosures.
•Servicing—While most lending partners and institutional investors choose to have us service their loans (through a branded servicing portal), each has the option of directly servicing loans itself. Our servicing platform manages all communication with borrowers, credit reporting agencies, and when necessary, collections agencies.
•Delivering returns—We focus on credit performance compared to the expectations set by us at the time of origination. An equal investment in all vintages of Upstart-powered core personal loans that originated in the first quarter of 2018 through the third quarter of 2023 is currently expected to deliver returns in line with a blended target of 9.0%. At a more granular level, all quarterly
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vintages of core personal loans that originated in 2018 through the fourth quarter of 2020 are currently forecasted to meet or exceed the target returns set at the time of loan origination. The quarterly vintages of core personal loans that originated in the first quarter 2021 through the second quarter 2023 are currently forecasted to underperform relative to their target returns. The core personal loans that originated in the third quarter of 2023 or later are currently forecasted to deliver returns in line with target yields. This reversion in performance was driven by a combination of factors including increased conservatism in underwriting and the relative stabilization of macroeconomic conditions, as reflected in UMI.
We have included similar disclosures in our Annual Report on Form 10-K for the year ended December 31, 2022, and in our Quarterly Reports on Form 10-Q starting from the quarter that ended June 30, 2022. We recently identified an error in the calculations that supported some of these statements. This resulted in an overstatement of the expected return of an equal investment in all vintages of Upstart-powered core personal loans that originated in the first quarter of 2018 through the third quarter of 2023 by 0.9 - 1.3% for each disclosure. The error also impacted our forecasts of the performance of certain quarterly loan vintages relative to target returns in the aforementioned reports. After correcting for the error, vintages retained by the hypothetical lending partner that we forecasted to meet or exceed target returns still include those originated from mid-2018 through mid-2021, but no longer include vintages from mid-2021 through mid-2022. Loans purchased by the hypothetical institutional investor would have been expected to experience underperformance relative to target returns through mid-2023 vintages, not through mid-2022 vintages. Importantly, the error did not impact any of our financial statements, any forecasts prepared for our actual lending partners or institutional investors, or the overall expected performance trend.
•New product offerings—Personal loans are one of the fastest-growing segments of credit in the U.S. and auto financing is the second largest segment of consumer lending. Our platform helps lenders provide a product their customers want, rather than letting customers seek loans from competitors. We continue to invest in expansion of our product offerings and launched a new HELOC product in 2023.
•Access to capital markets—We have built a broad network of institutional investors who provide loan funding through purchases of whole loans, pass-through certificates and asset-backed securitizations. We have secured multiple committed capital arrangements with institutional investors, which deliver a significant amount of loan funding to the Upstart marketplace. We continue our work on expanding committed capital arrangements for our marketplace.
•Continuous engagement with rating agencies—Upstart-powered personal loans are analyzed by credit rating agencies and are subject to significant and constant scrutiny from experts. Credit ratings are often publicly available, which help institutional investors and lending partners gain confidence in Upstart-powered loans.
•Insights into changes in the economy—Introduced in 2023, the Upstart Macro Index (“UMI”) estimates the impact of the macroeconomy on credit performance for Upstart-powered unsecured personal loans and helps our lending partners and institutional investors better understand and account for the effect that macroeconomic conditions have on our credit performance.
Our Technology Infrastructure
Our cloud-based software platform incorporates modern technologies and software development approaches to allow for rapid development of new features.
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Cloud-Native Technologies
We run our technology platform as containerized services on the Amazon Web Services cloud. Our architecture is designed for high availability and horizontal scalability. Our primary development platforms are Ruby on Rails and Python, but our Kubernetes-based compute environment gives us the flexibility to run heterogeneous workloads with minimal operational overhead. We deploy new software regularly without platform downtime, allowing borrowers and lenders to immediately benefit from the latest updates to our platform.
Data Integrity and Security
Our information security program governs how we safeguard the confidentiality, integrity, and availability of our consumer and lending partner data. Our environment is continuously monitored with a suite of tools designed to detect and respond to security events in both internal and user-facing systems. We have a robust secure software development cycle and regularly engage with third parties to audit our security program and to perform regular penetration tests of our Web application and cloud environment.
Configurable Multi-Tenant Architecture
Our multi-tenant architecture enables multiple lending partners to use the same version of our application while securely segmenting their data. Though all tenants are using the same version of our platform, our software is designed to be highly configurable to meet the needs of our diverse lending partners, allowing customizations to everything from the applicant user interface to the core rules governing credit decisioning.
Machine Learning Platform
In order to support innovation in our underwriting, fraud detection and acquisition models, we have developed proprietary technologies to enable our machine learning team to develop, train, test and deploy new model updates with minimal engineering support. Our backend systems are designed to flexibly integrate with multiple third-party data sources to feed these models and support real-time decisioning.
Responsive Web Design
Our user interface is responsive to ensure applicants and borrowers have a smooth experience regardless of whether they are accessing our website from a desktop, mobile device or tablet.
Robust Reporting and Integration Capabilities
Our reporting application programming interfaces (“APIs”) provide institutional investors and lending partners the ability to access data through a programmatic interface. Our integration capabilities with lending partners include an ability to pre-fill applicant information via API and provide loan details in real-time to facilitate a seamless process from application to origination. Our lending partner reporting portal provides our lending partners with a centralized console to view real time performance metrics of their lending program, view and verify their credit policy and program configuration, and on-demand access to operational reports and documents.
Consumer Marketing
Our growth and marketing approach is driven by the strength of our product and the interest rates we offer. While many lenders see consumer choice as a detractor from sales volume, we benefit when consumers compare our offers to other lenders’ offers. Over time, our ability to offer lower rates than our competitors has improved significantly. Because our model changes in real time, we are able to extend new loan offers to applicants who were previously not eligible or were previously quoted a higher rate.
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Our growth and marketing initiatives are primarily focused on bringing potential borrowers to Upstart.com, where they can learn if they qualify for a loan from one of our lending partners and the terms of the loan offer in only a few minutes. Our customer acquisition channels combine a mix of online and offline, as well as paid and unpaid, channels. While we constantly experiment to expand and optimize our acquisition strategies, our largest channels include:
•Marketing affiliates—A variety of online media partners, such as loan aggregators, send us traffic on a cost per origination basis. Many loan aggregators also incorporate application data to provide online prescreened offers, which leads to highly targeted and interested referrals. For example, a significant number of consumers that apply for a loan on Upstart.com learn about and access Upstart.com through the website of one of our partners, Credit Karma.
•Direct mail—We apply our strengths in data science to target individuals who both qualify for and may have a need for an Upstart-powered loan. The ability to analyze an individual’s credit data to target and mail prescreened offers of credit gives this channel a meaningful data advantage over other channels.
•Organic traffic—As our brand recognition and reputation grow, an increasing number of potential borrowers come directly to Upstart.com simply by word of mouth.
•Email marketing—We have an automated email program that sends customized messages and reminders to potential borrowers once they have created accounts to encourage them to complete their loan application.
•Online advertising—Search engines and social channels enable targeted outreach to potential borrowers with specific messages. In addition, we also advertise on streaming television services.
Operations
We have developed sophisticated tools that our internal operations team uses to support the origination and servicing of credit. Our operations teams, including credit analysts, fraud specialists, customer support, payments specialists, and supporting services (like quality assurance and training) work to deliver a seamless user experience to consumers on behalf of our lending partners.
Loan Origination Operations
While verification is primarily and increasingly handled by our software and AI models, we also offer Upstart-designed tools to guide credit analysts and fraud specialists in cases where our software is not yet able to sufficiently verify borrower information. By providing a prescriptive and unique path for each applicant, our system helps our operations team provide a streamlined experience for as many borrowers as possible.
This team focuses on the minority of borrowers whose applications are not entirely automated or any applicant who has questions or issues throughout the application process, while expediting the approval process to the extent possible, and identifying and rejecting fraudulent applications. Our operations team works closely with our engineering and machine learning teams to further increase our levels of automation.
Most prospective borrowers and applicants interact with Upstart via our online platform and help center, but we also make agent-based support readily available to all borrowers. For phone support, we partner with external call center vendors and have a team of dedicated Upstart agents with specialized training.
Servicing Operations
Upstart-powered loans are serviced via our homegrown platform. For borrowers who miss payments, we focus on early intervention and attempt to reach them via emails, calls, texts, and mail to help bring their account current or offer hardship options in accordance with the creditor’s servicing policies. Borrowers on our platform are supported via a combination of internal payments specialists and third-party service providers.
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We hold collections licenses in the majority of states and conduct some first-party collections activities. We also partner with third-party agencies for collections, especially for accounts more than 30 days past due. Debt collection calls and collection performance are reviewed regularly by our quality assurance or vendor management teams. Our operations and compliance teams each also perform vendor onsite audits annually.
Competition
Consumer lending is a vast and competitive market, and we compete in varying degrees with all other sources of unsecured consumer credit, including banks, non-bank lenders (including retail-based lenders) and other financial technology lending platforms. Because personal loans often serve as a replacement for credit cards, we also compete with the convenience and ubiquity that credit cards represent.
On the lending partnership side, we compete with a variety of technology companies that aim to help lenders with the digital transformation of their business, particularly with respect to all-digital lending. This includes new products from legacy lending technology providers as well as newer companies focused entirely on lending software infrastructure for lenders. We may also face competition from lenders or companies that have not previously competed in the consumer lending market, including companies with large and experienced machine learning teams and access to vast amounts of consumer-related information that could be used in the development of their own credit risk models.
We believe we compete favorably based on the following competitive factors:
•Constantly improving AI models;
•Compelling loan offers to consumers that improve regularly;
•Automated and user-friendly loan application process;
•Cloud-native, multi-tenant architecture;
•Combination of technology and customer acquisition for lending partners;
•Robust and diverse lending marketplace; and
•Brand recognition and trust.
Government Regulation
We and the loans made through our platform by our lending partners are subject to extensive and complex rules and regulations and examination by various federal, state and local government authorities. Failure to comply with any of the applicable rules and regulations may result in, among other things, revocation of required licenses or registration, loss of approved status, effective voiding or rescission of the loan contracts, class action lawsuits, administrative enforcement actions and civil and criminal liability. While compliance with such requirements is at times complicated by our novel business model, we believe we are, at a minimum, in substantial compliance with these rules and regulations.
We are currently, and expect in the future, to be subject to laws and regulations administered by the CFPB. In addition to the CFPB, the Federal Trade Commission has jurisdiction to investigate aspects of our business, including with respect to marketing practices. Other state and federal agencies, including prudential bank regulators and state attorneys general have the ability to regulate aspects of our business. Further, we are subject to inspections, examinations, supervision and regulation by applicable agencies in each state in which we are licensed. Regulatory oversight of our business may change over time. By way of example, in 2020, the California Consumer Financial Protection Law was enacted, which seeks to emulate the CFPB with respect to its enforcement and supervisory capabilities as well as require additional state registration for certain covered persons. We expect that regulatory examinations by both federal and state agencies will continue, and there can be no assurance that the results of such examinations will not have a material adverse effect on us.
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Below, we summarize several of the material federal lending, servicing and related laws applicable to our business. Many states have laws and regulations that are similar to the federal consumer protection laws referred to below, but the degree and nature of such laws and regulations vary from state to state.
Federal Lending and Related Laws
Truth in Lending Act
The Truth in Lending Act, or TILA, and Regulation Z, which implements it, require creditors to provide consumers with uniform, understandable information concerning certain terms and conditions of their loan and credit transactions, and to comply with certain lending practice requirements and restrictions. These rules apply to loans facilitated through our platform as well as to retail installment contracts purchased by Upstart from automotive dealerships, and we assist with compliance as part of the services we provide to our lending partners. For closed-end credit transactions, required disclosures include, among others, providing the annual percentage rate, the finance charge, the amount financed, the number of payments, the amount of the monthly payment, the presence and amount of certain fees, and the presence of certain contractual terms. For retail installment contracts, required disclosures can also include certain conditions related to Guaranteed Asset Protection waivers. For HELOCs, required open-end disclosures are provided during the origination process and servicing requirements under TILA are fulfilled by a third party servicer. TILA also regulates the advertising of credit and gives borrowers, among other things, certain rights regarding updated disclosures and the treatment of credit balances. We, on behalf of the applicable lending partner, provide applicants with a TILA disclosure when applicants complete their loan applications on our platform. If the applicant’s request is not fully funded and the applicant chooses to accept a lesser amount offered, we provide an updated TILA disclosure on behalf of the applicable lending partner. We also seek to comply with TILA’s disclosure requirements related to credit advertising and, to the extent that we hold or service loans, TILA’s requirements related to treatment of credit balances for closed-end loans.
Equal Credit Opportunity Act
The Equal Credit Opportunity Act, or ECOA, prohibits creditors from discriminating against credit applicants on the basis of race, color, sex, age (provided that the applicant has the capacity to enter into a binding contract), religion, national origin, marital status, the fact that all or part of the applicant’s income derives from any public assistance program, or the fact that the applicant has in good faith exercised any right under the federal Consumer Credit Protection Act or certain state laws. Regulation B, which implements ECOA, prohibits discrimination based on age, gender, ethnicity, nationality, or marital status, and restricts creditors from requesting certain types of information from loan applicants or engaging in certain loan-related practices, and from using advertising or making statements that would discourage on a prohibited basis a reasonable person from making or pursuing an application. These requirements apply to lending partners for loans facilitated through our platform, for automotive dealerships selling retail installment contracts, as well as to us as a service provider that assists in the process and as a loan originator for our HELOC product. We abide by policies and procedures implemented by our lending partners to comply with ECOA’s provisions prohibiting discouragement and discrimination. ECOA also requires creditors to provide applicants with timely notices of adverse action taken on credit applications, including disclosing to applicants who have been declined their rights and the reason for the denial. On behalf of our lending partners, we provide prospective borrowers who apply for a loan through our platform but are denied credit with an adverse action notice in compliance with applicable requirements. We comply with the ECOA and Regulation B requirements applicable to us in connection with the HELOC product.
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In 2020, we entered into an agreement with the NAACP Legal Defense and Education Fund and the Student Borrower Protection Center to participate in fair lending reviews of our AI underwriting models by an independent, third-party firm, Relman Colfax LLP, or Relman. Following a number of quantitative assessments, Relman has published three periodic reports and plans to publish a fourth and final report that summarizes the developments during the monitorship as well as industry recommendations. Notwithstanding our belief that our models and our lending partners’ lending facilitated by our models comply with ECOA, the reports from Relman and consumer advocacy groups and associated legislative and/or regulatory inquiries could create negative publicity and increase the risk of private litigation or government enforcement. For more information, see Item 1A. “Risk Factors” of this Annual Report on Form 10-K.
Fair Credit Reporting Act
The federal Fair Credit Reporting Act, or FCRA, as amended by the Fair and Accurate Credit Transactions Act, implemented by Regulation V, and administered by the CFPB, promotes the accuracy, fairness, and privacy of information in the files of consumer reporting agencies. FCRA requires a permissible purpose to obtain a consumer credit report and requires that persons who report loan payment information to credit bureaus do so accurately and to resolve disputes regarding reported information timely. FCRA also imposes disclosure requirements on creditors who take adverse action on credit applications based on information contained in a credit report.
Under FCRA, certain information must be provided to applicants whose credit applications are not approved on the basis of a report obtained from a consumer reporting agency, promptly update any credit information reported to a credit reporting agency about a customer and have a process by which customers may inquire about credit information furnished by us to a consumer reporting agency. We, our lending partners and the automotive dealerships with whom we partner have a permissible purpose for obtaining credit reports on potential borrowers, and we also obtain explicit consent from borrowers to obtain such reports. As part of our loan servicing activities, we accurately report loan payment and delinquency information to appropriate consumer reporting agencies on behalf of our lending partners. We provide an adverse action notice to rejected applicants on behalf of each lending partner at the time the applicant is rejected that includes all the required disclosures. We also have processes in place to ensure that consumers are given “opt-out” opportunities, as required by the FCRA, regarding the sharing of their personal information. We have also implemented an identity theft prevention program, as required by FCRA and its implementing regulations.
Fair Debt Collection Practices Act
The federal Fair Debt Collection Practices Act, or FDCPA, and Regulation F that implements FDCPA, provides guidelines and limitations on the conduct of certain debt collectors in connection with the collection of consumer debts. The FDCPA limits certain communications with third parties, imposes notice and debt validation requirements, and prohibits threatening, harassing or abusive conduct in the course of debt collection. While the FDCPA primarily applies to third-party debt collectors, debt collection laws of certain states impose similar requirements more broadly on creditors who collect their own debts and loan servicers of debt. In addition, the CFPB prohibits unfair, deceptive or abusive acts or practices, or UDAAPs, in debt collection, including first-party debt collection. We use our internal collection team, except for the HELOC product, and professional third-party debt collection agents to collect delinquent accounts. Any third-party debt collection agents we use are required to comply with the FDCPA and all other applicable laws in collecting delinquent accounts of borrowers. While our internal servicing team is not subject to the formal requirements of the FDCPA in most cases, we have established policies intended to substantially comply with the collection practice requirements under the FDCPA as a means of complying with more general UDAAP standards.
Privacy and Data Security Laws
The federal Gramm-Leach-Bliley Act, or GLBA, includes limitations on financial institutions’ disclosure of nonpublic personal information about a consumer to non-affiliated third parties, in certain circumstances requires financial institutions to limit the use and further disclosure of nonpublic personal information by non-affiliated third parties to whom they disclose such information and requires financial institutions to disclose certain privacy policies
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and practices with respect to information sharing with affiliated and non-affiliated entities as well as to safeguard personal customer information. We collect and use a wide variety of information to help ensure the integrity of our services and to provide features and functionality to borrowers on our platform. This aspect of our business, including the collection, use, and protection of the information we acquire from our own services as well as from third-party sources, is subject to laws and regulations in the United States. Accordingly, we publish our privacy policies and terms of service, which describe our practices concerning the use, transmission, and disclosure of information. We have a detailed privacy policy that addresses the GLBA and is accessible from every page of our website. We work to maintain the security of consumers’ personal information securely, and we do not sell, rent or share such information with third parties for marketing purposes unless previously agreed to by the consumer. In addition, we take measures to safeguard the personal information of borrowers and investors and protect against unauthorized access to this information. We also are subject to other privacy and security laws and regulations that apply to certain personal information that we collect or otherwise process, such as the California Consumer Privacy Act, or CCPA. The CCPA, which went into effect in 2020, requires, among other things, that covered companies provide disclosures to California consumers and afford such consumers rights with respect to how covered companies process their personal information. Other states have enacted similar laws, but many have GLBA exemptions that apply to us. As our business continues to expand, and as state and federal laws and regulations continue to be passed and their interpretations continue to evolve, additional laws and regulations may become relevant to us.
Dodd-Frank Wall Street Reform and Consumer Protection Act
In July 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act is extensive and significant legislation that includes consumer protection provisions. Among other things, the Dodd-Frank Act created the CFPB, which commenced operations in July 2011 and has significant authority to implement and enforce federal consumer financial laws, such as TILA and ECOA. The CFPB is authorized to prevent “unfair, deceptive or abusive acts or practices” through its regulatory, supervisory and enforcement authority. The CFPB also engages in consumer financial education, requests data and promotes the availability of financial services to underserved customers and communities. The CFPB has regulatory and enforcement powers over most providers of consumer financial products and services through the laws it enforces, including us. It also has supervisory and examination powers over certain providers of consumer financial products and services, including large banks, payday lenders, “larger participants” in certain financial services markets defined by CFPB regulation, and non-bank entities determined to present a risk to consumers after notice and an opportunity to respond.
The CFPB has imposed, and will continue to impose, restrictions on lending practices, including with respect to the terms of certain loans. We and our lending partners are subject to the CFPB’s enforcement authority. The CFPB may request reports concerning our organization, business conduct, markets and activities. In addition, the CFPB may, in connection with its supervisory authority, also conduct on-site examinations of our and our lending partners’ businesses on a periodic basis, subject to whether the applicable lending partner satisfies the assets threshold for CFPB supervision. If the CFPB were to conclude that our loan origination assistance or servicing activities, or any loans originated by our lending partners on our platform, violate applicable laws or regulations, we could be subject to a formal or informal inquiry, investigation and/or enforcement action. Formal enforcement actions are generally made public. We are not currently subject to any enforcement actions by the CFPB.
For more information regarding the CFPB and the CFPB rules to which we are subject or may become subject, see Item 1A. “Risk Factors” of this Annual Report on Form 10-K.
Federal Trade Commission Act
Under Section 5 of the Federal Trade Commission Act, we and our lending partners are prohibited from engaging in unfair and deceptive acts and practices, or UDAP. For nonbank financial institutions, the Federal Trade Commission, or the FTC, is the primary regulator enforcing this prohibition, and in recent years the FTC has been focused on practices of financial technology companies. The FTC is also the primary federal regulator for automotive dealerships. Based on publicly available actions, the FTC’s primary focus has been with respect to financial technology company marketing and disclosure practices as it relates to lending products, and on junk fees
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as it relates to automotive dealerships. We maintain policies and procedures that require our marketing and loan application and servicing operations comply with UDAP standards. We also maintain a dealership diligence program to monitor the fees charged for ancillary products, for example, for retail installment contracts we purchase from dealerships. For more information regarding the FTC’s enforcement actions, see Item 1A. “Risk Factors” of this Annual Report on Form 10-K.
Electronic Fund Transfer Act and NACHA Rules
The federal Electronic Fund Transfer Act, or EFTA, provides guidelines and restrictions on the electronic transfer of funds from consumers’ bank accounts. Under EFTA, and Regulation E that implements it, we must obtain consumer consents prior to receiving electronic transfer of funds from consumers’ bank accounts, and our lending partners may not condition an extension of credit on the borrower’s agreement to repay the loan through preauthorized (recurring) electronic fund transfers. In addition to compliance with federal laws, transfers performed by ACH electronic transfers are subject to detailed timing and notification rules and guidelines administered by the National Automated Clearinghouse Association, or NACHA. While NACHA guidelines are not laws, failure to comply with them may nevertheless result in commercial harm to our business. All transfers of funds related to our operations conform to the EFTA, its regulations and NACHA guidelines. As part of our servicing activities, we obtain necessary electronic authorization from borrowers and investors for such transfers in compliance with such rules. The loans offered on our platform by our lending partners must also comply with the requirement that a loan cannot be conditioned on the borrower’s agreement to repay the loan through recurring electronic fund transfers.
Electronic Signatures in Global and National Commerce Act
The federal Electronic Signatures in Global and National Commerce Act, or ESIGN, and similar state laws, particularly the Uniform Electronic Transactions Act, or UETA, authorize the creation of legally binding and enforceable agreements utilizing electronic records and signatures. ESIGN and UETA require businesses that want to use electronic records or signatures in consumer transactions to get affirmative consent from consumers to receive or sign electronically any documents otherwise required by law to be “in writing”. When a consumer registers on our platform, we obtain his or her consent to transact business electronically, receive electronic disclosures and maintain electronic records in compliance with ESIGN and UETA requirements, and we maintain electronic signatures and records in a manner intended to support enforceability of relevant consumer agreements and consents.
Federal Marketing Regulations
The Telephone Consumer Protection Act, or TCPA, and similar state laws, generally prohibits robocalls, including those calls made using an auto-dialer or prerecorded or artificial voice calls made to a wireless telephone without the prior express consent of the called party (or prior express written consent, if messages constitute telemarketing). In addition, the FTC Telemarketing Sales Rule implements the FTC’s Do-Not-Call Registry and imposes numerous other requirements and limitations in connection with telemarketing. Our policies address the requirements of TCPA as well as FTC Telemarketing Sales Rule and other laws limiting telephone outreach. Furthermore, Upstart does not engage in certain activities covered by TCPA.
The Federal Controlling the Assault of Non-Solicited Pornography and Marketing, or CAN-SPAM, Act makes it unlawful to send certain electronic mail messages that contain false or deceptive information and provide other protections for email users. CAN-SPAM also requires the need to provide a functioning mechanism that allows the recipient to opt-out of receiving future commercial e-mail messages from the sender of such messages. Our email communications with all consumers are formulated to comply with the CAN-SPAM Act.
Servicemembers Civil Relief Act
Under the Servicemembers Civil Relief Act, or SCRA, and similar state laws, there are limits on interest rates chargeable to military personnel and civil judicial proceedings against them, and there are limitations on our ability to collect on a loan to servicemembers on active duty originated prior to the servicemember entering active duty status and, in certain cases, for a period of time thereafter. The ability to repossess a vehicle is also limited
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under the SCRA. The SCRA allows military members to suspend or postpone certain civil obligations so that the military member can devote his or her full attention to military duties. The SCRA requires us to adjust the interest rate of borrowers who qualify for and request relief. If a borrower with an outstanding loan qualifies for SCRA protection the interest rate on their loan (including certain fees) will be reduced to 6% for the duration of the borrower’s active duty. During this period, any interest holder in the loan will not receive the difference between 6% and the loan’s original interest rate. As part of the services we provide, we require the borrower to send us a written request and a copy of the borrower’s mobilization orders to obtain an interest rate reduction on a loan due to military service. Other protections offered to servicemembers under the SCRA, including protections related to the collection of loans, do not require the servicemember to take any particular action, such as submitting military orders, to claim benefits.
Military Lending Act
Under the Military Lending Act, certain members of the armed forces serving on active duty and their dependents must be identified and be provided with certain protections when becoming obligated on a consumer credit transaction. These protections include: a limit on the Military Annual Percentage Rate (an all-in cost-of-credit measure which is the same as the APR for loans facilitated on our platform) of 36%, certain required disclosures before origination, a prohibition on charging prepayment penalties and a prohibition on arbitration agreements and certain other loan agreement terms. As part of the services we provide, we ensure compliance with the requirements of the Military Lending Act.
Bank Secrecy Act, USA PATRIOT Act, and U.S. Sanctions Laws
Under the Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act, or USA PATRIOT ACT, and certain U.S. sanctions laws, our lending partners are required to maintain anti-money laundering, customer due diligence and record-keeping policies and procedures, which we perform on behalf of our lending partners, and to avoid doing business with certain sanctioned persons or entities or certain types of sanctioned activity in certain countries. We have implemented an BSA/AML program, or AML program, designed to prevent our platform from being used to facilitate money laundering, terrorist financing, and other illicit activity. Our AML program is designed to prevent our platform from being used to facilitate business in countries, or with persons or entities, included on designated lists promulgated by the U.S. Department of the Treasury’s Office of Foreign Assets Controls and equivalent foreign authorities. Our AML compliance program includes policies, procedures, reporting protocols, and internal controls, including the designation of an AML compliance officer, and is designed to address these legal and regulatory requirements and to assist in managing risk associated with money laundering and terrorist financing. With respect to new borrowers, we apply the customer identification and verification program rules and screen names against the list of specially designated nationals maintained by the U.S. Department of the Treasury and the Office of Foreign Assets Control, or OFAC, pursuant to the USA PATRIOT Act amendments to the Bank Secrecy Act and its implementing regulation.
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Bankruptcy Code
Under the Bankruptcy Code, a lender is prohibited by the automatic stay, reorganization plan and discharge provisions, among others, in seeking enforcement of debts against parties who have filed for bankruptcy protection. The lender’s rights to repossess a vehicle subject to a loan in bankruptcy are also restricted. Our policies are designed to support compliance with the Bankruptcy Code as we service and collect both secured and unsecured loans.
Real Estate Settlement Procedures Act
Real Estate Settlement Procedures Act
The Real Estate Settlement Procedures Act, or RESPA, requires lenders and servicers of home loans to provide borrowers with pertinent and timely disclosures regarding the nature and costs of the real estate settlement process. RESPA also prohibits specific practices, such as kickbacks, and places limitations upon the use of escrow accounts. It also requires disclosures for mortgage escrow accounts at closing and annually thereafter, itemizing the charges to be paid by the borrower and what is paid out of the account by the servicer. Prior to referring a consumer to an affiliate, RESPA requires the person making each referral to provide each person to whom business is referred an Affiliated Business Arrangement Disclosure Statement. Our policies are designed to support compliance with RESPA.
State Lending Regulations
State Usury Limitations
With respect to lending partners that are subject to Section 521 of the Depository Institution Deregulation and Monetary Control Act of 1980, or DIDMCA, (for FDIC-insured, state banks originating loans on our platform, which represent the vast majority of loans originated) or Section 85 of the National Bank Act, or NBA, (for national banks originating loans on our platform), federal case law interpreting such provisions (including interpretations of the NBA under Tiffany v. National Bank of Missouri and Marquette National Bank of Minneapolis v. First Omaha Service Corporation), and relevant regulatory guidance (including FDIC advisory opinion 92-47) permit certain depository institutions to “export” requirements regarding interest rates and certain fees considered to be “interest” under federal law from the state or U.S. territory where the bank is located for all loans originated from such state, regardless of the usury limitations imposed by the state law of the borrower’s residence or other states with which the loan may have a geographic nexus, unless the state has chosen to opt out of the exportation regime. There are comparable permissions for federally chartered credit unions under the Federal Credit Union Act. See Item 1A “Risk Factors” of this Annual Report on Form 10-K for more information about the risk if any loans were deemed subject to any state’s usury limits.
There have also been recent judicial decisions and enacted legislation that could affect the collectability of loans sold by our lending partners after origination and the exposure of loan purchasers to potential fines or other penalties for usury violations. See Item 1A. “Risk Factors” of this Annual Report on Form 10-K for more information about recent case law developments.
With respect to our HELOC product, we are a non-bank financial institution that is subject to and complies with state-specific interest rate restrictions.
State Disclosure and Lending Practice Requirements
The loans originated on our platform by our lending partners may be subject to state laws and regulations that impose requirements related to loan disclosures and terms, credit discrimination, credit reporting, debt collection, and unfair or deceptive business practices. The retail installment contracts we purchase are subject to state laws and regulations that impose requirements on contract disclosures and terms, credit discrimination, credit reporting, debt collection and repossession, and unfair or deceptive business practices. Our ongoing compliance program seeks to comply with these requirements.
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State Licensing/Registration
We hold licenses, registrations, and similar filings so that we can conduct business, including providing referral services and origination assistance to lenders on our platform and servicing and collecting loans, and purchasing retail installment contracts, in all states and the District of Columbia where our activities require such licensure, registration or filing. We also hold licenses and registrations required by state laws or regulations to originate HELOCs in those states. With respect to our securitization trusts, we have a national bank that serves as our owner trustee and is itself exempt from licensure. Although we are not aware of a state taking the position that the trust itself needs licensure, it is possible that a state or states could take such position in the future. Licenses granted by the regulatory agencies in various states are subject to periodic renewal and may be revoked or suspended for failure to comply with applicable state and federal laws and regulations. In addition, as the product offerings of Upstart or our lending partners change, as states enact new licensing requirements or amend existing licensing laws or regulations, or as states regulators or courts adjust their interpretations of licensing statutes and regulations, we may be required to obtain additional licenses. To that end, we have a small number of applications submitted and pending to obtain additional licenses, particularly with respect to obtaining additional authorization to engage in home lending and the purchase of retail installment contracts. We are also typically required to complete an annual report (or its equivalent) to each state’s regulator. The statutes also typically subject us to the supervisory and examination authority of state regulators.
State licensing statutes impose a variety of requirements and restrictions, including:
•record-keeping requirements;
•collection and servicing practices;
•requirements governing electronic payments, transactions, signatures and disclosures;
•examination requirements;
•surety bond and minimum net worth requirements;
•financial reporting requirements;
•notification requirements for changes in principal officers, stock ownership or corporate control; and
•restrictions on advertising and other loan solicitation activity, as well as restrictions on loan referral or similar practices.
Federal Securities Regulations
Securities Act
Upstart and certain of our subsidiaries have relied on Section 4(a)(2) of the Securities Act for placement of asset-backed securities directly to investors or to investment bank initial purchasers, which have relied on Rule 144A and Regulation S exemptions from registration to place such asset-backed securities to qualified institutional buyers and non-U.S. investors, respectively.
Investment Advisers Act
The Investment Advisers Act of 1940, as amended, or IAA, contains substantive legal requirements that regulate the manner in which “investment advisers” are permitted to conduct their business activities. We believe that our business consists of providing a platform for consumer lending for which investment adviser registration and regulation does not apply under applicable federal or state law, and do not believe that we or any of our subsidiaries are required to register as an investment adviser with either the SEC or any of the various states.
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Broker-Dealer Regulations under the Exchange Act
We are not currently registered with the SEC as a broker-dealer under the Exchange Act or any comparable state law. The SEC heavily regulates the manner in which broker-dealers are permitted to conduct their business activities. We believe we have conducted, and we intend to continue to conduct, our business in a manner that does not result in Upstart being characterized as a broker-dealer, based on guidance published by the SEC and its staff.
ABS Risk Retention Rules
Regulation RR was jointly issued by a group of federal agencies under section 15G of the Exchange Act, as well as under the Federal Reserve Act, section 8 of the Federal Deposit Insurance Act, the Bank Holding Company Act of 1956, the Home Owners’ Loan Act of 1933; section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act; and the International Banking Act of 1978. Its purpose is to require securitizers to retain an economic interest in a portion of the credit risk of assets that the securitizer transfers or sells to an issuing entity and that collateralize asset-backed securities that are sold to a third party. We believe we have structured our organization such that we are in compliance with Regulation RR and will continue to conduct our business in a manner that allows us to remain in compliance with this regulation.
Compliance
We review our policies and procedures to ensure compliance with laws and regulations applicable to us and our lending partners. We have built our systems and processes with controls in place in order to permit our policies and procedures to be followed on a consistent basis. For example, to ensure proper controls are in place to maintain compliance with the consumer protection related laws and regulations, we have developed a compliance management system consistent with the regulatory expectations published by governmental agencies. While no compliance program can assure that there will not be violations, or alleged violations, of applicable laws, we believe that our compliance management system is reasonably designed and managed to minimize compliance-related risks.
Intellectual Property
We protect our intellectual property through a combination of patents, trademarks, domain names, copyrights and trade secrets, as well as through contractual provisions, our information security infrastructure and restrictions on access to or use of our proprietary technology. As of December 31, 2023, we had two patents issued and three patent applications in the United States related to our proprietary risk model and data engineering. We may file additional patent applications or pursue additional patent protection in the future to the extent we believe it will be beneficial.
We have trademark rights in our name, our logo and other brand indicia, and have trademark registrations for select marks in the United States. We will pursue additional trademark registrations to the extent we believe it will be beneficial. We also have registered domain names for websites that we use in our business. We may be subject to third party claims from time to time with respect to our intellectual property.
Additionally, we rely upon unpatented trade secrets and confidential know-how and continuing technological innovation to develop and maintain our competitive position. We also enter into confidentiality and intellectual property rights agreements with our employees, consultants, contractors and business partners. Under such agreements, our employees, consultants and contractors are subject to invention assignment provisions designed to protect our proprietary information and ensure our ownership in intellectual property developed pursuant to such agreements.
For additional information about our intellectual property and associated risks, see Item 1A. “Risk Factors” of this Annual Report on Form 10-K.
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Culture and Workforce
We have built a very special company culture at Upstart. Building the best place for top talent to do great work has been a priority for us from day one. It is not an accident that we have received best place to work awards in both our San Mateo and Columbus locations. In spite of the macro-economic challenges we encountered in 2023 - our employee engagement and retention of our top talent are both strong.
We brought together a remarkable diversity of thinkers to build Upstart. Our co-founders and the members of our management team come from diverse backgrounds with varying ethnicities, education backgrounds, genders and ages. This diversity of thought ensures we tackle problems from all angles and arrive at the best solution for all stakeholders.
Recruiting
We attract and recruit diverse, exceptionally talented, highly educated, experienced and motivated employees. We have an extremely rigorous recruiting and employee candidate screening process. For example, our machine learning team, responsible for the development and constant improvement of our AI models, is unlike any other that we are aware of in the consumer lending space. The majority of the members of this team have doctorate degrees in statistics, mathematics, computer science, economics or physics and many have extensive past experience in quantitative finance.
Culture
The Upstart culture is central to our talent advantage and we have carefully and thoughtfully built it as we have grown. Equity and inclusion underpin everything we do in the people programs we build. From our compensation practices to how we think about talent management and team development to the perks and benefits we invest in, we take a diversity, equity, and inclusion lens to each decision we make and every strategy we build.
Upstart employees are also passionate about building an environment that works for all. Over the last three years, we have invested heavily in growing our employee resource groups, and currently have nine employee led organizations designed to support employees in communities that matter to them. This includes our African American Employee Network, Catalyst (for our LGBTQ2IA+ community), Unidos, APU (for Asian American Upstarters), and most recently, a Veterans ERG, along with more than 20 clubs and special interest groups.
Digital First Approach
A few years ago, we shifted our talent location strategy to one that focused on “digital” work first. Employees in eligible roles (which comprise the majority of our full-time roles) can work from anywhere in the United States, including in one of our three offices in Austin, Texas; Columbus, Ohio; or San Mateo, California. However, to ensure we continue to build relationships and capture the magic of those innovative, in-person “aha” moments, we also provide travel and onsite budgets to ensure teams can come together regularly. We believe the benefits of in-office work can be captured in just a few well-considered days together, so this flexible approach provides Upstart the best of all worlds: in-person collaboration and team building as well as access to diverse talent all over the country.
Employee Benefits
In addition to providing competitive benefits like fully paid health insurance, life insurance and disability, flexible time off for our salaried employees, and fully paid parental leave, we invest in benefits that will provide financial flexibility and financial wellness for our employees - we see this as central to our brand as an employer, and to attracting the types of employees that will be passionate about our mission to serve borrowers. We continue to provide flexible “wellness” and “productivity” budgets allowing our diverse population of employees to spend in ways that will be most useful for them. Inspired by our company mission, we also provide important traditional financial benefits like a 401(k) match (where we match 401(k) contributions up to a set dollar amount, ensuring
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equal access to these benefits dollars regardless of salary level), a generous Employee Stock Purchase Plan, and access to a financial planning and money management platform. We believe that these employee benefits, combined with competitive salaries and an equity program that grants restricted stock units to all full-time employees, have ensured that we remain a top employer in our industry.
As of December 31, 2023, we had 1,388 full-time employees. We also engage temporary employees, contractors and consultants as needed to support our operations. None of our employees are represented by a labor union or subject to a collective bargaining agreement. We have not experienced any work stoppages, and we consider our relations with our employees to be good.
Corporate Information
Upstart Network, Inc. was incorporated in Delaware in 2012. Pursuant to a restructuring, Upstart Holdings, Inc. was incorporated in December 2013 and became the holding company of Upstart Network, Inc. Our principal executive offices are located at 2950 S. Delaware Street, Suite 410, San Mateo, California 94403, and our telephone number is (833) 212-2461. Our website address is www.upstart.com. The content of our websites and information that can be accessed through our websites is not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only.
Available Information
Our website is located at www.upstart.com and our investor relations website at ir.upstart.com. Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge on our investor relations website as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC. The SEC also maintains a website that contains our SEC filings at www.sec.gov. The content of our websites and information that can be accessed through our websites is not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only.
We announce material information to the public about us, our products and services and other matters through a variety of means, including filings with the SEC, press releases, public conference calls, webcasts, the investor relations section of our website (ir.upstart.com), in order to achieve broad, non-exclusionary distribution of information to the public and for complying with our disclosure obligations under Regulation FD.
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ITEM 1A. RISK FACTORS
RISK FACTORS
Investing in our common stock involves a high degree of risk. The risks and uncertainties described below should be carefully considered, together with all of the other information in this Annual Report on Form 10-K, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before making a decision to invest in our common stock. Our business, financial condition, results of operations, or prospects could also be harmed by risks and uncertainties not currently known to us or that we currently do not believe are material. If any of the risks actually occur, our business, financial condition, results of operations, and prospects could be adversely affected. In that event, the market price of our common stock could decline, and you could lose part or all of your investment.
SUMMARY OF RISK FACTORS
The material risks that may affect our business, financial condition or results of operations include, but are not limited to, those relating to the following:
•Our business has been and will continue to be adversely affected by economic conditions and other factors that we cannot control, including the recent bank failures and resulting disruption in the banking sector.
•If we are unable to maintain diverse and resilient loan funding to our marketplace from institutional investors, our growth prospects, business, financial condition and results of operations could be adversely affected.
•If we are unable to continue to improve our AI models or if our AI models contain errors or are otherwise ineffective, our growth prospects, business, financial condition and results of operations would be adversely affected.
•If our AI models do not accurately reflect the impact of economic conditions on borrowers’ credit risk in a timely manner, the performance of Upstart-powered loans may be worse than anticipated and our AI models may be perceived as ineffective.
•If our existing lending partners cease or limit their participation in our marketplace or if we are unable to attract new lending partners to our marketplace, our business, financial condition and results of operations will be adversely affected.
•We have a relatively limited operating history, which may result in increased risks, uncertainties, expenses and difficulties, and makes it difficult to evaluate our future prospects.
•If we are unable to manage the risks associated with the Upstart Macro Index (UMI), which is at an early research and development stage with an unproven track record, our credibility, reputation, business, financial condition and results of operations could be adversely affected.
•We have incurred net losses, and we may not be able to achieve profitability in the future.
•If we are unable to manage risks associated with the loans on our balance sheet, our business, financial condition and results of operations may be adversely affected.
•Our revenue growth rate and financial performance in the past may not be indicative of future performance.
•Our quarterly results are likely to fluctuate and as a result may adversely affect the trading price of our common stock.
•Our loan funding arrangements with institutional investors, securitizations and warehouse credit facilities expose us to certain risks, and if we fail to successfully manage such risks, it may result in the reduced supply of loan funding capital or require us to seek more costly or less efficient financing for our marketplace.
•Our top three lending partners account for a significant portion of loan originations on our marketplace and our revenue.
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•Our reputation and brand are important to our success, and if we are unable to continue developing our reputation and brand, our ability to retain existing and attract new lending partners, our ability to attract borrowers to our marketplace, our ability to maintain diverse and resilient loan funding and our ability to maintain and improve our relationship with regulators of our industry could be adversely affected.
•Our business is subject to a wide range of laws and regulations, many of which are evolving, and failure or perceived failure to comply with such laws and regulations could harm our business, financial condition and results of operations.
•If we are unable to manage the risks related to our loan servicing and collections obligations, our business,
financial condition and results of operations could be adversely affected.
•Substantially all of our revenue is derived from a single loan product, and we are thus particularly susceptible to fluctuations in the unsecured personal loan market. We also do not currently offer a broad suite of products that lending partners or institutional investors may find desirable.
•The sales and onboarding process of new lending partners could take longer than expected, leading to fluctuations or variability in expected revenues and results of operations.
•We are continuing to introduce and develop new loan products and services offerings, and if these products are not successful or we are unable to manage the related risks, our growth prospects, business, financial, condition and results of operations could be adversely affected.
•We rely on strategic relationships with loan aggregators to attract applicants to our marketplace, and if we cannot maintain effective relationships with loan aggregators or successfully replace their services, or if loan aggregators begin offering competing products, our business could be adversely affected.
RISKS RELATED TO OUR BUSINESS AND INDUSTRY
Our business has been and will continue to be adversely affected by economic conditions and other factors that we cannot control.
Uncertainty, volatility and negative trends in general economic conditions historically have created a difficult operating environment for our industry. Many factors, including factors that are beyond our control, have impacted and will continue to impact our business, financial condition and results of operations by affecting the supply of capital to our marketplace from our lending partners and institutional investors, the demand by borrowers of Upstart-powered loans, and borrowers’ ability and willingness to repay their loans. These factors include, but are not limited to, interest rates, inflation, fiscal and monetary policies, unemployment levels, personal savings rates, disruptions in the banking sector, lower consumer confidence, reduced consumer discretionary spending, conditions in the housing market, immigration policies, gas prices, energy costs, government shutdowns, trade wars and delays in tax refunds, as well as events such as natural disasters, acts of war, geopolitical conflicts, terrorism, catastrophes and pandemics. If any of these factors negatively affect borrowers, lending partners or institutional investors, or if we are unable to mitigate the risks associated with them, our business, financial condition and results of operations could be adversely affected.
In recent years, the United States has experienced historically high levels of inflation. In response, the government has implemented policy interventions, and the U.S. Federal Reserve has raised, and may continue to raise, interest rates. While the goal is to curb inflation, these interventions may have broad macroeconomic implications and may contribute to an economic downturn, higher unemployment rates or disrupt the banking sector.
The current macroeconomic environment and resulting uncertainty and volatility have had, and could continue to have, several effects on our business and results of operations, including, among other things:
•a decrease in loan origination volume;
•a reduction in loan funding from lending partners and institutional investors;
•a reduction in liquidity in the capital markets;
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•lower approvability of, and acceptance of loan offers by, applicants;
•increased utilization of our balance sheet to fund Upstart-powered loans;
•delays in the adoption of our AI lending marketplace by new lending partners;
•increased delinquencies and default rates for Upstart-powered loans; and
•reductions in workforce.
The current macroeconomic environment has had, and may continue to have, a material adverse effect on our business by affecting the supply of capital to our marketplace from institutional investors and lending partners. For more information, see the risk factors titled “—If we are unable to maintain diverse and resilient loan funding to our marketplace from institutional investors, our growth prospects, business, financial condition and results of operations could be adversely affected” and “—If our existing lending partners cease or limit their participation in our marketplace or if we are unable to attract new lending partners to our marketplace, our business, financial condition and results of operations will be adversely affected”.
We offer consumer loans, such as personal and auto loans, on our marketplace, and many consumers that come to our marketplace have poor, limited or no credit history. Such consumers have historically been, and may in the future be, disproportionately affected by adverse macroeconomic conditions. Inflation, higher interest rates, availability of welfare programs, unemployment, bankruptcy, government interventions, such as stimulus measures, major medical expenses, divorce or death may affect borrowers’ ability or willingness to borrow or make payments on loans. The recent macroeconomic trends have negatively impacted borrowers’ ability and willingness to borrow and make repayments. Such trends also have led to higher costs of borrowing on loans offered on our marketplace. While the costs of borrowing and risks associated with consumer lending have increased, the maximum annual percentage rate of Upstart-powered loans has been set and always has been less than 35.99% due to regulatory reasons. As a result, the pool of applicants that would qualify for a loan offer has become smaller, and fewer applicants have received or accepted loan offers than they have in the past. In a high interest rate environment, potential borrowers may also prefer to defer loans as they wait for interest rates to stabilize. These factors have and could continue to lower our loan origination volume.
During an economic down cycle, there is a greater risk that borrowers will not make payments on loans. Borrowers may not prioritize repayment of unsecured personal loans over loans that are secured by necessities, for example, mortgages or auto loans. Higher interest rates often lead to higher payment obligations, which may reduce the ability of borrowers to remain current on their obligations. These factors lead to increased delinquencies, defaults and bankruptcies declared by borrowers, resulting in more charge-offs and less recoveries, all of which have had, and could continue to have, a material adverse effect on the credit performance of loans facilitated on our marketplace and our business. For example, the vintages of core personal loans that originated in the first quarter of 2021 through the second quarter of 2023 are forecasted to underperform relative to the target returns set at the time of loan origination. When a borrower defaults on a loan, it increases our costs to service the loan. Because default rates have been higher than expected, it has negatively impacted, and may continue to negatively impact, demand by our lending partners to originate, and institutional investors to fund, loans facilitated through our marketplace. Any sustained decline in applicant approvability or acceptance of loan offers or loan origination volume, or any increase in delinquencies or defaults by borrowers beyond our expectation, would harm our business, financial condition and results of operations.
If we are unable to maintain diverse and resilient loan funding to our marketplace from institutional investors, our growth prospects, business, financial condition and results of operations could be adversely affected.
Our business depends on sourcing and maintaining diverse and resilient loan funding from institutional investors to our marketplace. The institutional investors provide loan funding to our marketplace by purchasing whole loans, pass-through certificates and asset-backed securities. As of December 31, 2023, out of the total principal of loan originations facilitated on our marketplace in 2023, 48% were purchased by institutional investors. The availability and capacity of loan funding from institutional investors depend on many factors that are outside of
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our control, such as economic and market conditions, interest rates, liquidity in the capital markets and regulatory reforms. We cannot be sure that the existing funding sources will continue to be available, or any new funding source will become available, on commercially reasonable terms or at all.
We have recently experienced reductions in capital to our marketplace due to the current macroeconomic environment, including rapidly rising interest rates, increased credit risk of consumers, recessionary concerns, and stress on banks’ balance sheets driven by bank failures in 2023. Our institutional investors have decreased their loan purchase volumes in light of the recent macroeconomic environment and have demanded a lower price and higher returns to cover the higher cost of funds and increased credit risks. A reduction in loan purchase volume and sale price has negatively impacted, and could continue to negatively impact, our revenue, operations and returns. Decreased funding from institutional investors, together with lower approvability of loan applicants, reduced loan origination volume on our marketplace, which has had and could continue to have a negative impact on our revenue. Any sustained decline in investor demand for Upstart-powered loans or securities secured by such loans, or any increase in delinquencies, defaults or losses beyond our expectation due to adverse economic conditions, may also reduce the price we receive on future loan sales.
In response to funding constraints, we have utilized, and expect to continue to utilize, our balance sheet to support funding of loans that would otherwise be sold to institutional investors. The use of our balance sheet to support loan funding diverts capital resources, increases our exposure to the changes in the fair value of such loans and has resulted in and could result in losses when such loans held on our balance sheet default or we sell them at a loss. Furthermore, we have sought, and continue to seek, committed capital arrangements with institutional investors. These arrangements may include terms that provide downside risk protection, subject to certain limits and conditions. In particular, we have agreed to compensate, subject to a limit, the committed capital investors if credit performance on the loans sold to them deviates from expectations. As of December 31, 2023, our capital at risk, which represents the maximum exposure to losses, under these arrangements was $98.5 million. Risk sharing arrangements have negatively impacted our financial results through unfavorable fair value adjustments and may continue to do so in the future. We may also experience declines in revenue and loan volume if the existing committed capital investors do not provide funding on the agreed upon terms or we fail to secure additional committed capital arrangements in the future on commercially reasonable terms or at all. Moreover, despite our efforts, we may continue to experience funding constraints and cannot be certain if any measures we have taken, such as committed capital arrangements, or will take to address or mitigate the effects of funding constraints, will be sufficient or successful. In the event of continued funding constraints, we may not be able to maintain our current loan origination volume without incurring substantially higher funding costs, agreeing to terms that are not favorable to us or further relying on our balance sheet to support funding, each of which could adversely affect our business, financial condition and results of operations.
Due to the adverse economic conditions and bank failures in 2023, the securitization markets in general have been constrained. We have experienced less demand for our asset-backed securities secured by Upstart-powered loans. Events of default or breaches of financial, performance or other covenants, or worse than expected performance of certain pools of loans underpinning our asset-backed securitizations, debt facilities or other structured and unstructured transactions, have limited in the past and could limit our access to funding from institutional investors. For example, the loans originated in 2021 through mid-2022 that were included in our asset-backed securitizations have underperformed relative to their expected target returns at the time of origination, resulting in negative rating agency actions in several of our asset-based securitizations. We cannot be certain if and when investor demand for securitizations will recover. Moreover, the funding arrangements that we have recently entered into during a high interest rate environment, such as the committed capital arrangements, may become more costly if interest rates fall and the terms of such arrangements remain through a full economic cycle.
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If we are unable to continue to improve our AI models or if our AI models contain errors or are otherwise ineffective, our growth prospects, business, financial condition and results of operations would be adversely affected.
Our ability to attract potential borrowers, and thus increase loan originations on our marketplace, depends in large part on our ability to effectively evaluate the creditworthiness of borrowers and likelihood of default and, based on that evaluation, offer competitively priced loans. Our overall operating efficiency and margins further depend in part on our ability to maintain a high degree of automation in our loan application process and achieve incremental improvements in the degree of automation. If our AI models fail to adequately predict the creditworthiness of borrowers and the likelihood of default due to the design of our models or programming or any other errors or inaccuracies, and our AI models do not detect or account for such errors or inaccuracies, or any of the other components of our credit decision process fails, we may experience higher than forecasted losses on loans. Any of the foregoing could result in sub-optimally priced loans or incorrect approvals or denials of loans, any of which may lead to lower demand by borrowers and reduce loan originations. Moreover, in addition to reduced borrower demand, higher than expected losses on Upstart-powered loans could further harm our ability to attract capital to our marketplace. Our lending partners and institutional investors may decide to limit their funding or reduce the number of loans or types of loans they fund if they experience higher than expected losses on their cost of funds due to underperformance of the loans. It may also hinder our ability to increase the size of, or enter into new, debt facilities or other financing arrangements.
Our AI models also target and optimize other aspects of the lending process, such as borrower acquisition, fraud detection, default timing, loan stacking and prepayment timing. Our continued improvements to such models have allowed us to facilitate loans inexpensively and virtually instantly, with a high degree of consumer satisfaction while maintaining loan performance. However, such applications of our AI models may prove to be less predictive than we expect, or than they have been in the past, for a variety of reasons, including inaccurate assumptions or other errors made in constructing such models, incorrect interpretations of the results of such models and failure to update model assumptions and parameters in a timely manner. Additionally, such models may not be able to effectively account for matters that are inherently difficult to predict and beyond our control, such as macroeconomic conditions, credit market volatility and interest rate fluctuations, which often involve complex interactions between a number of dependent and independent variables and factors. Material errors or inaccuracies in such AI models could lead us to make inaccurate or sub-optimal operational or strategic decisions, which could adversely affect our business, financial condition and results of operations.
Continuing to improve the accuracy of our AI models is central to our business strategy. However, such improvements could negatively impact transaction volume, such as by lowering approval or conversion rates. For example, in the third quarter of 2021, we made changes to our AI models in response to an increase in fraudulent activity on our platform. These changes, while effective at preventing fraudulent loans from being transacted, have resulted in a decrease in our Conversion Rate. While we believe that continuing to improve the accuracy of our AI models is key to our long-term success, those improvements have led us in the past and could, from time to time, lead us in the future to reevaluate our credit decisioning process, including the risks associated with certain borrowers. This has resulted, and could in the future result, in lower approval rates or higher interest rates for any borrowers identified as a higher risk, either of which could negatively impact our growth and results of operations in the short term.
If our AI models do not accurately reflect the impact of economic conditions on borrowers’ credit risk in a timely manner, the performance of Upstart-powered loans may be worse than anticipated and our AI models may be perceived as ineffective.
The performance of loans facilitated through our marketplace is significantly dependent on the effectiveness of our proprietary AI models used to evaluate a borrower’s credit profile and likelihood of default. Our AI models have not been extensively tested during economic downturn or recession. Even if credit decisions take into account macroeconomic conditions, there is no assurance that our AI models can accurately predict loan performance during periods of adverse economic conditions or quickly respond to changing economic conditions. If our AI models are unable to accurately reflect the credit risk of loans under such economic conditions, we, our
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lending partners and our institutional investors would experience greater than expected losses on such loans, which would harm our reputation and erode the trust we have built with our lending partners and institutional investors. We have experienced and may continue to experience high delinquency rates and underperformance of loans originated using our AI models in recent periods. For example, the quarterly vintages of core personal loans that originated in the first quarter of 2021 through the second quarter of 2023 are forecasted to underperform relative to the target returns set at the time of loan origination. The fair value of the loans on our balance sheet has declined and may continue to decline. Our business, financial condition and results of operations can continue to be adversely affected if our AI models are not able to accurately and timely assess the impact of macroeconomic conditions on the performance and default rates of loans facilitated through our marketplace.
If our existing lending partners cease or limit their participation in our marketplace or if we are unable to attract new lending partners to our marketplace, our business, financial condition and results of operations will be adversely affected.
Our success depends in significant part on the participation of our lending partners in our marketplace. In the year ended December 31, 2023, 86% of our total revenue was generated from platform, referral and servicing fees that we receive from our lending partners. Our lending partners also provide loan funding to our marketplace by retaining a significant portion of the loans facilitated through our marketplace. As of December 31, 2023, out of the total principal of loan originations facilitated on our marketplace in 2023, 32% were retained by our lending partners. If we are unable to keep existing lending partners or attract new lending partners to our marketplace, or if we are unable to maintain or increase the portion of loans retained by the lending partners, our financial performance could suffer.
Our lending partners may suspend, limit or cease their participation in our marketplace for a number of reasons. Several of our lending partners have paused or reduced loan origination in order to limit their exposure to consumer loans in the current macroeconomic environment. In connection with disruptions in the banking sector, lending partners are managing their balance sheets conservatively and are focused on liquidity, all of which have limited, and may continue to limit, our ability to attract new lending partners and maintain or increase loan originations on our marketplace. If our lending partners continue to suspend, limit or cease their operations or terminate their relationships with us, the number of loans facilitated through our marketplace will decrease and our revenue will be adversely affected. Moreover, new lending partners may find our sales and onboarding process to be long and unpredictable. If we are unable to timely onboard our lending partners, or if our lending partners are not willing to work with us to complete an onboarding process, our results of operations could be adversely affected.
We enter into a separate agreement with each of our lending partners. Our agreements with our lending partners are nonexclusive and may contain minimum fee amounts. Our lending partners could decide to stop working with us, ask to modify their agreement terms in a cost prohibitive manner when their agreement is up for renewal or enter into exclusive or more favorable relationships with our competitors. In addition, their regulators may require that they terminate or otherwise limit their business with us, or impose regulatory pressure limiting their ability to do business with us. See the risk factors titled “—Our business is subject to a wide range of laws and regulations, many of which are evolving, and failure or perceived failure to comply with such laws and regulations could harm our business, financial condition and results of operations” and “—The CFPB has sometimes taken expansive views of its authority to regulate consumer financial services, creating uncertainty as to how the agency’s actions or the actions of any other agency could impact our business” for more information. Moreover, we could in the future have disagreements or disputes with any of our lending partners, which could negatively impact or threaten our relationship with them. In our agreements with lending partners, we make certain representations and warranties and covenants concerning our compliance with specific policies of a lending partner, certain procedures and guidelines related to laws and regulations applicable to our lending partners, as well as the services to be provided by us. If those representations and warranties were not accurate when made or if we fail to perform a covenant, we may be liable for any resulting damages, including potentially any losses associated with impacted loans, and our reputation and ability to continue to attract new lending partners would be adversely affected. Additionally, our lending partners may engage in mergers, acquisitions or consolidations with each other, our competitors or with third parties, any of which could be disruptive to our existing and prospective relationships with
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our lending partners. If we fail to maintain or grow the number of lending partners, our business, financial condition and results of operation could be adversely affected.
We have a relatively limited operating history, which may result in increased risks, uncertainties, expenses and difficulties, and makes it difficult to evaluate our future prospects.
We were founded in 2012 and have been a publicly traded company for a limited number of years. Our limited operating history may make it difficult to make accurate predictions about our future performance. Assessing our business and future prospects may also be difficult because of the risks and difficulties we face. These risks and difficulties include our ability to:
•successfully mitigate any adverse effects of economic conditions such as high interest rates, inflation, unemployment levels, personal savings rates and other macroeconomic factors on our business;
•improve the effectiveness and predictiveness of our AI models, including successfully adjusting our proprietary AI models, products and services in a timely manner in response to changing macroeconomic conditions and fluctuations in the credit market;
•maintain and increase the volume of loans facilitated through our AI lending marketplace;
•successfully maintain diverse and resilient loan funding to our marketplace from institutional investors;
•attract new lending partners to our marketplace and maintain existing lending partnerships;
•successfully meet our borrower demand with competitive products and terms;
•offer competitive interest rates to borrowers on our marketplace, while enabling our lending partners and institutional investors to achieve an adequate return over their cost of funds;
•successfully build our brand and protect our reputation from negative publicity;
•increase the effectiveness of our marketing strategies;
•continue to expand the number of potential borrowers;
•comply with and successfully adapt to complex and evolving regulatory environments;
•protect against increasingly sophisticated fraudulent borrowing and online theft;
•successfully compete with companies that are currently in, or may in the future enter, the business of providing online lending services to financial institutions or consumer financial services to borrowers;
•enter into new markets and introduce new products and services;
•effectively secure and maintain the confidentiality of the information received, accessed, stored, provided and used across our systems;
•successfully obtain and maintain corporate funding and liquidity to support growth and for general corporate purposes;
•attract, integrate and retain qualified employees; and
•effectively manage and expand the capabilities of our operations teams, outsourcing relationships and other business operations.
If we are not able to timely and effectively address these risks and difficulties as well as those described elsewhere in this “Risk Factors” section, our business and results of operations may be harmed.
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If we are unable to manage the risks associated with the Upstart Macro Index (UMI), which is at an early research and development stage with an unproven track record, our credibility, reputation, business, financial condition and results of operations could be adversely affected.
UMI is our effort to quantify the level of macroeconomic risks in terms of the losses or defaults within Upstart-powered loan portfolios. UMI is at an early stage of its development and does not have a long history or track record. Since it is a relatively new initiative, UMI remains unproven and, therefore, may not perform as expected. We intend to continue our research and development efforts to improve UMI. In light of such efforts, we have revised our previously published UMI values, including to remove seasonal patterns, and may further change or revise the current or past UMI values in the future. Any significant changes or revisions could harm our reputation and credibility with our lending partners and institutional investors, which in turn could adversely affect our business, financial condition and results of operations.
Furthermore, the correlation between UMI and the level of macroeconomic risks in terms of losses or defaults within Upstart-powered loan portfolios may not be as significant or meaningful as we expect. If the correlation between UMI and the level of macroeconomic risks is misaligned or skewed in a way that is unacceptable to our lending partners or institutional investors, or UMI fails to accurately or adequately quantify the level of macroeconomic risks, this lack of a meaningful correlation may result in distrust or disregard of UMI. This outcome could adversely affect our reputation and credibility with our lending partners and institutional investors and thus, negatively impact our business, financial condition and results of operations.
UMI is based on our analysis of the losses within Upstart-powered loan portfolios and is specific to our borrower base. UMI is not intended to measure the macroeconomic risks in terms of losses of loan portfolios or assets that are not Upstart-powered loans, including loans held by other segments of the U.S. population. It is not designed to measure the current state of the overall economy or to measure or predict future macroeconomic conditions, trends or risks. It is also not designed to measure or predict Upstart’s future loan performance, results of operations or stock price. Investors, lending partners and analysts may improperly use or rely on UMI for these or other unintended purposes, or otherwise misunderstand or misinterpret UMI. If UMI is misunderstood or misinterpreted in these ways, it could harm our reputation and credibility with our lending partners and institutional investors and impair our ability to retain and attract them to our lending marketplace. This could further reduce the number or types of loan products that our lending partners and institutional investors are willing to fund. Any failure to manage the foregoing risks could adversely affect our ability to maintain diverse and resilient loan funding to our marketplace, which in turn would negatively impact our business, financial condition and results of operations.
We have incurred net losses, and we may not be able to achieve profitability in the future.
For the year ended December 31, 2023, we incurred a net loss of $240.1 million. We have expended, and intend to continue to expend, significant funds to develop and improve our proprietary AI models, attract additional borrowers to our marketplace, enhance the features and overall user experience on our platform, expand loan product offerings and otherwise continue to grow our business, and we may not be able to increase our revenue enough to offset these significant expenditures. We have incurred, and expect to incur in the future, significant losses for a number of reasons, including the other risks described in this section, and unforeseen expenses, difficulties, complications and delays, macroeconomic conditions and other unknown events. Any failure to increase our revenue sufficiently to keep pace with our investments and other expenses would prevent us from being profitable. If we are unable to successfully address these risks and challenges as we encounter them, our business, financial condition and results of operations could be adversely affected.
If we are unable to manage risks associated with the loans on our balance sheet, our business, financial condition and results of operations may be adversely affected.
We have held more Upstart-powered loans on our balance sheet in recent years and may continue to do so in the future. We have used, and may continue to use, our balance sheet to support our research and development activities for new loan products and borrower segments. In addition to research and development activities, we have used and may continue to use our balance sheet to purchase loans from lending partners to address fluctuations in
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supply and demand in our marketplace and periodically sell these loans to institutional investors prior to their maturity. As of December 31, 2023, out of the total principal of loan originations facilitated on our marketplace in 2023, 16% were held on our balance sheet, excluding loans held in consolidated securitization. As of December 31, 2023, we held $977.3 million of loans on our balance sheet, excluding loans held in consolidated securitization. We hold loans on our balance sheet at fair value and estimate fair value using a discounted cash flow methodology. An increase in the market interest rates reduces the fair value of loans held on our balance sheet by increasing the discount rate used to determine fair value under the discounted cash flow methodology. Currently, we are in a high interest rate environment. The high interest rates have negatively affected the fair value of loans held on our balance sheet and may continue to do so in the future. In addition, for these loans and any future loans to be held on our balance sheet, we bear the credit risk in the event of borrower default. Our exposure to rising borrower default rates and their volatility has increased, and may continue to increase, as we hold more Upstart-powered loans on our balance sheet. The R&D loans make up a substantial portion of the loans held on our balance sheet and are generally more risky and more likely to default than the core personal loans. Recently, the default rates and charge-offs for these loans have been higher than expected for certain loan categories, and consequently, we had to make unfavorable fair value adjustments to the loans on our balance sheet. These unfavorable fair value adjustments have negatively impacted our revenue, and if we continue to experience higher than expected default rates or the loans otherwise fail to perform as expected, we would need to make additional unfavorable fair value adjustments in the future, which would negatively impact our revenue. It is also possible that we may recognize a loss if we sell the loans held on our balance sheet, such as the R&D loans, at an unfavorable price. From a liquidity perspective, the growing amount of loans on our balance sheet increases our liquidity risk. We cannot be certain whether we will be able to sell these loans, or any future loans to be put on our balance sheet, on commercially reasonable terms or at all. If we are unable to do so, it is possible that our ability to meet our operational needs and obligations may be disrupted. Moreover, the use of our balance sheet diverts financial resources from other uses, such as improving our products and services, which could have an adverse effect on our results of operations.
Our revenue growth rate and financial performance in the past may not be indicative of future performance.
We grew rapidly in the past, and our historical revenue growth rate and financial performance may not be indicative of our future performance. Our revenue for any previous quarterly or annual periods should not be relied upon as any indication of our revenue or revenue growth in future. In fact, our revenue declined during the year ended December 31, 2023. Our revenue may continue to decline in the future for a number of reasons, which may include: adverse macroeconomic conditions, changing interest rates, slowing demand for or reduced funding through our lending marketplace, sales of loans held on our balance sheet at a loss, increasing competition, credit market volatility, increasing regulatory costs and challenges and our failure to capitalize on growth opportunities.
We believe our growth was driven in large part by our AI models and our continued improvements to our AI models. Future incremental improvements to our AI models may not lead to the same level of growth as they did in the past. In addition, we believe our past growth was driven in part by our ability to rapidly streamline and automate the loan application and origination process on our platform. We expect the Percentage of Loans Fully Automated to level off and remain relatively stable in the long term. However, the expansion of our loan offerings beyond unsecured personal loans, such as auto loans and home equity lines of credit, may cause fluctuations of such percentage from period to period depending on the loan offering mix. As a result of these factors, our revenue may further decline, and our financial performance may continue to be adversely affected.
Our quarterly results are likely to fluctuate and as a result may adversely affect the trading price of our common stock.
Our quarterly results of operations, including our revenue, net income (loss) and other key metrics, are likely to vary significantly in the future, and period-to-period comparisons of our results of operations may not be meaningful. Accordingly, the results for any one quarter are not necessarily an accurate indication of future performance. Our quarterly financial results may fluctuate due to a variety of factors, many of which are outside of our control. Factors that may cause fluctuations in our quarterly financial results include but are not limited to:
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•general economic conditions, including economic slowdowns, recessions, interest rate changes, inflation, tightening of credit markets and disruptions in the banking sector;
•our cost of borrowing money and access to loan funding sources;
•our ability to improve the effectiveness and predictiveness of our AI models, including improvements that negatively impact transaction volume, such as lower approval rates;
•our ability to attract new lending partners and institutional investors to our marketplace;
•our ability to maintain relationships with existing lending partners and institutional investors;
•our ability to maintain or increase loan volumes, and improve loan mix and the channels through which the loans, lending partners and loan funding are sourced;
•our ability to maintain effective relationships with loan aggregators from which prospective borrowers access our website;
•our ability to identify and prevent fraudulent activity and the impact of fraud prevention measures;
•changes in the fair value of assets and liabilities on our balance sheet;
•the timing and success of new products and services;
•the effectiveness of our direct marketing and other marketing channels;
•the amount and timing of operating expenses related to maintaining and expanding our business, operations and infrastructure, including acquiring new and maintaining existing lending partners and institutional investors and attracting borrowers to our marketplace;
•the number and extent of prepayments of loans facilitated on our platform;
•network outages or actual or perceived security breaches or incidents;
•our involvement in litigation or regulatory enforcement efforts (or the threat thereof) or those that impact our industry generally;
•the length of the onboarding process related to acquisitions of new lending partners;
•changes in laws and regulations that impact our business; and
•changes in the competitive dynamics of our industry, including consolidation among competitors or the development of competitive products by larger well-funded incumbents.
In addition, we typically experience seasonality in the demand for Upstart-powered loans, which is generally lower in the first quarter. This seasonal slowdown is primarily attributable to high loan demand around the holidays in the fourth quarter and the general increase in borrowers’ available cash flows in the first quarter, including cash received from tax refunds, which temporarily reduces borrowing needs. Such seasonality and other fluctuations in our quarterly results may also adversely affect and, increase the volatility of, the trading price of our common stock.
Our loan funding arrangements with institutional investors, securitizations and warehouse credit facilities expose us to certain risks, and if we fail to successfully manage such risks, it may result in the reduced supply of loan funding capital or require us to seek more costly or less efficient financing for our marketplace.
We have facilitated securitizations, and may in the future facilitate additional securitizations, of Upstart-powered loans to allow our institutional investors, certain lending partners and/or ourselves to liquidate or finance such loans through the asset-backed securities markets or through other capital markets products. In asset-backed securities transactions, we sell and convey pools of loans to a special purpose entity, or SPE. We likewise fund certain loans on our balance sheet by selling loans to warehouse trust SPEs and drawing on the associated warehouse credit facilities. Each securitization SPE issues notes and/or certificates pursuant to the terms of indentures and trust agreements, or in the case of the warehouse credit facilities, the warehouse trust SPE borrows money from banks
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pursuant to credit and security agreements. The securities issued by the SPEs in asset-backed securitization transactions and the lines of credit borrowed by the warehouse SPEs are each secured by the pool of loans owned by the applicable SPE. We, our institutional investors who have purchased whole loans or pass-through certificates, and/or our lending partners contribute loans to the SPE and in exchange, receive cash and/or securities representing debt and/or equity interests in such SPE.
When we are the sole sponsor of securitizations, we are required under Regulation RR to retain at least five percent of the credit risk in such transactions for a specific period of time, depending on the type of asset that is securitized. We have in the past and may choose to retain additional securities, such as notes or certificates, issued in asset-backed securitization transactions we sponsor or facilitate. The certificates represent residual equity interests in the SPEs and are subordinated to the notes and thus are exposed to greater credit risk. In 2023, we acted as a sole retaining sponsor to asset-backed securitizations and, in one instance, retained not only the securities required for risk retention purposes under Regulation RR, but also additional residual equity interests, exposing us to greater credit risk. The securities we retain may lose value, including becoming worthless. In the future, we may retain securities issued as part of our securitizations beyond risk retention requirements again. In addition, other matters, such as capital and leverage requirements applicable to banks and other regulated financial institutions holding asset-backed securities or increasing competition from other issuers of asset-backed securities, could negatively impact our business by decreasing institutional investor demand for securities issued through our securitization transactions. In addition, compliance with certain regulatory requirements, including the Dodd-Frank Act, the Investment Company Act and the so-called “Volcker Rule,” may affect the type of securitizations that we are able to complete.
If it is not possible or economical for us to securitize loans in the future, we may need to seek alternative financing to provide loan funding to our marketplace and to meet our existing debt obligations. Such funding may not be available on commercially reasonable terms, or at all. If the cost of such loan funding mechanisms were to be higher than that of our securitizations it would negatively impact our results of operations. If we are unable to access such financing, our ability to originate loans and our results of operations, financial condition and liquidity may be materially adversely affected.
The servicing fees generated by our loan servicing activities for the loans sold to institutional investors and contributed to asset-based securitizations and pass-through certificate transactions also represent a material portion of our earnings. There is no assurance that our institutional investors will continue to purchase loans or securities (either through whole loan sales, asset-backed securities, pass-through certificate issuances or other direct or indirect purchase arrangements) or that they will continue to purchase loans in transactions that generate the same spreads and/or fees that we have historically obtained. During the year ended December 31, 2023, we sold loans that had been originated in an earlier, lower interest rate environment. We recognized losses on these sales which reduced our revenue. As we hold more loans on our balance sheet, our business, financial condition and results of operation could be adversely affected, including further reductions in revenue. Factors that may affect demand by institutional investors for Upstart-powered loans include:
•competition in the whole loan sales markets where we compete with loan originators who can sell either larger loan portfolios or loans that have characteristics, pricing and terms that may be perceived to be more desirable to certain institutional investors than those offered in Upstart-powered loans that comprise our whole loan sales;
•competition in the securitization markets where we compete with loan originators and other issuers who can securitize or sell pools of loans (which such pools may include Upstart-powered loans, on a commingled basis or otherwise) with characteristics, pricing and terms that may be perceived to be more desirable to certain institutional investors than those offered in Upstart-powered loans contributed to asset-based securitization transactions that we facilitate;
•the extent to which servicing fees and other expenses may reduce overall net return on purchased pools of loans;
•the actual or perceived credit performance of loan products offered on our marketplace;
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•economic conditions such as high interest rates, inflation, economic volatility and other macroeconomic factors;
•risk appetite of our institutional investors;
•the loan grade and term mix of the portfolios of loans offered for sale;
•institutional investors’ sector and company investment diversification requirements and strategies;
•higher yielding investment opportunities at a risk profile deemed similar to our sold loan portfolios;
•borrower prepayment behavior within the underlying pools;
•regulatory or investment practices related to maintaining net asset value, mark-to-market and similar metrics surrounding pools of purchased loans; and
•the ability of our institutional investors to access funding and liquidity channels, including warehouse financing and securitization markets, on terms they find acceptable to deliver an appropriate return net of funding costs, as well as general economic conditions and market trends, such as increasing interest rates, that affect the appetite for loan financing investments.
In connection with our committed capital arrangements, we have agreed to compensate, subject to a limit, the committed capital investors if credit performance on the loans sold to them deviates from expectations. As of December 31, 2023, our capital at risk, which represents the maximum exposure to losses, under these arrangements was $98.5 million. See “Note 5. Beneficial Interests” for more information. Risk sharing arrangements could negatively impact our financial results. We may also experience declines in revenue and loan volume if the existing committed capital investors do not provide funding on the agreed upon terms or we fail to secure additional committed capital arrangements on commercially reasonable terms, or at all.
We are also subject to risk that arises from our derivative instruments, beneficial interests, warehouse facilities, and third-party custodians. These activities generally involve an exchange of obligations with unaffiliated lenders or other individuals or entities, referred to in such transactions as “counterparties”. If a counterparty were to default or otherwise fail to perform, we could potentially be exposed to loss if such counterparty were unable to meet its obligations to us, which could adversely affect our business, financial condition and results of operations.
Our top three lending partners account for a significant portion of loan originations on our marketplace and our revenue.
Our top three lending partners originate a significant portion of loans on our marketplace. In the year ended December 31, 2023, our top three lending partners collectively originated 80% of the Transaction Volume, Number of Loans and accounted for 63% of our total revenue. There are no minimum commitments to originate any loans under the agreements we have with our lending partners. If our top three lending partners were to suspend, limit or cease their operations or otherwise terminate their relationship with us, our business, financial condition and results of operations would be adversely affected. As of December 31, 2023, we had more than 100 lending partners participating on our marketplace, and we continue to expand our lending partnerships to new participants. If we are unable to continue to increase the participation by other lending partners on our marketplace, we will continue to be reliant on a small number of lending partners for a significant portion of loan originations and revenue, which could harm our business.
Our reputation and brand are important to our success, and if we are unable to continue developing our reputation and brand, our ability to retain existing and attract new lending partners, our ability to attract borrowers to our marketplace, our ability to maintain diverse and resilient loan funding and our ability to maintain and improve our relationship with regulators of our industry could be adversely affected.
We believe maintaining a strong brand and trustworthy reputation is critical to our success and our ability to attract borrowers to our marketplace, attract new lending partners, maintain diverse and resilient loan funding and sustain good relations with regulators. Factors that affect our brand and reputation include: perceptions of artificial intelligence, our industry and our company, including the quality and reliability of our AI lending marketplace; the
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accuracy of our AI models; characterizations of our company as a traditional lending company due to the amount of loans held on our balance sheet; perceptions regarding the application of artificial intelligence to consumer lending specifically and that algorithmic lending is inherently biased; the reputation of the vehicle dealerships with which we partner; loan funding to our marketplace; changes to the Upstart marketplace; our ability to effectively manage and resolve borrower complaints; collection practices; privacy and security practices; litigation, such as class action and shareholder derivative lawsuits described in “Legal” section under “Note 13. Commitments and Contingencies”; regulatory activity; and the overall user experience of our platform. Negative publicity or negative public perception of these factors, even if inaccurate, could adversely affect our brand and reputation.
For example, consumer advocacy groups, politicians and certain government and media reports have, in the past, advocated governmental action to prohibit or severely restrict consumer loan arrangements where banks contract with a third-party platform such as ours to provide origination assistance services to bank customers. These arrangements have sometimes been criticized as “renting-a-bank charter” or “rent-a-bank”. Such criticism has frequently been levied in the context of payday loan marketers, though other entities operating programs through which loans similar to Upstart-powered loans are originated have also faced criticism. The perceived improper use of a bank charter by these entities has been challenged by both governmental authorities and private litigants, in part because of the high rates and fees charged to consumers in certain payday and high-rate, small-dollar lending programs. Bank regulators have even required banks to exit third-party programs that the regulators determined involved unsafe and unsound practices. The payday loans that have been subject to more frequent criticism and challenge are fundamentally different from Upstart-powered loans in many ways, including that Upstart-powered loans typically have lower interest rates and longer terms, and Upstart-powered loans do not renew. In particular, interest rates of Upstart-powered loans have always been and are currently less than 36%, as compared to the triple-digit interest rates of many payday or small dollar loans that have been subject to such criticism. However, states that are addressing their rent-a-bank concerns through legislation may inadvertently capture Upstart’s AI marketplace, and if that were to happen, our lending partners may need to scale back lending on our marketplace to comply with state laws or terminate their participation in our marketplace, leading to a reduction in origination volume. It could also negatively impact demand for Upstart-powered loans, our ability to attract new lending partners, our ability to attract loan funding to our marketplace or reduce the number of potential borrowers to our marketplace. Any of the foregoing could adversely affect our results of operations and financial condition.
Any negative publicity or public perception of Upstart-powered loans or other similar consumer loans or the consumer lending service we provide may also result in us being subject to more restrictive laws and regulations and potential investigations and enforcement actions. For example, some unfair or deceptive practices by vehicle dealerships can be attributed to us as a purchaser of retail installment contracts under the FTC Holder Rule, which allows a vehicle purchaser to bring any claim against the dealership to the holder of a retail installment contract. In addition, regulators may decide they are no longer supportive of our AI lending marketplace if there is enough negative perception surrounding such practices. We may also become subject to lawsuits, including class action lawsuits, or other challenges such as government enforcement or arbitration, against our lending partners or us for loans originated by our lending partners on our marketplace, loans we service or have serviced, or retail installment contracts we have purchased. If there are changes in the laws or in the interpretation or enforcement of existing laws affecting consumer loans similar to those offered on our marketplace, or our marketing and servicing of such loans, or if we become subject to such lawsuits, our business, financial condition and results of operations would be adversely affected.
Artificial intelligence and related technologies are subject to public debate and heightened regulatory scrutiny. The Consumer Financial Protection Bureau (“CFPB”) recently indicated that artificial intelligence remains a regulatory hot topic for the agency including the use of complex credit scoring models as part of the loan underwriting process. The agency has taken several steps to increase regulatory scrutiny of financial technology companies that rely on artificial intelligence. In April 2023, the Federal Trade Commission (“FTC”), the Department of Justice (“DOJ”), the CFPB, and the Equal Employment Opportunity Commission (“EEOC”) released a joint statement on artificial intelligence demonstrating their interest in monitoring the development and use of automated systems and enforcement of their respective laws and regulations, and in October 2023, President Biden signed an Executive Order aimed at protecting consumers against harms caused by artificial intelligence. Any negative publicity or negative public perception of artificial intelligence could negatively impact demand for our AI lending
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marketplace, hinder our ability to attract new lending partners or slow the rate at which lending partners adopt our AI lending marketplace. From time to time, certain advocacy groups have made claims that unlawful or unethical discriminatory effects may result from the use of AI technology by various companies, including ours. Such claims, whether or not accurate, and whether or not concerning us or our AI lending marketplace, may harm our ability to attract prospective borrowers to our marketplace, retain existing and attract new lending partners and achieve regulatory acceptance of our business.
In 2020, we entered into an agreement with the NAACP Legal Defense Education Fund, the LDF, and the Student Borrower Protection Center, the SBPC, to participate in fair lending reviews of our AI underwriting models by an independent third-party firm, Relman Colfax LLC, or Relman. The fair lending testing was designed to determine if our AI underwriting models have caused or resulted in a disparate impact on any protected class, and if so, whether there are any alternative, less discriminatory practices without sacrificing the models’ predictiveness. Following a number of quantitative assessments, Relman has published three periodic reports and plans to publish a fourth and final report that summarizes the development during the monitorship as well as industry recommendations. While we have input on Relman’s reports and the agreement provides that Relman and the parties to the agreement will collaborate to reach agreement on any recommendations, we may disagree with Relman, the LDF or the SBPC regarding the contents of the reports or particular recommendations that were made, the manner in which they should be implemented, if at all, or whether they would maintain the predictiveness of our AI models or meet any other legitimate business needs of Upstart. If we do not implement Relman’s recommendations, the LDF and/or the SBPC could terminate the agreement with us. If Relman’s reports are viewed negatively for any reason, or Relman terminates its agreement with us and/or the agreement with the LDF and/or the SBPC is terminated for any reason, our brand and reputation and the overall market acceptance of, and trust in, our AI lending marketplace could suffer, and we could be subject to increased regulatory and litigation risk. In addition, the publication of information arising from our agreement with the LDF or the SBPC, including the reports published by Relman, could lead to additional regulatory scrutiny for our lending partners.
We have been subject to other governmental inquiries on this topic. See the risk factor titled “—We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business” for more information. Negative public perception, actions by advocacy groups or legislative and regulatory interest groups could lead to lobbying for and enactment of more restrictive laws and regulations that impact the use of AI technology in general, AI technology as applied to lending operations generally or as used in our applications more specifically. Any of the foregoing could negatively impact our business, financial condition and results of operations.
Harm to our reputation can also arise from many other sources, including inaccurate or unfavorable statements made by securities analysts or others, failure by us or our lending partners to meet minimum standards of service and quality, loan underperformance, inadequate protection of borrower information and compliance failures and claims, and employee or former employee misconduct, misconduct by outsourced service providers or other counterparties, as further described below. If we are unable to protect our reputation, our business, financial condition and results of operations would be adversely affected.
Our business is subject to a wide range of laws and regulations, many of which are evolving, and failure or perceived failure to comply with such laws and regulations could harm our business, financial condition and results of operations.
The legal and regulatory environment surrounding our AI lending marketplace is relatively new, susceptible to change and may require clarification or interpretive guidance with respect to existing laws and regulations. The body of laws and regulations applicable to our business are complex and subject to varying interpretations, in many cases due to the lack of specificity regarding the application of AI and related technologies to the already highly regulated consumer lending industry. As a result, the application of such laws and regulations in practice may change or develop over time as more products are offered on our marketplace, and through judicial decisions or as new guidance or interpretations are provided by regulatory and governing bodies, such as federal, state and local administrative agencies.
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New laws and regulations and changes to existing laws and regulations continue to be adopted, implemented and interpreted in response to our industry and the emergence of AI and related technologies. Recent financial, political and other events, including disruptions in the banking sector, may increase the level of regulatory scrutiny on financial technology companies. As we expand our business into new markets, introduce new loan products and continue to improve and evolve our AI models, regulatory bodies or courts may claim that we are subject to additional requirements. Such regulatory bodies could reject our applications for licenses or deny renewals, delay or impede our ability to operate, charge us fees or levy fines or penalties, commence investigations or inquiries into our business practices, or otherwise disrupt our ability to operate our AI lending marketplace, any of which could adversely affect our business, financial condition and results of operations. For example, in April 2022, the CFPB announced that it intends to examine non-bank financial companies that pose risks to consumers, and in November 2022, the Treasury Department issued a report encouraging the CFPB to increase its supervisory activity with respect to larger non-bank lenders. In July 2023, the CFPB announced that the agency had already begun supervision of at least three non-bank fintech companies. If the CFPB decides to subject us to its supervisory process, it could significantly increase the level of regulatory scrutiny of our business practices. Related to automotive lending, in January 2023, the CFPB and the New York Attorney General filed a complaint against an auto lender that criticized the profit-driven model in auto lending. The CFPB then entered into consent orders with several auto lenders as the year progressed, related to unfair or deceptive fees and servicing practices. With regulators actively scrutinizing the auto lending space, we may be subject to heightened scrutiny of the retail installment contracts we purchase and service. In addition, the Biden Administration recently announced a government-wide effort to eliminate “junk fees” which could subject our business practices to even further scrutiny. While what constitutes a “junk fee” remains undefined, the CFPB has called out certain ancillary products and pay-to-pay fees charged by debt collectors, and FTC issued a final rule on junk fees. These efforts signal that the “junk fee” initiative is likely to continue to broaden in scope. We may be subject to scrutiny should the “junk fee” initiative expand to include fees directly associated with consumer lending products.
Moreover, the CFPB has issued several interpretive statements and guidance documents that could impact our business practices including, but not limited to, a May 2022 statement on compliance obligations under the Equal Credit Opportunity Act (“ECOA”) for companies that rely on complex algorithms when making credit decisions and the fall 2023 statements on junk fees and, with the DOJ, on fair lending for non-citizens. The CFPB also issued an interpretive rule expanding states’ authority to enforce requirements of federal consumer financial laws, including the ECOA. State regulators have also increased the level of regulatory scrutiny on financial technology companies and the bank partnership model. For example, the State of Maryland initiated an enforcement action against a financial technology company and its bank partner for unlicensed lending within the state, and Colorado opted out of the federal law that allows out-of-state banks to export their rates to Colorado. Some states have codified in their laws a test to determine who is the true lender for certain loans. Moreover, the OCC has also indicated that it intends to use its supervisory authority to review bank third-party relationships with financial technology companies including a review of third-party business practices that could pose a risk of potential consumer harm that could impact the safety and soundness of the banks subject to agency supervision. Should the agency examine any of our lending partners, such examinations may involve a review of our business practices to determine whether they pose a risk to the safety and soundness of those lending partners.
While we have been proactively working with the federal government and regulatory bodies to ensure that our AI lending marketplace and other services are in compliance with applicable laws and regulations, we can provide no assurance that we will not be subject to any regulatory actions. For example, the CFPB issued Upstart the no-action letters, which provided that the CFPB would not take supervisory or enforcement action against Upstart for a violation of the ECOA. However, in June 2022, at our request, the no-action letter was terminated so that we can keep our models accurate and updated during a period of significant economic change. As a result, we can provide no assurance that the CFPB or any other federal or state regulator will not take supervisory or enforcement action against us in the future.
We have been subject to governmental inquiries as well. See the risk factor titled “—We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business” for more information. Any government investigations or inquiries, whether or not accurate or warranted, or whether concerning us or one of our competitors, could negatively affect our brand and reputation and the overall market
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acceptance of and trust in our AI lending marketplace. Any of the foregoing could harm our business, financial condition and results of operations.
If we are unable to manage the risks related to our loan servicing and collections obligations, our business, financial condition and results of operations could be adversely affected.
Our success depends in part on our loan servicing and collection efforts. In the year ended December 31, 2023, 28% of our revenue was generated from loan servicing fees. The vast majority of Upstart-powered loans are not secured by any collateral, guaranteed or insured by any third party or backed by any governmental authority. As a result, we are limited in our ability to collect on such loans on behalf of our lending partners and institutional investors if a borrower is unwilling or unable to repay them. Where the loan is secured by an automobile, we could still be limited in our ability to collect on the loan if we cannot secure the automobile. The ability to collect on the loans is largely dependent on the borrower’s continuing financial stability, and consequently, collections can be adversely affected by a number of factors, including, but not limited to, unemployment, divorce, death, illness, bankruptcy or the economic or social factors beyond personal circumstances of a borrower. In addition, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans. It is possible that a higher percentage of consumers will seek protection under bankruptcy or debtor relief laws as a result of the current inflationary environment, the possibility of a recession and market volatility. Federal, state, or other restrictions could impair our ability to collect amounts owed and due on the loans facilitated through our marketplace, reduce income received from the loans facilitated through our marketplace, or negatively affect our business, financial condition and results of operations.
We began conducting first-party collection activities for our lending partners in the fourth quarter of 2022 for loans facilitated through our marketplace. We have no prior experience conducting first-party or in-house collection activities, and we cannot be certain that we will be able to effectively manage risks associated with such activities. In addition to first-party collection activities, we partner with third-party collection agencies for loans we service. If such third-party collection agencies do not perform as expected under our agreements with them or if we or these collection agents act unprofessionally and otherwise harm the user experience for borrowers of Upstart-powered loans, our brand and reputation could be harmed and our ability to attract potential borrowers to our marketplace could be negatively impacted. For example, during periods of increased delinquencies caused by economic downturns or otherwise, it is important that we and the collection agents are proactive and consistent in contacting a borrower to bring a delinquent balance current and ultimately avoid the related loan becoming charged off. If we or the collection agents are unable to maintain a high quality of service, or fulfill the servicing obligations at all due to resource constraints, it could result in increased delinquencies and charge-offs on the loans, which could decrease fees payable to us, cause our lending partners to decrease the volume of Upstart-powered loans kept on their balance sheets, erode trust in our lending marketplace or increase the costs of loan funding for our marketplace. If we fail to successfully address any of the foregoing risks associated with our collection activities, our business, financial condition and results of operations could be adversely affected.
We are the loan servicer for most loans facilitated through our marketplace, including the loans that are sold as part of whole loan sales, contributed to asset-backed securitizations and pass-through certificate transactions, and pledged in connection with warehouse credit facilities. Loan servicing is a highly manual process and an intensely regulated activity. Errors in our servicing activities, including payment collection and charge-off processes, or failures to comply with our servicing obligations, have in the past and could in the future affect our internal and external reporting of the loans that we service, adversely affect our business and reputation and expose us to liability to borrowers, lending partners or institutional investors. In addition, we charge our loan holders a fixed percentage servicing fee based on the outstanding balance of loans serviced. If we fail to efficiently service or collect on such loans and the costs incurred exceed the servicing fee charged, our results of operations would be adversely affected. Moreover, the laws and regulations governing these activities are subject to change. If we are unable to comply with such laws and regulations, we could lose one or more of our licenses or authorizations, become subject to greater scrutiny by regulatory agencies or become subject to sanctions or litigation, which may have an adverse effect on our ability to perform our servicing obligations or make our marketplace available to borrowers in particular states. Any of the foregoing could adversely affect our business, financial condition and results of operations.
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While auto loans issued through our lending marketplace are secured by collateral, auto loans are inherently risky, as they are often secured by assets that may be difficult to locate and can depreciate rapidly. We generally begin the repossession process for auto loans that become 60 days past due. We have engaged a third-party auto repossession vendor to handle all repossession activity. Following a repossession, if a borrower fails to redeem their vehicle or reinstate their loan agreement, the repossessed vehicle is sold at an auction and the proceeds are applied to the unpaid balance of the loan and related expenses. If the proceeds do not cover the unpaid balance of the loan and any related expenses and we are unable to recover the deficiency balance from the borrower, where permitted, the deficiency would be charged-off. Further, if a vehicle cannot be located, repossession and sale of the vehicle would not be possible, which could also lead to delinquencies and charge-offs. A significant number of delinquencies and charge-offs could decrease fees payable to us, cause our lending partners to reduce loan originations, erode trust in our lending marketplace and increase the costs of loan funding for our marketplace.
Additionally, if such repossession vendors do not perform consistent with agreements entered into with us, or if vendors act unprofessionally or otherwise harm the user experience for borrowers of Upstart-powered loans, our brand and reputation could be harmed and our ability to attract potential borrowers to our marketplace could be negatively impacted. We may also become subject to regulatory scrutiny and potential litigation based on the conduct of our repossession vendors.
Substantially all of our revenue is derived from a single loan product, and we are thus particularly susceptible to fluctuations in the unsecured personal loan market. We also do not currently offer a broad suite of products that lending partners or institutional investors may find desirable.
The vast majority of loan originations currently facilitated through our marketplace are unsecured personal loans. While the market for unsecured personal loans has grown rapidly in recent years, it is unclear to what extent such market will continue to grow, if at all. A wide variety of factors could impact the market for unsecured personal loans, including macroeconomic conditions, competition, regulatory developments and other developments in the credit market. Our success will depend in part on the continued growth of the unsecured personal loan market, and if such market does not further grow or grows more slowly than we expect, our business, financial condition and results of operations could be adversely affected.
In addition, lending partners and institutional investors may find it desirable to partner with competitors that are able to offer them a broader array of credit products. In order to preserve and expand our relationships with our existing lending partners and institutional investors, and enter into new lending partnerships and arrangements with institutional investors, it may become important for us to be able to offer a wider variety of products than we currently provide. We are also susceptible to competitors that may intentionally underprice their loan products, even if such pricing practices lead to losses. Such practices by competitors would negatively affect the overall demand for loans facilitated through our marketplace.
Further, because such personal loans are unsecured, there is a risk that borrowers will not prioritize repayment of such loans, particularly in any economic downcycle. To the extent borrowers have or incur other indebtedness that is secured, such as a mortgage, a home equity line of credit or an auto loan, borrowers may choose to repay obligations under such secured indebtedness before repaying their Upstart-powered personal loans. In addition, borrowers may not view Upstart-powered loans, which were originated through an online lending marketplace, as having the same significance as other credit obligations arising under more traditional circumstances, such as loans from banks or other commercial financial institutions. Any of the foregoing could lead to higher default rates and decreased demand by our lending partners and institutional investors to fund loans facilitated through our marketplace, which would adversely affect our business, financial condition and results of operations.
We are also more susceptible to the risks of changing and increased regulations and other legal and regulatory actions targeted towards the unsecured personal loan market. It is possible that regulators may view unsecured personal loans as high risk for a variety of reasons, including that borrowers will not prioritize repayment of such loans due to the unsecured nature of such loans or because existing laws and regulations may not sufficiently address the benefits and corresponding risks related to financial technology as applied to consumer lending. If we
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are unable to manage the risks associated with the unsecured personal loan product, our business, financial condition and results of operations could be adversely affected.
The sales and onboarding process of new lending partners could take longer than expected, leading to fluctuations or variability in expected revenues and results of operations.
Our sales and onboarding process with new lending partners can be long, vary widely and generally takes approximately two to twelve months. As a result, revenues and results of operations may vary significantly from period to period. Prospective lending partners are often cautious in making decisions to implement our platform and related services because of the risk management alignment and regulatory uncertainties related to their use of our AI models, including their oversight, model governance and fair lending compliance obligations associated with using such models. In addition, prospective lending partners undertake an extensive diligence review of our platform, compliance and servicing activities before choosing to partner with us. Further, the implementation of our AI lending model often involves shifts by the lending partner to a new software platform or changes in their operational procedures, which may involve significant time and expense to implement. Delays in onboarding new lending partners can also arise while prospective lending partners complete their internal procedures to approve expenditures and test and accept our applications. Consequently, we face difficulty predicting the quarter in which new lending partners will begin using our platform and the volume of fees we will receive, which can lead to fluctuations in our revenues and results of operations.
We are continuing to introduce and develop new loan products and services offerings, and if these products are not successful or we are unable to manage the related risks, our growth prospects, business, financial condition and results of operations could be adversely affected.
We have introduced auto loan, small dollar loan, and home equity lines of credit products and are continuing to invest in developing these products and other new loan products and service offerings. New initiatives are inherently risky, as each involves unproven business strategies, new regulatory requirements and new financial products and services with which we, and in some cases our lending partners, have limited or no prior development or operating experience.
We cannot be sure that we will be able to develop, commercially market and achieve market acceptance of any new products and services. In addition, our investment of resources to develop new products and services may either be insufficient or result in expenses that are excessive in light of revenue actually derived from these new products and services. It is also possible that such investment of resources may need to be delayed or deferred, as was the case with respect to the small business loan product when we decided to suspend its development in January 2023 due to the adverse macroeconomic conditions affecting our business at that time. We may also have difficulty with securing adequate loan funding for new loan products and services, and if we are unable to do so, our ability to develop and grow these new offerings and services will be impaired. If the profile of borrowers using any new products and services is different from that of those currently served by the existing loan products offered on our marketplace, our AI models may not be able to accurately evaluate the credit risk of such borrowers, and we may not be able to obtain loan funding for new products and services on commercially reasonable terms, or at all. Moreover, it is possible that a new product in its development stage has a higher level of delinquencies or defaults than a more established product as our AI models calibrate to a potentially different set of data. Failure to accurately predict demand or growth with respect to our new products and services could have an adverse impact on our reputation and business, and there is always risk that new products and services will be unprofitable, will increase our costs, decrease operating margins or take longer than anticipated to achieve target margins. In addition, any new products or services may raise new and potentially complex regulatory compliance obligations, which would increase our costs and may cause us to change our business in unexpected ways. Further, our development efforts with respect to these initiatives could distract management from current operations and will divert capital and other resources from our existing business. If we are unable to effectively manage the foregoing risks, our growth prospects, business, financial condition and results of operations could be adversely affected.
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Misconduct and errors by our employees, former employees, vendors, or service providers could harm our reputation and subject us to significant legal liability.
We operate in an industry in which integrity and the confidence of our borrowers and lending partners is of critical importance. Our business depends on our employees, vendors, and service providers to process a large number of increasingly complex transactions, including transactions that involve significant dollar amounts and loan transactions that involve the use and disclosure of personal and business information. We are thus exposed to the risk of misconduct and errors by our employees, vendors, and other service providers that could adversely affect our business, including employees, vendors, or service providers taking, converting, or misusing funds, documents, or data, or failing to follow applicable laws and regulations or our internal policies or protocol when interacting with consumers and borrowers. It is not always possible to identify and deter misconduct or errors by employees, vendors, or service providers, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses. There have been numerous highly-publicized cases of fraud and other misconduct by financial services industry employees. We have experienced employee misconduct and may continue to do so in the future. Depending on the severity, any illegal, improper, or suspicious activity or other misconduct by our employees, vendors or service providers could result in serious harm to our reputation, financial condition, relationships with lending partners and borrowers, and our ability to attract new lending partners or borrowers. We could also be perceived to have facilitated or participated in the illegal misappropriation of funds, documents, or data, or the failure to follow protocol, and therefore be subject to civil or criminal liability. Any of these occurrences could result in our diminished ability to operate our business, inability to attract future borrowers or lending partners, reputational damage, regulatory intervention, and financial harm, which could negatively impact our business, results of operations, financial condition, and future prospects.
If we do not compete effectively in our target markets, our business, results of operations and financial condition could be harmed.
The consumer lending market is highly competitive and increasingly dynamic as emerging technologies continue to enter the marketplace. With the introduction of new technologies and the influx of new entrants, competition may persist and intensify in the future, which could have an adverse effect on our operations or business.
Our inability to compete effectively could result in reduced loan volumes, reduced average size of loans facilitated on our marketplace, reduced fees, increased marketing and borrower acquisition costs or the failure of the Upstart marketplace to achieve or maintain more widespread market acceptance, any of which could have an adverse effect on our business and results of operations.
Consumer lending is a vast and competitive market, and we compete to varying degrees with all other sources of unsecured consumer credit. This can include banks, non-bank lenders including retail-based lenders and other financial technology lending platforms. Because personal loans often serve as a replacement for credit cards, we also compete with the convenience and ubiquity that credit cards represent. Many of our competitors operate with different business models, such as lending-as-a-service, have different funding sources, have different cost structures or regulatory obligations, or participate selectively in different market segments. They may ultimately prove more successful or more adaptable to new regulatory, economic, technological and other developments, including utilizing new data sources or credit models. We may also face competition from banks or companies that have not previously competed in the consumer lending market, including companies with access to vast amounts of consumer-related information that could be used in the development of their own credit risk models. Our current or potential competitors may be better at developing new products due to their large and experienced data science and engineering teams, who are able to respond more quickly to new technologies. Many of our current or potential competitors have significantly more resources, such as financial, technical and marketing resources, than we do and may be able to devote greater resources to the development, promotion, sale and support of their platforms and distribution channels. We face competition in areas such as compliance capabilities, commercial financing terms and costs of capital, interest rates and fees (and other financing terms) available to consumers from our lending partners, approval rates, model efficiency, speed and simplicity of loan origination, ease-of-use, marketing expertise, service levels, products and services, technological capabilities and integration, borrower experience, brand and reputation,
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and terms available to our loan funding institutional investor base. Our competitors may also have longer operating histories, lower commercial financing costs or costs of capital, more extensive borrower bases, more diversified products and borrower bases, operational efficiencies, more versatile or extensive technology platforms, greater brand recognition and brand loyalty, broader borrower and partner relationships, more extensive and/or more diversified loan funding institutional investor bases than we have, greater capacity to fund loans through their balance sheets, and more extensive product and service offerings than we have. Furthermore, our existing and potential competitors may decide to modify their pricing and business models to compete more directly with us. Our ability to compete will also be affected by our ability to provide our lending partners with a commensurate or more extensive suite of loan products than those offered by our competitors. In addition, current or potential competitors, including financial technology lending platforms and existing or potential lending partners, may also acquire or form strategic alliances with one another, which could result in our competitors being able to offer more competitive loan terms due to their access to lower-cost capital. Such acquisitions or strategic alliances among our competitors or potential competitors could also make our competitors more adaptable to a rapidly evolving regulatory environment. To stay competitive, we may need to increase our regulatory compliance expenditures or our ability to compete may be adversely affected.
Our industry is driven by constant innovation. We utilize artificial intelligence and machine learning, which is characterized by extensive research efforts and rapid technological progress. If we fail to anticipate or respond adequately to technological developments, our ability to operate profitably could suffer. There can be no assurance that research, data accumulation and development by other companies will not result in AI models that are superior to our AI models or result in products superior to those we develop or that any technologies, products or services we develop will be preferred to any existing or newly-developed technologies, products or services. If we are unable to compete with such companies or fail to meet the need for innovation in our industry, the use of our technology could stagnate or substantially decline, or our AI lending marketplace could fail to maintain or achieve more widespread market acceptance, which could harm our business, results of operations and financial condition.
Our business is heavily concentrated in U.S. consumer credit, and therefore our results are more susceptible to fluctuations in that market than a more diversified company.
Our business is heavily concentrated in U.S. consumer credit. As a result, we are more susceptible to fluctuations and risks particular to U.S. consumer credit than a more diversified company. For example, our business is particularly sensitive to macroeconomic conditions that affect the U.S. economy and consumer spending and consumer credit, such as rising interest rates and changes in monetary policy. We are also more susceptible to the risks of increased regulations and legal and other regulatory actions that are targeted at consumer credit. Our business concentration could have a material adverse effect on our business, results of operations, financial condition, and future prospects.
If we are unable to manage the risks associated with fraudulent activity, our brand and reputation, business, financial condition and results of operations could be adversely affected.
Fraud is prevalent in the financial services industry and is likely to increase as perpetrators become more sophisticated. We are subject to the risk of fraudulent activity associated with borrowers and third parties handling borrower information and, in limited situations, we cover certain fraud losses of our lending partners and institutional investors. For example, in the third quarter of 2021 and the first quarter of 2022, we experienced temporary increases in fraudulent activity. Fraud rates could also increase in a down-cycle economy. We are also subject to risk of fraudulent activity associated with our own employees. We use several identity and fraud detection tools, including tools provided by third-party vendors and our proprietary AI models, to predict and otherwise validate or authenticate applicant-reported data and data derived from third-party sources. If such efforts are insufficient to accurately detect and prevent fraud, the level of fraud-related losses of Upstart-powered loans could increase, which would decrease confidence in our AI lending marketplace. In addition, our lending partners, institutional investors or we may not be able to recover amounts disbursed on loans made in connection with inaccurate statements, omissions of fact or fraud, which could erode the trust in our brand and negatively impact our ability to attract new lending partners and institutional investors to our marketplace.
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High profile fraudulent activity also could negatively impact our brand and reputation. In addition, significant increases in fraudulent activity could lead to regulatory intervention, which could increase our costs and also negatively impact our brand and reputation. Further, if there is any increase in fraudulent activity that increases the need for human intervention in screening loan application data, the level of automation on our platform could decline and negatively affect our unit economics. If we are unable to manage these risks, our business, financial condition and results of operations could be adversely affected.
We depend on our key personnel and other highly skilled personnel, and if we fail to attract, retain and motivate our personnel, our business, financial condition and results of operations could be adversely affected.
Our success significantly depends on the continued service of our senior management team and other highly skilled personnel. Our success also depends on our ability to identify, hire, develop, motivate and retain highly qualified personnel for all areas of our organization.
Competition is high for skilled personnel, including engineering and data analytics personnel, particularly in the San Francisco Bay Area where one of our headquarters is located. While we have transitioned to a Digital First work model which allows us to recruit nationwide, we have experienced, and expect to continue to face, some difficulty identifying and hiring qualified personnel, especially as we pursue our growth strategy. We may not be able to hire or retain such personnel at compensation or flexibility levels consistent with our existing compensation and salary structure and policies. We periodically review our compensation levels to ensure they remain competitive and have increased them when we believe market conditions warrant it. However, we may need to further increase our existing compensation levels in response to competition, rising inflation or labor shortages, which would increase our operating costs and reduce our margins. Many of the companies with which we compete for experienced employees have greater resources than we have and may be able to offer more attractive terms of employment. In particular, candidates making employment decisions, specifically in high-technology industries, often consider the value of any equity they may receive in connection with their employment. The recent significant volatility in the price of our stock may have adversely contributed to, and in the future may affect, our ability to attract or retain highly skilled technical, financial and marketing personnel.
In addition, we invest significant time and expense in training our employees, which increases their value to competitors who may seek to recruit them. If we fail to retain our employees, we could incur significant expenses in hiring and training their replacements. While we are in the process of training their replacements, the quality of our services and our ability to serve our lending partners, institutional investors and borrowers whose loans we service may suffer, resulting in an adverse effect on our business.
Furthermore, we have reduced our workforce in November 2022 and January 2023 and may further reduce our workforce in the future to lower our operating costs and streamline operations. These reductions in our workforce may adversely affect employee morale, our culture and our ability to attract and retain personnel who are critical to our business. It may also negatively impact our ability to pursue new initiatives due to insufficient resources and personnel. We may be unsuccessful in distributing duties and obligations of impacted employees among the remaining employees. We also may not realize the anticipated benefits and cost savings and may suffer unintended consequences, such as the loss of institutional knowledge, higher than expected employee turnover and significant disruptions in our day-to-day operations. If we are unable to realize the expected operational efficiencies or cost savings from the reductions in our workforce, or if we experience significant adverse consequences as a result, our business, financial conditions and results of operations may be adversely affected.
If we fail to effectively manage the fluctuations in our business, our business, financial condition and results of operations could be adversely affected.
Our growth in the past placed significant demands on our management, processes and operational, technological and financial resources. More recently, economic headwinds in 2022 led to us announcing reductions in our workforce in November 2022 and January 2023 which were intended to help us achieve a more cost-efficient organization. These fluctuations in the momentum of our business challenge our ability to manage our growth
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effectively and to integrate new employees and technologies into our existing business. Our success as a business continues to require us to retain, attract, train, motivate and manage employees and invest strategically to refine our operational, technological and financial infrastructure. See also the risk factor titled “—We depend on our key personnel and other highly skilled personnel, and if we fail to attract, retain and motivate our personnel, our business, financial condition and results of operations could be adversely affected.” As part of that effort and from time to time, we rely on temporary independent contractor programs to scale our operations team. Failure to effectively implement and manage such programs could result in misclassification or other employment related claims or inquiries by governmental agencies. Continued fluctuations in the momentum of our business will strain our ability to develop and improve our operational policies and procedures, AI models and technology, disclosure controls and procedures, internal control over financial reporting, management oversight, loan funding and relationships with borrowers, lending partners and institutional investors. For example, there are certain aspects of our information technology and our operations, such as servicing activities, that have required, and still require, manual processes which are prone to errors and that we have not yet fully automated with new technologies. Some of the foregoing factors, like the manual processes, have negatively affected, and could continue to negatively affect, our business, financial condition and results of operations.
Security breaches and incidents compromising borrowers’ confidential information that we store may harm our reputation, adversely affect our results of operations and expose us to liability.
We are increasingly dependent on information systems, services and infrastructure to operate our business. In the ordinary course of our business, we collect, process, transmit and store large amounts of sensitive information, including personal information, credit information and other sensitive data of borrowers and potential borrowers. It is critical that we do so in a manner designed to maintain the confidentiality, integrity and availability of such sensitive information. We also have arrangements in place with certain of our third-party vendors that require us to share consumer information. We have outsourced elements of our operations (including elements of our information technology infrastructure) to third parties, and as a result, we manage a number of third-party vendors who may have access to our computer networks and sensitive or confidential information. In addition, many of those third parties may in turn subcontract or outsource some of their responsibilities to other third parties. As a result, our information technology systems, including the functions of third parties that are involved or have access to those systems, are large and complex, with many points of entry and access. While all information technology operations are inherently vulnerable to inadvertent or intentional security breaches, incidents, attacks and exposures, the size, complexity, accessibility and distributed nature of our information technology systems, and the large amounts of sensitive information stored on those systems, make such systems potentially vulnerable to unintentional or malicious, internal and external attacks. Any vulnerabilities can be exploited from inadvertent or intentional actions of our employees, third-party vendors, lending partners, institutional investors, or by malicious threat actors. While we continuously refine our security controls to address the evolving threat landscape, attacks of this nature are increasing in their frequency, levels of persistence, sophistication and intensity, and are being conducted by sophisticated and organized groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, “hacktivists,” nation states and others. These risks may be heightened in connection with geopolitical conflicts. In addition to the extraction of sensitive information, such attacks could include the deployment of harmful malware, ransomware, denial-of-service attacks, social engineering and other means to affect service reliability and threaten the confidentiality, integrity and availability of information and systems. In addition, the prevalent use of mobile devices increases the risk of data security incidents. Further, our Digital First working environment could increase the risks of security breaches and incidents as more of our employees are accessing our servers remotely through home or other networks, reducing physical and social security controls on employee monitoring. Significant disruptions to information technology systems or other security incidents within our company, our lending partners and third-party vendors and/or other business partners could adversely affect our business operations and result in the loss, misappropriation, or unauthorized access, use or disclosure of, or the prevention of access to, sensitive information, which could result in financial, legal, regulatory, business and reputational harm to us. Our use of AI technology may create additional cybersecurity risks or increase cybersecurity risks, including risks of security breaches and incidents. Further, AI technology may be used in connection with certain types of cybersecurity attacks, resulting in heightened risks of security breaches and incidents.
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Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until they are launched against a target, we and our vendors may be unable to anticipate these techniques or to implement adequate preventative measures. In addition, many governments have enacted laws requiring companies to notify individuals of data security breaches involving their personal data. These mandatory disclosures regarding a security breach are costly to implement and often lead to widespread negative publicity following a breach, which may cause borrowers and potential borrowers to lose confidence in the effectiveness of our data security measures on our platform. Any security breach or incident, whether actual or perceived, would harm our reputation and ability to attract new borrowers to our marketplace.
We also face indirect technology, cybersecurity and operational risks relating to the borrowers, lending partners, institutional investors, vendors and other third parties with whom we do business or upon whom we rely on to facilitate or enable our business activities, including vendors, payment processors, and other parties who have access to confidential information due to our agreements with them. In addition, any security compromise in our industry, whether actual or perceived, or information technology system disruptions, whether from attacks on our technology environment or from computer malware, natural disasters, terrorism, war, geopolitical conflicts, or telecommunication or electrical failures, could interrupt our business or operations, harm our reputation, erode borrower confidence, negatively affect our ability to attract new borrowers, or subject us to third-party lawsuits, regulatory fines or other action or liability, which could adversely affect our business and results of operations.
Like other financial and technology services firms, we have been and continue to be the subject of actual or attempted unauthorized access, mishandling or misuse of information, computer viruses or malware, and cyber-attacks that could obtain confidential information, destroy data, disrupt or degrade service, sabotage systems or cause other damage, distributed denial of service attacks, data breaches and other infiltration, exfiltration or other similar events.
While we regularly monitor data flow inside and outside the company, attackers have become very sophisticated in the way they conceal access to systems, and we may not be aware that we have been attacked. Any event that leads to unauthorized access, use or disclosure of personal information or other sensitive information that we or our vendors maintain, including our own proprietary business information and sensitive information such as personal information regarding borrowers, loan applicants or employees, could disrupt our business, harm our reputation, compel us to comply with applicable federal and/or state breach notification laws and foreign law equivalents, subject us to time consuming, distracting and expensive litigation, regulatory investigation and oversight, mandatory corrective action, require us to verify the correctness of data, or otherwise subject us to liability under laws, regulations and contractual obligations, including those that protect the privacy and security of personal information. This could result in increased costs to us and result in significant legal and financial exposure and/or reputational harm. In addition, any failure or perceived failure by us or our vendors to comply with our privacy, confidentiality or data security-related legal or other obligations to our lending partners or other third parties, actual or perceived security breaches, or any security incidents or other events that result in the unauthorized access, release or transfer of sensitive information, which could include personally identifiable information, may result in governmental investigations, enforcement actions, regulatory fines, litigation, or public statements against us by advocacy groups or others, and could cause our lending partners and other third parties to lose trust in us or we could be subject to claims by our lending partners and other third parties that we have breached our privacy- or confidentiality-related obligations, which could harm our business and prospects. Moreover, data security incidents and other inappropriate access can be difficult to detect, and any delay in identifying them may lead to increased harm of the type described above. There can be no assurance that our security measures intended to protect our information technology systems and infrastructure will successfully prevent service interruptions or security incidents. For example, in April 2020, we were made aware of a software error which allowed access to certain consumers’ accounts through the Upstart website without providing such consumers’ passwords. As a result, certain of such consumers’ personal information, such as their name, address and job information (but not full social security information), could have been accessed by a third party. We promptly deployed an update to our software to address such vulnerability and conducted an internal investigation. We are not aware of any information being compromised as a result of this error. We cannot provide any assurance that similar vulnerabilities will not arise in the future as we continue to expand the features and functionalities of our platform and introduce new loan products
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on our platform, and we expect to continue investing substantially to protect against security vulnerabilities and incidents.
We maintain errors, omissions, and cyber liability insurance policies covering certain security and privacy damages. However, we cannot be certain that our coverage will continue to be available on economically reasonable terms or will be available in sufficient amounts to cover one or more large claims, or that an insurer will not deny coverage as to any future claim, or that any insurer will be adequately covered by reinsurance or other risk mitigants or that any insurer will offer to renew policies at an affordable rate or offer such coverage at all in the future. The successful assertion of one or more large claims against us that exceed available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have an adverse effect on our business, financial condition and results of operations.
Our proprietary AI models rely in part on the use of loan applicant and borrower data and other third-party data, and if we lose the ability to use such data, or if such data contain inaccuracies, our business could be adversely affected.
We rely on our proprietary AI models, which are statistical models built using a variety of data-sets. Our AI models rely on a wide variety of data sources, including data collected from applicants and borrowers, credit bureau data and our credit experience gained through monitoring the payment performance of borrowers over time. Under our agreements with our lending partners, we receive licenses to use data collected from loan applicants and borrowers. The CFPB has proposed rules on “open banking” that would give consumers certain rights in deciding how companies like us can use their personal financial data, and also proposed additional restrictions and requirements on companies that use such data. If we are unable to access and use data collected from applicants and borrowers, data received from credit bureaus, repayment data collected as part of our loan servicing activities, or any other data for our AI models, or our access to such data is limited, our ability to accurately evaluate potential borrowers, detect fraud and verify applicant data would be compromised. Any of the foregoing could negatively impact the accuracy of our pricing decisions, the degree of automation in our loan application process and the volume of loans facilitated on our marketplace.
Third-party data sources on which we rely include the consumer reporting agencies regulated by the CFPB and other alternative data sources. Such data is electronically obtained from third parties and used in our AI models to price applicants and in our fraud models to verify the accuracy of applicant-reported information. Data from national credit bureaus and other consumer reporting agencies, as well as other information that we receive from third parties about an applicant or borrower, may be inaccurate or may not accurately reflect the applicant or borrower’s creditworthiness for a variety of reasons, including inaccurate reporting by creditors to the credit bureaus, errors, staleness or incompleteness. For example, loan applicants’ credit scores may not reflect such applicants’ actual creditworthiness because the credit scores may be based on outdated, incomplete or inaccurate consumer reporting data, including, as a consequence of us utilizing credit reports for a specific period of time after issuance before such reports are deemed to be outdated. Similarly, the data taken from an applicant’s credit report may also be based on outdated, incomplete or inaccurate consumer reporting data. Although regulatory protections are in place to afford consumers the right to dispute inaccuracies and despite the fact that we use numerous third-party data sources and multiple credit factors within our proprietary models, which helps mitigate this risk, it does not eliminate the risk of an inaccurate individual report.
Further, although we attempt to verify the income, employment and education information provided by certain selected applicants, we cannot guarantee the accuracy of applicant information. Our fraud models rely in part on data we receive from a number of third-party verification vendors, data collected from applicants, and our experience gained through monitoring the performance of borrowers over time. Information provided by borrowers may be incomplete, inaccurate or intentionally false. Applicants may also misrepresent their intentions for the use of loan proceeds. We do not verify or confirm any statements by applicants as to how loan proceeds are to be used after loan funding. If an applicant supplied false, misleading or inaccurate information and our fraud detection processes do not flag the application, repayments on the corresponding loan may be lower, in some cases significantly lower, than expected, leading to losses for the lending partner or institutional investor.
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In addition, if any data used to train and improve our AI models is inaccurate or otherwise unreliable, or access to third-party data is limited or becomes unavailable to us, our ability to continue to improve our AI models would be adversely affected. Any of the foregoing could result in sub-optimally and inefficiently priced loans, incorrect approvals or denials of loans, or higher than expected loan losses, which in turn could adversely affect our ability to attract new borrowers, lending partners and institutional investors to our marketplace or increase the number of Upstart-powered loans and adversely affect our business, financial condition and results of operations.
In connection with asset-backed securitizations, pass-through certificate transactions, warehouse credit facilities and whole loan sales, we make representations and warranties concerning the loans transferred, and if such representations and warranties are not accurate when made, we could be required to repurchase the applicable loans.
In our asset-backed securitizations, pass-through certificate transactions, warehouse credit facilities and whole loan sale arrangements, we make numerous representations and warranties concerning the characteristics of the Upstart-powered loans sold and transferred in connection with such transactions, including representations and warranties that the loans meet the eligibility requirements of those facilities and of institutional investors. If those representations and warranties were not accurate when made and are not timely cured or incurable, we may be required to repurchase the underlying loans. Failure to repurchase such loans could constitute a default, an event of default or termination event under the agreements governing our various arrangements or transactions and could require us to indemnify certain financing parties. Through December 31, 2023, the number of repurchased Upstart-powered loans as a result of inaccurate representations and warranties represents less than 1% of all Upstart-powered loans. While only a small number of Upstart-powered loans have been historically repurchased by us, there can be no assurance that we would have adequate cash or other qualifying assets available to make such repurchases if and when required. Such repurchases could be limited in scope, relating to small pools of loans, or significant in scope, across multiple pools of loans. If we were required to make such repurchases and if we do not have adequate liquidity to fund such repurchases, our business, financial condition and results of operations could be adversely affected. In addition, a high volume of repurchases due to a breach of such representations and warranties could have an adverse impact on our reputation as a loan seller and servicer.
Borrowers may prepay a loan at any time without penalty, which could reduce our servicing fees and deter our lending partners and institutional investors from investing in loans facilitated through our lending marketplace.
A borrower may decide to prepay all or a portion of the remaining principal amount on a loan at any time without penalty. If the entire or a significant portion of the remaining unpaid principal amount of a loan is prepaid, we would not receive a servicing fee, or we would receive a significantly lower servicing fee associated with such prepaid loan. Prepayments may occur for a variety of reasons, including if interest rates decrease after a loan is made. If a significant volume of prepayments occurs, the amount of our servicing fees would decline, which could harm our business and results of operations. Our AI models are designed to predict prepayment rates. However, if a significant volume of prepayments occur that our AI models do not accurately predict, returns targeted by our lending partners and institutional investors would be adversely affected and our ability to attract new lending partners and institutional investors would be negatively affected.
Our marketing efforts and brand promotion activities may not be effective.
Promoting awareness of our AI lending marketplace is important to our ability to grow our business, attract new lending partners, increase the number of potential borrowers on our marketplace and attract institutional investors to our marketplace. We believe that the importance of brand recognition will increase as competition in the consumer lending industry expands. However, because our lending partners are increasingly adopting our lending partner-branded version of our AI lending marketplace through their own websites, potential borrowers may not be aware they are experiencing our AI lending marketplace, which may hinder recognition of our brand. Successful promotion of our brand will depend largely on the effectiveness of marketing efforts and the overall user experience
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of our lending partners and potential borrowers on the Upstart marketplace, which factors are outside our control. The marketing channels that we employ may also become more crowded and saturated by other lending platforms, which may decrease the effectiveness of our marketing campaigns and increase borrower acquisition costs. Also, the methodologies, policies and regulations applicable to marketing channels may change. For example, internet search engines could revise their methodologies, which could adversely affect borrower volume from organic ranking and paid search. Search engines may also implement policies that restrict the ability of companies such as us to advertise their services and products, which could prevent us from appearing in a favorable location or any location in the organic rankings or paid search results when certain search terms are used by the consumer.
Our brand promotion activities may not yield increased revenues. If we fail to successfully build trust in our AI lending marketplace and the performance and predictability of Upstart-powered loans, we may lose existing lending partners and institutional investors to our competitors or be unable to attract new lending partners and institutional investors, which in turn would harm our business, results of operations and financial condition. Even if our marketing efforts result in increased revenue, we may be unable to recover our marketing costs through increases in loan volume, which could result in a higher borrower acquisition cost per account. Any incremental increases in loan servicing costs, such as increases due to greater marketing expenditures, could have an adverse effect on our business, financial condition and results of operations.
Unfavorable outcomes in legal proceedings may harm our business and results of operations.
We are, and may in the future become, subject to litigation, claims, examinations, investigations, enforcement actions, legal and administrative cases and proceedings, whether civil or criminal, or lawsuits by governmental agencies or private parties, which may affect our results of operations. These claims, lawsuits, and proceedings could involve, and in some cases have involved, labor and employment, discrimination and harassment, commercial disputes, intellectual property rights (including patent, trademark, copyright, trade secret, and other proprietary rights), class actions, general contract, tort, defamation, data privacy rights, antitrust, common law fraud, government regulation, or compliance, alleged federal and state securities and “blue sky” law violations or other investor claims, and other matters. For example, we are a defendant in a number of securities class action and other related lawsuits. See the “Legal” section under “Note 12. Commitments and Contingencies” and the risk factor titled “—The trading price of our common stock may be volatile, and you could lose all or part of your investment” for more information.
Due to the consumer-oriented nature of our business and the application of certain laws and regulations, participants in our industry are regularly named as defendants in litigation alleging violations of federal and state laws and regulations and consumer law torts, including fraud. Many of these legal proceedings involve alleged violations of consumer protection laws. In addition, we have been in the past and may in the future be subject to litigation, claims, examinations, investigations, legal and administrative cases and proceedings related to the offer and sale of Upstart-powered loans.
In particular, lending programs that involve originations by a bank in reliance on origination-related services being provided by non-bank lending platforms and/or program managers are subject to potential litigation and government enforcement claims based on “rent-a-bank” or “true lender” theories, particularly where such programs involve the subsequent sale of such loans or interests therein through the lending marketplace. See the risk factor titled “—If loans facilitated through our marketplace for one or more lending partners were subject to successful challenge that the lending partner was not the “true lender,” such loans may be unenforceable, subject to rescission or otherwise impaired, we or other program participants may be subject to penalties, and/or our commercial relationships may suffer, each which would adversely affect our business and results of operations” for more information. In addition, loans originated by lending partners (which are exempt from certain state requirements under federal banking laws), followed by the sale, assignment, or other transfer to non-banks of such loans are subject to potential litigation and government enforcement claims based on the theory that transfers of loans from banks to non-banks do not transfer the ability to enforce contractual terms such as interest rates and fees from which only banks benefit under federal preemption principles. See the risk factors titled “—If loans originated by our lending partners were found to violate the laws of one or more states, whether at origination or after sale by the lending partner, loans facilitated through our marketplace may be unenforceable or otherwise impaired, we or
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other program participants may be subject to, among other things, fines and penalties, and/or our commercial relationships may suffer, each of which would adversely affect our business and results of operations” and “—We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business” for more information. If we were subject to such litigation or enforcement, then any unfavorable results of pending or future legal proceedings may result in contractual damages, usury related claims, fines, penalties, injunctions, the unenforceability, rescission or other impairment of loans originated on our marketplace or other censure that could have an adverse effect on our business, results of operations and financial condition. Even if we adequately address the issues raised by an investigation or proceeding or successfully defend a third-party lawsuit or counterclaim, we may have to devote significant financial and management resources to address these issues, which could harm our business, financial condition and results of operations.
We have a limited history of operating with a Digital First workforce, and the long-term impact on our business, financial condition and results of operations is uncertain.
Since our announcement of a Digital First work model in June 2021, remote work with less time in the office has been the primary experience for most of our employees. Our workforce is currently distributed across the U.S., and we expect this to continue. We have a limited history of operating with a Digital First workforce. Although we anticipate that this Digital First model will have a long-term positive impact on our business, financial condition and results of operations, there is no guarantee that we will realize any anticipated benefits to our business from this model, including cost savings, operational efficiencies, or productivity.
Our Digital First model could lead to a negative long-term impact on our operations, the execution of our business plans and sales and marketing efforts, our company culture, or the productivity and retention of key personnel and other employees necessary to conduct our business, or otherwise cause operational failures due to changes in our past business practices. If a natural disaster, power outage, connectivity issue, or other event were to occur that impacted our employees’ ability to work remotely, it may be difficult or, in certain cases, impossible, for us to continue our business for a substantial period of time. The increase in remote working may also result in increased exposure to consumer privacy and data security incidents, or fraudulent activity. Furthermore, our understanding of applicable legal and regulatory requirements related to a remote workforce may be subject to legal or regulatory challenge, particularly as regulatory guidance evolves in response to future developments. If we are unable to successfully address the foregoing risks and challenges as we encounter them, our business, financial condition and results of operations could be adversely affected.
We may evaluate and potentially consummate acquisitions or investments in complementary business and technologies, which could require significant management attention, consume our financial resources, disrupt our business and adversely affect our results of operations, and we may fail to realize the anticipated benefits of these acquisitions or investments.
Our success will depend, in part, on our ability to grow our business. In some circumstances, we may determine to do so through the acquisition of, or investments in, complementary businesses and technologies rather than through internal development. For example, in 2021, we completed the acquisition of Prodigy. The identification of suitable acquisition candidates can be difficult, time-consuming, and costly, and we may not be able to successfully complete identified acquisitions. In the future, we may acquire assets or businesses. The risks we face in connection with acquisitions include:
•diversion of management time and focus from operating our business to addressing acquisition integration challenges;
•utilization of our financial resources for acquisitions or investments that may fail to realize the anticipated benefits;
•inability of the acquired technologies, products or businesses to achieve expected levels of revenue, profitability, productivity or other benefits;
•coordination of technology, product development and sales and marketing functions and integration of administrative systems;
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•transition of the acquired company’s borrowers to our systems;
•retention of employees from the acquired company;
•regulatory risks, including maintaining good standing with existing regulatory bodies or receiving any necessary approvals, as well as being subject to new regulators with oversight over an acquired business;
•attracting financing;
•cultural challenges associated with integrating employees from the acquired company into our organization;
•the need to implement or improve controls, procedures and policies at a business that prior to the acquisition may have lacked effective controls, procedures and policies;
•potential write-offs of loans or intangibles or other assets acquired in such transactions that may have an adverse effect on our results of operations in a given period;
•liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, violations of laws, commercial disputes, tax liabilities and other known and unknown liabilities;
•assumption of contractual obligations that contain terms that are not beneficial to us, require us to license or waive intellectual property or increase our risk for liability; and
•litigation, claims or other liabilities in connection with the acquired company.
Our failure to address these risks or other problems encountered in connection with any future acquisitions and strategic investments could cause us to fail to realize the anticipated benefits of these acquisitions or investments, cause us to incur unanticipated liabilities and harm our business generally. Future acquisitions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, amortization expenses or the write-off of goodwill, any of which could harm our financial condition.
Strategic investments in which we have a minority ownership stake and that we do not control may from time to time have economic, business, or legal interests or goals that are inconsistent with our goals. As a result, business decisions or other actions or omissions of controlling shareholders, management, or other persons or entities who control companies in which we invest may adversely affect the value of our investment, result in litigation or regulatory action against us, or otherwise damage our reputation and brand.
Our business is subject to the risks of natural disasters and other catastrophic events, many of which are becoming more acute and frequent due to climate change, and to interruption by human-induced problems.
Significant natural disasters or other catastrophic events, such as earthquakes, fires, hurricanes, blizzards, or floods (many of which are becoming more acute and frequent as a result of climate change), or interruptions by strikes, crime, terrorism, epidemics, pandemics, cyber-attacks, computer viruses, internal or external system failures, telecommunications failures, a failure of banking or other financial institutions, power outages or increased risk of cybersecurity breaches due to a swift transition to remote work brought about by a catastrophic event, could have an adverse effect on our business, results of operations and financial condition.
The long-term effects of climate change on the global economy and our industry in particular are unclear; however, we recognize that there are inherent climate-related risks wherever business is conducted. Either of our headquarters may be vulnerable to the adverse effects of climate change. One of our headquarters is located in the San Francisco Bay Area, a region that is prone to seismic activity and has experienced and may continue to experience, climate-related events and at an increasing rate. Examples include but are not limited to drought and water scarcity, warmer temperatures, wildfires and air quality impacts and power shut-offs associated with wildfire prevention. The increasing intensity of drought throughout California and annual periods of wildfire danger increase the probability of planned power outages. Our other headquarters in Columbus, Ohio is a region at higher risk for extreme winter weather, including blizzards. Although we maintain a disaster response plan and insurance, such events could disrupt our business, the business of our lending partners or third-party suppliers, and may cause us to
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experience losses and additional costs to maintain and resume operations. We may not maintain sufficient business interruption or property insurance to compensate us for potentially significant losses, including potential harm to our business that may result from interruptions in our ability to provide our financial products and services.
In addition, acts of war and other armed conflicts, disruptions in global trade, travel restrictions and quarantines, terrorism and other civil, political and geopolitical conflicts, could cause disruptions in our business and lead to interruptions, delays or loss of critical data. Any of the foregoing risks may be further increased if our business continuity plans prove to be inadequate and there can be no assurance that both personnel and non-mission critical applications can be fully operational after a declared disaster within a defined recovery time. If our personnel, systems or data centers are impacted, we may suffer interruptions and delays in our business operations. In addition, to the extent these events impact the ability of borrowers to timely repay their loans, our business could be negatively affected.
If our estimates or judgments relating to our critical accounting policies prove to be incorrect or financial reporting standards or interpretations change, our results of operations could be adversely affected.
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States requires our management to make estimates and assumptions that affect the amounts reported and disclosed in our consolidated financial statements and accompanying notes. We base our estimates and assumptions on historical experience and on various other data points that we believe to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets, liabilities, and equity, and the amount of revenue and expenses that are not readily apparent from other sources. Significant estimates and assumptions which we believe are critical in understanding and evaluating our financial results include: (i) fair value determinations; (ii) stock-based compensation; (iii) consolidation of VIEs; and (iv) the evaluation for impairment of goodwill and acquired intangible assets. Our results of operations may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our results of operations to fall below the expectations of industry or financial analysts and investors, resulting in a decline in the trading price of our common stock.
Additionally, we regularly monitor our compliance with applicable financial reporting standards and review new pronouncements and drafts thereof that are relevant to us. As a result of new standards, or changes to existing standards, and changes in their interpretation, we might be required to change our accounting policies, alter our operational policies and implement new or enhance existing systems so that they reflect new or amended financial reporting standards, or we may be required to restate our published financial statements. Such changes to existing standards or changes in their interpretation may have an adverse effect on our reputation, business, financial condition, and profit and loss, or cause an adverse deviation from our revenue and operating profit and loss target, which may negatively impact our results of operations.
If we fail to maintain an effective system of disclosure controls and internal control over financial reporting, our ability to produce timely and accurate financial statements or comply with applicable regulations could be impaired.
As a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and regulations of the applicable listing standards of the Nasdaq Global Select Market. We expect that the requirements of these rules and regulations will continue to increase our legal, accounting, and financial compliance costs, make some activities more difficult, time-consuming, and costly, and place significant strain on our personnel, systems, and resources.
The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal controls over financial reporting. We are continuing to develop and refine our disclosure controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we will file with the SEC is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that information required to be disclosed in reports under the Exchange Act is accumulated and communicated to our principal executive and financial officers. We are also continuing to improve
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our internal controls over financial reporting. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal controls over financial reporting, we have expended, and anticipate that we will continue to expend significant resources, including accounting-related costs, and significant management oversight. Our current controls and any new controls that we develop may become inadequate because of changes in conditions in our business.
Weaknesses in our disclosure controls and internal control over financial reporting have been discovered in the past and may be discovered in the future. We cannot assure you that the measures we have taken to date, or any measures we may take in the future, will be sufficient to identify or prevent future material weaknesses or deficiencies. The nature of our business is such that our financial statements involve a number of complex accounting policies, many of which involve significant elements of judgment, including determinations regarding the consolidation of variable interest entities, determinations regarding the fair value of financial assets and liabilities (including loans, notes receivable, payable to securitization note holders and residual certificate holders, servicing assets and liabilities, and trailing fee liabilities) and the appropriate classification of various items within our financial statements. See Note 1 to our consolidated financial statements for more information about our significant accounting policies. The inherent complexity of these accounting matters and the nature and variety of transactions in which we are involved require that we have sufficient qualified accounting personnel with an appropriate level of experience and controls in our financial reporting process commensurate with the complexity of our business. While we believe we have sufficient internal accounting personnel and external resources and appropriate controls to address the demands of our business, we expect that the growth and development of our business will place significant additional demands on our accounting resources. Any failure to develop or maintain effective controls or any difficulties encountered in their implementation or improvement could harm our results of operations or cause us to fail to meet our reporting obligations and may result in a restatement of our financial statements for prior periods. Any failure to implement and maintain effective internal control over financial reporting could also adversely affect the results of periodic management evaluations and annual independent registered public accounting firm attestation reports regarding the effectiveness of our internal control over financial reporting that we will eventually be required to include in our periodic reports that will be filed with the SEC. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our common stock. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on the Nasdaq Global Select Market. As a public company, we are required to provide an annual management report on the effectiveness of our internal control over financial reporting. There can be no assurance that we will maintain internal control over financial reporting sufficient to enable us to identify or avoid material weaknesses in the future.
Any failure to maintain effective disclosure controls and internal control over financial reporting could materially and adversely affect our business, results of operations, and financial condition and could cause a decline in the trading price of our common stock.
Some of our estimates, including our key metrics in this report, are subject to inherent challenges in measurement, and any real or perceived inaccuracies may harm our reputation and negatively affect our business.
Certain estimates and forecasts included in this report, including those we have generated ourselves, are subject to significant uncertainty and are based on assumptions and estimates that may not prove to be accurate. The estimates and forecasts in this report relating to the size and expected growth of our target market may prove to be inaccurate. It is impossible to offer every loan product, term or feature that every customer wants or that any given lending partner is necessarily capable of supporting, and our competitors may develop and offer loan products, terms or features that we do not offer. Even if the markets in which we compete meet the size estimates and growth forecasted in this report, we may be unable to address these markets successfully and our business could fail to grow for a variety of reasons outside of our control, including competition in our industry. We regularly review and may adjust our processes for calculating our key metrics to improve their accuracy. For example, in the third quarter of 2021, we adjusted our process for calculating Conversion Rate to account for an increase in fraudulent applications. Our key metrics may differ from estimates published by third parties or from similarly titled metrics of our
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competitors due to differences in methodology. If investors or analysts do not perceive our metrics to be accurate representations of our business, or if we discover material inaccuracies in our metrics, our reputation, business, results of operations, and financial condition would be adversely affected.
We maintain cash deposits in excess of federally insured limits. Adverse developments affecting financial institutions, including bank failures, could adversely affect our liquidity and financial performance.
We regularly maintain domestic cash deposits in Federal Deposit Insurance Corporation (“FDIC”) insured banks that exceed the FDIC insurance limits. Bank failures, events involving limited liquidity, defaults, non-performance or other adverse developments that affect financial institutions, or concerns or rumors about such events, may lead to liquidity constraints. For example, on March 10, 2023, Silicon Valley Bank failed and was taken into receivership by the FDIC. Similarly, on March 12, 2023, Signature Bank and Silvergate Capital Corp. were each swept into receivership. The failure of a bank, or other adverse conditions in the financial or credit markets impacting financial institutions at which we maintain balances, could adversely impact our liquidity and financial performance. There can be no assurance that our deposits in excess of the FDIC or other comparable insurance limits will be backstopped by the U.S. treasury, or that any bank or financial institution with which we do business will be able to obtain needed liquidity from other banks, government institutions or by acquisition in the event of a failure or liquidity crisis.
RISKS RELATED TO OUR INTELLECTUAL PROPERTY AND PLATFORM DEVELOPMENT
It may be difficult and costly to protect our intellectual property rights, and we may not be able to ensure their protection.
Our ability to operate our platform depends, in part, upon our proprietary technology. We may be unable to protect our proprietary technology effectively which would allow competitors to duplicate our AI models or AI lending marketplace and adversely affect our ability to compete with them. We rely on a combination of copyright, trade secret, patent, trademark laws and other rights, as well as confidentiality procedures, contractual provisions and our information security infrastructure to protect our proprietary technology, processes and other intellectual property. While we have two patents issued and three patent applications pending, we have limited patent protection and our patent application may not be successful. A third party may attempt to reverse engineer or otherwise obtain and use our proprietary technology without our consent. The pursuit of a claim against a third party for infringement of our intellectual property could be costly, and there can be no guarantee that any such efforts would be successful. Our failure to secure, protect and enforce our intellectual property rights could adversely affect our brand and adversely impact our business.
Our proprietary technology, including our AI models, may actually or may be alleged to infringe upon third-party intellectual property, and we may face intellectual property challenges from such other parties. We may not be successful in defending against any such challenges or in obtaining licenses to avoid or resolve any intellectual property disputes. If we are unsuccessful, such claims or litigation could result in a requirement that we pay significant damages or licensing fees, or we could in some circumstances be required to make changes to our business to avoid such infringement, which would negatively impact our financial performance. We may also be obligated to indemnify parties or pay substantial settlement costs, including royalty payments, in connection with any such claim or litigation and to modify applications or refund fees, which could be costly. Even if we were to prevail in such a dispute, any litigation regarding our intellectual property could be costly and time consuming and divert the attention of our management and key personnel from our business operations.
Moreover, it has become common in recent years for individuals and groups to purchase intellectual property assets for the sole purpose of making claims of infringement and attempting to extract settlements from companies such as ours. Even in instances where we believe that claims and allegations of intellectual property infringement against us are without merit, defending against such claims is time consuming and expensive and could result in the diversion of time and attention of our management and employees. In addition, although in some cases a third party may have agreed to indemnify us for such costs, such indemnifying party may refuse or be unable to
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uphold its contractual obligations. In other cases, our insurance may not cover potential claims of this type adequately or at all, and we may be required to pay monetary damages, which may be significant.
Furthermore, our technology may become obsolete or inadequate, and there is no guarantee that we will be able to successfully develop, obtain or use new technologies to adapt our models and systems to compete with other technologies as they develop. If we cannot protect our proprietary technology from intellectual property challenges, or if our technology becomes obsolete or inadequate, our ability to maintain our model and systems, facilitate loans or perform our servicing obligations on the loans could be adversely affected.
Any significant disruption in our AI lending platform could prevent us from processing loan applicants and servicing loans, reduce the effectiveness of our AI models and result in a loss of lending partners, institutional investors, applicants or borrowers.
In the event of a system outage or other event resulting in data loss or corruption, our ability to process loan applications, service loans or otherwise facilitate loans on our marketplace would be adversely affected. We also rely on facilities, components, and services supplied by third parties, including data center facilities, cloud storage services and national consumer reporting agencies. We host our AI lending platform using Amazon Web Services, or AWS, a provider of cloud infrastructure services. In the event that our AWS service agreements are terminated, or there is a lapse of service, interruption of internet service provider connectivity or damage to AWS data centers, we could experience interruptions in access to our platform as well as delays and additional expense in the event we must secure alternative cloud infrastructure services. For a large portion of borrowers’ data used in our AI lending marketplace, we obtain borrowers’ data from national consumer reporting agencies, such as TransUnion, and rely on their services in order to process loan applications. Any interference or disruption of our technology and underlying infrastructure or our use of third-party services could adversely affect our relationships with our lending partners and institutional investors, and the overall user experience of our marketplace. Depending on the type and severity of any such disruption, we could be exposed to litigation and regulatory risk. For example, a cybersecurity incident could result in the exposure of consumer data triggering remedial measures, notification requirements, as well as litigation and regulatory exposure. Also, as our business grows, we may be required to expand and improve the capacity, capability and reliability of our infrastructure. If we are not able to effectively address capacity constraints, upgrade our systems as needed and continually develop our technology and infrastructure to reliably support our business, our business, financial condition and results of operations could be adversely affected.
Additionally, in the event of damage or interruption, our insurance policies may not adequately compensate us for any losses incurred. Our disaster recovery plan has not been tested under actual disaster conditions, and we may not have sufficient capacity to recover all data and services in the event of an outage or other event resulting in data loss or corruption. These factors could prevent us from processing or posting payments on the loans, damage our brand and reputation, divert our employees’ attention, subject us to liability and cause borrowers to abandon our business, any of which could adversely affect our business, results of operations and financial condition.
Our platform and internal systems rely on software that is highly technical, and if our software contains undetected errors, our business could be adversely affected.
Our platform and internal systems rely on software that is highly technical and complex. In addition, our platform and internal systems depend on the ability of such software to store, retrieve, process and manage high volumes of data. The software on which we rely has contained, and may now or in the future contain, undetected errors or bugs. Some errors may only be discovered after the code has been released for external or internal use. Errors or other design defects within the software on which we rely may result in failure to accurately predict a loan applicant’s creditworthiness, failure to comply with applicable laws and regulations, approval of sub-optimally priced loans, incorrectly displayed interest rates to applicants or borrowers, or incorrectly charged interest to borrowers or fees to lending partners or institutional investors, failure to present or properly display regulatory disclosures to applicants for an extended period of time, failure to detect fraudulent activity on our platform, a negative experience for consumers or lending partners, delayed introductions of new features or enhancements, or failure to protect borrower data or our intellectual property. Any errors, bugs or defects discovered in the software on which we rely could result in harm to our reputation, loss of consumers or lending partners, increased regulatory
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scrutiny, fines or penalties, loss of revenue or liability for damages, any of which could adversely affect our business, financial condition and results of operations. Furthermore, updates made to our software to remediate any errors discovered may prove to be ineffective, resulting in repeated issues and further harm to our business.
Some aspects of our business processes include open source software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business.
We incorporate open source software into processes supporting our business. Such open source software may include software covered by licenses like the GNU General Public License and the Apache License. The terms of various open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that limits our use of the software, inhibits certain aspects of our systems and negatively affects our business operations.
Some open source licenses contain requirements that we make source code available at no cost for modifications or derivative works we create based upon the type of open source software we use.
We may face claims from third parties demanding the release or license of, such modifications or derivative works (which could include our proprietary source code or AI models) or otherwise seeking to enforce the terms of the applicable open source license. If portions of our proprietary AI models are determined to be subject to an open source license, or if the license terms for the open source software that we incorporate change, we could be required to publicly release the affected portions of our source code, re-engineer all or a portion of our model or change our business activities, any of which could negatively affect our business operations and potentially our intellectual property rights. If we were required to publicly disclose any portion of our proprietary models, it is possible we could lose the benefit of trade secret protection for our models.
In addition to risks related to license requirements, the use of open source software can lead to greater risks than the use of third-party commercial software, as open source licensors generally do not provide warranties or controls on the origin of the software. Use of open source software may also present additional security risks because the public availability of such software may make it easier for hackers and other third parties to determine how to breach our website and systems that rely on open source software. Many of the risks associated with the use of open source software cannot be eliminated and could adversely affect our business.
The use of generative AI technologies by our employees or contractors could expose us to unexpected liability.
Our employees and contractors use generative AI technologies in connection with their performance of services and, as with many developing technologies, generative AI presents risks and challenges that could affect its further development, adoption, and use, and therefore our business. We face the risk of security threats from employee or contractor errors (such as unauthorized use of third party generative AI technologies in job functions, our products, or in the operation of our business) or malfeasance in connection with generative AI technologies. Even authorized use of generative AI technologies by our employees or contractors may generate content, including software code, that appears facially correct but is factually inaccurate or flawed or contains security vulnerabilities. Our customers, employees, or others may rely on or use such factually incorrect or flawed content to their detriment, which may expose us to brand or reputational harm, competitive harm, and/or legal liability. Further, security vulnerabilities introduced by generative AI technologies into our software could expose us to cybersecurity risks. Questions surrounding license rights and liability for infringement in AI technology generally, and generative AI technology specifically, have not been fully addressed by competent legal tribunals or applicable laws or regulations. The use or adoption of third-party AI technology, including generative AI technology, into our products and services and our internal business operations may result in exposure to claims of copyright infringement, other intellectual property-related causes of action, or other potential reputational harms.
While we have policies governing our personnel’s use of third party generative AI technologies, we cannot guarantee that the policies will be adhered to by all of our employees and contractors and we cannot guarantee that the policies will protect us from all potential liability relating to our adoption of generative AI technologies.
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RISKS RELATED TO OUR DEPENDENCE ON THIRD PARTIES
We rely on strategic relationships with loan aggregators to attract applicants to our marketplace, and if we cannot maintain effective relationships with loan aggregators or successfully replace their services, or if loan aggregators begin offering competing products, our business could be adversely affected.
A significant number of consumers that apply for a loan on Upstart.com learn about and access Upstart.com through the website of a loan aggregator, typically with a hyperlink from such loan aggregator’s website to a landing page on our website. While we are continuing to expand our direct acquisition channels, we anticipate that we will continue to depend in significant part on relationships with loan aggregators to maintain and grow our business. For example, a significant amount of our loan originations was derived from traffic from Credit Karma, one of the loan aggregators with whom we partner. The loan aggregators, including Credit Karma, are not required to display offers from our lending partners on Upstart.com nor are they prohibited from working with our competitors or adding our competitors to their platforms. If traffic from Credit Karma or other loan aggregators decreases in the future for any reason, our loan originations and results of operations would be adversely affected. There is also no assurance that Credit Karma or other loan aggregators will continue to partner with us on commercially reasonable terms or at all. Our competitors may be effective in providing incentives to loan aggregators to favor their products or services or in reducing the volume of loans facilitated through our marketplace. Loan aggregators may not perform as expected under our agreements with them, and we may have disagreements or disputes with them, which could adversely affect our brand and reputation. If we cannot successfully enter into and maintain effective strategic relationships with loan aggregators, our business could be adversely affected.
Such loan aggregators also face litigation and regulatory scrutiny for their part in the consumer lending ecosystem, and as a result, their business models may require fundamental change or may not be sustainable in the future. For example, loan aggregators are increasingly required to be licensed as loan brokers or lead generators in many states, subjecting them to increased regulatory supervision and more stringent business requirements. While we require loan aggregators to make certain disclosures in connection with our lending partners’ offers and restrict how loan aggregators may display such loan offers, loan aggregators may nevertheless alter or even remove these required disclosures without notifying us, which may result in liability to us. Further, we do not have control over any content on loan aggregator websites, and it is possible that our brand and reputation may be adversely affected by being associated with such content. An unsatisfied borrower could also seek to bring claims against us based on the content presented on a loan aggregator’s website. Such claims could be costly and time consuming to defend and could distract management’s attention from the operation of the business.
We rely on third-party vendors and if such third parties do not perform adequately or terminate their relationships with us, our costs may increase and our business, financial condition and results of operations could be adversely affected.
Our success depends in part on our relationships with third-party vendors. In some cases, third-party vendors are one of a limited number of sources. For example, we rely on national consumer reporting agencies, such as TransUnion, for a large portion of the data used in our AI models. In addition, we rely on third-party verification technologies and services that are critical to our ability to maintain a high level of automation on our platform. In addition, because we are not a bank, we cannot belong to or directly access the ACH payment network. As a result, we rely on one or more banks with access to the ACH payment network to process collections on Upstart-powered loans. Many of our vendor agreements are terminable by either party without penalty and with little notice. If any of our third-party vendors terminates its relationship with us or refuses to renew its agreement with us on commercially reasonable terms, we would need to find an alternate provider, and may not be able to secure similar terms or replace such providers in an acceptable time frame. We also rely on other software and services supplied by vendors, such as communications, analytics and internal software, and our business may be adversely affected to the extent such software and services do not meet our expectations, contain errors or vulnerabilities, are compromised or experience outages. Any of these risks could increase our costs and adversely affect our business, financial condition and results of operations. Further, any negative publicity related to any of our third-party partners, including any publicity related to quality standards or safety concerns, could adversely affect our reputation and brand, and could potentially lead to increased regulatory or litigation exposure.
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We incorporate technology from third parties into our platform. We cannot be certain that our licensors are not infringing the intellectual property rights of others or that the suppliers and licensors have sufficient rights to the technology in all jurisdictions in which we may operate. Some of our license agreements may be terminated by our licensors for convenience. If we are unable to obtain or maintain rights to any of this technology because of intellectual property infringement claims brought by third parties against our suppliers and licensors or against us, or if we are unable to continue to obtain the technology or enter into new agreements on commercially reasonable terms, our ability to develop our platform containing that technology could be severely limited and our business could be harmed. Additionally, if we are unable to obtain necessary technology from third parties, we may be forced to acquire or develop alternate technology, which may require significant time and effort and may be of lower quality or performance standards. This would limit and delay our ability to provide new or competitive loan products or service offerings and increase our costs. If alternate technology cannot be obtained or developed, we may not be able to offer certain functionality as part of our platform and service offerings, which could adversely affect our business, financial condition and results of operations.
Failure by our third-party vendors or our failure to comply with legal or regulatory requirements or other contractual requirements could have an adverse effect on our business.
We have significant vendors that provide us with a number of services to support our platform. If any third-party vendors fail to comply with applicable laws and regulations or comply with their contractual requirements, including failure to maintain adequate systems addressing privacy and data protection and security, we could be subject to regulatory enforcement actions and suffer economic and reputational harm that could harm our business. Further, we may incur significant costs to resolve any such disruptions in service or failure to provide contracted services, which could adversely affect our business.
The CFPB and each of the prudential bank regulators that supervise our lending partners have issued guidance stating that institutions under their supervision may be held responsible for the actions of the companies with which they contract. As a service provider to those supervised entities, we must ensure we have implemented an adequate vendor management program. We or our lending partners could be adversely impacted to the extent we fail to implement a vendor management system that is satisfactory to the CFPB and other regulators or our vendors fail to comply with the legal requirements applicable to the particular products or services being offered. Our use of third-party vendors is subject to increasing regulatory attention.
The CFPB and other regulators have also issued regulatory guidance that has focused on the need for financial institutions to perform increased due diligence and ongoing monitoring of third-party vendor relationships, including, for example, the June 2023 interagency guidance on third party risk management. Such guidance increases the scope of management involvement in connection with using third-party vendors. Moreover, if regulators conclude that we or our lending partners have not met the heightened standards for oversight of our third-party vendors, we or our lending partners could be subject to enforcement actions, civil monetary penalties, supervisory orders to cease and desist or other remedial actions, which could have an adverse effect on our business, financial condition and results of operations.
If loans originated by our lending partners were found to violate the laws of one or more states, whether at origination or after sale by the lending partner, loans facilitated through our marketplace may be unenforceable or otherwise impaired, we or our lending partners or institutional investors may be subject to, among other things, fines and penalties, and/or our commercial relationships may suffer, each of which would adversely affect our business and results of operations.
When establishing the interest rates and structures (and the amounts and structures of certain fees constituting interest under federal banking law, such as origination fees, late fees and non-sufficient funds fees) that are charged to borrowers on loans originated on our marketplace, our lending partners rely on certain authority under federal law to export the interest rate requirements of the state where each lending partner is located to borrowers in all other states. Further, we, our securitization vehicles and our institutional investors that purchase Upstart-powered loans originated by our lending partners rely on the ability, as subsequent holders of the loans, to continue charging
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the interest rates and fee structures and enforce other contractual terms agreed to between the lending partners and the borrowers, as permitted under federal banking laws. The current maximum annual percentage rate of the loans facilitated through our marketplace is 35.99%. In some states, the interest rates of certain Upstart-powered loans exceed the maximum interest rate permitted for consumer loans applicable to non-bank lenders to borrowers residing in, or that have nexus to, such states. In addition, the rate structures for Upstart-powered loans may not be permissible in all states for non-bank purchasers and/or the amount or structures of certain fees charged in connection with Upstart-powered loans may not be permissible in all states for non-bank purchasers. Furthermore, other states have proposed or enacted additional limitations on interest rates and fees, such as laws in Illinois, Maine and New Mexico that cap interest rates on certain loans at an “all-in” 36% APR.
Usury, fee, and disclosure related claims involving Upstart-powered loans may be raised in multiple ways. We or the participants in our marketplace, including lending partners and institutional investors, may face litigation, government enforcement or other challenges, for example, based on claims that our lending partners did not establish loan terms that were permissible in the state they were located or did not correctly identify the home or host state in which they were located for purposes of interest exportation authority under federal law. Alternatively, we or our institutional investors may face litigation, government enforcement or other challenge, for example, based on claims that rates and fees were lawful at origination and through any period during which the lending partner retained the loan and interests therein, but following the sale of loans, we or other purchasers of the loans, including our institutional investors, are not permitted to enforce the loans pursuant to their contracted-for terms, or that while certain disclosures were not required at origination because the loans were originated by banks, they may be required following the sale of such loans.
In Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), cert. denied, 136 S.Ct. 2505 (June 27, 2016), for example, the United States Court of Appeals for the Second Circuit held that the non-bank purchaser of defaulted credit card debt could not rely on preemption standards under the National Bank Act applicable to the originator of such debt in defense of usury claims. Madden addressed circumstances under which a defaulted extension of credit under a consumer credit card account was assigned, following default, to a non-bank debt buyer that then attempted to collect the loan and to continue charging interest at the contracted-for rate. The debtor filed a suit claiming, among other claims, that the rate charged by the non-bank collection entity exceeded the usury rates allowable for such entities under New York usury law. Reversing a lower court decision, the Second Circuit held that preemption standards under the National Bank Act applicable to the bank that issued the credit card were not available to the non-bank debt buyer as a defense to usury claims. Following denial of a petition for rehearing by the Second Circuit, the defendant sought review by the United States Supreme Court. The Supreme Court denied certiorari on June 27, 2016, and therefore, the Second Circuit’s decision remains binding on federal courts in the Second Circuit (which include all federal courts in New York, Connecticut, and Vermont). Upon remand to the District Court for consideration of additional issues, the parties settled the matter in 2019.
The scope and validity of the Second Circuit’s Madden decision remain subject to challenge and clarification. For example, the Colorado Administrator of the Colorado Uniform Consumer Credit Code, or the UCCC, reached a settlement with respect to complaints against two online lending platforms whose operations share certain commonalities with ours, including with respect to the role of lending partners originating loans and non-bank purchasers of such loans. The complaints included, among other claims, allegations, grounded in the Second Circuit’s Madden decision, that the rates and fees for certain loans could not be enforced lawfully by non-bank purchasers of bank-originated loans. Under the settlement, the banks and non-bank purchasers committed to, among other things, limit the annual percentage rates, or APR, on loans to Colorado consumers to 36% and take other actions to ensure that the banks were in fact the true lenders. The non-bank purchasers also agreed to obtain and maintain a Colorado lending license. In Colorado, this settlement created a helpful model for what constitutes an acceptable bank partnership model; however, Colorado opted out of the federal law that allows state-chartered banks to export their rates, with such law becoming effective July 1, 2024 and putting the settlement model in jeopardy. Regardless, the settlement may also invite other states to initiate their own actions, and set their own regulatory standards through enforcement.
In addition, in June 2019, private plaintiffs filed class action complaints against multiple traditional credit card securitization programs, including, Petersen, et al. v. Chase Card Funding, LLC, et al., (No. 1:19-cv-00741-
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LJV-JJM (W.D.N.Y. June 6, 2019)) and Cohen, et al. v. Capital One Funding, LLC et al., (No. 19-03479 (E.D.N.Y. June 12, 2019)). In Petersen, the plaintiffs sought class action status against certain defendants affiliated with a national bank that have acted as special purpose entities in securitization transactions sponsored by the bank. The complaint alleges that the defendants’ acquisition, collection and enforcement of the bank’s credit card receivables violated New York’s civil usury law and that, as in Madden, the defendants, as non-bank entities, are not entitled to the benefit of federal preemption of state usury law. The complaint sought a judgment declaring the receivables unenforceable, monetary damages and other legal and equitable remedies, such as disgorgement of all sums paid in excess of the usury limit. Cohen was a materially similar claim against another national bank. On January 22, 2020, the magistrate judge in Petersen issued a report and recommendation responding to the defendants’ motion to dismiss. The magistrate recommended that the motion to dismiss be granted as to both of the plaintiffs’ claims (usury and unjust enrichment). On September 21, 2020, the District Court accepted the magistrate’s recommendation and dismissed all claims. The District Court found that the usury claims were expressly preempted by the National Bank Act and referenced the OCC’s recent rulemaking (discussed further below) that “[i]nterest on a loan that is permissible under [the National Bank Act] shall not be affected by the sale, assignment, or other transfer of the loan.” Among other things, the Court deferred to the “OCC’s reasoned judgment that enforcing New York’s usury laws against the Chase defendants would significantly interfere with [the bank’s] exercise of its [National Bank Act] powers.” The Cohen case was dismissed on September 29, 2020. The plaintiffs in both Cohen and Petersen filed, but ultimately dropped, their appeals of the decision to the second circuit.
As noted above, federal prudential regulators have also taken actions to address the Madden decision. On May 29, 2020, the OCC issued a final rule clarifying that, when a national bank or savings association sells, assigns, or otherwise transfers a loan, interest permissible before the transfer continues to be permissible after the transfer. That rule took effect on August 3, 2020. Similarly, the FDIC finalized on June 25, 2020 its 2019 proposal declaring that the interest rate for a loan is determined when the loan is made, and will not be affected by subsequent events. On July 29, 2020, California, New York and Illinois filed suit in the U.S. District Court for the Northern District of California to enjoin enforcement of the OCC rule (Case No. 20-CV-5200) and, similarly in the same court, on August 20, 2020 California, Illinois, Massachusetts, Minnesota, New Jersey, New York, North Carolina, and the District of Columbia sought to enjoin enforcement of the FDIC rule (Case No. 20-CV-5860), in each case related to permissible interest rates post-loan transfer on the grounds that the OCC and FDIC exceeded their authority when promulgating those rules. While the court ruled in favor of the OCC and FDIC holding that the agencies did not exceed their statutory authorities when promulgating their “valid when made” rules, there is risk that the OCC and FDIC rules continue to be challenged or are repealed in the future through legislation.
There are factual distinctions between our program and the circumstances addressed in the Second Circuit’s Madden decision, as well as the circumstances in the Colorado UCCC settlement, credit card securitization litigation, and similar cases. As noted above, there are also bases on which the Madden decision’s validity might be subject to challenge or the Madden decision may be addressed by federal regulation or legislation. Nevertheless, there can be no guarantee that a Madden-like claim will not be brought successfully against us, our lending partners or our institutional investors.
Effective October 2021, Maine updated its Consumer Credit Code to include a statutory “true lender” test, providing that an entity is a “lender” subject to certain requirements of the Consumer Credit Code if the person, among other things: (i) has the predominant economic interest in a loan; (ii) brokers, arranges, or facilitates a loan and has the right to purchase the loan; or (iii) based on the totality of the circumstances, appears to be the lender, and the transaction is structured to evade certain statutory requirements. Me. Rev. Stat. § 2-702. Connecticut and Minnesota codified a “true lender” test into their laws in 2023, which similarly focus on the totality of the circumstances or who has the “predominant economic interest” in the loans. More states may also institute similar statutory “true lender” tests. The statutory “true lender” tests may increase the risk of true lender litigation in certain jurisdictions and impact how the tests are applied by courts and regulators in determining the true lender. They may also result in increased usury and licensing risk. Other states may take different paths to promulgate similar “true lender” restrictions, and if not through a legislative path, impacted parties may have little to no advance notice of new restrictions and compliance obligations.
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If a borrower or any state agency were to successfully bring a claim against us, our lending partners, our securitization vehicles and/or the trustees of such vehicles or our institutional investors for a state usury law or fee restriction violation and the rate or fee at issue on the loan was impermissible under applicable state law, we, our lending partners, securitization vehicles and/or trustees or institutional investors may face various commercial and legal repercussions, including that such parties would not receive the total amount of interest expected, and in some cases, may not receive any interest or principal, may hold loans that are void, voidable, rescindable, or otherwise impaired or may be subject to monetary, injunctive or criminal penalties. Were such repercussions to apply to us, we may suffer direct monetary loss or may be a less attractive candidate for lending partners, securitization trustees or institutional investors to enter into or renew relationships; and were such repercussions to apply to our lending partners or institutional investors, such parties could be discouraged from using our marketplace. We may also be subject to payment of damages in situations where we agreed to provide indemnification, as well as fines and penalties assessed by state and federal regulatory agencies.
If loans facilitated through our marketplace for one or more lending partners were subject to successful challenge that the lending partner was not the “true lender,” such loans may be unenforceable, subject to rescission or otherwise impaired, we or other program participants may be subject to penalties, and/or our commercial relationships may suffer, each which would adversely affect our business and results of operations.
Upstart-powered loans are originated in reliance on the fact that our lending partners are the “true lenders” for such loans. That true lender status determines various Upstart-powered loan program details, and Upstart-powered loans may involve interest rates and structures (and certain fees and fees structures) permissible at origination only because the loan terms and lending practices are permissible only when the lender is a bank, and/or the disclosures provided to borrowers would be accurate and compliant only if the lender is a bank. Because the loans facilitated by our marketplace are originated by our lending partners, many state consumer financial regulatory requirements, including usury restrictions (other than the restrictions of the state in which a lending partner originating a particular loan is located) and many licensing requirements and substantive requirements under state consumer credit laws, are treated as inapplicable based on principles of federal preemption or express exemptions provided in relevant state laws for certain types of financial institutions or loans they originate.
Certain recent litigation and regulatory enforcement has challenged, or is currently challenging, the characterization of bank partners as the “true lender” in connection with programs involving origination and/or servicing relationships between a bank partner and non-bank lending platform or program manager. As noted above, the Colorado Administrator has entered into a settlement agreement with certain banks and non-banks that addresses this true lender issue. Specifically, the settlement agreement sets forth a safe harbor indicating that a bank is the true lender if certain specific terms and conditions are met. However, other states could also bring lawsuits based on these types of relationships. For example, in June 2020, the Washington, DC Attorney General filed a lawsuit against online lender Elevate for allegedly deceptively marketing high-cost loans with interest rates above the Washington, DC usury cap. The usury claim is based on an allegation that Elevate, which was not licensed in Washington, DC, and not its partner bank, originated these loans, and was therefore in violation of the state’s usury laws. This case ultimately settled, with Elevate agreeing to charge rates only up to 24% and to refund consumers who were charged rates over what is allowed under Washington, DC law. A similar complaint against an online lender, Opportunity Financial, LLC, was filed in early 2021, alleging that it rather than a bank originated these loans and the loans were therefore in violation of Washington, DC usury laws. The parties settled this case in November 2021. Also in April 2021, the Maryland Office of the Commissioner of Financial Regulation also alleged in the context of a civil suit that a state-chartered bank and its fintech partners engaged in a bank partnership program that violated various state licensing and credit statutes. The case is pending before the Office of the Commissioner of Financial Regulation for administrative adjudication. In June 2021, a putative class action lawsuit was filed against the online lender Marlette Funding LLC in the Court of Common Pleas of Allegheny County, Pennsylvania, alleging that the company, doing business as Best Egg, was the true lender of usurious loans, with a rate of interest far in excess of the 6% rate permitted to be charged in Pennsylvania by unlicensed non-banks, originated through a partnership with Cross River Bank (Case No. 21-CV-985). Furthermore, in April 2022, the California Department of Financial Protection and Innovation filed a complaint in Los Angeles Superior Court alleging that Opportunity Financial, LLC is the “true lender” of several loans to California residents that exceeded the applicable California
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usury limit for small dollar loans. While Opportunity Financial received a favorable decision in October 2023 that denied California’s motion for preliminary injunction, in California and other states, there is an ongoing risk that government agencies and private plaintiffs will seek to challenge these types of relationships that are similar to our business model.
We note that the OCC issued on October 27, 2020, a final rule to address the “true lender” issue for lending transactions involving a national bank. For certain purposes related to federal banking law, including the ability of a national bank to “export” interest-related requirements from the state from which they lend, the rule would treat a national bank as the “true lender” if it is named as the lender in the loan agreement or funds the loan. However, the rule was subsequently challenged by the Attorneys General from seven states and ultimately repealed by Congress pursuant to the Congressional Review Act on June 30, 2021. No similar rule applicable to state-chartered banks was issued by the FDIC, and thus there is no longer a clear federal standard.
While we have taken steps to comply with the safe harbor in the Colorado settlement and other laws, regulations and guidance, we, lending partners, institutional investors, securitization vehicles and other similarly situated parties could become subject to challenges like those presented by the Colorado settlement and, if so, we could face penalties and/or Upstart-powered loans may be void, voidable or otherwise impaired in a manner that may have adverse effects on our operations (directly, or as a result of adverse impact on our relationships with our lending partners, institutional investors or other commercial counterparties). There have been no formal proceedings against us or indication of any proceedings against us to date, but there can be no assurance that the Colorado Administrator or any other regulator will not make assertions similar to those made in its present actions with respect to the loans facilitated by our marketplace in the future.
It is also possible that other state agencies or regulators could make similar assertions. If a court, or a state or federal enforcement agency, were to deem Upstart, rather than our lending partners, the “true lender” for loans originated on our marketplace, and if for this reason (or any other reason) the loans were deemed subject to and in violation of certain state consumer finance laws, we could be subject to fines, damages, injunctive relief (including required modification or discontinuation of our business in certain areas) and other penalties or consequences, and the loans could be rendered void or unenforceable in whole or in part, any of which could have a material adverse effect on our business (directly, or as a result of adverse impact on our relationships with our lending partners, institutional investors or other commercial counterparties).
We are subject to counterparty risk with respect to the capped call transactions.
The counterparties to the capped call transactions entered into in connection with the offering of the Notes (as defined below) are financial institutions, and we are subject to the risk that one or more of the counterparties may default or otherwise fail to perform, or may exercise certain rights to terminate, their obligations under the capped call transactions. Our exposure to the credit risk of the counterparties will not be secured by any collateral. Global economic conditions have in the past resulted in the actual or perceived failure or financial difficulties of many financial institutions. If a counterparty to one or more capped call transactions becomes subject to bankruptcy or other insolvency proceedings, we will become an unsecured creditor in those proceedings with a claim equal to our exposure at the time under such transactions. Our exposure will depend on many factors but, generally, our exposure will increase if the market price or the volatility of our common stock increases. In addition, upon a default or other failure to perform, or a termination of obligations, by a counterparty, the counterparty may fail to deliver the shares of our common stock or cash required to be delivered to us under the capped call transactions and we may suffer adverse tax consequences or experience more dilution than we currently anticipate with respect to our common stock. We can provide no assurances as to the financial stability or viability of the counterparties.
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RISKS RELATED TO OUR REGULATORY ENVIRONMENT
Litigation, regulatory actions and compliance issues could subject us to significant fines, penalties, judgments, remediation costs and/or requirements resulting in increased expenses.
In the ordinary course of business, we have been named as a defendant in various legal actions, including a class action lawsuit and other litigation. Generally, this litigation arises from the dissatisfaction of a consumer with the products or services offered on our marketplace; some of this litigation, however, has arisen from other matters, including claims of violation of laws related to credit reporting, collections and do-not-call. All such legal actions are inherently unpredictable and, regardless of the merits of the claims, litigation is often expensive, time-consuming, disruptive to our operations and resources, and distracting to management. In addition, certain actions may include claims for indeterminate amounts of damages. Our involvement in any such matter also could cause significant harm to our or our lending partners’ reputations and divert management attention from the operation of our business, even if the matters are ultimately determined in our favor. If resolved against us, legal actions could result in excessive verdicts and judgments, injunctive relief, equitable relief, and other adverse consequences that may affect our financial condition and how we operate our business.
In addition, a number of participants in the consumer financial services industry have been the subject of putative class action lawsuits, state attorney general actions and other state regulatory actions, federal regulatory enforcement actions, including actions relating to alleged unfair, deceptive or abusive acts or practices, violations of state licensing and lending laws, including state usury and disclosure laws, actions alleging discrimination on the basis of race, ethnicity, gender or other prohibited bases, and allegations of noncompliance with various state and federal laws and regulations relating to originating, servicing, and collecting consumer finance loans and other consumer financial services and products. The current regulatory environment, increased regulatory compliance efforts and enhanced regulatory enforcement have resulted in us undertaking significant time-consuming and expensive operational and compliance efforts to operate in accordance with relevant laws, which may delay or preclude our or our lending partners’ ability to provide certain new products and services. There is no assurance that these regulatory matters or other factors will not, in the future, affect how we conduct our business and, in turn, have a material adverse effect on our business. In particular, legal proceedings brought under state consumer protection statutes or under several of the various federal consumer financial services statutes may result in a separate fine assessed for each statutory and regulatory violation or substantial damages from class action lawsuits, potentially in excess of the amounts we earned from the underlying activities.
Some of our agreements used in the course of our business include arbitration clauses. If our arbitration agreements were to become unenforceable for any reason, we could experience an increase to our consumer litigation costs and exposure to potentially damaging class action lawsuits, with a potential material adverse effect on our business and results of operations.
We contest our liability and the amount of damages, as appropriate, in each pending matter. The outcome of pending and future matters could be material to our results of operations, financial condition and cash flows, and could materially adversely affect our business.
In addition, from time to time, through our operational and compliance controls, we identify compliance issues that require us to make operational changes and, depending on the nature of the issue, result in financial remediation to impacted borrowers. These self-identified issues and voluntary remediation payments could be significant, depending on the issue and the number of borrowers impacted, and could generate litigation or regulatory investigations that subject us to additional risk.
We are subject to or facilitate compliance with a variety of federal, state, and local laws, including those related to consumer protection and loan financings.
We must comply with regulatory regimes or facilitate compliance with regulatory regimes on behalf of our lending partners that are independently subject to federal and/or state oversight by bank regulators, including those applicable to our referral and marketing services, consumer credit transactions, loan servicing and collection
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activities and the purchase and sale of whole loans and other related transactions. The current presidential administration has brought an increased focus on enforcement of federal consumer protection laws, notably those related to artificial intelligence, and has appointed consumer-oriented regulators at federal agencies such as the CFPB and the OCC. It is possible that regulators in the current or future presidential administration could promulgate rulemakings and bring enforcement actions that materially impact our business and the business of our lending partners. These regulators may augment requirements that apply to loans facilitated by our marketplace, or impose new programs and restrictions, and could otherwise revise or create new regulatory requirements that apply to us (or our lending partners), impacting our business, operations, and profitability.
Certain state laws generally regulate interest rates and other charges and require certain disclosures. In addition, other federal and state laws may apply to the origination, servicing and collection of loans originated on our marketplace, and the purchase and sale of whole loans or asset-backed securitizations. In particular, certain laws, regulations and rules we or our lending partners are subject to include:
•state lending laws and regulations that require certain parties to hold licenses or other government approvals or filings in connection with specified activities, and impose requirements related to loan disclosures and terms, fees and interest rates, credit discrimination, credit reporting, servicemember relief, debt collection, repossession, unfair or deceptive business practices and consumer protection, as well as other state laws relating to privacy, information security, conduct in connection with data breaches and money transmission;
•the Truth-in-Lending Act and Regulation Z promulgated thereunder, and similar state laws, which require certain disclosures to borrowers regarding the terms and conditions of their loans and credit transactions, require creditors to comply with certain lending practice restrictions, limit the ability of a creditor to impose certain loan terms and impose disclosure requirements in connection with credit card origination;
•the Equal Credit Opportunity Act and Regulation B promulgated thereunder, and similar state fair lending laws, which prohibit creditors from discouraging or discriminating against credit applicants on a prohibited basis, including race, color, sex, age, religion, national origin, marital status, the fact that all or part of the applicant’s income derives from any public assistance program or the fact that the applicant has in good faith exercised any right under the federal Consumer Credit Protection Act;
•the Fair Credit Reporting Act and Regulation V promulgated thereunder, imposes certain obligations on users of consumer reports and those that furnish information to consumer reporting agencies, including obligations relating to obtaining consumer reports, marketing using consumer reports, taking adverse action on the basis of information from consumer reports, addressing risks of identity theft and fraud and protecting the privacy and security of consumer reports and consumer report information;
•Section 5 of the Federal Trade Commission Act, which prohibits unfair and deceptive acts or practices in or affecting commerce, and Section 1031 of the Dodd-Frank Act, which prohibits unfair, deceptive or abusive acts or practices in connection with any consumer financial product or service, and analogous state laws prohibiting unfair, deceptive or abusive acts or practices;
•the Credit Practices Rule which (i) prohibits lenders from using certain contract provisions that the Federal Trade Commission has found to be unfair to consumers; (ii) requires lenders to advise consumers who co-sign obligations about their potential liability if the primary obligor fails to pay; and (iii) prohibits certain late charges;
•the Fair Debt Collection Practices Act, Regulation F, and similar state debt collection laws, which provide guidelines and limitations on the conduct of third-party debt collectors (and some limitation on creditors collecting their own debts) in connection with the collection of consumer debts;
•the Gramm-Leach-Bliley Act, or GLBA, and Regulation P promulgated thereunder, which includes limitations on financial institutions’ disclosure of nonpublic personal information about a consumer to nonaffiliated third parties, in certain circumstances requires financial institutions to limit the use and further disclosure of nonpublic personal information by nonaffiliated third parties to whom they disclose such information and requires financial institutions to disclose certain privacy notices and practices with respect
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to information sharing with affiliated and unaffiliated entities as well as to safeguard personal borrower information, and other state privacy laws and regulations;
•the Bankruptcy Code, which limits the extent to which creditors may seek to enforce debts against parties who have filed for bankruptcy protection;
•the Servicemembers Civil Relief Act, which allows military members to suspend or postpone certain civil obligations, requires creditors to reduce the interest rate to 6% on loans to military members under certain circumstances, and imposes restrictions on enforcement of loans to servicemembers, so that the military member can devote his or her full attention to military duties;
•the Military Lending Act, which requires those who lend to “covered borrowers”, including members of the military and their dependents, to only offer Military APRs (a specific measure of all-in-cost-of-credit) under 36%, prohibits arbitration clauses in loan agreements, and prohibits certain other loan agreement terms and lending practices in connection with loans to military servicemembers, among other requirements, and for which violations may result in penalties including voiding of the loan agreement;
•the Electronic Fund Transfer Act and Regulation E promulgated thereunder, which provide guidelines and restrictions on the electronic transfer of funds from consumers’ bank accounts, including a prohibition on a creditor requiring a consumer to repay a credit agreement in preauthorized (recurring) electronic fund transfers and disclosure and authorization requirements in connection with such transfers;
•the Telephone Consumer Protection Act and the regulations promulgated thereunder, which impose various consumer consent requirements and other restrictions in connection with telemarketing activity and other communication with consumers by phone, fax or text message, and which provide guidelines designed to safeguard consumer privacy in connection with such communications;
•the Federal Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 and the Telemarketing Sales Rule and analogous state laws, which impose various restrictions on marketing conducted use of email, telephone, fax or text message;
•the Electronic Signatures in Global and National Commerce Act and similar state laws, particularly the Uniform Electronic Transactions Act, which authorize the creation of legally binding and enforceable agreements utilizing electronic records and signatures and which require creditors and loan servicers to obtain a consumer’s consent to electronically receive disclosures required under federal and state laws and regulations;
•the Right to Financial Privacy Act and similar state laws enacted to provide the financial records of financial institution customers a reasonable amount of privacy from government scrutiny;
•the Bank Secrecy Act and the USA PATRIOT Act, which relate to compliance with anti-money laundering, borrower due diligence and record-keeping policies and procedures;
•the regulations promulgated by the Office of Foreign Assets Control under the U.S. Treasury Department related to the administration and enforcement of sanctions against foreign jurisdictions and persons that threaten U.S. foreign policy and national security goals, primarily to prevent targeted jurisdictions and persons from accessing the U.S. financial system;
•federal and state securities laws, including, among others, the Securities Act of 1933, as amended, or the Securities Act, the Exchange Act, the Investment Advisers Act of 1940, as amended, or the IAA, and the Investment Company Act of 1940, as amended, or the Investment Company Act, rules and regulations adopted under those laws, and similar state laws and regulations, which govern how we offer, sell and transact in our loan financing products; and
•other state-specific and local laws and regulations.
We may not always have been, and may not always be, in compliance with these and other applicable laws, regulations and rules. And while compliance with these requirements is a business priority for us, it is also costly, time-consuming and limits our operational flexibility. Additionally, Congress, the states and regulatory agencies, as well as local municipalities, could further regulate the consumer financial services industry in ways that make it
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more difficult or costly for us to offer our AI lending marketplace and related services or facilitate the origination of loans for our lending partners. These laws also are often subject to changes that could severely limit the operations of our business model. Further, changes in the regulatory application or judicial interpretation of the laws and regulations applicable to financial institutions also could impact the manner in which we conduct our business. The regulatory environment in which financial institutions operate has become increasingly complex, and following the financial crisis that began in 2008, supervisory efforts to apply relevant laws, regulations and policies have become more intense. Additionally, states are increasingly introducing and, in some cases, passing laws that restrict interest rates and APRs on loans similar to the loans made on our marketplace. For example, Illinois, Maine and New Mexico enacted laws that cap interest rates on certain loans at an “all-in” 36% APR. Further, in late 2020, California created a “mini-CFPB,” which could increase its oversight over bank partnership relationships and strengthen state consumer protection authority of state regulators to police debt collections and unfair, deceptive or abusive acts and practices. Voter referendums also have been introduced and, in some cases, passed, restrictions on interest rates and/or APRs. If such legislation or bills were to be propagated, or state or federal regulators seek to restrict regulated financial institutions such as our lending partners from engaging in business with Upstart in certain ways, our lending partners’ ability to originate loans in certain states could be greatly reduced, and as a result, our business, financial condition and results of operations would be adversely affected.
Where applicable, we seek to comply with state broker, credit service organization, small loan, finance lender, servicing, collection, money transmitter and similar statutes. Nevertheless, if we are found to not comply with applicable laws, we could lose one or more of our licenses or authorizations, become subject to greater scrutiny by other state regulatory agencies, face other sanctions or be required to obtain a license in such jurisdiction, which may have an adverse effect on our ability to continue to facilitate loans, perform our servicing obligations or make our marketplace available to consumers in particular states, which may harm our business. Further, failure to comply with the laws and regulatory requirements applicable to our business and operations may, among other things, limit our ability to collect all or part of the principal of or interest on Upstart-powered loans. In addition, non-compliance could subject us to damages, revocation of required licenses, class action lawsuits, administrative enforcement actions, rescission rights held by investors in securities offerings and civil and criminal liability, all of which would harm our business.
Internet-based loan origination processes may give rise to greater risks than paper-based processes and may not always be allowed under state law.
We use the internet to obtain application information and distribute certain legally required notices to applicants and borrowers, and to obtain electronically signed loan documents in lieu of paper documents with actual borrower signatures. These processes may entail greater risks than would paper-based loan origination processes, including risks regarding the sufficiency of notice for compliance with consumer protection laws, risks that borrowers may challenge the authenticity of loan documents, and risks that despite internal controls, unauthorized changes are made to the electronic loan documents. In addition, our software could contain “bugs” that result in incorrect calculations or disclosures or other non-compliance with federal or state laws or regulations. If any of those factors were to cause any loans, or any of the terms of the loans, to be unenforceable against the borrowers, or impair our ability to service loans, the performance of the underlying promissory notes could be adversely affected.
For auto loans issued through our auto lending marketplace, certain state laws may not allow for electronic lien and title transfer, which would require us to use a paper-based title process to secure title to the underlying collateral. While this process may help mitigate some of the risks associated with online processes, because it is highly manual and outside of our usual practices and titling rules can vary by state, we may be prone to errors and encounter greater difficulty complying with the proper procedures. If we fail to effectively follow such procedures we may, among other things, be limited in our ability to secure the collateral associated with loans issued through our auto lending marketplace.
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If we are found to be operating without having obtained necessary state or local licenses, our business, financial condition and results of operations could be adversely affected.
Certain states have adopted laws regulating and requiring licensing by parties that engage in certain activities regarding consumer finance transactions, including facilitating and assisting such transactions in certain circumstances. Furthermore, certain states and localities have also adopted laws requiring licensing for consumer debt collection or servicing and/or purchasing or selling consumer loans. While we believe we have obtained or are in the process of obtaining all necessary licenses, the application of some consumer finance licensing laws to our AI lending marketplace and the related activities we perform, as well as to our lending partners, is unclear. In addition, state licensing requirements may evolve over time, including, in particular, recent trends toward increased licensing requirements and regulation of parties engaged in loan solicitation and student loan servicing activities. States also maintain licensing requirements pertaining to the transmission of money, and certain states may broadly interpret such licensing requirements to cover loan servicing and the transmission of funds to investors. If we or one of our lending partners were found to be in violation of applicable state licensing requirements by a court or a state, federal, or local enforcement agency, we could be subject to fines, damages, injunctive relief (including required modification or discontinuation of our business in certain areas), criminal penalties and other penalties or consequences, and the loans originated by our lending partners on our marketplace could be rendered void or unenforceable in whole or in part, any of which could have a material adverse effect on our business.
The CFPB has sometimes taken expansive views of its authority to regulate consumer financial services, creating uncertainty as to how the agency’s actions or the actions of any other agency could impact our business.
The CFPB, which commenced operations in July 2011, has broad authority to create and modify regulations under federal consumer financial protection laws and regulations, such as the Truth in Lending Act and Regulation Z, ECOA and Regulation B, the Fair Credit Reporting Act and Regulation V, the Electronic Funds Transfer Act and Regulation E, among other regulations, and to enforce compliance with those laws. The CFPB supervises banks, thrifts and credit unions with assets over $10 billion and examines certain of our lending partners. Further, the CFPB is charged with the examination and supervision of certain participants in the consumer financial services market, including short-term, small dollar lenders, non-bank mortgage originators and servicers, and larger participants in other areas of financial services. The CFPB is also authorized to prevent “unfair, deceptive or abusive acts or practices” through its rulemaking, supervisory and enforcement authority. To assist in its enforcement, the CFPB maintains an online complaint system that allows consumers to log complaints with respect to various consumer finance products, including the loan products offered on our marketplace. This system could inform future CFPB decisions with respect to its regulatory, enforcement or examination focus. The CFPB may also request reports concerning our organization, business conduct, markets and activities and conduct on-site examinations of our business on a periodic basis if the CFPB were to determine, through its complaint system, that we were engaging in activities that pose risks to consumers.
There continues to be uncertainty about the future of the CFPB and as to how its strategies and priorities, including in both its examination and enforcement processes, will impact our business and our results of operations going forward. This uncertainty is increased in light of the fact that the new director of the CFPB has new examination and enforcement priorities, including safeguarding against algorithmic bias. In April 2022, the CFPB announced that it intends to examine non-bank financial companies that pose risks to consumers. If the CFPB decides to subject us to its supervisory process, it could significantly increase the level of regulatory scrutiny of our business practices. See the risk factor titled “—Our business is subject to a wide range of laws and regulations, many of which are evolving, and failure or perceived failure to comply with such laws and regulations could harm our business, financial condition and results of operations” for more information.
In addition, evolving views regarding the use of alternative variables and machine learning in assessing credit risk could result in the CFPB taking actions that result in requirements to alter or cease offering affected financial products and services, making them less attractive and restricting our ability to offer them. See the risk factor titled “—Our reputation and brand are important to our success, and if we are unable to continue developing our reputation and brand, our ability to retain existing and attract new bank partners, our ability to attract borrowers to our marketplace, our ability to maintain diverse and resilient loan funding and our ability to maintain
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and improve our relationship with regulators of our industry could be adversely affected” for more information. The CFPB could also implement rules that restrict our effectiveness in servicing our financial products and services.
Although we have committed resources to enhancing our compliance programs, future actions by the CFPB (or other regulators) against us, our lending partners or our competitors could discourage the use of our services or those of our lending partners, which could result in reputational harm, a loss of lending partners, borrowers or institutional investors, or discourage the use of our or their services and adversely affect our business. If the CFPB changes regulations that were adopted in the past by other regulators and transferred to the CFPB by the Dodd-Frank Act, or modifies through supervision or enforcement past regulatory guidance or interprets existing regulations in a different or stricter manner than they have been interpreted in the past by us, the industry or other regulators, our compliance costs and litigation exposure could increase materially. This is particularly true with respect to the application of ECOA and Regulation B to credit risk models that rely upon alternative variables and machine learning, an area of law where regulatory guidance is currently uncertain and still evolving, and for which there are not well-established regulatory norms for establishing compliance.
The current presidential administration has appointed and is expected to continue to appoint consumer-oriented regulators at federal agencies such as the CFPB, the FTC, the OCC and the FDIC and the government’s focus on enforcement of federal consumer protection laws is expected to increase. It is possible that these regulators could promulgate rulemakings and bring enforcement actions that materially impact our business and the business of our lending partners. If future regulatory or legislative restrictions or prohibitions are imposed that affect our ability to offer certain of our products or that require us to make significant changes to our business practices, and if we are unable to develop compliant alternatives with acceptable returns, these restrictions or prohibitions could have a material adverse effect on our business. If the CFPB, or another regulator, were to issue a consent decree or other similar order against us, this could also directly or indirectly affect our results of operations.
Our compliance and operational costs and litigation exposure could increase if and when the CFPB or another agency amends or finalizes any proposed regulations, including the regulations discussed above or if the CFPB or other regulators enact new regulations, change regulations that were previously adopted, modify, through supervision or enforcement, past regulatory guidance, or interpret existing regulations in a manner different or stricter than have been previously interpreted.
We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business.
We have, from time to time in the normal course of our business, received, and may in the future receive or be subject to, inquiries or investigations by state and federal regulatory agencies and bodies such as the CFPB, the FTC, state Attorneys General, the SEC, state financial regulatory agencies and other state or federal agencies or bodies regarding the Upstart marketplace, including the marketing of loans for lenders, underwriting and pricing of consumer loans for our lending partners, our fair lending compliance program and licensing and registration requirements. While we expect to address inquiries or investigations and engage in open dialogue with regulators, we cannot guarantee that a federal or state regulator will not take supervisory or enforcement action against us in the future. Since the no-action letter with the CFPB was terminated in June 2022, we no longer enjoy the protection of the no-action letter which had provided that the CFPB would not take supervisory or enforcement action against us for a violation of ECOA. We intend to continue to pursue a transparent and cooperative relationship with the CFPB, which could involve sharing information about our models and other aspects of our business. It is also possible the CFPB may take supervisory or enforcement action against us in the future.
We have also received inquiries from state regulatory agencies regarding requirements to obtain licenses from or register with those states, including in states where we have determined that we are not required to obtain such a license or be registered with the state, and we expect to continue to receive such inquiries. Any such inquiries or investigations could involve substantial time and expense to analyze and respond to, could divert management’s attention and other resources from running our business, and could lead to public enforcement actions or lawsuits and fines, penalties, injunctive relief, and the need to obtain additional licenses that we do not currently possess. Our involvement in any such matters, whether tangential or otherwise and even if the matters are ultimately determined
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in our favor, could also cause significant harm to our reputation, lead to additional investigations and enforcement actions from other agencies or litigants, and further divert management attention and resources from the operation of our business. Formal enforcement actions are generally made public, which carries reputational risk. The market price of our common stock could decline as a result of the initiation of a CFPB investigation of Upstart or even the perception that such an investigation could occur, even in the absence of any finding by the CFPB that we have violated any state or federal law. As a result, the outcome of legal and regulatory actions arising out of any state or federal inquiries we receive could be material to our business, results of operations, financial condition and cash flows and could have a material adverse effect on our business, financial condition or results of operations.
For non-bank financial institutions, the FTC is also a primary regulator, and in recent years the FTC has been focused on practices of financial technology companies. Based on publicly available actions, the FTC’s primary focus has been with respect to financial technology company marketing and disclosure practices. For instance, in October 2018 the FTC took action against student loan refinance lender SoFi, claiming that the company made prominent false statements regarding the average savings a consumer would realize over the lifetime of the loan if they refinanced with SoFi. In addition, SoFi allegedly exaggerated claims of anticipated borrower savings by excluding certain customer populations from the analysis. In addition, in July 2021 the FTC settled litigation with LendingClub regarding, among other things, the adequacy of its disclosures of an origination fee associated with the product. Moreover, the FTC recently issued a staff report on digital “dark patterns,” sophisticated design practices that can trick or manipulate consumers into buying products or services or giving up their private information, that, among other things, highlighted marketing and disclosure practices by some financial technology companies that the FTC claimed were deceptive because of their use of dark patterns. Based upon prior enforcement actions, staff reports, and statements by FTC officials, we believe this scrutiny of financial technology company marketing and disclosure practices will continue in the near future. While we maintain policies and procedures that require our marketing and loan application and servicing operations comply with UDAP standards, we may not be successful in our efforts to achieve compliance either due to internal or external factors, such as resource allocation limitations or a lack of vendor cooperation.
The collection, processing, storage, use and disclosure of personal data could give rise to liabilities as a result of existing or new governmental regulation, conflicting legal requirements or differing views of personal privacy rights.
We receive, transmit and store large volumes of personal information and other sensitive data, which may potentially include biometric data as defined by state law, from applicants and borrowers. Each lending partner can access information about their respective borrowers and declined applicants via daily loan reports and other reporting tools that are provided via the platform. For loan institutional investors, while we generally limit access to personal information, we do share some personal information about borrowers with certain institutional investors. There are federal, state and foreign laws regarding privacy and the storing, sharing, use, disclosure and protection of personal information and sensitive data including those specific to biometric data. Specifically, cybersecurity and data privacy issues, particularly with respect to personal information, are increasingly subject to legislation and regulations to protect the privacy and security of personal information that is collected, processed and transmitted. For example, the GLBA includes limitations on financial institutions’ disclosure of nonpublic personal information about a consumer to non-affiliated third parties, in certain circumstances requires financial institutions to limit the use and further disclosure of nonpublic personal information by non-affiliated third parties to whom they disclose such information and requires financial institutions to disclose certain privacy notices and practices with respect to information sharing with affiliated and unaffiliated entities as well as to safeguard personal borrower information. Privacy requirements under the GLBA are enforced by the CFPB, as well as the FTC, and under Section 5 of the Federal Trade Commission Act, we and our lending partners are prohibited from engaging in unfair and deceptive acts and practices, or UDAP. For example, both the FTC and CFPB have relied on UDAP/UDAAP principles to increase enforcement of “dark patterns”, the definition of which varies but has been defined as “design features used to deceive, steer, or manipulate users into behavior that is profitable for an online service, but often harmful to users or contrary to their intent.”
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At the state level, the California Consumer Privacy Act, or the CCPA, which went into effect on January 1, 2020, requires, among other things, that covered companies provide disclosures to California residents and afford such persons new abilities to opt-out of certain sales or retention of their personal information by us. Aspects of the CCPA and its interpretation remain unclear. In addition, California voters approved Proposition 24 in the November 2020 election to create the California Privacy Rights Act, or CPRA, which amends and purports to strengthen the CCPA and created a state agency, the California Privacy Protection Agency, to enforce privacy laws. The CPRA amendments create obligations relating to consumer data as of January 1, 2023 (with a one-year lookback), and enforcement beginning March 29, 2024. Following the enactment of the CCPA, certain states, including but not limited to Texas, Virginia, Colorado and Utah, have enacted, and other states are proposing to enact, laws and regulations that impose obligations similar to the CCPA or that otherwise involve significant obligations and restrictions. While many of these laws include exemptions for information covered by the GLBA, and we therefore may be exempt from all or most obligations under many of these state privacy laws, some states may not provide for such exemptions, and such exemptions may not fully exempt us from compliance with state laws.
Many privacy and data security laws, such as the CCPA, apply to biometric data. However, some states have passed or are considering legislation that are biometric specific. For instance, in Illinois, the Biometric Information Privacy Act, or BIPA, specifically governs the collection, possession, and disclosure of biometric information or biometric identifiers. There has been a corresponding increase in litigation related specifically to state biometric privacy laws. Whether information we receive from borrowers is subject to state laws expressly governing biometric data depends on how such laws define “biometric data” or other similar terms of art.
Compliance with current and future borrower privacy data protection and information security laws and regulations could result in higher compliance, technical or operating costs. We cannot fully predict the impact of the CCPA, BIPA, or other privacy and data security state laws on our business or operations, but it may require us to further modify our data infrastructure and data processing practices and policies and to incur additional costs and expenses in an effort to continue to comply. Further, any actual or perceived violations of these laws and regulations may require us to change our business practices, data infrastructure or operational structure, address legal claims and regulatory investigations and proceedings and sustain monetary penalties and/or other harms to our business. We could also be adversely affected if new legislation or regulations are adopted or if existing legislation or regulations are modified such that we are required to alter our systems or change our business practices or privacy policies.
As the regulatory framework for artificial intelligence and machine learning technology evolves, our business, financial condition and results of operations may be adversely affected.
The regulatory framework for artificial intelligence and machine learning technology is evolving and remains uncertain. For example, in April 2023, the FTC, DOJ, EEOC and CFPB released a joint statement on potential “threats” posed by artificial intelligence, such as contributing to discriminatory outcomes. Additionally, the CFPB published statements in May 2022 and September 2023 on the applicability of ECOA to artificial intelligence and machine learning underwriting models when generating adverse action notices. However, the language of ECOA remains unaltered. Therefore, it is possible that new laws and regulations will be adopted in the United States, or existing laws and regulations may be interpreted in new ways, that would affect the operation of our marketplace and the way in which we use artificial intelligence and machine learning technology, including with respect to fair lending laws. Further, the cost to comply with such laws or regulations could be significant and would increase our operating expenses, which could adversely affect our business, financial condition and results of operations.
If we are required to register under the Investment Company Act, our ability to conduct business could be materially adversely affected.
The Investment Company Act contains substantive legal requirements that regulate the manner in which “investment companies” are permitted to conduct their business activities. In general, an “investment company” is a company that holds itself out as an investment company or holds more than 40% of the total value of its assets (minus cash and government securities) in “investment securities.” We believe we are not an investment company. Our business involves developing and operating an online lending marketplace that provides our lending partners
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with access to technology, including proprietary AI models, and related services, so lending partners can assess the credit risk of potential borrowers and offer loans online, and our revenue derives primarily from fees based on the platform and referral services provided to our lending partners and loan servicing. We do not hold ourselves out as an investment company. We understand, however, that the loans held on our balance sheet could be viewed by the SEC or its staff as “securities,” which could in turn cause the SEC or its staff to view Upstart Holdings, Inc., Upstart Network, Inc., or an affiliate as an “investment company” subject to regulation under the Investment Company Act. We believe that we have never been an investment company because, among other reasons, we are primarily engaged in the business of providing an AI-based lending marketplace, and therefore can reasonably rely on exemptions from investment company status.
If we are not able to rely on exemptions from investment company status, we could be deemed an investment company and may be required to institute burdensome compliance requirements, restricting our activities in a way that could adversely affect our business, financial condition and results of operations. For example, among other things, we could be subject to investment company governance requirements; restricted as to future borrowings and in our transactions with affiliates; and be more limited in available corporate financing alternatives and compensation arrangements. If we were ever deemed to be in non-compliance with the Investment Company Act, we could also be subject to various penalties, including administrative or judicial proceedings that might result in censure, fine, civil penalties, cease-and-desist orders or other adverse consequences, as well as private rights of action, any of which could materially adversely affect our business.
If we are required to register under the Investment Advisers Act, our ability to conduct business could be materially adversely affected.
The IAA contains substantive legal requirements that regulate the manner in which “investment advisers” are permitted to conduct their business activities. We do not believe that we or our affiliates are required to register as an investment adviser with either the SEC or any of the various states, because our business consists of providing a marketplace for consumer lending and loan financing for which investment adviser registration and regulation does not apply under applicable federal or state law. However, one of our affiliates, Upstart Network, Inc., has notice filed as an exempt reporting adviser with the state of California based on its limited activities advising a fund.
While we believe our current practices do not require us or any of our other affiliates or subsidiaries to register or notice file as an investment adviser, or require us to extend regulations related to Upstart Network, Inc.’s status as an exempt reporting adviser to our other operations, if a regulator were to disagree with our analysis with respect to any portion of our business, we or a subsidiary may be required to register or notice file as an investment adviser and to comply with applicable law. Registering as an investment adviser could adversely affect our method of operation and revenues. For example, the IAA requires that an investment adviser act in a fiduciary capacity for its clients. Among other things, this fiduciary obligation requires that an investment adviser manage a client’s portfolio in the best interests of the client, have a reasonable basis for its recommendations, fully disclose to its client any material conflicts of interest that may affect its conduct and seek best execution for transactions undertaken on behalf of its client. The IAA also limits the ways in which a company can market its services and offerings. It could be difficult for us to comply with these obligations without meaningful changes to our business operations, and there is no guarantee that we could do so successfully. If we were ever deemed to be in non-compliance with applicable investment adviser regulations, we could also be subject to various penalties, including administrative or judicial proceedings that might result in censure, fine, civil penalties, cease-and-desist orders or other adverse consequences, as well as private rights of action, any of which could materially adversely affect our business.
If our transactions involving institutional investors who provide loan funding to our marketplace are found to have been conducted in violation of the Securities Act or similar state law, or we have generally violated any applicable law, our ability to obtain financing for loans facilitated through our marketplace could be materially adversely affected, and we could be subject to private or regulatory actions.
Certain transactions involving institutional investors or related to acquisitions may rely or have relied on exemptions from the registration requirements of the Securities Act provided for in Regulation D or Section 4(a)(2)
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of the Securities Act. If any of these transactions were found to not be in compliance with the requirements necessary to qualify for these exemptions from Securities Act registration, or otherwise found to be in violation of the federal or state securities laws, our business could be materially adversely affected. The SEC or state securities regulators could bring enforcement actions against us, or we could be subject to private litigation risks as a result of any violation of the federal or state securities laws, which could result in civil penalties, injunctions and cease and desist orders from further violations, as well as monetary penalties of disgorgement, pre-judgment interest, rescission of securities sales, or civil penalties, any of which could materially adversely affect our business.
If we are found to be in violation of state or federal law generally, we also may be limited in our ability to conduct future transactions. For example, we could in the future become ineligible to sell securities under Regulation D if we become subject to “bad actor” disqualification pursuant to Rule 506(d) of Regulation D. Under Rule 506(d), issuers are ineligible “bad actors” if they or certain related persons, including directors and certain affiliates, are subject to disqualifying events, including certain cease-and-desist orders obtained by the SEC. If we were subject to this or other “bad actor” provisions of the securities laws, we may not be able to continue sales of whole loans, fractional interests in loans, or asset-backed securities, or we could be subject to significant additional expense associated with making our offerings, which would adversely affect our business, financial condition and results of operations.
If we are required to register with the SEC or under state securities laws as a broker-dealer, our ability to conduct business could be materially adversely affected.
We are not currently registered with the SEC as a broker-dealer under the Exchange Act or any comparable state law. The SEC heavily regulates the manner in which broker-dealers are permitted to conduct their business activities. We believe we have conducted, and we intend to continue to conduct, our business in a manner that does not result in our being characterized as a broker-dealer, based on guidance published by the SEC and its staff. Among other reasons, this is because we do not believe we take any compensation that would be viewed as being based on any transactions in securities in any of our business lines. To the extent that the SEC or its staff publishes new or different guidance with respect to these matters, we may be required to adjust our business operations accordingly. Any additional guidance from the SEC staff could provide additional flexibility to us, or it could inhibit our ability to conduct our business operations. There can be no assurance that the laws and regulations governing our broker-dealer status or that SEC guidance will not change in a manner that adversely affects our operations. If we are deemed to be a broker-dealer, we may be required to institute burdensome compliance requirements and our activities may be restricted, which would adversely affect our business, financial condition and results of operations. We may also be subject to private litigation and potential rescission of certain investments investors in our loan financing products have made, which would harm our operations as well.
Similarly, we do not believe that our sales of whole loans and asset-backed securities will subject us to broker-dealer registration in any state in which we operate, primarily because we do not accept compensation that we believe could be viewed as transaction-based. However, if we were deemed to be a broker-dealer under a state’s securities laws, we could face civil penalties, or costly registration requirements, that could adversely affect our business.
Anti-money laundering, anti-terrorism financing, anti-corruption and economic sanctions laws could have adverse consequences for us.
We maintain a compliance program designed to enable us to comply with all applicable anti-money laundering and anti-terrorism financing laws and regulations, including the Bank Secrecy Act and the USA PATRIOT Act and U.S. economic sanctions laws administered by the Office of Foreign Assets Control. This program includes policies, procedures, processes and other internal controls designed to identify, monitor, manage and mitigate the risk of money laundering and terrorist financing and engaging in transactions involving sanctioned countries, persons and entities. These controls include procedures and processes to detect and report suspicious transactions, perform borrower due diligence, respond to requests from law enforcement, and meet all recordkeeping and reporting requirements related to particular transactions involving currency or monetary instruments. During 2020, we failed to file timely reports of suspicious transactions as required with appropriate regulatory agencies. We
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remediated the failure to file and have added additional resources to support our compliance with these reporting requirements. We are also subject to anti-corruption and anti-bribery and similar laws, such as the U.S. Foreign Corrupt Practices Act of 1977, as amended, or the FCPA, the U.S. domestic bribery statute contained in 18 U.S.C. § 201, and the U.S. Travel Act, which prohibit companies and their employees and agents from promising, authorizing, making, or offering improper payments or other benefits to government officials and others in the private sector in order to influence official action, direct business to any person, gain any improper advantage, or obtain or retain business. We have implemented an anti-corruption policy to ensure compliance with these anti-corruption and anti-bribery laws. No assurance is given that our programs and controls will be effective to ensure compliance with all applicable anti-money laundering and anti-terrorism financing and anti-corruption laws and regulations, and our failure to comply with these laws and regulations could subject us to significant sanctions, fines, penalties, contractual liability to our lending partners or institutional investors, and reputational harm, all of which could harm our business.
Our securitizations are subject to regulation under federal law, and failure to comply with those laws could adversely affect our business.
Our loan securitizations and sales of asset-backed securities are subject to regulation under federal law, and banks and other regulated financial institutions acquiring and holding asset-based securities, including asset-backed securities sponsored by us, are subject to capital and leverage requirements. These requirements, which are costly to comply with, could decrease investor demand for securities issued through our securitization transactions. For example, the Credit Risk Retention rule, codified as Regulation RR under the Exchange Act, was jointly adopted by the SEC, the Department of the Treasury, the Federal Reserve System, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, and the Department of Housing and Urban Development in 2014. Regulation RR generally requires the sponsor of asset-backed securities to retain not less than five percent of the credit risk of the assets collateralizing the securities, and generally prohibits the sponsor or its affiliate from directly or indirectly hedging or otherwise selling or transferring the retained credit risk for a specified period of time, depending on the type of asset that is securitized. Some aspects of these risk retention rules have not been the subject of significant separate guidance. We believe, but cannot be certain, that we have conducted our business, and will continue to conduct our business, in such a way that we are compliant with these risk retention rules. However, if we have failed to comply, or should fall out of compliance with these rules, it could adversely affect our source of funding and our business.
We may also face regulatory risks related to compliance with Section 13 of the Bank Holding Company Act, commonly known as the “Volcker Rule,” which prohibits banking entities from acquiring an ownership interest in entities that are investment companies for purposes of the Investment Company Act, or would be investment companies but for Sections 3(c)(1) or 3(c)(7) of the Investment Company Act, which are generally known as “private funds.” This means that in order for a banking entity regulated under the Volcker Rule to purchase certain asset-backed securities issued by our affiliates, such affiliates may need to rely on another exemption or exception from being deemed “investment companies” if they wish to continue selling to banking entities. Currently, those affiliates generally rely on Rule 3a-7 under the Investment Company Act, which provides an exclusion to the definition of an investment company for issuers that pool income-producing assets and issue securities backed by those assets. However, if a regulator or other third party were to find or assert that our analysis under Rule 3a-7 (or, where applicable, some other exemption or exemption) is incorrect, banks that have purchased asset-backed securities may be able to rescind those sales, which would adversely affect our business. We believe, but cannot guarantee, that we have conducted our business, and will continue to conduct our business, in such a way that enables our applicable banking entity investors to be compliant with the Volcker Rule.
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RISKS RELATED TO INDEBTEDNESS
We rely on borrowings under our warehouse credit facilities to fund certain aspects of our operations, and any inability to meet our obligations as they come due or to comply with various covenants or representations contained in our warehouse credit facilities could harm our business.
We, through our warehouse trust special purpose entities, have entered into warehouse credit facilities to partially finance the purchase of loans from certain lending partners that originate loans through our marketplace, which credit facilities are secured by the purchased loans.
Under our warehouse credit facility for unsecured personal loans (the “ULT Warehouse Credit Facility”), we may borrow from an aggregate of $250.0 million financing capacity, $75.0 million of which is available to us at the discretion of the lender, until the earlier of June 2025 and an accelerated amortization event. Any outstanding principal, together with any accrued and unpaid interest, are due and payable by the warehouse trust special purpose entity in June 2026. As of December 31, 2023, the amount borrowed under the ULT Warehouse Credit Facility was $247.9 million, and $350.4 million of aggregated fair value of loans purchased were pledged as collateral. Under our warehouse facility for auto loans (the “UAWT Warehouse Credit Facility”), we may borrow up to $200 million until June 14, 2024, and any outstanding principal, together with any accrued and unpaid interest, are due and payable by the warehouse trust special purpose entity twelve months after the determined amortization date. As of December 31, 2023, the amount borrowed under the UAWT Warehouse Credit Facility was $139.5 million, and $277.6 million of aggregated fair value of loans purchased were pledged as collateral.
Our warehouse credit facilities impose operating and financial covenants on the applicable warehouse trust special purpose entity, and under certain events of default, the applicable lender could require that all or a portion of our outstanding borrowings become immediately due and payable or terminate their respective agreement with us. We have in the past, and may in the future, fail to comply with certain operating or financial covenants in our warehouse credit facilities, requiring a waiver from our lenders. If we are unable to repay our obligations at maturity or in the event of default, the applicable borrowing warehouse trust special purpose entity may have to liquidate the loans held as collateral at an inopportune time or price or, if the lender liquidated the loans, such warehouse trust would have to pay any amount by which the original purchase price exceeded their sale price. An event of default would negatively impact our ability to purchase loans from our marketplace and require us to rely on alternative funding sources, which might increase our costs or which might not be available when needed. If we were unable to arrange new or alternative methods of financing on favorable terms, we might have to limit our loan funding, which could have an adverse effect on our lending partners’ ability or willingness to originate new loans or our ability to use leverage for the loans we hold, which in turn would have an adverse effect on our business, results of operations and financial condition.
Corporate and asset-backed debt ratings could adversely affect our ability to support loan funding for our marketplace at attractive rates, which could negatively affect our results of operations, financial condition and liquidity.
Our unsecured senior corporate debt currently has no rating. Asset-backed securities sponsored or co-sponsored by us are currently rated by a limited number of credit rating agencies. Structured finance ratings reflect these rating agencies’ opinions of our receivables credit performance and ability of the receivables cash flows to pay interest on a timely basis and repay the principal of such asset-backed securitizations, as well as our ability to service the receivables and comply with other obligations under such programs, such as the obligation to repurchase loans subject to breaches of loan-level representations and warranties. Such ratings also reflect the rating agencies’ opinions of other service providers in such transactions, such as trustees, back-up servicers, charged-off loan purchasers and others.
Our asset-backed securities have been subject to downgrades in the past, and any future downgrade or non-publication of ratings may increase the interest rates that are required to attract investment in such asset-backed securities, adversely impacting our ability to provide liquidity or financing to our lending partners and institutional
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investors. Our lack of parent debt rating and any further downgrades to the ratings of our asset-backed securities could negatively impact our business, financial condition and results of operations.
We may need to raise additional funds in the future, including through equity, debt or convertible debt financings, to support business growth and those funds may not be available on acceptable terms, or at all.
We may continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new loan products, enhance our AI models, supplement loan funding, improve our operating infrastructure, acquire complementary businesses and technologies, or make strategic investments. Accordingly, we may need to engage in equity, debt or convertible debt financings to secure additional funds. If we raise additional funds by issuing equity securities or securities convertible into equity securities, our stockholders may experience dilution. For example, if we elect to deliver shares of our common stock to settle the conversion (other than paying cash in lieu of delivering any fractional share) of the Notes (as defined below), it may have a dilutive effect on our stockholders’ equity holdings. Further, debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any debt or additional equity financing that we raise may contain terms that are not favorable to us or our stockholders.
If we are unable to obtain adequate financing or on terms satisfactory to us when we require it, we may pursue alternate transactions or be unable to pursue certain business opportunities and our ability to continue to support our business growth and to respond to business challenges could be impaired and our business may be harmed.
In addition, in August 2021, we issued $661.3 million aggregate principal amount of 0.25% convertible senior notes due 2026, or Notes (including the exercise in full of the initial purchasers’ option to purchase an additional $86.3 million aggregate principal of additional Notes). Holders of the Notes may require us to purchase all or a portion of their Notes upon the occurrence of a fundamental change before the maturity date at a fundamental change repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any. Additionally, upon conversion of the Notes, unless we elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the Notes being converted. Moreover, we will be required to pay the Notes in cash at their maturity unless earlier converted, redeemed or repurchased. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of the Notes or pay cash for Notes being converted or at their maturity. In addition, our ability to repurchase the Notes or to pay cash upon conversions of the Notes may be limited by law, by regulatory authority or by agreements governing our future indebtedness at the time. Our failure to repurchase Notes at a time when the repurchase is required by the indenture or to pay any cash payable on future conversions of the Notes as required by the indenture would constitute a default under the indenture. A default under the indenture or the fundamental change itself could also lead to a default under agreements governing our other existing or future indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the Notes or pay cash with respect to Notes being converted or at maturity of the Notes.
Provisions in the indenture for the Notes may deter or prevent a business combination that may be favorable to you.
If a fundamental change occurs prior to the maturity date of the Notes, holders of the Notes will have the right, at their option, to require us to repurchase all or a portion of their Notes. In addition, if a make-whole fundamental change occurs prior to the maturity date of the Notes, we will in some cases be required to increase the conversion rate for a holder that elects to convert its Notes in connection with such make-whole fundamental change in the manner specified in the indenture. Furthermore, the indenture will prohibit us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under the Notes. These and other provisions in the indenture could deter or prevent a third party from acquiring us even when the acquisition may be favorable to you.
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RISKS RELATED TO TAXES
Our ability to use our deferred tax assets to offset future taxable income may be subject to certain limitations, which may have a material impact on our result of operations.
As of December 31, 2023, a valuation allowance has been recorded to recognize only deferred tax assets that are more likely than not to be realized in the United States federal, state and local tax jurisdictions. We assess the available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. Certain of our deferred tax assets may expire unutilized or underutilized, which could prevent us from offsetting future taxable income.
We may also be limited in the portion of NOLs that we can use in the future to offset taxable income for U.S. federal and state income tax purposes. The Tax Cuts and Jobs Act, or the Tax Act made broad and complex changes to U.S. tax law, including changes to the uses and limitations of NOLs. A lack of future taxable income would adversely affect our ability to utilize NOLs. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its NOLs to offset future taxable income. Future changes in our stock ownership, including future offerings, as well as other changes that may be outside of our control, could result in additional ownership changes under Section 382 of the Code. Our NOLs may also be limited under similar provisions of state and local law.
We continue to assess the realizability of our deferred tax assets in the future. Future adjustments in our valuation allowance may be required, which may have a material impact on our quarterly and annual operating results.
Changes in tax laws could have a material adverse effect on our business, financial condition and results of operations.
We are subject to taxes in the United States under federal, state and local jurisdictions in which we operate. The governing tax laws and applicable tax rates vary by jurisdiction and are subject to interpretation and macroeconomic, political or other factors. For example, the results of U.S Presidential and Congressional elections may lead to tax law changes. We may be subject to examination in the future by federal, state and local authorities on income, employment, sales and other tax matters. While we regularly assess the likelihood of adverse outcomes from such examinations and the adequacy of our provision for taxes, there can be no assurance that such provision is sufficient and that a determination by a tax authority would not have an adverse effect on our business, financial condition and results of operations. Various tax authorities may disagree with tax positions we take and if any such tax authorities were to successfully challenge one or more of our tax positions, the results could adversely affect our financial condition. Further, the ultimate amount of tax payable in a given financial statement period may be impacted by sudden or unforeseen changes in tax laws, changes in the mix and level of earnings by taxing jurisdictions, or changes to existing accounting rules or regulations. For example, the Inflation Reduction Act of 2022, enacted on August 16, 2022, imposes a one-percent non-deductible excise tax on repurchases of stock that are made by U.S. publicly traded corporations on or after January 1, 2023, which may affect our share repurchase program. In addition, effective as of January 1, 2022, the Tax Cuts and Jobs Act requires research and experimental expenditures attributable to research conducted within the United States to be capitalized and amortized ratably over a five-year period. Any such expenditures attributable to research conducted outside the United States must be capitalized and amortized over a 15-year period. Accordingly, the determination of our overall provision for income and other taxes is inherently uncertain as it requires significant judgment around complex transactions and calculations. As a result, fluctuations in our ultimate tax obligations may differ materially from amounts recorded in our financial statements and could adversely affect our business, financial condition and results of operations in the periods for which such determination is made.
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Taxing authorities may successfully assert that we should have collected or in the future should collect sales and use, gross receipts, value added or similar taxes and may successfully impose additional obligations on us, and any such assessments or obligations could adversely affect our business, financial condition and results of operations.
The application of indirect taxes, such as sales and use tax, value-added tax, digital services tax, digital advertising tax, business tax, gross receipts tax, and other similar tax to platform and financial technology businesses is a complex and evolving issue. Many of the fundamental statutes and regulations that impose these taxes were established before the adoption and growth of the Internet and e-commerce. Significant judgment is required on an ongoing basis to evaluate applicable tax obligations and as a result amounts recorded are estimates and are subject to adjustments. In many cases, the ultimate tax determination is uncertain because it is not clear how new and existing statutes might apply to our business. In addition, proposed or newly enacted laws regarding indirect tax could increase our compliance obligation. Any failure by us to prepare for and to comply with the reporting and record-keeping obligations could result in penalties and other sanctions, and could adversely affect our financial condition and results of operations.
We have faced, and may face in the future, various indirect tax audits in various U.S. jurisdictions. Tax authorities may raise questions about or challenge or disagree with our calculation, reporting or collection of taxes and may require us to collect taxes in jurisdictions in which we do not currently do so or to remit additional taxes and interest, and could impose associated penalties and fees. Although we have reserved for potential payments of past tax liabilities on our financial statements, a successful assertion by one or more tax authorities could result in substantial tax liabilities in excess of such reserves as well as penalties and interest, and could harm our business, financial condition and results of operations.
As a result of these and other factors, the ultimate amount of tax obligations owed may differ from the amounts recorded in our financial statements and any such difference may adversely impact our results of operations in future years in which we change our estimates of our tax obligations or in which the ultimate tax outcome is determined.
RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK
The trading price of our common stock may be volatile, and you could lose all or part of your investment.
The trading price of our common stock may be volatile and could be subject to fluctuations in response to various factors, some of which are beyond our control. These fluctuations could cause you to lose all or part of your investment in our common stock. Factors that could cause fluctuations in the trading price of our common stock include:
•price and volume fluctuations in the overall stock market from time to time;
•volatility in the trading prices and trading volumes of financial technology stocks;
•general economic conditions, including economic slowdowns, recessions, rising interest and inflation rates, tightening of credit markets and disruptions in the banking sector;
•a reduction in the availability of loan funding and liquidity from lending partners and institutional investors;
•quarterly fluctuations in demand for the loans we facilitate through our marketplace;
•changes in operating performance and stock market valuations of other financial technology companies and technology companies that offer services to financial institutions;
•sales of shares of our common stock by us or our stockholders, including sales to cover tax withholding obligations upon vesting of RSUs issued to our employees;
•issuance of shares of our common stock, whether in connection with an acquisition or upon conversion of some or all of the outstanding Notes;
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•failure of securities analysts to maintain coverage of us, changes in financial estimates or other statements made by securities analysts or others, or our failure to meet these estimates or the expectations of investors;
•the financial projections we may provide to the public, any changes in those projections, or our failure to meet those projections;
•announcements by us or our competitors of new products, features, or services;
•the public’s reaction to our press releases, other public announcements, and filings with the SEC;
•rumors and market speculation involving us or other companies in our industry;
•actual or anticipated changes in our results of operations or fluctuations in our results of operations;
•fluctuations in the trading volume of our shares or the size of our public float;
•actual or anticipated developments in our business, our competitors’ businesses or the competitive landscape generally;
•litigation involving us, our industry, or both, or investigations by regulators into our operations or those of our competitors;
•compliance with government policies or regulations;
•the issuance of any cease-and-desist orders from regulatory agencies that we are subject to;
•developments or disputes concerning our intellectual property or other proprietary rights;
•market perception of the accuracy of our AI models;
•actual or perceived data security breaches or other data security incidents;
•announced or completed acquisitions of businesses, products, services, or technologies by us or our competitors;
•new laws or regulations or new interpretations of existing laws or regulations applicable to our business;
•changes in accounting standards, policies, guidelines, interpretations, or principles;
•recruitment or departure of key personnel; and
•other events or factors, including those resulting from war, incidents of terrorism, political unrest, natural disasters, pandemics or responses to these events.
The stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of listed companies. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance. In the past, following periods of volatility in the overall market and the market prices of particular companies’ securities, securities class action litigation has often been instituted against these companies. For example, in May 2022, June 2022 and July 2022, we and certain of our officers were sued in purported class action lawsuits alleging violations of the federal securities laws for allegedly making materially false and misleading statements about our business, operations, and prospects. This litigation could result in substantial costs and a diversion of our management’s attention and resources, which could harm our business. We may be the target of additional litigation of this type in the future as well.
We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term shareholder value. Share repurchases could also affect the trading price of our stock, increase volatility of our stock and diminish our cash reserves.
Although our Board of Directors has authorized a share repurchase program that does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The timing and number of shares repurchased under the program will
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depend on a variety of factors, including stock price, trading volume, and general business and market conditions. The program could affect the trading price of our stock, increase volatility and diminish our cash reserves. Our Board of Directors will review the program periodically and may authorize adjustments of its terms if appropriate. Any announcement of a suspension or termination of this program may result in a decrease in the trading price of our stock.
The capped call transactions may affect the price of our common stock.
In connection with the issuance of the Notes, we entered into privately negotiated capped call transactions with certain financial institutions as counterparties. The capped call transactions initially cover, subject to customary adjustments, the number of shares of our common stock initially underlying the Notes. The capped call transactions are intended to offset the potential dilution and/or offset any cash payments we make in excess of the aggregate principal amount of converted Notes, as the case may be, as a result of conversion of the Notes.
From time to time, the counterparties or their respective affiliates may modify their hedge positions by entering into or unwinding various derivatives with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions prior to the maturity of the Notes (and are likely to do so during any observation period related to a conversion of the Notes or following any repurchase of the Notes). This activity could also cause or prevent an increase or a decrease in the market price of our common stock.
Certain insiders have significant voting power, which could limit your ability to influence the outcome of key transactions, including a change of control.
Our directors, officers, and each of our stockholders who own greater than 5% of our outstanding capital stock and their affiliates, in the aggregate, beneficially own a significant portion of the outstanding shares of our capital stock. As a result, these stockholders, if acting together, are able to influence matters requiring approval by our stockholders, including the election of directors and the approval of mergers, acquisitions, or other extraordinary transactions. They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale, and might ultimately affect the trading price of our common stock.
The large number of shares of our capital stock eligible for public sale or subject to rights requiring us to register them for public sale could depress the market price of our common stock.
The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market, and the perception that these sales could occur may also depress the market price of our common stock. Certain stockholders are entitled, under our investors’ rights agreement, to require us to register shares owned by them for public sale in the United States. In addition, we may file a registration statement to register shares reserved for future issuance under our equity compensation plans. As a result, subject to the satisfaction of applicable exercise periods, the shares issued upon exercise of outstanding stock options will be available for immediate resale in the United States in the open market.
Sales of our shares may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. These sales also could cause the trading price of our common stock to fall and make it more difficult for you to sell shares of our common stock.
Our common stock does not provide any rights directly related to the loans we hold.
Investors in our common stock own a form of equity that may provide returns based on either an increase in the value of the stock or any distributions made to common stockholders. Investors will not, however, receive any interest in or fees based on the loans or other assets we hold on our balance sheet. In particular, investors in our common stock will not receive any distributions directly based on principal or interest payments made by borrowers on the loans we hold. Those loans are not directly related in any way to the common stock investors’ purchase.
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You may be diluted by the future issuance of additional common stock in connection with our equity incentive plans, acquisitions or otherwise.
Our amended and restated certificate of incorporation authorizes us to issue 613,669,697 shares of authorized but unissued common stock and rights relating to common stock for the consideration and on the terms and conditions established by our Board of Directors in its sole discretion, whether in connection with acquisitions or otherwise. We have reserved 6,420,703 shares for issuance under our 2020 Equity Incentive Plan subject to adjustment in certain events. Any common stock that we issue, including under our 2020 Equity Incentive Plan or other equity incentive plans that we may adopt in the future, could dilute the percentage ownership held by the investors in our common stock.
To the extent a large number of shares of our common stock are sold in connection with any “sell to cover” transactions upon vesting of restricted stock units (RSUs) issued to our employees, our stock price may fluctuate.
Under U.S. tax laws, employment tax withholding and remittance obligations for RSUs arise in connection with their vesting. To fund the tax withholding and remittance obligations arising in connection with the vesting of RSUs, we use the “sell-to-cover” method, under which shares with a market value equivalent to the tax withholding obligation are sold by a broker on behalf of the holder of the RSUs upon vesting to cover the tax withholding liability and the cash proceeds from such sales are subsequently remitted by us to the taxing authorities. The tax withholding due in connection with such RSU vesting is based on the then-current value of the underlying shares of our common stock. Such sales do not result in the expenditure of additional cash by us to satisfy the tax withholding obligations for RSUs. To the extent a large number of shares are sold in connection with any vesting event, such sales volume may cause our stock price to fluctuate.
Delaware law and provisions in our amended and restated certificate of incorporation and amended and restated bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the market price of our common stock.
Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder unless certain conditions are met, even if a change of control would be beneficial to our existing stockholders. In addition, our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make the acquisition of our company more difficult, including the following:
•our Board of Directors is classified into three classes of directors with staggered three-year terms and directors are only able to be removed from office for cause;
•vacancies and newly-created seats on our Board of Directors will be able to be filled only by our Board of Directors and not by stockholders;
•only the Chair of our Board of Directors, our Chief Executive Officer, our president, or a majority of our entire Board of Directors are authorized to call a special meeting of stockholders;
•certain litigation against us or our directors, stockholders, officers or employees can only be brought in Delaware;
•advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; and
•any amendment of the above anti-takeover provisions in our amended and restated certificate of incorporation or amended and restated bylaws will require the approval of at least 66 2/3% of the combined voting power of our then-outstanding shares of our capital stock.
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These anti-takeover defenses could discourage, delay, or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors of their choosing and to cause us to take other corporate actions they desire, any of which, under certain circumstances, could limit the opportunity for our stockholders to receive a premium for their shares of our capital stock, and could also affect the price that some investors are willing to pay for our common stock.
Our amended and restated bylaws designate a state or federal court located within the State of Delaware (or any federal district court, for Securities Act claims) as the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to choose the judicial forum for disputes with us or our directors, officers or employees.
Our amended and restated bylaws provide that, unless we consent in writing to the selection of an alternative forum, to the fullest extent permitted by law, the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, stockholders, officers, or other employees to us or our stockholders, (iii) any action arising pursuant to any provision of the Delaware General Corporation Law, our amended and restated certificate of incorporation, or our amended and restated bylaws, or (iv) any other action asserting a claim that is governed by the internal affairs doctrine shall be the Court of Chancery of the State of Delaware (or, if the Court of Chancery does not have jurisdiction, another state court in Delaware or the federal district court for the District of Delaware), in all cases subject to the court having jurisdiction over the claims at issue and the indispensable parties; provided that the exclusive forum provision will not apply to suits brought to enforce any liability or duty created by the Exchange Act.
Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all such Securities Act actions. Accordingly, both state and federal courts have jurisdiction to entertain such claims. To prevent having to litigate claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different courts, among other considerations, our amended and restated bylaws also provide that, unless we consent in writing to the selection of an alternative forum, the federal district courts of the United States of America are the sole and exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. We note, however, that investors cannot waive compliance with the federal securities laws and the rules and regulations thereunder, and that there is uncertainty as to whether a court would enforce this exclusive forum provision. Further, the enforceability of similar choice of forum provisions in other companies’ governing documents has been challenged in legal proceedings, and it is possible that a court could find these types of provisions to be inapplicable or unenforceable. For example, in December 2018, the Court of Chancery of the State of Delaware determined that a provision stating that U.S. federal district courts are the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act is not enforceable. Although this decision was reversed by the Delaware Supreme Court in March 2020, other courts may still find these provisions to be inapplicable or unenforceable.
Any person or entity purchasing, holding or otherwise acquiring any interest in any of our securities shall be deemed to have notice of and consented to this provision. This exclusive-forum provision may limit a stockholder’s ability to bring a claim in a judicial forum of its choosing for disputes with us or our directors, officers, or other employees, which may discourage lawsuits against us and our directors, officers, and other employees. This exclusive forum provision does not apply to any causes of action arising under the Exchange Act or any other claim for which the federal or other courts have exclusive jurisdiction. If a court were to find either of the exclusive-forum provisions in our amended and restated bylaws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving the dispute in other jurisdictions, which could harm our results of operations.
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Our common stock market price and trading volume could decline if equity or industry analysts do not publish research or publish inaccurate or unfavorable research about our business.
The trading market for our common stock will depend in part on the research and reports that equity or industry analysts publish about us or our business. The analysts’ estimates are based upon their own opinions and are often different from our estimates or expectations. If one or more of the analysts who cover us downgrade our common stock or publish inaccurate or unfavorable research about our business, the price of our securities would likely decline. If few securities analysts commence coverage of us, or if one or more of these analysts cease coverage of us or fail to publish reports on us regularly, demand for our securities could decrease, which might cause the price and trading volume of our common stock to decline.
The requirements of being a public company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board members.
As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Act, the listing requirements of the Nasdaq Global Select Market and other applicable securities rules and regulations. Compliance with these rules and regulations will increase our legal and financial compliance costs, make some activities more difficult, time-consuming or costly and increase demand on our systems and resources, especially once we are no longer an “emerging growth company.” The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and results of operations. In addition, we expect that our management and other personnel will need to divert attention from operational and other business matters to devote substantial time to these public company requirements. We cannot predict or estimate the amount of additional costs we may incur as a result of becoming a public company or the timing of such costs.
Being a public company also makes it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage, incur substantially higher costs to obtain coverage or only obtain coverage with a significant deductible. These factors could also make it more difficult for us to attract and retain qualified executive officers and qualified members of our Board of Directors, particularly to serve on our audit committee and compensation committee.
In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time-consuming. These laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If, notwithstanding our efforts, we fail to comply with new laws, regulations and standards or our efforts differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us, and our business may be adversely affected.
We do not intend to pay dividends for the foreseeable future.
We have never declared nor paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, as well as to fund our share repurchase program, and we do not expect to declare or pay any dividends in the foreseeable future. In addition, the terms of our existing corporate debt agreements do, and any future debt agreements may, preclude us from paying dividends. As a result, capital appreciation of our common stock, if any, will be the only way for stockholders to realize any future gains on their investment for the foreseeable future.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 1C. CYBERSECURITY
Risk Management and Strategy
We have established policies and processes for identifying, assessing, and managing material risk from cybersecurity threats, and have integrated these processes into our overall risk management systems and processes. We routinely assess material risks from cybersecurity threats, including any potential unauthorized occurrence on or conducted through our information systems that may result in adverse effects on the confidentiality, integrity, or availability of our information systems or any information residing therein.
We conduct risk assessments to identify cybersecurity threats annually as well as in the event of a material change in our business practices that may affect information systems that are vulnerable to such cybersecurity threats. These risk assessments include identification of reasonably foreseeable internal and external risks, the likelihood and potential damage that could result from such risks, and the sufficiency of existing policies, procedures, systems, and safeguards in place to manage such risks.
Following these risk assessments, we re-design, implement, and maintain reasonable safeguards to mitigate identified risks; reasonably address any identified gaps in existing safeguards; and monitor the effectiveness of our safeguards. We devote resources and designate high-level personnel, including our Chief Information Security Officer who reports to our Chief Risk Officer, to manage the risk assessment and mitigation process. Our Chief Information Security Officer works closely with a team of cybersecurity professionals with extensive experience and expertise in cybersecurity threat assessments and detection, incident response and mitigation.
As part of our overall risk management system, we assess our safeguards in collaboration with various functional teams, including Information Security, Information Technology, Risk and Legal, and train our employees on these safeguards. Personnel at all levels and teams are required to receive periodic security awareness training to ensure that they understand our cybersecurity policies and their roles in protecting our information systems or any information residing therein.
We have a set of company-wide policies and procedures concerning cybersecurity matters that include security risk assessment, identity and access control, vendor security and network security. There are other policies related to cybersecurity involving employees' use of company equipment and resources, generative AI, remote work and workplace security and safety. These policies are reviewed periodically and approved by appropriate members of management.
We engage assessors, consultants, auditors, or other third parties in connection with our risk assessment processes. These service providers assist us to design and implement our cybersecurity policies and procedures, as well as to monitor and test our safeguards. These services include Web Application Penetration Testing, Infrastructure security testing, NIST assessments, third party partner due diligence audits, consultant engagements, incident response preparedness, and vendor security review. We require each third-party service provider to certify that it has the ability to implement and maintain appropriate security measures, consistent with all applicable laws, in connection with the services they provide to us, and to promptly report any suspected breach of its security measures that may affect us.
For additional information regarding whether any risks from cybersecurity threats, including as a result of any previous cybersecurity incidents, have materially affected or are reasonably likely to materially affect our company, including our business strategy, results of operations, or financial condition, please see Item 1.A. “Risk Factors” of this Annual Report on Form 10-K, including the risk factors titled “—Security breaches and incidents compromising borrowers’ confidential information that we store may harm our reputation, adversely affect our results of operations and expose us to liability”.
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Governance
One of the key functions of our Board of Directors is informed oversight of our risk management process, including risks from cybersecurity threats. Our Board of Directors is responsible for oversight of our risk management framework, which is designed to monitor and manage strategic and operational risks. Management is responsible for the day-to-day identification, assessment and management of risks in our operations, including cybersecurity risks. Our Board of Directors administers its cybersecurity risk oversight function directly as a whole, as well as through the audit committee.
Our Chief Information Security Officer has more than 20 years of information security expertise and is primarily responsible to identify, assess and manage our material risks from cybersecurity threats. Our Chief Information Security Officer started his career as a security engineer and has held various leadership positions in the security function at Microsoft, Netflix, Bridgewater Associates and, most recently, Robinhood. He received a bachelor degree in management information systems and holds an industry certification.
Our Chief Information Security Officer oversees our cybersecurity policies and processes, including those described in “Risk Management and Strategy” above. The processes by which our Chief Information Security Officer is informed about and monitors the prevention, detection, mitigation, and remediation of cybersecurity incidents include the following: tabletop exercises, vulnerability management programs, internal & external security risk assessments, threat modeling processes of new services, third party security risk functions, incident response processes, phishing awareness programs, and additional control validation services.
Our Chief Risk Officer reports to our CEO, and our Chief Risk Officer and/or Chief Information Security Officer provide quarterly briefings to the audit committee regarding our company’s cybersecurity risks and activities, including any recent cybersecurity incidents and related responses, cybersecurity systems testing and activities of third parties. Our audit committee provides updates to the Board of Directors on such reports. We also have an established incident response plan led by our Chief Information Security Officer that lays out the process for the assessment, response and notifications internally and externally upon the occurrence of a cybersecurity incident. Depending on the nature and severity of an incident, our process, including those set forth in the incident response plan, provides for escalation and notification to management, the audit committee and the Board of Directors and/or external parties, as appropriate.
ITEM 2. PROPERTIES
Our corporate headquarters are located in San Mateo, California and Columbus, Ohio and consist of 108,015 square feet and 54,870 square feet of space, respectively, under leases that expire in February 2028 and June 2027, respectively. In addition to our headquarters, we lease 146,024 square feet of office space for origination and servicing operations in Columbus, Ohio expiring in August 2029 and we lease 12,493 square feet of office space in Austin, Texas expiring in February 2028.
We lease all of our facilities and do not own any real property. We believe our facilities are adequate and suitable for our current needs and that, should it be needed, suitable additional or alternative space will be available to accommodate our operations.
ITEM 3. LEGAL PROCEEDINGS
For a description of our material pending legal proceedings, please see “Note 13. Commitments and Contingencies” in Part II, Item 8 of this Annual Report on Form 10-K and “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K incorporated herein by reference.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information for Common Stock
Our common stock has been traded on the Nasdaq Global Select Market under the ticker symbol “UPST” since December 16, 2020. Prior to that date, there was no public trading market for our common stock.
Holders of Record
As of February 8, 2024, we had 160 holders of record of our common stock. Because many of our shares of common stock are held in street name by brokers and other nominees on behalf of stockholders, we are unable to estimate the total number of beneficial owners of our common stock represented by these holders of record.
Dividend Policy
We have never declared nor paid cash dividends on our capital stock and we do not expect to declare or pay any dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our Board of Directors, subject to applicable laws, and will depend on a number of factors, including our financial condition, results of operations, capital requirements, contractual restrictions, general business conditions, and other factors that our Board of Directors may deem relevant.
Unregistered Sales of Equity Securities
There were no repurchases of the Company’s common stock during the three months ended December 31, 2023.
Issuer Purchases of Equity Securities
None.
Securities Authorized for Issuance under Equity Compensation Plans
The information required by this item with respect to our equity compensation plans is incorporated by reference to our Proxy Statement for the 2024 Meeting of Stockholders to be filed with the SEC within 120 days of the year ended December 31, 2023.
Stock Performance Graph
The following graph compares the cumulative total return to stockholders on our common stock relative to the cumulative total returns of the Nasdaq Global Select Index and the S&P Information Technology Index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock and in each index on December 16, 2020, the date our common stock began trading on the Nasdaq Global Select Market, and its relative performance is tracked through December 31, 2023. The returns shown are based on historical results and are not intended to suggest future performance.
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This performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act), or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Upstart Holdings, Inc. under the Securities Act of 1933, as amended, or the Exchange Act.
ITEM 6. [RESERVED]
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Factors that could cause or contribute to such differences include those identified below and those discussed in the section titled “Risk Factors” and other parts of this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results that may be expected for any period in the future.
Overview
Upstart applies artificial intelligence models and cloud applications to the process of underwriting consumer credit. Our AI marketplace connects consumers with our lending partners. Consumers can access Upstart-powered loans via Upstart.com, through a lender-branded product on our lending partners’ own websites, and through auto dealerships that use our Upstart Auto Retail software. We enable our lending partners to provide an exceptional digital-first experience to consumers and originate valuable credit products. As our technology continues to improve and additional lending partners adopt our platform, consumers benefit from improved access to affordable and frictionless credit.
We believe that banks and other traditional lenders will continue to be at the forefront of consumer lending in the United States. We believe AI lending will become increasingly critical as this industry continues to undergo a broad digital transformation. Our strategy is to partner with banks and credit unions and provide them with access to an AI lending marketplace that they can configure as they originate consumer loans under their own brand, according to their own business and regulatory requirements.
Loans issued through our marketplace are retained by our lending partners, purchased by our network of institutional investors, or funded by Upstart’s balance sheet. Investors may also invest in Upstart-powered loans through our pass-through and securitization programs.
As of December 31, 2023, out of the total principal of loans transacted on our marketplace in 2023, 48% were purchased by institutional investors, 32% were retained by our lending partners, 16% were held on our balance sheet, and the remaining 4% were contributed as collateral to the securitization transaction we completed in July 2023, which we have consolidated in our financial statements. Starting in 2022, we increased the utilization of our balance sheet to fund loans to fill gaps in investor demand, to aid in price discovery, and to hold loans on our balance sheet for research and development purposes (“R&D Loans”), including to test and evaluate our AI models for these loans. R&D Loans are primarily our auto refinance and auto retail loan products, personal loan products issued to new categories of borrowers, and other new loan products. R&D Loans are not yet part of our established capital markets programs or other loan funding programs with institutional investors. The remainder of loans on our balance sheet represent core personal loans, which Upstart would sell to institutional investors.
To improve the loan funding capacity for our marketplace across business and macroeconomic cycles, we secured multiple committed capital arrangements with institutional investors in 2023, which delivered a significant amount of loan funding to the Upstart marketplace. We continue our work on expanding committed capital arrangements for our marketplace.
Our Economic Model
Upstart’s revenues are primarily earned in exchange for the use of our platform and for borrower referral services provided to our lending partners through our lending marketplace. Fees for these services can be either fixed or based on a variable price per unit, depending on the contractual arrangement. Platform services result in
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
loan originations by our lending partners using our platform and referral services result in a referral of a borrower obtaining a loan from our lending partners. These fees are combined for accounting purposes as they represent a single performance obligation. We do not charge the borrowers on our platform any referral, platform or other similar fees for our loan matching services.
We also charge the holder of the loan (either a lending partner or institutional investor) a servicing fee based on the outstanding principal over the lifetime of the loan for ongoing servicing of the loan. In addition, we earn a smaller portion of our revenue from interest income for loans held on our balance sheet and gain or (loss) generated through our capital markets programs.
Loans on our platform today are predominantly sourced from Upstart.com. For these loans, we incur variable costs in the form of borrower acquisition costs and borrower verification and servicing costs. Borrower acquisition, verification and servicing costs are highly correlated with Transaction Volume, which fluctuates on a quarter by quarter basis. We continue to focus on improvements to our level of automation and Conversion Rate (as defined below) through our increasingly sophisticated risk models and our evolving channel mix which have contributed to improving our loan unit economics over time.
Credit Performance
While the credit performance of Upstart-powered loans can be impacted by a variety of macroeconomic and other factors, we consider credit performance to be one of the most important measures of the effectiveness of our AI models. We evaluate the credit performance of core personal loans by comparing the target returns expected at the time of origination to the returns received by our lending partners and institutional investors. The target return, a critical component of our loan pricing, is calculated using estimated cash flows, which are developed based on a number of factors, including credit losses and prepayment rates. While target returns across our lending partners and institutional investors vary depending on their programs’ objectives and risk tolerance, overall performance is calculated based on the variance between the initially expected returns and the actual return on capital invested in Upstart-powered loans.
Lending is a cyclical industry, and we believe it is important to take a long-term view of credit performance. An equal investment in all vintages of Upstart-powered core personal loans that originated in the first quarter of 2018 through the third quarter of 2023 is currently expected to deliver returns in line with a blended target of 9.0%. At a more granular level, all quarterly vintages of core personal loans that originated in 2018 through the fourth quarter of 2020 are currently forecasted to meet or exceed the target returns set at the time of loan origination. The quarterly vintages of core personal loans that originated in the first quarter 2021 through the second quarter 2023 are currently forecasted to underperform relative to their target returns. The core personal loans that originated in the third quarter of 2023 or later are currently forecasted to deliver returns in line with target yields. This reversion in performance was driven by a combination of factors including increased conservatism in underwriting and the relative stabilization of macroeconomic conditions, as reflected in UMI. Refer to section “Factors Affecting Our Performance - Impact of Macroeconomic Environment” for additional details.
We have included similar disclosures in our Annual Report on Form 10-K for the year ended December 31, 2022, and in our Quarterly Reports on Form 10-Q starting from the quarter that ended June 30, 2022. We recently identified an error in the calculations that supported some of these statements. This resulted in an overstatement of the expected return of an equal investment in all vintages of Upstart-powered core personal loans that originated in the first quarter of 2018 through the third quarter of 2023 by 0.9 - 1.3% for each disclosure. The error also impacted our forecasts of the performance of certain quarterly loan vintages relative to target returns in the aforementioned reports. After correcting for the error, vintages retained by the hypothetical lending partner that we forecasted to meet or exceed target returns still include those originated from mid-2018 through mid-2021, but no longer include vintages from mid-2021 through mid-2022. Loans purchased by the hypothetical institutional investor would have been expected to experience underperformance relative to target returns through mid-2023 vintages, not through
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
mid-2022 vintages. Importantly, the error did not impact any of our financial statements, any forecasts prepared for our actual lending partners or institutional investors, or the overall expected performance trend.
For the core personal loans held on our balance sheet, target returns are set similar to those of our institutional investors. We purchase core personal loans to address fluctuations of supply and demand in our marketplace and periodically sell these loans to institutional investors prior to their maturity. Demonstrated credit performance significantly influences sale prices in these transactions and impacts our overall financial results.
We measure credit performance of R&D loans, which are a substantial part of the loan portfolio held on our balance sheet (refer to section “Liquidity and Capital Resources - Composition of Retained Loan Portfolio”), using an approach similar to the core personal loans held on our balance sheet. Variances between targeted and actual returns for these loans are expected to be higher, as the underlying risk models are in the early phases of their development cycle. The initial target returns for these products are also generally lower than comparative market benchmarks. The combination of these factors decreases the value of R&D loans on our balance sheet, which negatively impacts our overall financial results. However, this is a required part of our product development cycle, and should be considered alongside other product development costs, such as data science and engineering. These costs collectively are managed as part of overall investment in product development. As our R&D models improve, we expect the difference between target and delivered returns will decrease and converge to market returns. This will allow us to launch these products for our lending partners and institutional investors, at which point they become part of our core product offerings.
Factors Affecting Our Performance
Continued Improvements to Our AI Models
Much of our historical growth has been driven by improvements to our AI models. These models benefit over time from a flywheel effect that is characteristic of machine learning systems: accumulation of repayment data leads to improved accuracy of risk and fraud predictions, which generally results in higher approval rates and lower interest rates, leading to increased volume, and consequently greater accumulation of repayment data. This virtuous cycle describes an important mechanism by which our business grows simply through model learning and recalibration. We expect to continue to invest significantly in the development of our AI models and platform functionalities.
Beyond the ongoing accumulation of repayment data used to train our models, we also frequently make discrete improvements to model accuracy by upgrading algorithms and incorporating new variables, both of which have historically resulted in higher approval rates, more competitive loan offers, increased automation, and faster growth. As a second order effect, the impact of these improvements on our conversion funnel also allows us to unlock new marketing channels over time that have previously been unprofitable.
We believe that ongoing improvements to our technology in this manner will allow us to further expand access and lower rates for creditworthy borrowers, which will continue to fuel our growth. Should the pace of these improvements slow down or cease, or should we discover forms of model upgrades which improve accuracy at the expense of volume, our growth rates could be adversely affected.
Impact of Macroeconomic Environment
In an economic downturn, we believe consumer lending will generally contract. Lending partners and institutional investors will generally require higher rates of return, which in turn increases the interest rates offered to borrowers, leading to lower borrower demand. Macroeconomic factors can also cause fluctuations of available capital in our lending marketplace due to shifts in the risk preferences of our lending partners and institutional investors. We expect these dynamics would generally invert in an economic upswing.
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Loan funding provided by institutional investors started to become constrained in the second quarter of 2022 and has remained constrained, largely due to concerns about the macroeconomic environment. In response to inflationary pressure, the U.S. Federal Reserve has raised, and may continue to raise, interest rates, leading to more expensive loan offers across borrower categories. At the same time, macroeconomic uncertainty had generally made institutional investors more cautious and caused them to reduce the amount of capital available to fund Upstart-powered loans.
In response to this challenging macroeconomic environment where many lenders and credit investors have significantly reduced or paused investments in Upstart-powered loans, we announced reductions in workforce in November 2022 (“November 2022 Plan”) and January 2023 (“January 2023 Plan”) that resulted in the termination of approximately 7% and 20% of our workforce, respectively. These steps were designed to reduce operating costs, streamline operations and return Upstart to profitability in the future. As of December 31, 2023, we have completed both the November 2022 Plan and January 2023 Plan. Refer to “Note 16. Reorganization Expenses” for more information.
Further, several of our lending partners have paused or reduced loan originations in order to limit their exposure in the current macroeconomic environment. Further disruption in financial markets could impair our lending partners and result in further constrained funding, which would adversely impact our business, financial condition and operating results. In order to create greater stability for our business, in 2023 we secured several committed capital arrangements with institutional investors that contribute loan funding over longer durations. We continue our work on expanding committed capital arrangements and in the interim period, we have utilized and may continue to utilize our balance sheet to support loan funding. While our goal remains to operate as a capital-light marketplace for credit, we will continue to leverage our balance sheet in the short term as we evaluate opportunities to implement a committed capital structure.
Our credit decisioning process takes into account macroeconomic conditions, such as unemployment levels and personal savings rates, that we receive from third party sources. To respond to macroeconomic changes and provide relevant and up-to-date information to our lending partners, we introduced a new metric, UMI, in 2023. UMI is designed to quantify the level of underlying macroeconomic risk, specific to our borrower base, relative to a benign credit environment. A UMI of 1.0 reflects loan losses at this baseline rate. We subsequently launched an update to UMI which removes seasonal patterns to better describe the underlying macroeconomic effects. As of December 31, 2023, UMI was measured at approximately 1.65, meaning that current macroeconomic conditions contributed an incremental risk of approximately 65% to the repayment performance of an Upstart-powered loan, compared to the baseline.
UMI impacts interest rates for loans offered on our marketplace and, as a result, affects the pool of qualified potential borrowers and consumer demand for the loans. The elevated level of UMI resulted in higher interest rates for the loans offered on our marketplace and in turn, decreased the size of the pool of qualified potential borrowers and the borrower acceptance rates of such loans. With our investment in UMI, we focus on our ability to better separate risk among borrowers in our credit decisioning process in changing macroeconomic conditions.
We continuously monitor the direct and indirect impacts of the current macroeconomic conditions on our business, financial condition, and results of operations.
Lending Partner and Market Adoption
Lending partners play two key roles in Upstart’s ecosystem: funding loans and acquiring new customers. Traditional lenders, such as banks, tend to enjoy efficient sources of funding due to their expansive base of deposits. As they adopt our technology and fund a growing proportion of our marketplace transactions, offers made to borrowers will typically improve, generally leading to higher conversion rates and faster growth for our platform.
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
New lending partners also represent additional acquisition channels through which we can reach and source prospective new borrowers, as these lending partners develop and implement their own digital and in-branch campaigns to drive traffic from their existing customer base to our platform. We view this emerging growth channel to be additive to the marketing acquisition programs we currently run at Upstart.
To provide funding support beyond our lending partners, we have built, and continue to expand, a broad network of institutional investors that can fund Upstart-powered loans through secondary loan purchasing and issuance of pass-through certificates and asset-backed securitizations. This diverse network of capital helps to minimize our reliance on any one funding source. However, any trend towards reduced participation by lending partners will generally erode the overall competitiveness of the offers on our platform, and any declining trend in the participation of broader institutional investment markets with respect to funding availability for Upstart-powered loans will adversely affect our business.
We believe that disruptions in the banking sector may limit our ability to attract new lending partners and may cause existing lending partners to reduce loan originations on our platform. In order to address recent funding constraints for our personal loans, Upstart has utilized its balance sheet to support short-term funding requirements of loans that would otherwise be purchased and held by institutional investors or securitized. In 2023, we secured several committed capital arrangements with institutional investors, which have delivered, and are expected to deliver, a significant amount of loan funding to the Upstart marketplace.
We believe that continued focus on improving our AI models and demonstrating strong performance of Upstart-powered loans over time will allow us to further diversify our sources of capital for our lending marketplace and mitigate the volatility in our loan funding supply.
Product Expansion and Innovation
We believe that significant growth opportunities exist to apply our evolving AI technology to additional segments of credit, and we continue to invest in research and development of our products. In 2022, we introduced a new offering of personal loans for borrowers interested in small dollar loans, and in the third quarter of 2023, we launched a HELOC product on our platform. We may incur expenses to support the launch of new products and fund early loan originations. Monetization prospects for new products are uncertain, and costs associated with integrating, developing and marketing new products might not be recovered, which could weigh on our top-line growth and profitability.
In 2020, we announced our entry into the auto lending market and in April 2021, we acquired Prodigy Software, Inc. (“Prodigy”), a leader in automotive commerce software solutions. Prodigy provided a modern multi-channel car buying experience, helping dealerships serve consumers with a holistic software solution that integrates legacy systems. The acquisition enabled the launch of Upstart Auto Retail software, a cloud-based solution that enables dealerships across the country, where the vast majority of auto loans are transacted, to provide consumers with access to Upstart-powered auto loans.
As part of the January 2023 Plan, we suspended development work for small business loans to focus our resources on acceleration of further development of our personal loan, auto loan, and HELOC products.
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Key Operating and Non-GAAP Financial Metrics
We focus on several key operating and Non-GAAP financial metrics to measure the performance of our business and help determine strategic direction. The following presents our key operating and financial metrics:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Transaction Volume, Dollars | $ | 11,751,762 | $ | 11,204,274 | $ | 4,645,669 | |||||||||||
Transaction Volume, Number of Loans(1) | 1,314,591 | 1,129,672 | 437,659 | ||||||||||||||
| Conversion Rate | 23.7% | 14.1% | 9.7% | ||||||||||||||
| Percentage of Loans Fully Automated | 69% | 75% | 87% | ||||||||||||||
Contribution Profit(2) | $ | 397,880 | $ | 446,751 | $ | 353,294 | |||||||||||
Contribution Margin(2) | 50% | 49% | 63% | ||||||||||||||
Adjusted EBITDA(2) | $ | 231,946 | $ | 37,161 | $ | (17,217) | |||||||||||
Adjusted EBITDA Margin(2) | 27% | 4% | (3)% | ||||||||||||||
Adjusted Net Income (Loss)(2) | $ | 224,141 | $ | 19,373 | $ | (46,933) | |||||||||||
| Adjusted Net Income (Loss) Per Share: | |||||||||||||||||
Basic(2) | $ | 2.87 | $ | 0.23 | $ | (0.56) | |||||||||||
Diluted(2) | $ | 2.37 | $ | 0.21 | $ | (0.56) | |||||||||||
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(1)Transaction Volume, Number of Loans is shown in ones for the years presented.
(2)Represents a non-GAAP financial measure. See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for further information.
Transaction Volume
We define Transaction Volume, Dollars as the total principal of loan originations facilitated on our marketplace during the years presented. We define Transaction Volume, Number of Loans as the number of loan originations facilitated on our marketplace during the years presented. Increases in Transaction Volume are dependent on our loan funding programs having sufficient access to capital. Decreases in the availability of funding due to factors such as volatility in the capital markets and macroeconomic conditions will generally cause a decline in Transaction Volume. Transaction Volume is driven by improvements in our AI models and technology, including our ability to streamline and automate the loan application and origination process. Transaction Volume can also be driven by borrower acceptance rates and their sensitivity to the interest rates offered through our platform. We believe these metrics are good proxies for our overall scale and reach as a marketplace. Transaction Volume, Dollars decreased by 59% in the year ended December 31, 2023 compared to the prior year and Transaction Volume, Number of Loans decreased by 61% over the same year. This contraction was driven by a reduction in funding availability caused by macroeconomic uncertainty and by elevated consumer risk and cost of funds. These changing macroeconomic conditions required adjustments to our models which resulted in our loans becoming more expensive and decreasing both the pool of qualified potential borrowers and overall consumer demand.
Conversion Rate
We define Conversion Rate as the Transaction Volume, Number of Loans in a period divided by the number of rate inquiries received that we estimate to be legitimate, which we record when a borrower requests a loan offer on our platform. We track this metric to understand the impact of improvements to the efficiency of our borrower funnel on our overall growth. Historically, our Conversion Rate has benefited from improvements to our technology, which have made our evaluation of risk more accurate and our verification process more automated, or from the addition of lending partners that have made our offers more competitive. However, our Conversion Rate can be impacted by a variety of internal factors such as changes in the amount of origination fees that we charge or
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
changes in the rate of returns we target for our lending partners and institutional investors. External factors, including shifts in macroeconomic conditions, also impact our Conversion Rate. For example, as the U.S. Federal Reserve raises interest rates, the average interest rates charged to borrowers for Upstart-powered loans also increase, which results in decreases to our Conversion Rate. Our ability to continue to improve our Conversion Rate depends in part on our ability to continue to improve our AI models and Percentage of Loans Fully Automated and the mix of marketing channels in any given period. Our Conversion Rate decreased to 9.7% in the year ended December 31, 2023 from 14.1% in the year ended December 31, 2022 primarily driven by lower approval rates following the significant increase in interest rates, which were in turn driven by elevated risk and cost of capital. The impact of these factors was partially offset by an increased portion of repeat borrowers on our platform.
Percentage of Loans Fully Automated
A driver of our Contribution Margin and operating efficiency is the Percentage of Loans Fully Automated, which is defined as the total number of loans in a given period originated end-to-end (from initial rate request to final funding for personal loans and small dollar loans and from initial rate request to signing of the loan agreement for auto loans) with no human involvement required divided by the Transaction Volume, Number of Loans in the same period. We have been successful in increasing the level of loan automation on the platform over the past few years while simultaneously holding fraud rates constant and at very low levels. We believe our growth over the last several years has been driven in part by our ability to rapidly streamline and automate the loan application and origination process on our platform. We expect growth of the percentage of loans fully automated to subside in the near term. However, the expansion of our loan offerings may cause it to fluctuate from period to period depending on the loan offering mix and other external factors. Our Percentage of Loans Fully Automated increased to 87% in the year ended December 31, 2023 from 75% in the year ended December 31, 2022 , driven primarily by increasing the accuracy of our models, by eliminating previously manual processes, and by an increased portion of repeat borrowers on our platform.
Contribution Profit and Contribution Margin
To derive Contribution Profit, we subtract from revenue from fees, net our borrower acquisition costs as well as our borrower verification and servicing costs. To calculate Contribution Margin we divide Contribution Profit by revenue from fees, net.
The following table provides a calculation of Contribution Profit and Contribution Margin:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Revenue from fees, net | $ | 801,275 | $ | 907,272 | $ | 560,431 | |||||||||||
Borrower acquisition costs(1) | (307,613) | (302,713) | (90,517) | ||||||||||||||
Borrower verification and servicing costs(2) | (95,782) | (157,808) | (116,620) | ||||||||||||||
| Total direct expenses | (403,395) | (460,521) | (207,137) | ||||||||||||||
| Contribution Profit | $ | 397,880 | $ | 446,751 | $ | 353,294 | |||||||||||
| Contribution Margin | 50 | % | 49 | % | 63 | % | |||||||||||
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(1)Borrower acquisition costs consist of our sales and marketing expenses adjusted to exclude costs not directly attributable to attracting a new borrower, such as payroll-related expenses for our business development and marketing teams, as well as other operational, brand awareness and marketing activities. These costs do not include reorganization expenses associated with the January 2023 Plan.
(2)Borrower verification and servicing costs consist of payroll and other personnel-related expenses for personnel engaged in loan onboarding, verification and servicing, as well as servicing system costs. It excludes payroll and personnel-related expenses and stock-based compensation for certain members of our customer operations team whose work is not directly attributable to onboarding and servicing loans. These costs do not include reorganization expenses associated with the January 2023 Plan.
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of income from operations to Contribution Profit.
Adjusted EBITDA and Adjusted EBITDA Margin
We calculate Adjusted EBITDA as net income (loss) adjusted to exclude stock-based compensation expense and certain payroll tax expenses, depreciation and amortization, expense on convertible notes, net gain on a lease modification, provision for income taxes, and reorganization expenses. We calculate Adjusted EBITDA Margin as Adjusted EBITDA divided by total revenue. Adjusted EBITDA and Adjusted EBITDA Margin includes interest expense from corporate debt and warehouse credit facilities which is incurred in the course of earning corresponding interest income. See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of net income (loss) to Adjusted EBITDA and Adjusted EBITDA Margin.
Adjusted Net Income (Loss) and Adjusted Net Income (Loss) Per Share
We define Adjusted Net Income (Loss) as net income (loss) exclusive of stock-based compensation expense and certain payroll tax expenses as well as certain items that are not related to core business and ongoing operations, such as reorganization expenses and net gain on a lease modification. Adjusted Net Income (Loss) Per Share is calculated by dividing Adjusted Net Income (Loss) Per Share by the weighted-average common shares outstanding. See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures” for a reconciliation of net income (loss) to Adjusted Net Income (Loss) and Adjusted Net Income (Loss) per Share.
Components of Results of Operations
Revenue from Fees, Net
Platform and Referral Fees, Net
We charge our lending partners platform fees in exchange for usage of our AI lending marketplace, which includes collection of loan application data, underwriting of credit risk, verification and fraud detection, and the delivery of electronic loan offers and associated documentation. We also charge referral fees to our lending partners in exchange for the referral of borrowers from Upstart.com. Referral fees are charged to lending partners on a per borrower basis upon origination of a loan. These fees are charged net of any fees the lending partner charges Upstart. Upstart pays these lending partners a one-time loan premium fee upon completion of the minimum holding periods. Upstart also pays lending partners monthly loan trailing fees based on the amount and timing of principal and interest payments made by borrowers of the underlying loans.
The Company also recognizes fees in relation to contracts with auto dealers for the use of Upstart Auto Retail software, a cloud-based solution that facilitates dealership operations and enables them to provide consumers with access to Upstart-powered auto loans. Refer to “Note 2. Revenue” to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for more information.
Servicing and Other Fees, Net
Servicing fees are calculated as a percentage of outstanding principal and are charged monthly to any entities holding loans facilitated through our marketplace, to compensate us for activities we perform throughout the loan term, including collection, processing and reconciliations of payments received, institutional investor reporting and borrower customer support. Servicing fees are recorded net of any gains, losses or changes to fair value recognized in the underlying servicing rights and obligations, which are carried as assets and liabilities on our consolidated balance sheets. Upstart currently acts as loan servicer for substantially all outstanding loans facilitated
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
through the Upstart marketplace. Borrower payment collections for loans that are more than 30 days past due or charged off are generally outsourced to third-party collection agencies. Upstart charges lending partners and institutional investors for collection agency fees related to their outstanding loan portfolio. Upstart also receives certain ancillary fees on a per transaction basis inclusive of late payment fees and ACH fail fees.
Interest Income, Interest Expense, and Fair Value Adjustments, Net
Interest income, interest expense, and fair value adjustments, net is comprised of interest income, interest expense and net changes in the fair value of financial instruments held on our consolidated balance sheets as part of our ongoing operating activities, excluding loan servicing assets and liabilities. Interest income, interest expense, and fair value adjustments, net also includes realized gain (loss) on the sale of loans. Interest income, interest expense, and fair value adjustments, net can fluctuate based on the fair value of financial instruments held on our consolidated balance sheets. This amount has historically been a small percentage of our total revenue, and we do not manage our business with a focus on growing this component of revenue.
Sales and Marketing
Sales and marketing expenses primarily consist of costs incurred across various advertising channels, including expenses for partnerships with third parties providing borrower referrals, direct mail and digital advertising campaigns, as well as other expenses associated with building overall brand awareness and experiential marketing costs. Sales and marketing expenses also include payroll and other personnel-related costs, including stock-based compensation expense. These costs are recognized in the period incurred. We expect that our sales and marketing expenses will generally fluctuate as a percentage of our total revenue from period to period and may increase as we hire additional sales and marketing personnel, increase our marketing activities and build greater brand awareness.
Customer Operations
Customer operations expenses include payroll and other personnel-related expenses, including stock-based compensation expense, for personnel engaged in borrower onboarding, loan servicing, customer support and other operational teams. These costs also include systems, third-party services and tools we use as part of loan servicing, information verification, fraud detection and payment processing activities. These costs are recognized in the period incurred. We expect that our customer operations expenses will generally fluctuate as a percentage of our total revenue from period to period, and may increase in absolute dollars as we expand our portfolio.
Engineering and Product Development
Engineering and product development expenses primarily consist of payroll and other personnel-related expenses, including stock-based compensation expense, for the engineering and product development teams as well as the costs of systems and tools used by these teams. These costs are recognized in the period incurred. We expect that our engineering and product development expenses will generally fluctuate as a percentage of our total revenue from period to period, and may increase in absolute dollars as we expand our engineering and product development team to continue to improve our AI models and develop new products and product enhancements.
General, Administrative and Other
General, administrative and other expenses consist primarily of payroll and other personnel-related expenses, including stock-based compensation expense, for legal and compliance, finance and accounting, human resources and facilities teams, as well as depreciation and amortization of property, equipment, software, and intangibles, professional services fees, facilities and travel expenses. These costs are recognized in the period incurred. We expect to increase the size of our general and administrative function to support the further growth of our business. As a result, we expect that our general, administrative and other expenses will increase in absolute dollars but may fluctuate as a percentage of our total revenue from period to period.
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Other Income (Expense), Net
For the year ended December 31, 2021, other income (expense), net primarily consists of our voluntarily repayment of proceeds received in the previous year under the Paycheck Protection Program plus related accrued interest. In the year ended December 31, 2022 and 2023, other income (expense), net primarily consists of dividend income earned by the Company on its unrestricted cash balances.
Expense on Convertible Notes
Expense on convertible notes is comprised of coupon interest expense and amortization of the debt discount on our convertible notes.
Results of Operations
The following table summarizes our historical consolidated statements of operations and comprehensive income (loss):
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Revenue: | |||||||||||||||||
| Revenue from fees, net | $ | 801,275 | $ | 907,272 | $ | 560,431 | |||||||||||
| Interest income, interest expense, and fair value adjustments, net: | |||||||||||||||||
| Interest income | 20,634 | 105,580 | 168,996 | ||||||||||||||
| Interest expense | (3,274) | (10,843) | (34,894) | ||||||||||||||
| Fair value and other adjustments | 29,954 | (159,565) | (180,971) | ||||||||||||||
Interest income, expense, and fair value adjustments, net | 47,314 | (64,828) | (46,869) | ||||||||||||||
| Total revenue | 848,589 | 842,444 | 513,562 | ||||||||||||||
Operating expenses(1): | |||||||||||||||||
| Sales and marketing | 333,453 | 345,776 | 127,143 | ||||||||||||||
| Customer operations | 117,579 | 187,994 | 150,418 | ||||||||||||||
| Engineering and product development | 133,999 | 237,247 | 280,138 | ||||||||||||||
| General, administrative, and other | 122,677 | 185,290 | 212,388 | ||||||||||||||
| Total operating expenses | 707,708 | 956,307 | 770,087 | ||||||||||||||
| Income (loss) from operations | 140,881 | (113,863) | (256,525) | ||||||||||||||
| Other income (expense), net | (5,174) | 9,473 | 21,206 | ||||||||||||||
| Expense on convertible notes | (1,976) | (4,684) | (4,706) | ||||||||||||||
| Net income (loss) before income taxes | 133,731 | (109,074) | (240,025) | ||||||||||||||
| (Benefit) provision for income taxes | (1,712) | (409) | 107 | ||||||||||||||
| Net income (loss) | $ | 135,443 | $ | (108,665) | $ | (240,132) | |||||||||||
________
(1)Includes stock-based compensation expense as follows:
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Sales and marketing | $ | 6,059 | $ | 11,354 | $ | 8,166 | |||||||||||
| Customer operations | 6,251 | 9,355 | 10,683 | ||||||||||||||
| Engineering and product development | 39,191 | 72,169 | 110,381 | ||||||||||||||
| General, administrative, and other | 21,685 | 33,067 | 45,809 | ||||||||||||||
| Total stock-based compensation | $ | 73,186 | $ | 125,945 | $ | 175,039 | |||||||||||
Revenue
Revenue from Fees, Net
The following table sets forth our revenue from fees, net in the years presented:
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2023 | $ | % | ||||||||||||||||||||
| Platform and referral fees, net | $ | 732,237 | $ | 414,120 | $ | (318,117) | (43) | % | |||||||||||||||
| Servicing and other fees, net | 175,035 | 146,311 | (28,724) | (16) | % | ||||||||||||||||||
| Total revenue from fees, net | $ | 907,272 | $ | 560,431 | $ | (346,841) | (38) | % | |||||||||||||||
Revenue from fees, net decreased $346.8 million, or 38%, in the year ended December 31, 2023, compared to the prior year, due to a $318.1 million decrease in revenue from platform and referral fees, net and a $28.7 million decrease in servicing and other fees, net. The decrease of the platform and referral fees, net was primarily driven by a 61% decrease in the Transaction Volume, Number of Loans from 1,129,672 in the year ended December 31, 2022 to 437,659 in the year ended December 31, 2023, which was partially offset by increases in prices of our services. The decrease in servicing fees was primarily due to a decrease in the outstanding principal of serviced loans, as well as a decrease in net gain related to loan servicing rights upon loan sales.
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Interest Income, Interest Expense, and Fair Value Adjustments, Net
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2023 | $ | % | ||||||||||||||||||||
Operating entities(1): | |||||||||||||||||||||||
| Interest income | $ | 105,580 | $ | 149,299 | $ | 43,719 | 41 | % | |||||||||||||||
| Interest expense | (10,843) | (28,161) | (17,318) | (160) | % | ||||||||||||||||||
| Fair value adjustments, net | (159,565) | (175,475) | (15,910) | (10) | % | ||||||||||||||||||
Consolidated securitization entities: | |||||||||||||||||||||||
| Interest income | $ | — | $ | 19,697 | $ | 19,697 | 100 | % | |||||||||||||||
| Interest expense | — | (6,733) | (6,733) | (100) | % | ||||||||||||||||||
| Fair value adjustments, net | — | (5,496) | (5,496) | 100 | % | ||||||||||||||||||
Total Company: | |||||||||||||||||||||||
| Interest income | $ | 105,580 | $ | 168,996 | $ | 63,416 | 60 | % | |||||||||||||||
| Interest expense | (10,843) | (34,894) | (24,051) | (222) | % | ||||||||||||||||||
| Fair value adjustments, net | (159,565) | (180,971) | (21,406) | (13) | % | ||||||||||||||||||
| Total interest income, interest expense, and fair value adjustments, net | $ | (64,828) | $ | (46,869) | $ | 17,959 | 28 | % | |||||||||||||||
_________
(1)Consists of balances recognized by entities participating in ongoing operating activities of the Company, excluding entities associated with the UPST 2023-2 consolidated securitization.
Interest income, interest expense, and fair value adjustments, net increased $18.0 million, or 28%, in the year ended December 31, 2023, compared to the prior year. The increase was primarily driven by a $63.4 million increase in interest income, including a $19.7 million increase in interest income recognized by consolidated securitization entities, due to an increase in unpaid principal balance of loans held on the consolidated balance sheets. The increase was partially offset by a $24.1 million increase in interest expense due to an increase in borrowings compared to the prior year, including $6.7 million of interest expense recognized by consolidated securitization entities. The increase in unfavorable fair value adjustments, net is primarily attributable to a $29.0 million net impact of increased loan charge-offs and the impact of mark-to-market fair value adjustments, including $5.5 million recognized by consolidated securitization entities, and fair value adjustments related to the beneficial interests of $26.5 million. This net impact was partially offset by a $34.1 million decrease in realized loss on loan sales during the year ended December 31, 2023 compared to the prior year.
Operating Expenses
Sales and Marketing
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2023 | $ | % | ||||||||||||||||||||
| Sales and marketing | $ | 345,776 | $ | 127,143 | $ | (218,633) | (63) | % | |||||||||||||||
| % of revenue | 41 | % | 25 | % | |||||||||||||||||||
Sales and marketing expenses decreased by $218.6 million, or 63%, in the year ended December 31, 2023 compared to the prior year. The decrease was primarily due to a $212.2 million decrease in advertising and other traffic acquisition cost. As a percentage of total revenue, sales and marketing expenses decreased from 41% to 25%.
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Customer Operations
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2023 | $ | % | ||||||||||||||||||||
| Customer operations | $ | 187,994 | $ | 150,418 | $ | (37,576) | (20) | % | |||||||||||||||
| % of revenue | 22 | % | 29 | % | |||||||||||||||||||
Customer operations expenses decreased by $37.6 million, or 20%, in the year ended December 31, 2023, compared to the prior year. The decrease was primarily due to a $35.6 million decrease in payroll and other personnel-related expenses due to a decrease in headcount and Transaction Volume. As a percentage of total revenue, customer operations expenses increased from 22% to 29%.
Engineering and Product Development
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2023 | $ | % | ||||||||||||||||||||
| Engineering and product development | $ | 237,247 | $ | 280,138 | $ | 42,891 | 18 | % | |||||||||||||||
| % of revenue | 28 | % | 55 | % | |||||||||||||||||||
Engineering and product development expenses increased by $42.9 million, or 18%, for the year ended December 31, 2023, compared to the prior year. The increase was primarily due to a $45.8 million increase in payroll and other personnel-related expenses, primarily driven by a $39.0 million expense related to the one time cancellation of PRSUs for our CTO. The increase was offset by a $2.9 million decrease on engineering infrastructure, support services, and consultants. As a percentage of total revenue, engineering and product development expenses increased from 28% to 55%.
General, Administrative, and Other
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2023 | $ | % | ||||||||||||||||||||
| General, administrative, and other | $ | 185,290 | $ | 212,388 | $ | 27,098 | 15 | % | |||||||||||||||
| % of revenue | 22 | % | 41 | % | |||||||||||||||||||
General, administrative, and other expenses increased by $27.1 million, or 15%, for the year ended December 31, 2023, compared to the prior year. The increase was primarily due to an increase of $22.9 million in payroll and personnel-related costs as a result of increased stock-based compensation expense and severance payments under the January 2023 Plan and an increase of $11.4 million in depreciation and amortization expense. The increase was partially offset by a decrease of $6.0 million in other personnel-related expenses driven by a decrease in headcount and a $3.1 million decrease in insurance expense. As a percentage of total revenue, general, administrative, and other expenses increased from 22% to 41%.
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Other Income (Expense), Net
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2023 | $ | % | ||||||||||||||||||||
| Other income (expense), net | $ | 9,473 | $ | 21,206 | $ | 11,733 | 124 | % | |||||||||||||||
In the year ended December 31, 2023, other income (expense), net increased by $11.7 million, or 124%, compared to the prior year. The increase was primarily due to an increase of $11.7 million in dividend income as yields on sweep investments have increased due to rising interest rates.
Expense on Convertible Notes
| Year Ended December 31, | Change | ||||||||||||||||||||||
| 2022 | 2023 | $ | % | ||||||||||||||||||||
| Expense on convertible notes | $ | 4,684 | $ | 4,706 | $ | 22 | — | % | |||||||||||||||
For the year ended December 31, 2023 the expense on convertible notes remained relatively consistent compared to the prior year.
Reconciliation of Non-GAAP Financial Measures
To supplement our consolidated financial statements prepared and presented in accordance with GAAP, we use the non-GAAP financial measures of Contribution Profit, Contribution Margin, Adjusted EBITDA, Adjusted EBITDA Margin, and Adjusted Net Income (Loss) and Adjusted Net Income (Loss) Per Share to provide investors with additional information about our financial performance and to enhance the overall understanding of our past performance and future prospects. We are presenting these non-GAAP financial measures because we believe they provide an additional tool for investors to use in comparing our core financial performance over multiple years with the performance of other companies.
However, non-GAAP financial measures have limitations in their usefulness to investors because they have no standardized meaning prescribed by GAAP and are not prepared under any comprehensive set of accounting rules or principles. In addition, non-GAAP financial measures may be calculated differently from, and therefore may not be directly comparable to, similarly titled measures used by other companies. As a result, non-GAAP financial measures should be viewed as supplementing, and not as an alternative or substitute for, our consolidated financial statements prepared and presented in accordance with GAAP.
To address these limitations, we provide a reconciliation of Contribution Profit, Contribution Margin, Adjusted EBITDA, Adjusted EBITDA Margin, and Adjusted Net Income (Loss) and Adjusted Net Income (Loss) Per Share to loss from operations and net income (loss), respectively. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure and to view Contribution Profit, Contribution Margin, Adjusted EBITDA, Adjusted EBITDA Margin, Adjusted Net Income (Loss), and Adjusted Net Income (Loss) Per Share in conjunction with their respective related GAAP financial measures.
Contribution Profit and Contribution Margin
We use Contribution Profit and Contribution Margin as part of our overall assessment of performance, including the preparation of our annual operating budget and quarterly forecasts, to evaluate the effectiveness of our business strategies, and to communicate with our Board of Directors concerning our financial performance. We believe Contribution Profit and Contribution Margin are useful to investors for year-to-year comparisons of our
102
Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
business and in evaluating and understanding our operating results and ability to scale. Contribution Profit and Contribution Margin are also useful to investors because our management uses Contribution Profit and Contribution Margin, in conjunction with financial measures prepared in accordance with GAAP, to evaluate our operating results and financial performance and the effectiveness of our strategies.
Contribution Profit and Contribution Margin have limitations as an analytical tool, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Contribution Profit and Contribution Margin are not GAAP financial measures of, nor do they imply profitability. Even if our revenue exceeds variable expenses over time, we may not be able to achieve or maintain profitability, and the relationship of revenue to variable expenses is not necessarily indicative of future performance. Contribution Profit and Contribution Margin do not reflect all of our variable expenses and involve some judgment and discretion around what costs vary directly with loan volume. Other companies that present Contribution Profit and Contribution Margin may calculate it differently and, therefore, similarly titled measures presented by other companies may not be directly comparable to ours.
The following table presents a reconciliation of income (loss) from operations to Contribution Profit and Contribution Margin. We define Operating Margin as our income (loss) from operations divided by revenue from fees, net.
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Revenue from fees, net | $ | 801,275 | $ | 907,272 | $ | 560,431 | |||||||||||
Income (loss) from operations | 140,881 | (113,863) | (256,525) | ||||||||||||||
| Operating Margin | 18 | % | (13) | % | (46) | % | |||||||||||
Sales and marketing, net of borrower acquisition costs(1) | $ | 25,840 | $ | 43,063 | $ | 36,626 | |||||||||||
Customer operations, net of borrower verification and servicing costs(2) | 21,797 | 30,186 | 33,798 | ||||||||||||||
| Engineering and product development | 133,999 | 237,247 | 280,138 | ||||||||||||||
| General, administrative, and other | 122,677 | 185,290 | 212,388 | ||||||||||||||
Interest income, interest expense, and fair value adjustments, net | (47,314) | 64,828 | 46,869 | ||||||||||||||
| Contribution Profit | $ | 397,880 | $ | 446,751 | $ | 353,294 | |||||||||||
| Contribution Margin | 50 | % | 49 | % | 63 | % | |||||||||||
_________
(1)Borrower acquisition costs were $307.6 million, $302.7 million, and $90.5 million for the year ended December 31, 2021, 2022 and 2023, respectively. Borrower acquisition costs consist of our sales and marketing expenses adjusted to exclude costs not directly attributable to attracting a new borrower, such as payroll-related expenses for our business development and marketing teams, as well as other operational, brand awareness and marketing activities. These costs do not include reorganization expenses associated with the January 2023 Plan.
(2)Borrower verification and servicing costs were $95.8 million, $157.8 million, and $116.6 million for the year ended December 31, 2021, 2022 and 2023, respectively. Borrower verification and servicing costs consist of payroll and other personnel-related expenses for personnel engaged in loan onboarding, verification and servicing, as well as servicing system costs. It excludes payroll and personnel-related expenses and stock-based compensation for certain members of our customer operations team whose work is not directly attributable to onboarding and servicing loans. These costs do not include reorganization expenses associated with the January 2023 Plan.
Adjusted EBITDA and Adjusted EBITDA Margin
We believe that Adjusted EBITDA and Adjusted EBITDA Margin are useful for investors to use in comparing our financial performance with the performance of other companies for the following reasons:
•Adjusted EBITDA and Adjusted EBITDA Margin are widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as depreciation, and interest expense, that can vary substantially from company to company depending upon their financing and capital structures, and the method by which assets were acquired; and
103
Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
•Adjusted EBITDA and Adjusted EBITDA Margin eliminate the impact of certain items such as stock-based compensation expense and certain payroll tax expense, expense on convertible notes, acquisition-related costs, reorganization expenses, and net gain on lease modification that may obscure trends in the underlying performance of our business; and
•Adjusted EBITDA and Adjusted EBITDA Margin provide consistency and comparability with our past financial performance, and facilitate comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results.
Our use of Adjusted EBITDA and Adjusted EBITDA Margin has limitations as an analytical tool, and these measures should not be considered in isolation or as a substitute for analysis of our financial results as reported under GAAP. Some of these limitations are as follows:
•Although depreciation expense is a non-cash charge, the assets being depreciated may have to be replaced in the future, and Adjusted EBITDA and Adjusted EBITDA Margin does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
•Adjusted EBITDA and Adjusted EBITDA Margin exclude stock-based compensation expense and certain employer payroll taxes on employee stock transactions. Stock-based compensation expense has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy. The amount of employer payroll tax-related expense on employee stock transactions is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of the business;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect: (1) changes in, or cash requirements for, our working capital needs; (2) interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us; or (3) tax payments that may represent a reduction in cash available to us; and
•the expenses and other items that we exclude in our calculation of Adjusted EBITDA and Adjusted EBITDA Margin may differ from the expenses and other items, if any, that other companies may exclude from Adjusted EBITDA and Adjusted EBITDA Margin when they report their operating results.
Because of these limitations, Adjusted EBITDA and Adjusted EBITDA Margin should be considered along with other operating and financial performance measures presented in accordance with GAAP. The following table provides a reconciliation of net income (loss) and Net Income (Loss) Margin to Adjusted EBITDA Margin. We define Net Income (Loss) Margin as net income (loss) divided by total revenue.
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
Total revenue | $ | 848,589 | $ | 842,444 | $ | 513,562 | |||||||||||
| Net income (loss) | 135,443 | (108,665) | (240,132) | ||||||||||||||
| Net Income (Loss) Margin | 16 | % | (13) | % | (47) | % | |||||||||||
| Adjusted to exclude the following: | |||||||||||||||||
Stock-based compensation and certain payroll tax expenses(1) | $ | 87,461 | $ | 128,038 | $ | 178,400 | |||||||||||
| Depreciation and amortization | 7,541 | 13,513 | 24,903 | ||||||||||||||
| Reorganization expenses | — | — | 15,536 | ||||||||||||||
| Expense on convertible notes | 1,976 | 4,684 | 4,706 | ||||||||||||||
| Net gain on lease modification | — | — | (737) | ||||||||||||||
(Benefit) provision for income taxes | (1,712) | (409) | 107 | ||||||||||||||
| Acquisition-related costs | 1,237 | — | — | ||||||||||||||
| Adjusted EBITDA | $ | 231,946 | $ | 37,161 | $ | (17,217) | |||||||||||
| Adjusted EBITDA Margin | 27 | % | 4 | % | (3) | % | |||||||||||
_________
104
Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
(1)Payroll tax expenses include the employer payroll tax-related expense on employee stock transactions, as the amount is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of our business.
Adjusted Net Income (Loss) and Adjusted Net Income (Loss) Per Share
We define Adjusted Net Income (Loss) as net income (loss) exclusive of stock-based compensation expense and certain payroll tax expense, reorganization expenses, and net gain on lease modification. Adjusted Net Income (Loss) Per Share is calculated by dividing Adjusted Net Income (Loss) Per Share by the weighted-average common shares outstanding. We believe Adjusted Net Income (Loss) and Adjusted Net Income (Loss) Per Share are useful measures for investors in evaluating our ability to generate earnings, more readily compare between past and future years, and provide comparability of our performance with the performance of other companies.
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Net income (loss) | $ | 135,443 | $ | (108,665) | $ | (240,132) | |||||||||||
| Adjusted to exclude the following: | |||||||||||||||||
Stock-based compensation and certain payroll tax expenses(1) | 87,461 | 128,038 | 178,400 | ||||||||||||||
| Reorganization expenses | — | — | 15,536 | ||||||||||||||
| Net gain on lease modification | — | — | (737) | ||||||||||||||
| Acquisition-related costs | 1,237 | — | — | ||||||||||||||
| Adjusted Net Income (Loss) | $ | 224,141 | $ | 19,373 | $ | (46,933) | |||||||||||
Net income (loss) per share: | |||||||||||||||||
| Basic | $ | 1.73 | $ | (1.31) | $ | (2.87) | |||||||||||
| Diluted | $ | 1.43 | $ | (1.31) | $ | (2.87) | |||||||||||
| Adjusted Net Income (Loss) per Share: | |||||||||||||||||
| Basic | $ | 2.87 | $ | 0.23 | $ | (0.56) | |||||||||||
| Diluted | $ | 2.37 | $ | 0.21 | $ | (0.56) | |||||||||||
| Weighted-average common shares outstanding: | |||||||||||||||||
| Basic | 78,106,359 | 82,771,268 | 83,765,896 | ||||||||||||||
| Diluted | 94,772,641 | 92,023,924 | 83,765,896 | ||||||||||||||
_________
(1)Payroll tax expenses include the amount of employer payroll tax-related expense on employee stock transactions, as the amount is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of our business.
Liquidity and Capital Resources
Sources and Uses of Cash
As of December 31, 2023, our primary source of liquidity was cash of $368.4 million. We also held $5.0 million of investments in certificates of deposit with maturities greater than three months as of December 31, 2023. Certificates of deposit provide a secondary source of liquidity since they can be converted into cash in a timely manner. Changes in the balance of cash are generally a result of working capital fluctuations and the timing of purchases and sales of loans facilitated through our marketplace. To finance purchases of certain loans facilitated through our lending marketplace, we rely on our warehouse credit facilities through the special-purpose trusts and corporate cash.
Our convertible senior notes have a principal balance of $661.3 million and bear interest at a rate of 0.25% per year, payable semiannually in arrears on February 15 and August 15 of each year. The Notes mature on
105
Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
August 15, 2026 unless earlier converted, redeemed, or repurchased in accordance with their terms. Refer to “Note 10. Borrowings” in Part II, Item 8 of this Annual Report on Form 10-K for further details on our Notes.
Our ULT Warehouse Credit Facility, which matures in June 2026, allows us to borrow up to $250.0 million to purchase unsecured personal loans. Our UAWT Warehouse Credit Facility, which matures in June 2025, allows us to borrow up to $200.0 million to purchase secured auto loans. As of December 31, 2023, we have drawn an aggregate of $387.4 million on our warehouse credit facilities. Refer to “Note 10. Borrowings” in Part II, Item 8 of this Form 10-K for further details on our warehouse credit facilities.
We lease office facilities under operating lease agreements which expire between 2027 and 2029. Our cash requirements related to these lease agreements are $70.8 million, of which $15.0 million is expected to be paid within the next 12 months. Refer to “Note 12. Leases” in Part II, Item 8 of this Annual Report on Form 10-K for further details on our operating lease obligations.
We have committed to purchase loans from certain lending partners at the conclusion of the required holding period, which is generally equal to three business days. As of December 31, 2023, the total loan purchase commitment was $36.6 million. See “Note 13. Commitments and Contingencies” in Part II, Item 8 of this Annual Report on Form 10-K for further details on our loan purchase obligations.
In connection with our committed capital arrangements, we have agreed to risk sharing arrangements whereby we are obligated to put a certain amount of our capital at risk in relation to the credit performance of the loans. As of December 31, 2023, the amount of our capital at risk is $98.5 million. Refer to “Note 5. Beneficial Interests” for additional information.
As of December 31, 2023, the potential value of these risk sharing arrangements, to be realized over time, ranges between $0 to $205.2 million, depending on the actual future performance of the loans sold under these arrangements. The estimated value of our risk sharing arrangements is $95.0 million, which represents the undiscounted value of the capital at risk and is based on the actual and expected future performance of the underlying loans.
Additionally, our cash requirements for the next 12 months for the committed capital arrangements are expected to be $21.5 million.
While we believe that our cash on hand will be sufficient to meet our liquidity needs for at least the next 12 months, our future capital requirements will depend on multiple factors, including our revenue growth, working capital requirements, volume of loan purchases for product development purposes or during market downturns, and our capital expenditures. We may decide to raise additional capital through the sale of equity, equity-linked or debt securities or other debt financing arrangements. If we raise additional funds by issuing equity or equity-linked securities, our stockholders may experience dilution. Future debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any debt or equity financing that we raise may contain terms that are not favorable to us or our stockholders. Further, if we are unable to raise additional capital when our cash balances and cash generated by operations are insufficient to satisfy liquidity needs, our results of operations and financial condition would be materially and adversely impacted.
Cash Flows
The following table summarizes our cash flows during the years indicated:
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Upstart Holdings, Inc.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| Year Ended December 31, | |||||||||||
| 2022 | 2023 | ||||||||||
Net cash used in operating activities | $ | (674,681) | $ | (160,493) | |||||||
| Net cash used in investing activities | (114,125) | (118,455) | |||||||||
| Net cash provided by financing activities | 130,032 | 214,268 | |||||||||
| Change in cash and restricted cash | $ | (658,774) | $ | (64,680) | |||||||
Net Cash from Operating Activities
Our main sources of cash provided by operating activities are our revenue from fees earned under contracts with lending partners and institutional investors and interest income we receive for loans held on our balance sheet.
Our main uses of cash in our operating activities include payments to marketing partners, vendor payments, payroll and other personnel-related expenses, payments for facilities, and other general business expenditures.
Net cash used in operating activities was $160.5 million for the year ended December 31, 2023, which primarily consisted of adjustments for non-cash items of $420.2 million, net loss of $240.1 million, and $340.6 million in net changes in operating assets and liabilities. The increase in non-cash adjustments was primarily related to $234.8 million of changes in fair value of financial instruments held on the Company’s balance sheet, $175.0 million of stock-based compensation, and $24.9 million of depreciation and amortization, partially offset by $13.7 million gain on loan servicing rights. The decrease in net changes in operating assets and liabilities was primarily related to $491.9 million in net purchases of loans held-for-sale, a $43.0 million decrease in amounts payable to investors, a $8.9 million increase in other assets, a $6.8 million decrease in operating lease liabilities and right-of-use assets, and a $6.1 million decrease in accounts payable partially offset by $189.7 million in principal payments received for loans held-for-sale, $24.8 million in principal payments received for loans held in consolidated securitization and a $2.2 million increase in accrued expenses.
Net Cash from Investing Activities
Net cash used in investing activities was $118.5 million for the year ended December 31, 2023 as a result of $157.2 million purchases and originations of loans held-for-investment, $56.9 million acquisition of beneficial interest assets, $10.6 million of capitalized software costs, partially offset by $102.4 million in principal payments received for loans held-for-investment and $4.3 million of principal payments received for notes receivable and repayments of residual certificates.
Net Cash from Financing Activities
Net cash provided by financing activities was $214.3 million for the year ended December 31, 2023 as a result of $626.9 million proceeds from borrowings, $165.3 million proceeds from the issuance of securitization notes, $8.4 million in proceeds from issuance of common stock under ESPP, and $12.9 million proceeds from exercise of stock options, partially offset by $575.9 million repayments of borrowings and $23.3 million in principal payments made on securitization notes.
Composition of Balance Sheet Loan Portfolio
As of December 31, 2023, we held $1,156.4 million of loans on our consolidated balance sheet. $411.1 million of these loans were originated for research and development purposes, primarily in support of our auto lending products and expansion of our unsecured personal loan product to new categories of borrowers. We also held $566.2 million of core personal loans which would otherwise be immediately purchased by institutional investors and $179.1 million of core personal loans held by the consolidated securitization. We will continue to utilize our capital to support research and development activities and, at times, as a funding source for core personal loans during periods of marketplace funding constraints. The extent and timing of utilizing our capital as a funding
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
source for loans will largely depend on the availability of capital in our marketplace relative to the demand from qualified borrowers and our business priorities. We plan to sell loans held on our balance sheet to institutional investors over time in the form of secondary sales or securitizations.
Off-Balance Sheet Arrangements
In the ordinary course of business, we engage in activities that are not reflected on our consolidated balance sheets, generally referred to as off-balance sheet arrangements. These activities involve transactions with unconsolidated VIEs, including sale of whole loans and sponsored and co-sponsored securitization transactions, which we contractually service. We use these transactions to provide a source of liquidity to finance our business and to diversify our institutional investor base. If we are the retaining sponsor of a securitization transaction, we are required by law to retain at least 5% of the credit risk of the securities issued in these securitizations. We provide additional information regarding transactions with unconsolidated VIEs in “Note 3. Variable Interest Entities” in Part II, Item 8 of this Annual Report on Form 10-K.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from our estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. Our significant accounting policies are described in “Note 1. Description of Business and Significant Accounting Policies” in Part II, Item 8 of this Annual Report on Form 10-K.
Fair Value
Financial instruments measured at fair value on a recurring basis include, loans, beneficial interest assets and liabilities, notes receivable and residual certificates, and payable to securitization note holders. We believe the estimate of fair value of these financial instruments requires significant judgment. We use a discounted cash flow model to estimate the fair value of these financial instruments based on the present value of estimated future cash flows. This model uses both observable and unobservable inputs and reflects our best estimates of the assumptions a market participant would use to calculate fair value. Primary inputs that require significant judgment include discount rates, credit risk rates and expected prepayment rates. These inputs are based on historical performance of loans facilitated through our platform, as well as the consideration of market participant requirements.
We have also elected the fair value option for servicing assets and liabilities. We record servicing assets and liabilities at estimated fair value when we transfer loans which qualify as sales under Topic 860, Transfers and Servicing. We use a discounted cash flow model to estimate the fair value of loan servicing assets and liabilities. The cash flows in the valuation model represent the difference between the servicing fees charged to institutional investors and an estimated market servicing fee. Since servicing fees are generally based on the monthly unpaid principal balance of the underlying loans, the expected cash flows in the model incorporate estimated credit risk and expected prepayments on the loans. For further information on fair value measurement refer to “Note 6. Fair Value Measurement” in Part II, Item 8 of this Annual Report on Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks in the ordinary course of our business, which primarily relate to fluctuations in market discount rates, credit risks, and interest rates. We are exposed to market risk directly through loans and securities held on our consolidated balance sheets, access to the securitization markets, institutional
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investor demand for loans facilitated through our marketplace, and availability of funding under our current credit facilities and term loans. Our inability or failure to manage market risks could harm our business, financial condition or results of operations.
Discount Rate Risk
Discount rate sensitivity refers to the risk of loss to future earnings, values or future cash flows that may result from changes in market discount rates.
As of December 31, 2022 and 2023, we were exposed to market discount rate risk on $1,010.4 million and $977.3 million, respectively, of loans held on our consolidated balance sheets, excluding loans held in consolidated securitization. The fair value of these loans is estimated using a discounted cash flow methodology, where the discount rate represents an estimate of the required rate of return by market participants. The changes in the discount rates for loans held on our balance sheet reflect the expected returns of similar financial instruments available in the market and can be caused by changes in the market interest rates, expected loan performance, and other factors. Any gains and losses from discount rate changes are recorded in earnings. A hypothetical 100 basis point and 200 basis point increase in the discount rate would result in a $12.0 million and $23.7 million decrease, respectively, in the fair value of loans held on our consolidated balance sheet as of December 31, 2022 and a $11.7 million and $23.1 million decrease, respectively, as of December 31, 2023.
Loans held in the consolidated securitization are included in loans, at fair value on the consolidated balance sheets. The fair value of these loans is determined by the sum of the fair value of the related securitization notes and residual certificates issued as part of the consolidated securitization, and uses the same projected net cash flows as the underlying collateral loan pool. As the Company retained all residual certificates issued by the consolidated securitization, their value is eliminated as part of the consolidation process. A hypothetical 100 basis point and 200 basis point increase in the discount rate would result in a $2.4 million and $4.8 million decrease, respectively, in the fair value of loans held in the consolidated securitization on the consolidated balance sheet as of December 31, 2023.
As of December 31, 2023, we were also exposed to market discount rate risk on payable to securitization note holders of $141.4 million. A hypothetical 100 basis point and 200 basis point increase in the discount rate would result in a $1.9 million and $3.7 million decrease, respectively, in the fair value of payable to securitization note holders on the consolidated balance sheet as of December 31, 2023.
As of December 31, 2023, we were also exposed to market discount rate risk on other financial instruments, including $41.0 million of beneficial interest assets. Beneficial interest assets are estimated at fair value using a discounted cash flow model which considers projected defaults, losses and recoveries to project future losses and net cash flows on the underlying loans. We use two different discount rates for expected cash flows associated with demonstrated to-date credit performance and those associated with future credit performance. Any gains and losses from discount rate changes are recorded in earnings. A hypothetical 100 basis point and 200 basis point increase in the discount rate would result in a $1.2 million and $2.4 million decrease, respectively, in the fair value of beneficial interest assets held on our consolidated balance sheet as of December 31, 2023.
Credit Risk
Credit risk refers to the risk of loss of the loans on our consolidated balance sheets arising from individual borrower default due to inability or unwillingness to meet their financial obligations. The performance of certain financial instruments, including loans, beneficial interests, securitization notes and residual certificates, and payable to securitization note holders on our consolidated balance sheets are dependent on the credit performance of loans facilitated by us. To manage this risk, we monitor borrower payment performance through our lending marketplace and utilize our AI capabilities to price loans in a manner that we believe is reflective of their credit risk.
The fair values of these loans, beneficial interests, securitization notes and residual certificates, and payable to securitization note holders are estimated based on a discounted cash flow model which involves the use of significant unobservable inputs and assumptions. These instruments are sensitive to changes in credit risk.
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As of December 31, 2022 and 2023, we were exposed to credit risk on $1,010.4 million and $977.3 million, respectively, of loans held on our consolidated balance sheet excluding loans held in consolidated securitization. Loans bear fixed interest rates and are carried on our consolidated balance sheets at fair value. As of December 31, 2022, a hypothetical 10% and 20% increase in credit risk would result in a $11.9 million and $23.9 million decrease, and as of December 31, 2023, a hypothetical 10% and 20% increase in credit risk would result in a $12.5 million and $25.0 million decrease in the fair value of loans held on our consolidated balance sheets, respectively.
Loans held in the consolidated securitization are included in loans, at fair value on the consolidated balance sheets. The fair value of these loans is determined by the sum of the fair value of the related securitization notes and residual certificates issued by the consolidated entities, and uses the same projected net cash flows as the underlying collateral loan pool. As the Company retained all residual certificates issued by the consolidated securitization, the residual certificates value is eliminated as part of the consolidation process. A hypothetical 100 and 200 basis point increase in the credit risk would result in a $2.7 million and $5.2 million decrease, respectively, in the fair value of loans held in consolidated securitization on the consolidated balance sheet as of December 31, 2023.
We are also exposed to credit risk on $41.0 million of beneficial interest assets and $4.2 million of beneficial interest liabilities held on the consolidated balance sheet as of December 31, 2023. A hypothetical 10% and 20% increase in credit risk spread would result in a $9.1 million and $16.7 million decrease, respectively, in the fair value of beneficial interest assets held on our consolidated balance sheet, and would result in a $5.6 million and $11.2 million increase in the fair value of beneficial interest liabilities on our consolidated balance sheet, respectively, as of December 31, 2023.
Counterparty Risk
We are subject to risk that arises from our derivative financial instruments, beneficial interests, warehouse facilities, and third-party custodians. These activities generally involve an exchange of obligations with unaffiliated lenders or other individuals or entities, referred to in such transactions as “counterparties”. If a counterparty were to default or otherwise fail to perform, we could potentially be exposed to loss if such counterparty were unable to meet its obligations to us. We manage this risk by selecting only counterparties that we believe to be financially strong, spreading the risk among multiple such counterparties, and placing contractual limits on the amount of dependence on any single counterparty.
As of December 31, 2022 and 2023, we held $532.5 million and $467.8 million, respectively, related to cash and restricted cash in business checking accounts and interest-bearing deposit accounts at various financial institutions in the United States. We are exposed to credit risk in the event of default by these financial institutions to the extent the amount recorded on our consolidated balance sheets exceeds the insured amounts by the Federal Deposit Insurance Corporation, or FDIC. We reduce credit risk by placing our cash and restricted cash in reputable institutions.
Interest Rate Risk
An increase in interest rates typically results in an increase in the rate of return required by lending partners and institutional investors, and therefore leads to a decrease in borrower demand. Higher interest rates also correspond with higher payment obligations for borrowers, which may reduce the ability of individual borrowers to remain current on their obligations, leading to increased delinquencies, defaults, customer bankruptcies and charge-offs, and decreasing recoveries, all of which could have a material adverse effect on our business. We expect these outcomes would generally invert in an environment of decreasing interest rates.
An increase or decrease in interest rates may also impact our exposure to interest rate risk on our warehouse credit facilities. As of December 31, 2022 and 2023, we were exposed to interest rate risk on $336.5 million and $387.4 million, respectively, under our warehouse credit facilities, which bear floating interest rates. Changes in interest rates may impact our cost of borrowing. During the year ended December 31, 2023 we entered into interest
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Upstart Holdings, Inc.
rate cap agreements in connection with our warehouse credit facilities with an aggregate notional amount of $299.6 million. The interest rate caps provide protection to the credit facilities against exposure to changes in cash flows to the extent the 1-month SOFR exceeds the strike rate. The UAWT interest rate cap matures in April 2029 and the ULT interest rate cap matures June 2025. Refer to “Note 4. Derivative Financial Instruments” for further details.
Equity Investment Risk
Our non-marketable equity securities are subject to a wide variety of market-related risks that could substantially reduce or increase the carrying value of our investments.
Our non-marketable equity investments are in equity securities of privately-held companies without readily determinable fair values. We elected to account for each such investment using the measurement alternative which is cost less impairment, if any, and adjusted for changes resulting from observable price changes in orderly transactions for an identical or similar investment in the same issuer. The determination of whether an orderly transaction is for an identical or similar investment requires significant management judgment and is inherently complex due to the lack of readily available market data. We consider factors such as differences in the rights and preferences of the investments and the extent to which those differences would affect the fair values of each investment. We also assess our non-marketable equity securities for impairment on a quarterly basis. Our impairment analysis encompasses an assessment of both qualitative and quantitative factors including the investee's financial metrics, market acceptance of the investee's product or technology, general market conditions and liquidity considerations. Adjustments and impairments are recorded in other expense on the consolidated statements of operations and comprehensive income (loss) upon recognition of such adjustments or impairments. As of December 31, 2022 and 2023, the carrying value of our non-marketable equity securities, which do not have readily determinable fair values, totaled $41.3 million.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Upstart Holdings, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| Page | |||||
Report of Independent Registered Public Accounting Firm (PCAOB ID: | |||||
| Financial Statements: | |||||
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Upstart Holdings, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Upstart Holdings, Inc. and subsidiaries (the “Company”) as of December 31, 2023 and 2022, the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2023, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2023, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 15, 2024, expressed an unqualified opinion on the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Valuation of Level 3 Financial Assets and Liabilities (“level 3 financial instruments”) and Unobservable Inputs Therein
– Loans at Fair Value – See Notes 1 and 6
– Loan Servicing Assets and Liabilities at Fair Value – See Notes 1 and 6
– Beneficial Interest Assets at Fair Value – See Notes 1, 5 and 6
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Critical Audit Matter Description
The Company has elected the fair value option for loans, which are valued using unobservable inputs significant to the fair value measurement. The Company estimates the fair value of these loans using a discounted cash flow model based on the present value of estimated future cash flows. This model uses both observable and unobservable inputs and reflects the Company’s best estimates of the assumptions a market participant would use to calculate the fair value. The fair value methodology considers historical defaults, losses and recoveries to project future losses and net cash flows on loans that are discounted using an estimate of market rates of return. Primary inputs that require significant judgment include discount rates and credit risk rates. These inputs are based on historical performance of loans facilitated through the Company’s platform, as well as management’s consideration of assumptions a market participant would use.
The Company has elected the fair value option for loan servicing assets and liabilities, which are valued using unobservable inputs significant to the fair value measurement. The Company estimates the fair value of its loan servicing assets and liabilities using a discounted cash flow model based on the difference between the servicing fees charged to institutional investors and an estimated market servicing fee on the monthly unpaid principal balance of the underlying loans.
The Company has elected the fair value option for beneficial interest assets, and estimates the fair value of its beneficial interest assets using a discounted cash flow model based on projected defaults, losses and recoveries to project future losses and net cash flows on the underlying loans. Net cash flows are discounted using an estimate of market rates of return that reflect the risk premium related to those cash flows. The model uses discount rates that are inherently judgmental and reflect the Company’s best estimates of the assumptions a market participant would use to determine fair value of its beneficial interest assets.
Given the significant judgments made by management in selecting the unobservable inputs used in estimating the fair value of these level 3 financial instruments, performing audit procedures to evaluate the reasonableness of management’s judgments related to the selection of the discount rates and credit risk rates for loans, market servicing fee for loan servicing assets and liabilities, and discount rates for beneficial interest assets required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the unobservable inputs used by management to estimate the fair value of these level 3 financial instruments, included the following, among others:
•We tested the effectiveness of management’s internal controls relating to estimation of the fair value of these level 3 financial instruments, including controls related to management’s selection of the discount rates and credit risk rates for loans, market servicing fee for loan servicing assets and liabilities, and discount rates for beneficial interest assets.
•We evaluated the accuracy and completeness of the data used in estimation of the fair value of these level 3 financial instruments.
•With the assistance of our fair value specialists, we developed independent estimates of the fair value of these level 3 financial instruments, and compared our estimates to the Company’s estimates.
/s/ Deloitte & Touche LLP
February 15, 2024
We have served as the Company’s auditor since 2015.
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Upstart Holdings, Inc.
Consolidated Balance Sheets
(In thousands, except share data)
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Assets | |||||||||||
| Cash | $ | $ | |||||||||
| Restricted cash | |||||||||||
Loans (at fair value)(1) | |||||||||||
| Property, equipment, and software, net | |||||||||||
| Operating lease right of use assets | |||||||||||
| Beneficial interest assets (at fair value) | |||||||||||
| Non-marketable equity securities | |||||||||||
| Goodwill | |||||||||||
Other assets (includes $ | |||||||||||
Total assets(2) | $ | $ | |||||||||
| Liabilities and Stockholders’ Equity | |||||||||||
| Liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Payable to investors | |||||||||||
| Borrowings | |||||||||||
| Payable to securitization note holders (at fair value) | |||||||||||
Accrued expenses and other liabilities (includes $ | |||||||||||
| Operating lease liabilities | |||||||||||
Total liabilities(2) | |||||||||||
| Stockholders’ equity: | |||||||||||
Common stock, $ | |||||||||||
| Additional paid-in capital | |||||||||||
| Accumulated deficit | ( | ( | |||||||||
| Total stockholders’ equity | |||||||||||
| Total liabilities and stockholders’ equity | $ | $ | |||||||||
____________
(1)As of December 31, 2023, includes $179.1 million of loans, at fair value, contributed as collateral for the consolidated securitization. No such loans were held as of December 31, 2022. Refer to “Note 6. Fair Value Measurement” for details.
(2)The following table presents information on assets and liabilities related to variable interest entities (“VIEs”) that are consolidated by Upstart Holdings, Inc. at December 31, 2022 and December 31, 2023. The assets in the table below may only be used to settle obligations of consolidated VIEs and are in excess of those obligations. The liabilities in the table below include liabilities for which creditors do not have recourse to the general credit of Upstart Holdings, Inc. The assets and liabilities in the table below include third-party assets and liabilities of consolidated VIEs and exclude intercompany balances that eliminate in consolidation.
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Consolidated Balance Sheets (Continued)
(In thousands, except share data)
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Assets | |||||||||||
| Cash | $ | $ | |||||||||
| Restricted cash | |||||||||||
| Loans (at fair value) | |||||||||||
Other assets (includes $ | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities | |||||||||||
| Payable to investors | $ | $ | |||||||||
| Borrowings | |||||||||||
| Payable to securitization note holders (at fair value) | |||||||||||
| Accrued expenses and other liabilities | |||||||||||
| Total liabilities | |||||||||||
| Total net assets | $ | $ | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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Upstart Holdings, Inc.
Consolidated Statements of Operations and Comprehensive Income (Loss)
(In thousands, except share and per share data)
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Revenue: | |||||||||||||||||
| Revenue from fees, net | $ | $ | $ | ||||||||||||||
Interest income, interest expense, and fair value adjustments, net: | |||||||||||||||||
Interest income(1) | |||||||||||||||||
Interest expense(1) | ( | ( | ( | ||||||||||||||
Fair value and other adjustments(1) | ( | ( | |||||||||||||||
Total interest income, interest expense, and fair value adjustments, net | ( | ( | |||||||||||||||
| Total revenue | |||||||||||||||||
| Operating expenses: | |||||||||||||||||
| Sales and marketing | |||||||||||||||||
| Customer operations | |||||||||||||||||
| Engineering and product development | |||||||||||||||||
| General, administrative, and other | |||||||||||||||||
| Total operating expenses | |||||||||||||||||
| Income (loss) from operations | ( | ( | |||||||||||||||
| Other income (expense), net | ( | ||||||||||||||||
Expense on convertible notes | ( | ( | ( | ||||||||||||||
| Net income (loss) before income taxes | ( | ( | |||||||||||||||
| (Benefit) provision for income taxes | ( | ( | |||||||||||||||
| Net income (loss) | $ | $ | ( | $ | ( | ||||||||||||
| Net income (loss) per share, basic | $ | $ | ( | $ | ( | ||||||||||||
| Net income (loss) per share, diluted | $ | $ | ( | $ | ( | ||||||||||||
| Weighted-average number of shares outstanding used in computing net income (loss) per share, basic | |||||||||||||||||
| Weighted-average number of shares outstanding used in computing net income (loss) per share, diluted | |||||||||||||||||
(1)Balances for year ended December 31, 2023 include amounts related to the consolidated securitization. Refer to “Note 2. Revenue” for details.
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Stockholders’ Equity
(In thousands, except share data)
| Common Stock | Additional Paid-in Capital | Retained Earnings (Accumulated Deficit) | Total Stockholders’ Equity | ||||||||||||||||||||||||||
| Shares | Amount | ||||||||||||||||||||||||||||
| Balance as of December 31, 2020 | $ | $ | $ | ( | $ | ||||||||||||||||||||||||
| Issuance of common stock upon exercise of stock options | — | — | |||||||||||||||||||||||||||
| Issuance of common stock upon settlement of restricted stock units | — | — | — | — | |||||||||||||||||||||||||
| Exercise of common stock warrants | — | — | — | — | |||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Shares withheld related to net share settlement of restricted stock units | ( | — | ( | — | ( | ||||||||||||||||||||||||
| Issuance of common stock in connection with acquisition | — | — | |||||||||||||||||||||||||||
| Issuance of common stock in connection with follow-on offering, net of underwriting discounts, commissions, and offering costs | — | ||||||||||||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | — | — | |||||||||||||||||||||||||||
| Purchase of capped calls | — | — | ( | — | ( | ||||||||||||||||||||||||
| Net income | — | — | — | ||||||||||||||||||||||||||
| Balance as of December 30, 2021 | $ | $ | $ | $ | |||||||||||||||||||||||||
| Issuance of common stock upon exercise of stock options | — | ||||||||||||||||||||||||||||
| Issuance of common stock upon settlement of restricted stock units | — | — | — | — | |||||||||||||||||||||||||
| Shares withheld related to net share settlement of restricted stock units | ( | — | ( | — | ( | ||||||||||||||||||||||||
| Repurchase and retirement of restricted stock | ( | — | — | — | — | ||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | — | — | |||||||||||||||||||||||||||
| Repurchases of stock | ( | ( | ( | — | ( | ||||||||||||||||||||||||
| Net loss | — | — | — | ( | ( | ||||||||||||||||||||||||
| Balance as of December 31, 2022 | $ | $ | $ | ( | $ | ||||||||||||||||||||||||
| Issuance of common stock upon exercise of stock options | — | ||||||||||||||||||||||||||||
| Issuance of common stock upon settlement of restricted stock units | — | — | — | — | |||||||||||||||||||||||||
| Shares withheld related to net share settlement of restricted stock units | ( | — | ( | — | ( | ||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | ||||||||||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | — | — | |||||||||||||||||||||||||||
| Net loss | — | — | — | ( | ( | ||||||||||||||||||||||||
| Balance as of December 31, 2023 | $ | $ | $ | ( | $ | ||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Cash flows from operating activities | |||||||||||||||||
| Net income (loss) | $ | $ | ( | $ | ( | ||||||||||||
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | |||||||||||||||||
| Change in fair value of financial instruments | ( | ||||||||||||||||
| Stock-based compensation | |||||||||||||||||
| Gain on loan servicing rights, net | ( | ( | ( | ||||||||||||||
| Depreciation and amortization | |||||||||||||||||
| Non-cash interest expense | |||||||||||||||||
| Other | ( | ||||||||||||||||
| Net changes in operating assets and liabilities: | |||||||||||||||||
| Purchases of loans held-for-sale | ( | ( | ( | ||||||||||||||
| Proceeds from sale of loans held-for-sale | |||||||||||||||||
| Principal payments received for loans held-for-sale | |||||||||||||||||
| Principal payments received for loans held by consolidated securitization | |||||||||||||||||
| Settlements of beneficial interest liabilities | ( | ||||||||||||||||
| Other assets | ( | ( | |||||||||||||||
| Operating lease liability and right-of-use asset | ( | ||||||||||||||||
| Accounts payable | ( | ( | |||||||||||||||
| Payable to investors | ( | ( | |||||||||||||||
| Accrued expenses and other liabilities | ( | ||||||||||||||||
| Net cash provided by (used in) operating activities | ( | ( | |||||||||||||||
| Cash flows from investing activities | |||||||||||||||||
| Purchases and originations of loans held-for-investment | ( | ( | ( | ||||||||||||||
| Proceeds from sale of loans held-for-investment | |||||||||||||||||
| Principal payments received for loans held-for-investment | |||||||||||||||||
| Principal payments received for notes receivable and repayments of residual certificates | |||||||||||||||||
| Purchases of property and equipment | ( | ( | ( | ||||||||||||||
| Capitalized software costs | ( | ( | ( | ||||||||||||||
| Acquisition of beneficial interest assets | ( | ||||||||||||||||
| Purchases of non-marketable equity securities | ( | ( | |||||||||||||||
| Purchase of certificates of deposit | ( | ||||||||||||||||
| Acquisition, net of cash acquired | ( | ||||||||||||||||
| Net cash used in investing activities | ( | ( | ( | ||||||||||||||
| Cash flows from financing activities | |||||||||||||||||
| Proceeds from borrowings | |||||||||||||||||
| Repayments of borrowings | ( | ( | ( | ||||||||||||||
119
Upstart Holdings, Inc.
Consolidated Statements of Cash Flows (Continued)
(In thousands)
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Principal payments made on securitization notes | ( | ||||||||||||||||
| Proceeds from issuance of securitization notes | |||||||||||||||||
| Proceeds from secondary offering, net of underwriting discounts, commissions, and offering costs | |||||||||||||||||
| Payment of debt issuance costs | ( | ||||||||||||||||
| Purchase of capped calls | ( | ||||||||||||||||
| Proceeds from issuance of common stock under employee stock purchase plan | |||||||||||||||||
| Proceeds from exercise of stock options | |||||||||||||||||
| Taxes paid related to net share settlement of equity awards | ( | ( | ( | ||||||||||||||
| Repurchases of common stock | ( | ||||||||||||||||
| Net cash provided by financing activities | |||||||||||||||||
| Change in cash and restricted cash | ( | ( | |||||||||||||||
| Cash and restricted cash | |||||||||||||||||
| Cash and restricted cash at beginning of year | |||||||||||||||||
| Cash and restricted cash at end of year | $ | $ | $ | ||||||||||||||
| Supplemental disclosures of cash flow information | |||||||||||||||||
| Cash paid for interest | $ | $ | $ | ||||||||||||||
| Cash (received) paid for income taxes, net | ( | ||||||||||||||||
| Supplemental disclosures of non-cash investing and financing activities | |||||||||||||||||
| Securities retained under consolidated securitization transaction | $ | $ | $ | ||||||||||||||
| Residual certificates retained under unconsolidated securitization | |||||||||||||||||
| Beneficial interest assets included in payable to investors | |||||||||||||||||
| Capitalized stock-based compensation expense | |||||||||||||||||
| Issuance of common stock in connection with acquisition | |||||||||||||||||
The following presents cash and restricted cash by category within the consolidated balance sheets:
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Cash | $ | $ | |||||||||
| Restricted cash | |||||||||||
| Total cash and restricted cash | $ | $ | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
120
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
1. Description of Business and Significant Accounting Policies
Description of Business
Upstart Holdings, Inc. and its subsidiaries (together “Upstart”, the “Company”, “management”, “we”, or “our”) apply modern data science and technology to the process of originating consumer credit. The Company helps originate credit, including personal and auto loans, by providing lending partners with access to a proprietary, cloud-based, artificial intelligence lending marketplace. As the Company’s technology continues to improve and additional lending partners adopt the Upstart platform, consumers benefit from improved access to affordable and frictionless credit. The Company currently operates in the United States and is headquartered in San Mateo, California and Columbus, Ohio. The Company’s fiscal year ends on December 31.
Basis of Presentation and Consolidation
Follow-on Offering
On April 13, 2021, the Company completed a follow-on offering, in which 2,300,000 shares of common stock (including the exercise in full of the underwriters’ option to purchase 300,000 additional shares) were issued and sold at $120.00 per share. The Company received net proceeds of $263.9 million after deducting underwriting discounts and commissions of $11.0 million and offering expenses of $1.0 million. Offering expenses consisted of incremental accounting, legal, and other fees incurred related to the follow-on offering.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods.
Significant estimates and assumptions made in the accompanying consolidated financial statements, which management believes are critical in understanding and evaluating the Company’s reported financial results include: (i) fair value determinations; (ii) stock-based compensation; (iii) consolidation of VIEs; and (iv) the evaluation for impairment of goodwill and acquired intangible assets. The Company bases its estimates on various factors it believes to be reasonable under the circumstances. Actual results could differ from those estimates and such differences could affect the results of operations reported in future years.
Cash and Restricted Cash
Cash consists of bank deposits held in business checking and interest-bearing deposit accounts. As of December 31, 2022 and 2023, the Company did not have any cash equivalent balances, defined as highly liquid financial instruments purchased with original maturities of three months or less.
Restricted cash primarily consists of deposit accounts that are held in our custody but restricted for regulatory or legal purposes. This balance includes amounts that are: (i) received from borrowers for interest and
121
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Fair Value Measurement
Assets and liabilities recorded at fair value on a recurring basis on the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is defined as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The price used to measure fair value is not adjusted for transaction costs. The principal market is the market in which the Company would sell or transfer the asset with the greatest volume and level of activity for the asset. In determining the principal market for an asset or liability, it is assumed that the Company has access to the market as of the measurement date. If no market for the asset exists, or if the Company does not have access to the principal market, a hypothetical market is used.
The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:
Level 1—Unadjusted quoted market prices in active markets for identical assets or liabilities;
Level 2— Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; and
Level 3— Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Assets and liabilities measured at fair value on a recurring basis include loans, notes receivable and residual certificates, loan servicing assets and liabilities, derivatives, beneficial interests, payable to securitization note holders, and trailing fee liabilities. When developing fair value measurements, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs.
Financial Instruments not Measured at Fair Value
The Company’s financial instruments not measured at fair value consist primarily of cash, restricted cash, and other assets (excluding certain financial instruments, which are measured at fair value, such as loan servicing assets, interest rate caps, notes receivable and residual certificates), accounts payable, payable to investors, and other liabilities (excluding certain financial instruments, such as loan servicing liabilities, beneficial interest liabilities, and trailing fee liabilities which are measured at fair value). Payable to investors includes amounts of loan repayments not yet distributed to institutional investors, as well as amounts received from institutional investors but not yet invested directly in whole loans. The carrying values of these financial instruments are approximates of their respective fair values due to their short-term nature.
122
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Borrowings are presented at par, net of debt issuance costs and amortized over the contractual term using the effective interest method, with accrued interest included as part of accrued expenses and other liabilities on the consolidated balance sheets. The carrying value of borrowings associated with the warehouse credit facilities approximates the fair value due to their relatively short maturities.
Variable Interest Entities
A legal entity is considered a VIE if it has either a total equity investment that is insufficient to finance its operations without additional subordinated financial support or whose equity holders lack the characteristics of a controlling financial interest. The Company’s variable interests arise from contractual, ownership, or other monetary interests in the entity. The Company consolidates a VIE when it is deemed to be the primary beneficiary. The Company determines it is the primary beneficiary if it has the power to direct activities that most significantly impact the VIE’s economic performance and has the obligation to absorb losses or the right to receive benefits of the VIE that could be potentially significant to the VIE. The Company assesses whether or not it is the primary beneficiary of a VIE on an ongoing basis.
Consolidated Securitization
The Company elected the measurement alternative under Accounting Standards Codification (“ASC”) 810, Consolidation, and maximizes the use of observable inputs to estimate the fair value of the financial assets and liabilities of a consolidated securitization entity. Under the measurement alternative, the Company determined that the fair value of the liabilities, which consists of securitization notes and residual certificates issued by the entity, is based on more observable inputs than inputs used to determine the fair value of the assets, which consists of held-for-sale loans. Thus, the fair value of these loans is determined by the sum of the fair value of the related securitization notes and residual certificates. Changes in the fair value of these assets and liabilities are included in the consolidated statements of operations and comprehensive income (loss).
Transfer of Financial Assets
Loan Servicing Assets and Liabilities
Loan servicing assets and liabilities are recognized at fair value when the Company transfers loans, which qualify as sales under ASC 860 with servicing rights retained or when the Company enters into servicing agreements with lending partners who retain Upstart-powered loans. A loan servicing asset or liability exists depending on whether the revenue from servicing is expected to more than adequately compensate the Company for carrying out its servicing obligations.
123
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Property, Equipment, and Software, Net
The Company evaluates its long-lived assets for potential impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. When such an event occurs the carrying amount of the asset is reduced to its estimated fair value.
Leases
The Company determines if an arrangement is or contains a lease at inception. Operating leases are recorded on the consolidated balance sheets with right-of-use assets representing the right to use the underlying asset and lease liabilities representing the obligation to make lease payments. Right-of-use assets (“ROU”) and lease liabilities are recognized at lease commencement primarily based on the present value of lease payments over the lease term, and as necessary, at modification. The operating lease ROU assets also include any initial direct costs, lease payments made prior to lease commencement, and lease incentives received. Variable lease payments are expensed as incurred and are not included within the ROU asset and lease liability calculation. Variable lease payments primarily include reimbursements of costs incurred by lessors for common area maintenance and utilities. The Company’s lease terms are the non-cancelable period including any rent-free periods provided by the lessor and may include options to extend or terminate the lease when it is reasonably certain that it will exercise that option. At lease inception, and in subsequent periods as necessary, the Company estimates the lease term based on its assessment of extension and termination options that are reasonably certain to be exercised. Lease costs for lease payments are recognized on a straight-line basis over the lease term. As the rate implicit on the Company’s leases is not readily determinable, the Company uses its secured incremental borrowing rate to determine the present value of lease payments. The incremental borrowing rate is the rate of interest that the Company would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term and in a similar economic environment.
124
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Derivative Financial Instruments
Beneficial Interests
Non-marketable Equity Securities
The Company’s strategic investments consists of non-marketable equity securities on the consolidated balance sheets which are investments in privately held companies. Non-marketable equity securities do not have a readily determinable fair value and are measured by the Company at cost less impairment, if any, and adjusted for changes resulting from observable price changes in orderly transactions for an identical or similar investment in the same issuer (the “measurement alternative”). Gains and losses on the investment, realized and unrealized, are recognized in other income (expense), net on our consolidated statements of operations and comprehensive income (loss) and a new carrying value is established for the investment upon such recognition of the gains and losses. There have been no unrealized or realized gains and losses or impairments related to the non-marketable equity securities accounted for under the measurement alternative for the years presented. As of December 31, 2022 and 2023, the carrying value of our non-marketable equity securities was $41.3
Business Combinations
The Company accounts for business combinations using the acquisition method of accounting which requires the fair values of assets acquired and liabilities assumed to be recognized in the consolidated financial statements. Assets acquired and liabilities assumed in a business combination are recognized at their estimated fair value as of the acquisition date. The excess purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. The allocation of fair values may be subject to adjustment after the initial allocation for up to a one-year period, with the corresponding offset to goodwill. Acquisition-related costs, such as legal and consulting fees, are recognized separately from the business combination and are expensed as incurred.
125
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Goodwill and Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired. Goodwill is reviewed for impairment annually, or more frequently if an event or a change in circumstances indicates that goodwill may be impaired. We first assess qualitative factors to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying value. Examples of qualitative factors include, but are not limited to, a significant adverse change in legal factors or in the business climate, a significant decline in our stock price, a significant decline in our projected revenue or cash flows, or the presence of other indicators that would indicate a reduction in the fair value of a reporting unit. If the Company concludes that it is more likely than not that the fair value of the reporting unit is less than its carrying value, a quantitative test is performed. We perform a quantitative goodwill impairment test by determining the fair value of the reporting unit and comparing it to the carrying value of the reporting unit. If the fair value of the reporting unit is greater than the reporting unit’s carrying value, then the carrying value of the reporting unit is deemed to be recoverable. If the carrying value of the reporting unit is greater than the reporting unit’s fair value, goodwill is impaired and written down to the reporting unit’s fair value.
Acquired intangible assets are recorded at fair value on the date of acquisition and amortized on a straight-line basis over their estimated useful lives. Acquired intangible assets are presented net of accumulated amortization on the consolidated balance sheets. The Company reviews the carrying amounts of intangible assets for impairment whenever an event or change in circumstances indicates that the carrying amount of the assets may not be recoverable. We measure the recoverability of intangible assets by comparing the carrying amount of each asset to the future undiscounted cash flows we expect the asset to generate. Impairment is measured by the amount in which the carrying value of the asset exceeds its fair value. In addition, we periodically evaluate the estimated remaining useful lives of long-lived intangible assets to determine whether events or changes in circumstances warrant a revision to the remaining period of amortization.
Revenue Recognition
Operating Expenses
Sales and Marketing
Sales and marketing expenses primarily consist of costs incurred across various advertising channels, including expenses for partnerships with third-parties providing borrower referrals, direct mail and digital advertising campaigns, as well as other expenses associated with building overall brand awareness and experiential marketing costs. Sales and marketing expenses also include payroll and other personnel-related costs, including stock-based compensation expense, for related teams. These costs are recognized in the period incurred.
Customer Operations
Customer operations expenses include payroll and other personnel-related expenses, including stock-based compensation expense, for personnel engaged in onboarding, loan servicing, customer support and other related operational teams. These costs also include costs of third-party collection agencies and other systems and tools the Company uses as part of information verification, fraud detection, and payment processing activities. These costs are recognized in the period incurred.
126
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Engineering and Product Development
Engineering and product development expenses primarily consist of payroll and other employee-related expenses, including stock-based compensation expenses, for the engineering and product development teams as well as the costs of systems and tools used by these teams. These costs are recognized in the period incurred.
General, Administrative, and Other
Stock-Based Compensation
Other Income (Expense), Net
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance may be established to reduce the deferred tax asset to the level at which it is “more likely than not” that the tax asset or benefits will be realized. Realization of tax benefits of deductible temporary differences and operating loss carryforwards depends on having sufficient taxable income of an appropriate character within the carryback or carryforward periods.
127
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Net Income (Loss) Per Share
The Company follows the two-class method when computing net income (loss) per common share when shares are issued that meet the definition of participating securities. The two-class method determines net income (loss) per common share for each class of common stock and participating securities according to dividends declared or accumulated and participation rights in undistributed earnings. The two-class method requires income available to common stockholders for the year to be allocated between common stock and participating securities based upon their respective rights to receive dividends as if all income for the year had been distributed.
Basic net income (loss) per share is computed by dividing the net income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding for the year.
Recently Adopted Accounting Pronouncements
On January 1, 2023, the Company adopted Accounting Standards Update (“ASU”) 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which was issued by the FASB in October 2021. The new guidance requires contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers, as if it had originated the contracts. Under the previous business combinations guidance, such assets and liabilities are recognized by the acquirer at fair value on the acquisition date. The ASU will be applied prospectively to business combinations occurring after the adoption date. The adoption of this new standard did not have an impact on the Company's consolidated financial statements or related disclosures.
In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. The amendments in this update improve reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses. Specifically, the new guidance requires disclosure, on an annual and interim basis, of significant segment expenses that are regularly provided to the chief operating decision maker, and an amount for other segment items by reportable segment, with a description of its composition. In addition, the amendments enhance interim disclosure requirements, clarify circumstances in which an entity can disclose multiple segment measures of profit or loss, and provide new segment disclosure requirements for entities with a single reportable segment. This ASU is effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. The Company is currently evaluating the impact of the amendments to its consolidated financial statements and related disclosures.
In December 2023, the FASB issued ASU 2023-08, Intangibles—Goodwill and Other—Crypto Assets (Subtopic 350-60): Accounting for and Disclosure of Crypto Assets. The amendments in this update require entities that hold certain crypto assets to subsequently measure them at fair value, with changes in fair value recorded in net income. In addition, entities are required to provide additional disclosures about the holdings of certain crypto assets. This ASU is effective for fiscal years beginning after December 15, 2024, including interim periods within
128
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
those fiscal years, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements or related disclosures.
In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. The amendments in this update require entities to disclose specific categories in the effective tax rate reconciliation and provide additional information for reconciling items where the effect of those reconciling items is equal to or greater than 5% of the amount computed by multiplying pretax income/loss by the applicable statutory income tax rate. In addition, entities are required to disclose the year-to-date amount of income taxes paid (net of refunds received) disaggregated by jurisdictions. This ASU is effective for annual periods beginning after December 15, 2024 with early adoption permitted. The Company is currently evaluating the impact of these amendments on its consolidated financial statements and related disclosures.
2. Revenue
Revenue from Fees, Net
The Company disaggregates revenue from fees by type of service for the years presented as follows:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Revenue from fees, net: | |||||||||||||||||
| Platform and referral fees, net | $ | $ | $ | ||||||||||||||
| Servicing and other fees, net | |||||||||||||||||
| Total revenue from fees, net | $ | $ | $ | ||||||||||||||
Platform and Referral Fees, Net
The Company enters into contracts with lending partners to provide access to a cloud-based artificial intelligence lending marketplace developed by the Company (the “Upstart platform”) to enable lending partners to originate unsecured personal and secured auto loans. The Upstart platform includes a cloud-based application (through Upstart.com or a lending partner-branded program) for submitting loan applications, verifying information provided within submitted applications, risk underwriting (through a series of proprietary technology solutions), delivery of electronic loan offers, and if the offer is accepted by the borrower, electronic loan documentation signed by the borrower. Lending partners can specify certain parameters of loans they are willing to originate. Under these contracts, lending partners can choose to use Upstart’s referral services, which allow them to access new borrowers through Upstart’s marketing channels.
After origination, Upstart-powered loans are either retained by lending partners, purchased by the Company for immediate resale to institutional investors under loan sale agreements, or purchased and held by the Company. For loans purchased by the Company, Upstart pays lending partners a one-time loan premium fee upon completion of the minimum contractual holding period. Upstart also pays lending partners monthly loan trailing fees based on the amount and timing of principal and interest payments made by borrowers of the underlying loans. Both the loan premium fees and loan trailing fees are consideration payable to customers, which are our lending partners, and are recorded as a reduction to platform and referral fees, net, which is part of revenue from fees, net, in the consolidated statements of operations and comprehensive income (loss). The Company recognized $23.6 million, $27.7 million, and $8.1 million of loan premium fees and loan trailing fees as contra-revenue within platform and referral fees, net during the year ended December 31, 2021, 2022, and 2023, respectively.
As of December 31, 2022 and 2023, the Company recognized $4.9 million and $4.3 million of loan trailing fee liability, respectively, which is recorded at fair value and included within accrued expenses and other liabilities
129
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
on the Company’s consolidated balance sheets. Refer to “Note 6. Fair Value Measurement” for additional information on changes in fair value associated with trailing fee liabilities.
The Company’s arrangements for platform and referral services typically consist of an obligation to provide one or both of these services to customers, on a when and if needed basis (a stand-ready obligation), and revenue is recognized as such services are performed. Additionally, the services have the same pattern and period of transfer, and when provided individually or together, are accounted for as a single combined performance obligation representing a series of distinct services.
Platform and referral services are typically provided under a fixed or variable price per unit based on a percentage of the value of loans originated each period with certain lending partners subject to minimum fees; however, pricing for these services may also be based on usage fees, calculated as a percentage of each loan originated. The nature of the Company’s promise is to stand-ready and provide continuous access to and process transactions through the platform. Platform and referral fees represent variable consideration as loan origination volume is not known at contract inception. These fees are determined each time a loan is originated. Fees for platform and referral services are typically billed and paid on either a daily or monthly basis. As such, the Company’s contracts with customers do not include a significant financing component.
The Company also enters into subscription agreements with auto dealerships to access Upstart Auto Retail software, a cloud-based solution that facilitates dealership operations and enables them to provide consumers with access to Upstart-powered auto loans. Subscription agreements generally have a contractual term of to six months with evergreen monthly renewals. The Company bills customers on a monthly basis. Subscription fees are recognized over the contract term as the performance obligation is satisfied, and is included within platform and referral fees, net in the consolidated statements of operations and comprehensive income (loss). During the year ended December 31, 2021 and 2022 the Company recognized immaterial 3.8 million during the year ended December 31, 2023.
The Company had $31.1 million and $19.5 million of accounts receivable that are included in other assets on the consolidated balance sheets related to contracts with customers as of December 31, 2022 and 2023, respectively. The standard payment terms on accounts receivable are 30 days. The Company’s allowance for bad debt and bad debt expense were immaterial for the years presented.
The Company capitalizes incremental costs of obtaining a contract with a customer, which are certain sales commissions paid to employees in connection with the acquisition of lending partners. Capitalized costs are amortized over the expected period of benefit, which we have determined, based on an analysis, to be three years . The Company applies the practical expedient to expense costs to obtain contracts with customers if the amortization period is one year or less. As of December 31, 2022 and 2023, the Company had $2.6 million and $2.7 million of contract costs, respectively, capitalized within other assets on the consolidated balance sheets. During the years ended December 31, 2021, 2022 and 2023, the Company amortized an immaterial amount, $2.8 million, and $3.2 million, respectively, of capitalized contracts costs to sales and marketing in the consolidated statements of operations and comprehensive income (loss) for the years presented.
Customers accounting for greater than 10% of total revenue were as follows:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Customer A | |||||||||||||||||
| Customer B | |||||||||||||||||
| Customer C | * | * | |||||||||||||||
* Less than 10%
130
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Customers accounting for greater than 10% of accounts receivable were as follows:
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Customer C | |||||||||||
| Customer A | * | ||||||||||
* Less than 10%
Servicing and Other Fees, Net
The Company also enters into contracts with lending partners and institutional investors to provide loan servicing for the life of Upstart-powered loans. These services commence upon origination of these loans by lending partners and include collection, processing and reconciliations of payments received, institutional investor reporting and borrower customer support as well as distribution of funds to the holders of the loans. The Company charges the loan holder a monthly servicing fee calculated based on a predetermined percentage of the outstanding principal balance. Servicing fees also include certain ancillary fees charged on a per transaction basis for processing late payments and payments declined due to insufficient funds. Servicing fees are recognized in the period the services are provided. Loan servicing fees are not within the scope of ASC 606, Revenue from Contracts with Customers, and are accounted for under ASC 860, Transfers and Servicing.
The Company charges lending partners and institutional investors for collection agency fees related to their outstanding loan portfolio. The Company either performs borrower collection activities in-house, or outsources to third-party collection agencies particularly for loans that are more than 30 days past due or charged off. The Company has discretion in hiring the collection agencies and determining the scope of their work. As the principal in the arrangement, the Company recognizes gross revenue from collection agency fees in the period that the services are provided. Upstart also receives certain ancillary borrower fees inclusive of late payment fees and ACH fail fees. The total fees charged by collection agencies are recognized in the period incurred and reported as part of customer operations expenses.
Servicing and other fees, net also includes gains and losses on assets and liabilities recognized under loan servicing arrangements for loans retained by lending partners or loans sold to institutional investors. Such gains or losses are recognized based on whether the benefits of servicing are expected to be more or less than adequate compensation for servicing obligations performed by the Company. Servicing fees also include changes in fair value of loan servicing assets and liabilities. Refer to “Note 6. Fair Value Measurement” for additional information on changes in fair value associated with servicing assets and liabilities.
The following table presents the components of servicing and other fees, net as part of revenue from fees, net in the Company’s consolidated statements of operations and comprehensive income (loss):
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Servicing fees | $ | $ | $ | ||||||||||||||
| Borrower fees | |||||||||||||||||
| Collection agency fees | |||||||||||||||||
| Other fees | |||||||||||||||||
| Net gain (loss) on servicing rights and fair value adjustments | ( | ||||||||||||||||
| Total servicing and other fees, net | $ | $ | $ | ||||||||||||||
131
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Interest Income, Interest Expense, and Fair Value Adjustments, Net
Interest income, interest expense, and fair value adjustments, net is comprised of interest income, interest expense and net changes in the fair value of financial instruments, held in the Company’s normal course of business at fair value, including loans, derivatives, beneficial interests, notes receivable and residual certificates, trailing fee liabilities, and payable to securitization note holders.
The following table presents components of the interest income, interest expense, and fair value adjustments, net presented in the Company’s consolidated statements of operations and comprehensive income (loss):
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
Interest income(1) | $ | $ | $ | ||||||||||||||
Interest expense(1) | ( | ( | ( | ||||||||||||||
| Fair value and other adjustments | |||||||||||||||||
Unrealized gain (loss) on loans, loan charge-offs, and other fair value adjustments, net | ( | ( | |||||||||||||||
Realized gain (loss) on sale of loans, net | ( | ( | |||||||||||||||
Fair value losses on beneficial interests | ( | ||||||||||||||||
Total fair value and other adjustments, net(1) | ( | ( | |||||||||||||||
| Total interest income, interest expense, and fair value adjustments, net | $ | $ | ( | $ | ( | ||||||||||||
__________
(1) Includes interest income, interest expense and fair value and other adjustments, net related to the consolidated securitization as follows:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Interest income, interest expense, and fair value adjustments, net related to consolidated securitization: | |||||||||||||||||
| Interest income | $ | $ | $ | ||||||||||||||
| Interest expense | ( | ||||||||||||||||
Unrealized loss on loans, loan charge-offs, and other fair value adjustments, net | ( | ||||||||||||||||
| Total interest income, interest expense, and fair value adjustments, net | $ | $ | $ | ||||||||||||||
Interest Income
Interest income is recognized based on the terms of the underlying agreements with borrowers for loans held on the Company’s consolidated balance sheets and is earned over the life of a loan.
Interest income also includes accrued interest earned on outstanding loans but not collected. Loans that have reached a delinquency of over 120 days are classified as non-accrual status and any accrued interest recorded in relation to these loans is reversed in the respective period. The Company does not record an allowance for credit losses on accrued interest receivable. As of December 31, 2022 and 2023, the Company has recorded $12.8 million and $14.2 million of accrued interest income in , respectively.
132
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Interest Expense
Interest expense is primarily related to interest recorded on the Company’s borrowings on warehouse credit facilities, and interest expense related to the consolidated securitization. Interest expense includes accrued interest incurred but not paid. Accrued interest expenses were immaterial as of December 31, 2022 and 2023. Interest expense also includes changes in fair value of the interest rate cap. Refer to “Note 4. Derivative Financial Instruments” for additional information.
Fair Value and Other Adjustments, Net
Fair value and other adjustments, net include changes in fair value of financial instruments, other than loan servicing assets and liabilities and the interest rate cap. These adjustments are recorded in the Company’s consolidated statements of operations and comprehensive income (loss) and include both realized and unrealized changes to the value of related assets and liabilities. Refer to “Note 6. Fair Value Measurement” for additional information.
3. Variable Interest Entities
Consolidated VIEs
The Company consolidates VIEs in which the Company has a variable interest and is determined to be the primary beneficiary. This determination is based on whether the Company has a variable interest (or combination of variable interests) that provides the Company with (a) the power to direct the activities that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses or right to receive benefits that could be potentially significant to the VIE. The Company continually reassesses whether it is the primary beneficiary of a VIE throughout the entire period the Company is involved with the VIE.
133
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following tables present a summary of financial assets and liabilities from the Company’s involvement with consolidated VIEs:
| Assets | Liabilities | Net Assets | |||||||||||||||
| December 31, 2022 | |||||||||||||||||
| Consolidated securitization | $ | $ | $ | ||||||||||||||
| Consolidated warehouse entities | |||||||||||||||||
| Other consolidated VIEs | |||||||||||||||||
| Total consolidated VIEs | $ | $ | $ | ||||||||||||||
| Assets | Liabilities | Net Assets | |||||||||||||||
| December 31, 2023 | |||||||||||||||||
| Consolidated securitization | $ | $ | $ | ||||||||||||||
| Consolidated warehouse entities | |||||||||||||||||
| Other consolidated VIEs | |||||||||||||||||
| Total consolidated VIEs | $ | $ | $ | ||||||||||||||
Consolidated Securitization
On July 6, 2023, the Company completed a private securitization securities offering (“UPST 2023-2”). As a retaining sponsor of the transaction, under risk retention requirements in Title 17 U.S. Code of Federal Regulations Part 246, Credit Risk Retention, promulgated by the Securities and Exchange Commission, the Company is required to retain at least 5% of the economic risk in UPST 2023-2. The Company elected to satisfy the risk retention requirements by holding eligible vertical retained interests in the form of a combination of securitization notes and residual certificates. The Company has also retained the remainder of the residual certificates issued as part of the transaction. The Company was the sole contributor of the collateral, which included $204.7 million unpaid principal balance of Upstart-powered loans held by the Company. The weighted-average coupon of the securitization notes issued was approximately 9.2 %, and their sale generated approximately $165.3 million in gross cash proceeds. These proceeds and payments made on securitization notes are classified as financing activities in the statement of cash flows.
Upon closing of UPST 2023-2, the Company determined that servicing fees represent a variable interest due to the retained interests held by the Company. The retained interests held by the Company were deemed to potentially absorb more than an insignificant amount of expected losses or expected returns at the inception of the securitization transaction. The Company, as servicer, also has the power to direct the activities that most significantly impact the economics of the entities associated with the UPST 2023-2 securitization, and as such, the Company determined it was the primary beneficiary and consolidated the entities associated with UPST 2023-2.
The loans held in the consolidated securitization trust are classified as held-for-sale and included in loans, at fair value, and the notes sold to third-party investors are recorded at fair value as payable to securitization note holders on the consolidated balance sheets. Refer to “Note 6. Fair Value Measurement” for additional information on determination of fair value of these assets and liabilities. The value of the residual certificates issued as part of the securitization and retained by the Company was eliminated as part of the consolidation.
134
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Warehouse Entities
The Company established Upstart Loan Trust (“ULT”) and Upstart Auto Warehouse Trust (“UAWT”) to enter into warehouse credit facilities for the purpose of purchasing Upstart-powered loans. Refer to “Note 10. Borrowings” for additional information. These entities are Delaware statutory trusts that are structured to be bankruptcy-remote, with third-party banks operating as trustees.
Other Consolidated VIE
The Company has formed a number of VIEs for the purpose of holding Upstart-powered loans that are not pledged or eligible to be pledged to the Company’s warehouse credit facilities.
Unconsolidated VIEs
The Company’s transactions with unconsolidated VIEs include securitizations of unsecured personal whole loans and sales of whole loans to VIEs. While the Company continues to be involved with the unconsolidated VIEs in its role as the sponsor and the servicer of securitization transactions, the Company does not hold a significant economic interest in these entities and has determined that it is not the primary beneficiary of these entities. The Company’s unconsolidated VIEs include entities established as the issuers and grantor trusts for various securitization transactions.
In cases where the VIEs are not consolidated and the transfer of the loans from the Company to the securitization trust meets sale accounting criteria, the Company recognizes a gain or loss on sales of loans. The net proceeds of the sale represent the fair value of any assets obtained or liabilities incurred as part of the transaction. The assets are transferred into a trust such that the assets are legally isolated from the creditors of the Company and are not available to satisfy obligations of the Company. These assets can only be used to settle obligations of the underlying securitization trusts.
During the year ended December 31, 2023, the Company exercised a clean up call related to two unconsolidated VIEs and subsequently liquidated the associated entities. A clean up call option allows the Company, as servicer, to repurchase the remaining transferred financial asset once the collateral falls below a predefined level, which represents the point where servicing becomes administratively burdensome. The clean up calls had no material impact on the consolidated financial statements of the Company.
The following tables summarize the aggregate value of assets and liabilities of unconsolidated VIEs in which the Company holds a variable interest but is not the primary beneficiary:
| Assets | Liabilities | Net Assets | Maximum Exposure to Losses | ||||||||||||||||||||
| December 31, 2022 | |||||||||||||||||||||||
| Securitizations and other | $ | $ | $ | $ | |||||||||||||||||||
| Assets | Liabilities | Net Assets | Maximum Exposure to Losses | ||||||||||||||||||||
| December 31, 2023 | |||||||||||||||||||||||
| Securitizations and other | $ | $ | $ | $ | |||||||||||||||||||
135
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The Company’s maximum exposure to loss from its involvement with unconsolidated VIEs represents the estimated loss that would be incurred under severe, hypothetical circumstances, for which the Company believes the possibility is remote. The carrying value of assets that relate to variable interests in unconsolidated VIEs consists of $6.2 million and $14.8 million of securitization notes and residual certificates which are included in other assets on the consolidated balance sheets as of December 31, 2022 and 2023, respectively. The Company also had $7.1 million and $6.0 million of cash deposits held as reserve accounts for related securitizations, included in other assets on the consolidated balance sheets as of December 31, 2022 and 2023.
For securitization transactions where the Company is not the risk retaining sponsor, and servicing is the only form of continuing involvement, the Company would only experience a loss if it were required to repurchase such a loan due to a breach in representations and warranties and is not able to collect all repayments, refer to “Note 13. Commitments and Contingencies” for further information.
4. Derivative Financial Instruments
In February 2023 and June 2023, UAWT and ULT entered into interest rate cap agreements with a strike rate of 3.0 % and 3.25 %, respectively. The agreements were entered into in relation to the warehouse credit facilities which bear floating interest rates, refer to “Note 10. Borrowings” for further information. The interest rate caps provide protection to the credit facilities against exposure to changes in cash flows to the extent the underlying interest rate on the facility exceeds the strike rate. The UAWT interest rate cap matures in April 2029 and the ULT interest rate cap matures June 2025. The interest rate cap agreements meet the definition of a derivative and are reported at fair value. Refer to “Note 6. Fair Value Measurement” for additional information.
The following table presents the notional amount as well as the fair value of interest rate caps, which is reported as part of other assets on the consolidated balance sheets. There were no material derivative financial instruments held by the Company as of December 31, 2022.
| December 31, 2023 | |||||||||||
| Notional Amount | Fair Value | ||||||||||
| Interest rate caps | $ | $ | |||||||||
The Company recognizes changes in fair value of these instruments in earnings and reports them as part of the interest expense on the consolidated statements of operations and comprehensive income (loss). The Company recognized no immaterial amount of fair value gains, net on interest rate caps during the year ended December 31, 2023.
136
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
5. Beneficial Interests
In connection with certain committed capital agreements, the Company has risk sharing arrangements in which it is obligated to make payments to the loan buyer or is entitled to receive payments from the loan buyer if credit performance on the underlying loans subject to the arrangements deviates from initial expectations, subject to a dollar cap. The Company has beneficial interests in these arrangements which either meet the definition of a derivative or that meet the criteria of a debt security. As of December 31, 2023 the Company’s capital at risk, which represents the maximum exposure to losses, under these arrangements was $98.5 million. The Company had no risk sharing arrangements as of December 31, 2022.
The following table presents the aggregate unpaid principal balance of the underlying portfolio as well as the fair value of beneficial interest assets, which are presented as a separate asset line item on the consolidated balance sheets and beneficial interest liabilities which are included in other liabilities on the consolidated balance sheets. There were no beneficial interest assets or liabilities held by the Company as of December 31, 2022.
| December 31, 2023 | |||||||||||
| Unpaid Principal Balance | Fair Value | ||||||||||
Beneficial interest assets | $ | $ | |||||||||
Beneficial interest liabilities | $ | $ | |||||||||
The Company recognizes beneficial interests at fair value with changes reported as part of the fair value and other adjustments on the consolidated statements of operations and comprehensive income (loss). The table below presents losses recognized on beneficial interests during the year ended December 31, 2023 The Company recognized no
| Year Ended December 31, 2023 | |||||
Fair value losses on beneficial interests | $ | ( | |||
Refer to “Note 6. Fair Value Measurement” for additional information.
137
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
6. Fair Value Measurement
The following tables presents assets and liabilities measured at fair value and categorized in accordance with the fair value hierarchy:
| December 31, | December 31, | |||||||||||||
| Level | 2022 | 2023 | ||||||||||||
| Assets | ||||||||||||||
| Loans | 3 | $ | $ | |||||||||||
| Beneficial interests | 3 | |||||||||||||
| Loan servicing assets | 3 | |||||||||||||
| Notes receivable and residual certificates | 3 | |||||||||||||
Interest rate caps(1) | 2 | |||||||||||||
| Total assets | $ | $ | ||||||||||||
| Liabilities | ||||||||||||||
| Payable to securitization note holders | 3 | $ | $ | |||||||||||
| Trailing fee liabilities | 3 | |||||||||||||
| Beneficial interest liabilities | 3 | |||||||||||||
| Loan servicing liabilities | 3 | |||||||||||||
| Total liabilities | $ | $ | ||||||||||||
__________
(1) The fair value of interest rate caps is determined based on the present value of the estimated future cash flows over the contract term using observable market-based inputs as of the valuation date, including implied interest rates.
Financial instruments are categorized in the fair value hierarchy based on the significance of unobservable inputs and assumptions in the overall fair value measurement. Financial instruments classified as Level 3 within the fair value hierarchy do not trade in an active market with readily observable prices. The Company uses significant unobservable inputs to measure the fair value of these assets and liabilities.
There were no transfers between Level 1, Level 2 or Level 3 of the fair value hierarchy during the years presented.
Loans
Loans included in the Company’s consolidated balance sheets are classified as either held-for-sale or held-for-investment based on the Company’s intent and ability to sell the loans prior to maturity. From time to time, the Company transfers loans between the classification categories based on changes in the Company’s intent and ability. Loans held in the consolidated securitization include loans contributed as collateral to and held in the consolidated securitization (UPST 2023-2) and are classified as held-for-sale following their classification upon the contribution.
138
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Loans held-for-sale | $ | $ | |||||||||
| Loans held-for-investment | |||||||||||
| Loans held in consolidated securitization | |||||||||||
Total | $ | $ | |||||||||
Valuation Methodology
Loans held-for-sale and held-for-investment are measured at estimated fair value using a discounted cash flow model. The fair valuation methodology considers projected prepayments and historical defaults, losses and recoveries to project future losses and net cash flows on loans. Net cash flows are discounted using an estimate of market rates of return. The fair value of these loans also includes accrued interest.
The Company elected the measurement alternative under Topic 810, Consolidation, and maximizes the use of observable inputs to estimate the fair value of the financial assets and liabilities of UPST 2023-2. Under the measurement alternative, the Company determined that inputs used to determine the value of UPST 2023-2 liabilities, which consist of securitization notes and residual certificates issued as part of this securitization, are more observable than those used to measure fair value of UPST 2023-2 financial assets, which consist of held-for-sale loans contributed as collateral. Thus, the loans are measured based on the sum of the fair value of the UPST 2023-2 securitization notes and residual certificates, with changes in fair value included in the consolidated statements of operations and comprehensive income (loss).
Significant Inputs and Assumptions
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements for loans held-for-investment and held-for-sale:
| December 31, 2022 | December 31, 2023 | ||||||||||||||||||||||||||||||||||
| Minimum | Maximum | Weighted-Average (2) | Minimum | Maximum | Weighted-Average (2) | ||||||||||||||||||||||||||||||
| Discount rate | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Credit risk rate (1) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Prepayment rate (1) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
_________
(1) Expressed as a percentage of the original principal balance of the loans.
(2) Unobservable inputs were weighted by relative fair value.
The following table presents quantitative information about the significant unobservable inputs implied for the Company’s Level 3 fair value measurements for loans held in consolidated securitization, which is determined by the sum of the fair value of the related securitization notes and residual certificates:
139
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| December 31, 2022 | December 31, 2023 | ||||||||||||||||||||||||||||||||||
| Minimum | Maximum | Weighted-Average (2) | Minimum | Maximum | Weighted-Average (2) | ||||||||||||||||||||||||||||||
| Discount rate | * | * | * | % | % | % | |||||||||||||||||||||||||||||
Credit risk rate (1) | * | * | * | % | % | % | |||||||||||||||||||||||||||||
Prepayment rate (1) | * | * | * | % | % | % | |||||||||||||||||||||||||||||
_________
(1) Expressed as a percentage of the original principal balance of the loans.
(2) Unobservable inputs were weighted by relative fair value.
* Not applicable
Discount rates–The discount rates are rates of return used to discount future expected cash flows to arrive at a present value, which represents the fair value. The discount rates used for the projected net cash flows are the Company’s estimates of the rates of return that market participants would require when investing in these financial instruments with cash flows dependent on credit quality of the related loan. A risk premium component is implicitly included in the discount rates to reflect the amount of compensation market participants require due to the uncertainty inherent in the instruments’ cash flows resulting from risks such as credit and liquidity.
Credit risk rates–The credit risk rates are an estimate of the net cumulative principal payments that will not be repaid over the entire life of a financial instrument. The credit risk rates are expressed as a percentage of the original principal amount of the instrument. The estimated net cumulative loss represents the sum of the net losses estimated to occur each month of the life of the instrument, net of the average recovery expected to be received.
Prepayment rates–Prepayment rates are an estimate of the cumulative principal prepayments that will occur over the entire life of a loan as a percentage of the original principal amount of the loan. The assumption regarding cumulative prepayments impacts the projected balances and expected terms of the loans.
Significant Recurring Level 3 Fair Value Input Sensitivity
The following table presents the sensitivity of the fair value of loans held-for-sale and held-for-investment to adverse changes in key assumptions used in the valuation model as of December 31, 2022 and 2023, respectively.
| December 31, | |||||||||||
| 2022 | 2023 | ||||||||||
| Fair value of loans held-for-sale and held-for-investment | $ | $ | |||||||||
| Discount rates | |||||||||||
| 100 basis point increase | ( | ( | |||||||||
| 200 basis point increase | ( | ( | |||||||||
| Expected credit loss rates on underlying loans | |||||||||||
| 10% adverse change | ( | ( | |||||||||
| 20% adverse change | ( | ( | |||||||||
| Expected prepayment rates | |||||||||||
| 10% adverse change | ( | ( | |||||||||
| 20% adverse change | ( | ( | |||||||||
The following table presents the sensitivity of the fair value of loans in consolidated securitization to adverse changes in key assumptions used in the valuation model as of December 31, 2023. No loans were held in consolidated securitization as of December 31, 2022.
140
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| December 31, | ||||||||
| 2023 | ||||||||
Fair value of loans held in consolidated securitization | $ | |||||||
| Discount rates | ||||||||
| 100 basis point increase | ( | |||||||
| 200 basis point increase | ( | |||||||
| Expected credit loss rates on underlying loans | ||||||||
| 10% adverse change | ( | |||||||
| 20% adverse change | ( | |||||||
| Expected prepayment rates | ||||||||
| 10% adverse change | ( | |||||||
| 20% adverse change | ( | |||||||
Rollforward of Level 3 Fair Values
The following tables include a rollforward of the loans classified within Level 3 of the fair value hierarchy:
| Loans Held-for- Sale | Loans Held-for-Investment | Loans Held in Consolidated Securitization | Total | ||||||||||||||||||||
| Fair value at December 31, 2021 | $ | $ | $ | $ | |||||||||||||||||||
Reclassification of loans(1) | ( | ||||||||||||||||||||||
Purchases of loans(1) | |||||||||||||||||||||||
Sale of loans(1) | ( | ( | |||||||||||||||||||||
Purchase of loans for immediate resale(1) | |||||||||||||||||||||||
Immediate resale of loans(1) | ( | ( | |||||||||||||||||||||
Repayments received(1) | ( | ( | ( | ||||||||||||||||||||
| Charge-offs and changes in fair value recorded in earnings | ( | ( | ( | ||||||||||||||||||||
| Other charges | |||||||||||||||||||||||
| Fair value at December 31, 2022 | $ | $ | $ | $ | |||||||||||||||||||
Transfer of loans to consolidated securitization (2) | ( | ||||||||||||||||||||||
Purchases and originations of loans(1)(3) | |||||||||||||||||||||||
Sale of loans(1) | ( | ( | |||||||||||||||||||||
Purchase of loans for immediate resale(1) | |||||||||||||||||||||||
Immediate resale of loans(1) | ( | ( | |||||||||||||||||||||
Repayments received(1) | ( | ( | ( | ( | |||||||||||||||||||
| Charge-offs and changes in fair value recorded in earnings | ( | ( | ( | ( | |||||||||||||||||||
| Other changes | |||||||||||||||||||||||
| Fair value at December 31, 2023 | $ | $ | $ | $ | |||||||||||||||||||
(1) Represents the principal balance.
(2) Transfer of loans to consolidated securitization at fair value.
(3) Purchase activity includes an immaterial unpaid principal balance related to securitization clean-up calls during the year ended December 31, 2023.
141
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following table presents the aggregate fair value and aggregate principal outstanding of all loans and loans that were 90 days or more past due included in the consolidated balance sheets:
| Loans | Loans > 90 Days Past Due | ||||||||||||||||||||||
| December 31, | December 31, | December 31, | December 31, | ||||||||||||||||||||
| 2022 | 2023 | 2022 | 2023 | ||||||||||||||||||||
| Outstanding principal balance | $ | $ | $ | $ | |||||||||||||||||||
| Net fair value and accrued interest adjustments | ( | ( | ( | ( | |||||||||||||||||||
Fair value(1) | $ | $ | $ | $ | |||||||||||||||||||
_________
The Company places loans on non-accrual status at 120 days past due. Any accrued interest recorded in relation to these loans is reversed in the respective period. The Company charges-off loans no later than 120 days past due.
Assets and Liabilities related to Securitization Transactions
As of December 31, 2022 and 2023, the Company held notes receivable and residual certificates with an aggregate fair value of $6.2 million and $14.8 million, respectively, within other assets on the Company’s consolidated balance sheets. The balances consist of securitization notes and residual certificates retained from securitization transactions.
As of December 31, 2023, the Company recognized payables to securitization note holders of $141.4 million at fair value. The balance represents the value of the securitization notes issued and owned by third-party investors in connection with UPST 2023-2. Accrued interest on these financial instruments is immaterial as of December 31, 2023. The value of the UPST 2023-2 securitization notes and residual certificates retained by the Company is eliminated in the consolidation process. As of December 31, 2022, the Company did not hold liabilities related to the consolidated securitization transaction.
Valuation Methodology
The Company prioritizes the use of observable inputs in estimating the fair value of notes receivable and residual certificates and payable to securitization note holders when available. When market activity for these financial instruments is not observable, the fair value is determined using a discounted cash flow methodology. This approach uses assumptions of projected cash flows of the underlying collateral loan pools adjusted for features of these securities, which reflect the Company’s best estimates of the assumptions a market participant would use to calculate fair value.
Significant Inputs and Assumptions
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements related to note receivable, residual certificates, and payable to securitization note holders:
142
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| December 31, 2022 | December 31, 2023 | ||||||||||||||||||||||||||||||||||
| Minimum | Maximum | Weighted-Average (2) | Minimum | Maximum | Weighted-Average (2) | ||||||||||||||||||||||||||||||
| Notes receivable and residual certificates | |||||||||||||||||||||||||||||||||||
| Discount rate | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Credit risk rate (1) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Prepayment rate (1) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Payable to securitization note holders | |||||||||||||||||||||||||||||||||||
| Discount rate | * | * | * | % | % | % | |||||||||||||||||||||||||||||
Credit risk rate (1) | * | * | * | % | % | % | |||||||||||||||||||||||||||||
Prepayment rate (1) | * | * | * | % | % | % | |||||||||||||||||||||||||||||
(1)Expressed as a percentage of the original principal balance of the loans underlying the financial instruments.
(2)Unobservable inputs were weighted by relative fair value.
* Not applicable
Significant Recurring Level 3 Fair Value Input Sensitivity
Notes Receivable and Residual Certificates
Adverse changes in discount rates, credit risk rates, or prepayment rates do not result in a material impact to the fair value of notes receivable and residual certificates as of December 31, 2022 and 2023.
Payable to Securitization Note Holders
The fair value of the payable to securitization note holders is sensitive to adverse changes in discount rates, which represent estimates of the rates of return that institutional investors would require when investing in financial instruments with similar risk and return characteristics. On average, a hypothetical 100 and 200 basis point increase in discount rates results in a decrease in fair value of payable to securitization note holders of $1.9 million and $3.7 million, respectively, as of December 31, 2023. Adverse changes in credit risk rates and expected prepayment rates do not result in a material impact to the fair value of payable to securitization note holders as of December 31, 2023. The Company held no payable to securitization note holders as of December 31, 2022.
Rollforward of Level 3 Fair Values
The following tables include a rollforward of the notes receivable and residual certificates and payables to securitization note holders related to securitization transactions classified by the Company within Level 3 of the fair value hierarchy:
143
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| Notes Receivable and Residual Certificates | Payable to Securitization Note Holders | ||||||||||
| Fair value at December 31, 2021 | $ | $ | |||||||||
| Additions | |||||||||||
| Repayments and settlements | ( | ||||||||||
| Changes in fair value recorded in earnings | ( | ||||||||||
| Fair value at December 31, 2022 | $ | $ | |||||||||
| Additions | |||||||||||
| Repayments and settlements | ( | ( | |||||||||
| Changes in fair value recorded in earnings | ( | ( | |||||||||
| Fair value at December 31, 2023 | $ | $ | |||||||||
Loan Servicing Assets and Liabilities
As of December 31, 2022 and 2023, the Company’s loan servicing assets had a fair value of $36.5 million and $28.1 million, respectively, recorded within other assets on the consolidated balance sheets. As of December 31, 2022 and 2023, the Company’s loan servicing liabilities had a fair value of $4.0 million and $2.0 million, respectively, recorded within other accrued expenses and other liabilities on the consolidated balance sheets.
Valuation Methodology
Loan servicing assets and liabilities are measured at estimated fair value using a discounted cash flow model. The cash flows in the valuation model represent the difference between the contractual servicing fees charged to institutional investors and an estimated market servicing fee. Since contractual servicing fees are generally based on the monthly unpaid principal balance of the underlying loans, the expected cash flows in the model incorporate estimates of net losses and prepayments.
Significant Inputs and Assumptions
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements for loan servicing assets and liabilities:
| December 31, 2022 | December 31, 2023 | ||||||||||||||||||||||||||||||||||
| Minimum | Maximum | Weighted-Average (2) | Minimum | Maximum | Weighted-Average (2) | ||||||||||||||||||||||||||||||
| Discount rate | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Credit risk rate (1) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Market-servicing rate (3)(4) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Prepayment rate (1) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
(1)Expressed as a percentage of the original principal balance of the loans underlying the servicing arrangement.
(2)Unobservable inputs were weighted by relative fair value.
(3)Excludes ancillary fees that would be passed on to a third-party servicer.
144
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Discount rates–The discount rates are the Company’s estimate of the rates of return that market participants in servicing rights would require when investing in similar servicing rights. Discount rates for servicing rights on existing loans are adjusted to reflect the time value of money and a risk premium intended to reflect the amount of compensation market participants would require due to the uncertainty associated with these instruments’ cash flows.
Credit risk rates–The credit risk rates are the Company’s estimate of the net cumulative principal payments that will not be repaid over the entire life of a loan expressed as a percentage of the original principal amount of the loan. The assumption regarding net cumulative losses impacts the projected balances and expected terms of the loans, which are used to project future servicing revenues.
Market-servicing rates–Market-servicing rate is an estimated measure of adequate compensation for a market participant, if one was required. The rate is expressed as a fixed percentage of outstanding principal balance per annum. The estimate considers the profit that would be demanded in the marketplace to service the portfolio of outstanding loans subject to the Company’s servicing agreements.
Prepayment rates–Prepayment rates are the Company’s estimate of the cumulative principal prepayments that will occur over the entire life of a loan as a percentage of the original principal amount of the loan. The assumption regarding cumulative prepayments impacts the projected balances and expected terms of the loans, which are used to project future servicing revenues.
Significant Recurring Level 3 Fair Value Input Sensitivity
The table below presents the fair value sensitivity of loan servicing assets and liabilities to adverse changes in key assumptions. The fair value of loan servicing assets and liabilities is not sensitive to adverse changes in discount rates and prepayments rates as such changes would not result in a significant impact on the fair value as of December 31, 2022 and 2023, respectively.
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Fair value of loan servicing assets | $ | $ | |||||||||
| Expected market-servicing rates | |||||||||||
| 10% market-servicing rates increase | ( | ( | |||||||||
| 20% market-servicing rates increase | ( | ( | |||||||||
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Fair value of loan servicing liabilities | $ | $ | |||||||||
| Expected market-servicing rates | |||||||||||
| 10% market-servicing rates increase | |||||||||||
| 20% market-servicing rates increase | |||||||||||
145
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Rollforward of Level 3 Fair Values
The following tables present a rollforward of the loan servicing assets and liabilities classified by the Company within Level 3 of the fair value hierarchy:
| Loan Servicing Assets | Loan Servicing Liabilities | ||||||||||
| Fair value at December 31, 2021 | $ | $ | |||||||||
| Sale of loans | |||||||||||
| Repayments and other changes in fair value recorded in earnings | ( | ( | |||||||||
| Fair value at December 31, 2022 | $ | $ | |||||||||
| Sale of loans | |||||||||||
| Repayments and other changes in fair value recorded in earnings | ( | ( | |||||||||
| Fair value at December 31, 2023 | $ | $ | |||||||||
Beneficial Interests
In connection with certain loan sale agreements, the Company is obligated to make payments to the loan buyer or is entitled to receive payments from the buyer if credit performance on personal loans subject to the arrangement deviate from initial expectations, subject to a dollar cap. As of December 31, 2023, the Company held beneficial interest assets related to these arrangements of $41.0 million and beneficial interest liabilities of $4.2 million. The Company held no
Valuation Methodology
Beneficial interests are measured at estimated fair value using a discounted cash flow model. The fair valuation methodology considers projected defaults, losses and recoveries to project future losses and net cash flows on the underlying loans. Net cash flows are discounted using an estimate of market rates of return that reflect the risk premium related to those cash flows. The models use inputs that are inherently judgmental and reflect the Company’s best estimates of the assumptions a market participant would use to determine fair value.
Significant Inputs and Assumptions
The following table presents quantitative information about the significant unobservable inputs used for the Company’s fair value measurements of beneficial interests as of December 31, 2023:
| Minimum | Maximum | Weighted-Average(1) | |||||||||||||||
| Beneficial interest assets | |||||||||||||||||
| Discount rate | % | % | % | ||||||||||||||
Credit risk rate spread (2) | ( | % | ( | % | ( | % | |||||||||||
| Beneficial interest liabilities | |||||||||||||||||
| Discount rate | % | % | % | ||||||||||||||
Credit risk rate spread (2) | % | % | % | ||||||||||||||
_________
(1) Unobservable inputs were weighted by relative fair value.
(2) Expressed as a percentage of cumulative loss expectations as of the valuation date compared to the origination date.
146
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Discount rates–The discount rates are rates of return used to discount future expected cash flows to arrive at a present value, which represents the fair value. The discount rates used for the projected net cash flows are the Company’s estimates of the rates of return that market participants would require when investing in these financial instruments with cash flows dependent on credit performance of the underlying loan portfolio. A risk premium component is implicitly included in the discount rates to reflect the amount of compensation market participants require due to the uncertainty inherent in the instruments’ cash flows resulting from risks such as credit and liquidity. The Company uses two different discount rates for expected cash flows associated with demonstrated to-date credit performance and those associated with future credit performance. The difference in these rates reflects the level of uncertainty and, as a result, risk premium that would be required by market participants when investing in these instruments.
Credit risk rate spreads–Credit risk rates for beneficial interests are determined the same way as for underlying loan portfolios. Credit risk rates are an estimate of cumulative losses, net of average recoveries, of the underlying portfolio, which represent the amount of principal that will not be repaid over the entire life of a financial instrument. The credit risk rate spreads are the relative difference, expressed as a percentage, between the expected credit risk rate on origination date and the estimated credit risk rate as of a valuation date.
The following table presents the sensitivity of beneficial interest assets and liabilities to adverse changes in key assumptions used in the valuation model as of December 31, 2023. Adverse changes in discount rates do not result in a material impact to the fair value of beneficial interest liabilities as of December 31, 2023.
Significant Recurring Level 3 Fair Value Input Sensitivity
| December 31, 2023 | |||||
| Fair value of beneficial interest assets | $ | ||||
| Discount rate | |||||
| 100 basis point increase | ( | ||||
| 200 basis point increase | ( | ||||
| Expected credit rate spreads on underlying loans | |||||
| 10% adverse change | ( | ||||
| 20% adverse change | ( | ||||
| Fair value of beneficial interest liabilities | $ | ||||
| Expected credit rate spreads on underlying loans | |||||
| 10% adverse change | |||||
| 20% adverse change | |||||
147
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Rollforward of Level 3 Fair Values
The following tables present a rollforward of beneficial interest assets and liabilities:
Beneficial Interest Assets | Beneficial Interest Liabilities | ||||||||||
Fair value as of December 31, 2022 | $ | $ | |||||||||
| Additions | |||||||||||
| Settlements | ( | ||||||||||
| Changes in fair value recorded in earnings | ( | ||||||||||
Fair value at December 31, 2023 | $ | $ | |||||||||
Trailing Fee Liabilities
The Company pays certain bank partners monthly trailing fees based on the amount and timing of principal and interest payments made by borrowers of the underlying loans. As of December 31, 2022 and 2023, the Company held trailing fee liabilities of $4.9 million and $4.3 million, respectively.
Valuation Methodology
The discounted cash flow methodology, which is used to estimate the fair value of trailing fee liabilities, uses the same projected net cash flows as the underlying loans. The fair valuation methodology considers projected prepayments and historical defaults, losses and recoveries to project future losses and net cash flows of the underlying loans. Net cash flows are discounted using an estimate of market rates of return.
Significant Inputs and Assumptions
The following table presents quantitative information about the significant unobservable inputs used for the Company’s Level 3 fair value measurements for trailing fee liabilities:
| December 31, 2022 | December 31, 2023 | ||||||||||||||||||||||||||||||||||
| Minimum | Maximum | Weighted-Average (2) | Minimum | Maximum | Weighted-Average (2) | ||||||||||||||||||||||||||||||
| Discount rate | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Credit risk rate (1) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
Prepayment rate (1) | % | % | % | % | % | % | |||||||||||||||||||||||||||||
_________
(1) Expressed as a percentage of the original principal balance of the loans.
(2) Unobservable inputs were weighted by relative fair value.
Significant Recurring Level 3 Fair Value Input Sensitivity
The fair value sensitivity of trailing fee liabilities to adverse changes in key assumptions would not result in a material impact on the Company’s financial position or results of operations.
148
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Rollforward of Level 3 Fair Values
The following tables include a rollforward of trailing fee liabilities classified by the Company within Level 3 of the fair value hierarchy:
| Trailing Fee Liabilities | |||||
| Fair value at December 31, 2021 | $ | ||||
| Issuances | |||||
| Repayments and settlements | ( | ||||
| Changes in fair value recorded in earnings | ( | ||||
Fair value at December 31, 2022 | $ | ||||
| Issuances | |||||
| Repayments and settlements | ( | ||||
| Changes in fair value recorded in earnings | |||||
Fair value at December 31, 2023 | $ | ||||
7. Acquisitions
In April 2021, the Company completed its acquisition of Prodigy Software, Inc. (“Prodigy”). Prodigy provided a modern multi-channel car buying experience, helping dealerships serve consumers with a holistic software solution that integrates legacy systems. The acquisition enabled the launch of Upstart Auto Retail software, a cloud-based solution that enables dealerships to provide consumers with access to Upstart-powered auto loans by combining Prodigy Software and Upstart intellectual property.
The total consideration the Company provided for Prodigy was $89.0 million, comprised of the following:
| April 8, 2021 | |||||
Fair value of Upstart common stock issued to Prodigy stockholders(1) | $ | ||||
Cash paid to common and preferred stockholders, warrant holders, and vested option holders | |||||
| Fair value of assumed Prodigy options attributable to pre-combination service period | |||||
| Transactions costs paid by Upstart on behalf of Prodigy | |||||
| Total purchase consideration | $ | ||||
_________
(1) The fair value is based on 568,539 shares of Company common stock at $123.33 per share, the closing stock price on April 8, 2021, and 87,339 shares are held in escrow as security for certain indemnification obligations of former Prodigy stockholders.
Excluded from the total purchase consideration above are 82,201 shares of the Company’s restricted common stock (“restricted stock”) with a fair value of $10.1 million issued to certain Prodigy employees. As of the year ended December 31, 2023, all restricted stock was fully lapsed. Refer to “Note 11. Stockholders' Equity” for further information.
The acquisition was accounted for as a business combination. The purchase consideration was allocated to the tangible and intangible assets and liabilities acquired as of the acquisition date, with the excess recorded to goodwill. The values assigned to the assets acquired and liabilities assumed were based on estimates of fair value available to us as of the date of acquisition, and adjusted during the measurement period, which ended on January 1,
149
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
2022. No material adjustments to the fair value of assets and liabilities were made during the measurement period. Refer to “Note 8. Goodwill and Intangible Assets” for further information.
The Company recognized acquisition-related costs of $1.2 million in the year ended December 31, 2021, which are included in the general and administrative expense in the consolidated statement of operations and comprehensive income (loss). No
We have included the financial results of the acquired business in our consolidated financial statements from the date of acquisition. These revenues and expenses were immaterial for the year ended December 31, 2021. Pro forma results of operations have not been presented because the effects of this acquisition were not material to our financial results.
8. Goodwill and Intangible Assets
Goodwill
During the year ended December 31, 2022 and 2023, there were no changes in the carrying amount of goodwill of $67.1
Intangible Assets
Acquired intangible assets subject to amortization consist of developed technology and customer relationships, and are recorded net of amortization and included within other assets on the consolidated balance sheets. The gross and net carrying values and accumulated amortization are as follows:
| December 31, 2022 | December 31, 2023 | ||||||||||||||||||||||||||||||||||
Gross Carrying Value | Accumulated Amortization | Net Carrying Value | Gross Carrying Value | Accumulated Amortization | Net Carrying Value | ||||||||||||||||||||||||||||||
| Developed technology | $ | $ | ( | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||
| Customer relationships | ( | ( | |||||||||||||||||||||||||||||||||
Total intangible assets | $ | $ | ( | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||
Amortization expense was $3.2 million, $4.3 million and $4.3 million for the year ended December 31, 2021, 2022, and 2023, respectively.
Expected future amortization expense for intangible assets as of December 31, 2023 is as follows:
| Fiscal Years: | |||||
| 2024 | $ | ||||
| 2025 | |||||
| 2026 | |||||
| 2027 | |||||
| 2028 | |||||
| Thereafter | |||||
| Total | $ | ||||
150
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
9. Balance Sheet Components
Other Assets
Other assets consisted of the following:
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Servicing fees and other receivables | $ | $ | |||||||||
| Loan servicing assets (at fair value) | |||||||||||
| Other assets | |||||||||||
| Prepaid expenses | |||||||||||
| Notes receivable and residual certificates (at fair value) | |||||||||||
Intangible assets, net(2) | |||||||||||
| Deposits | |||||||||||
Interest rate caps (at fair value)(1) | |||||||||||
| Total other assets | $ | $ | |||||||||
_________
(1)Refer to “Note 4. Derivative Financial Instruments” for further information.
(2)Refer to “Note 8. Goodwill and Intangible Assets” for further information.
Servicing fees and other receivables represent amounts recognized as revenue but not yet collected in relation to servicing and other agreements with institutional investors and lending partners.
Property, Equipment, and Software, Net
Property, equipment, and software, net consisted of the following:
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Internally developed software | $ | $ | |||||||||
| Leasehold improvements | |||||||||||
| Computer and networking equipment | |||||||||||
| Furniture and fixtures | |||||||||||
| Total property, equipment, and software | |||||||||||
| Accumulated depreciation and amortization | ( | ( | |||||||||
| Total property, equipment, and software, net | $ | $ | |||||||||
For the year ended December 31, 2021, 2022 and 2023, depreciation and amortization expense on property, equipment, and software was $4.2 million, $13.5 million, and $20.6 million, respectively. Capitalized internally developed software balances, net of accumulated amortization, were $27.4 million and $31.3 million as of December 31, 2022 and 2023, respectively. The Company also recognized impairment charges to internally developed software of $2.6 million during the year ended December 31, 2023 as a result of the January 2023 Plan. Refer to “Note 16. Reorganization Expenses” for more information. There were no impairments of long-lived assets during the year ended December 31, 2022.
151
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consisted of the following:
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Accrued payroll | $ | $ | |||||||||
| Accrued expenses | |||||||||||
| Trailing fee liability (at fair value) | |||||||||||
| Beneficial interest liabilities (at fair value) | |||||||||||
| Other liabilities | |||||||||||
| Loan servicing liabilities (at fair value) | |||||||||||
| Total accrued expenses and other liabilities | $ | $ | |||||||||
10. Borrowings
The following table presents the aggregate principal outstanding of all debt mentioned in this note that are included in the consolidated balance sheets:
| Borrowings | |||||||||||
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Warehouse credit facilities | $ | $ | |||||||||
| Convertible senior notes | |||||||||||
| Total payments due | |||||||||||
| Unamortized debt discount | ( | ( | |||||||||
| Total borrowings | $ | $ | |||||||||
Warehouse Credit Facilities
Upstart Loan Trust Warehouse Credit Facility
In November 2015, the Company’s consolidated VIE, ULT, entered into a revolving credit and security agreement with a third-party lender (the “ULT Warehouse Credit Facility”). The credit and security agreement for the ULT Warehouse Credit Facility was amended and restated in its entirety in May 2020 and has been further amended from time to time. Under the revolving credit and security agreement, the ULT Warehouse Credit Facility provides an aggregate of $250.0 million financing capacity of which $175.0 million is committed and $75.0 million is uncommitted. ULT may borrow up to this capacity until the earlier of June 15, 2025 or the occurrence of an accelerated amortization event. Accelerated amortization events include, but are not limited to, failure to satisfy certain loan performance metrics or the occurrence of an event of default. The proceeds may only be used to purchase unsecured personal loans and to pay fees and expenses related to the credit facility. The ULT Warehouse Credit Facility matures on the earlier of June 15, 2026 or acceleration of the facility following an event of default, upon which date 100 % of the outstanding principal amount, together with any accrued and unpaid interest, becomes due and payable. The ULT Warehouse Credit Facility bears a floating interest rate of Compounded Secured Overnight Financing Rate (“SOFR”) plus a spread ranging from 2.75 % to 4.13 % per annum, due and payable monthly in arrears. The Company is also subject to a monthly unused fee ranging from 0.15 % to 1.00 % per annum
152
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
on the undrawn balance. The maximum advance rate under the ULT Warehouse Credit Facility on outstanding principal of loans held by ULT was 72.5
In June 2023, ULT entered into an interest rate cap agreement intended to protect against exposure to changes in cash flows attributable to interest rate risk on the warehouse facility. Refer to “Note 4. Derivative Financial Instruments” for further details related to the agreement.
The ULT Warehouse Credit Facility contains certain financial covenants. As of December 31, 2022 and 2023, ULT was in compliance with all applicable covenants under the ULT Warehouse Credit Facility. The creditors of ULT have no recourse to the general credit of the Company, except for certain limited obligations of ULT to its creditors that are guaranteed by the Company. The Company does not guarantee the credit performance of the loans owned by ULT, and the loans and other assets owned by ULT are not available to settle the claims of creditors of the Company.
The following table includes the aggregate balances held by ULT that were pledged as collateral for the ULT Warehouse Credit Facility and included in loans at fair value and restricted cash in the consolidated balance sheets:
ULT Warehouse Credit Facility | |||||||||||
| December 31, 2022 | December 31, 2023 | ||||||||||
| Outstanding borrowings | $ | $ | |||||||||
| Aggregate outstanding principal of loans pledged as collateral | |||||||||||
| Aggregate fair value of loans purchased and held by ULT | |||||||||||
| Restricted cash pledged as collateral | $ | $ | |||||||||
Upstart Auto Warehouse Trust Credit Facility
In December 2021, the Company’s consolidated VIE, UAWT, entered into a revolving credit and security agreement with a third-party lender (the “UAWT Warehouse Credit Facility”). The credit and security agreement for the UAWT Warehouse Credit Facility was amended and restated in its entirety in August 2022 and has been further amended from time to time.
On January 31, 2023, UAWT entered into the Omnibus Amendment to the Credit Agreement with the existing third-party lender which extended the last date by which UAWT may make a drawdown from its existing $200 million UAWT Warehouse Credit Facility until the earlier of June 2024 or an accelerated amortization event. An accelerated amortization event includes, but is not limited to, failure to satisfy certain loan performance metrics or the occurrence of an event of default. The proceeds may only be used to purchase secured auto loans originated using Upstart’s platform and to pay fees and expenses related to the credit facility. The UAWT Warehouse Credit Facility matures in June 2025, at which time all outstanding amounts owed must be repaid. As of December 31, 2023 the UAWT Warehouse Credit Facility bears interest per annum at a rate equivalent to the weighted-average cost of commercial paper notes issued by the lender (the “UAWT Benchmark Rate”), plus a spread ranging from 3.0 % to 4.0 %, and the maximum advance rate under the credit facility on outstanding principal of loans held by UAWT was 82.5 % as of December 31, 2022 and 72.5 % as of December 31, 2023. All other key terms of the Omnibus Amendment to the Credit Agreement were the same as those as of December 31, 2022.
In February 2023, UAWT entered into an interest rate cap agreement intended to protect against exposure to changes in cash flows attributable to interest rate risk on the warehouse facility. Refer to “Note 4. Derivative Financial Instruments” for further details related to the agreement.
153
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The UAWT Warehouse Credit Facility contains certain financial covenants. As of December 31, 2022 and 2023, UAWT was in compliance with all applicable covenants under the UAWT Warehouse Credit Facility. The creditors of UAWT have no recourse to the general credit of the Company, except for certain limited obligations of UAWT to its creditors that are guaranteed by the Company.
The following table includes the aggregate balances held by UAWT that were pledged as collateral for the UAWT Warehouse Credit Facility and included in loans at fair value and restricted cash in the consolidated balance sheets as of December 31, 2022 and 2023.
| UAWT Warehouse Credit Facility | |||||||||||
| December 31, 2022 | December 31, 2023 | ||||||||||
| Outstanding borrowings | $ | $ | |||||||||
| Aggregate outstanding principal of loans pledged as collateral | |||||||||||
| Aggregate fair value of loans purchased and held by UAWT | |||||||||||
| Restricted cash pledged as collateral | $ | $ | |||||||||
Convertible Senior Notes
On August 20, 2021, the Company issued $661.3 million aggregate principal amount of 0.25 % convertible senior notes due 2026 (“Notes”) pursuant to an indenture (the “Indenture”), (including the exercise in full of the initial purchasers’ option of an additional $86.3 million aggregate principal of additional notes) in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. The net proceeds from the sale of the Notes were $645.5 million after deducting debt issuance costs.
The Notes represent senior unsecured obligations of the Company and bear interest at a rate of 0.25 % per year, payable semiannually in arrears on February 15 and August 15 of each year beginning on February 15, 2022. The Notes mature on August 15, 2026 unless earlier converted, redeemed, or repurchased in accordance with their terms.
The Notes will be convertible at an initial conversion rate of 3.5056 shares of our common stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of $285.26 per share, subject to adjustment if certain events occur. Following certain corporate events that may occur prior to the maturity date or following our issuance of a notice of redemption, the Company will increase the conversion rate for a holder who elects to convert its Notes in connection with such corporate event or during the related redemption period in certain circumstances. Additionally, upon the occurrence of a corporate event that constitutes a “fundamental change” per the Indenture, holders of the Notes may require the Company to repurchase for cash all or a portion of their respective notes at a purchase price equal to 100 % of the principal amount of the Note plus accrued and unpaid interest.
Holders may convert their Notes at their option any time prior to the close of business on the business day immediately preceding May 15, 2026 only under the following circumstances:
(1) during any calendar quarter commencing after December 31, 2021 (and only during such calendar quarter), if the last reported sale price of the Common Stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130 % of the conversion price on each applicable trading day;
(2) during the five business-day period after any five consecutive trading-day period in which the trading price per $1,000 principal amount of Notes for each trading day of such five consecutive trading-day period was less
154
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
than 98 % of the product of the last reported sale price of the Common Stock and the conversion rate on each such trading day;
(3) if we call any or all of the Notes for redemption, at any time prior to the close of business on the second scheduled trading day immediately preceding the redemption date; or
(4) upon the occurrence of specified corporate events.
On or after May 15, 2026, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders of the Notes may convert all or any portion of their Notes regardless of the foregoing conditions. Upon conversion, the Company will pay or deliver, as the case may be, either cash, shares of common stock or a combination of cash and shares of common stock, at its election.
The Company may not redeem the Notes prior to August 20, 2024. The Company may redeem for cash all or any portion of the Notes, at our option, on or after August 20, 2024, if the last reported sale price of our common stock has been at least 130 % of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading-day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which the Company provides a notice of redemption at a redemption price equal to 100 % of the principal amount of the Notes to be redeemed, plus any accrued and unpaid interest to, but excluding, the redemption date.
The Company accounted for the issuance of the Notes as a single liability at par as the conversion feature does not require bifurcation as a derivative under ASC 815 and the Notes were not issued at a substantial premium. Debt issuance costs related to the Notes totaled $15.7 million and consisted of underwriting fees and third-party offering costs, which are amortized to interest expense using the effective interest method over the contractual term. The Company recorded immaterial coupon interest expense for all years presented. The Company also recorded $1.4 million, $3.0 million, and $3.1 million for the year ended December 31, 2021, 2022, and 2023 respectively, of amortization of debt issuance costs within expense on convertible notes on the consolidated statements of operations and comprehensive income (loss). The effective interest rate of the Notes is 0.7 %.
The estimated fair value of the Notes as of December 31, 2022 and 2023 was approximately $364.8 million and $488.7 million, respectively, which represent Level 2 valuations in the fair value hierarchy. The estimated fair value was determined based on the estimated or actual bids and offers of the Notes in an over-the-counter market. The carrying value of the Notes as of December 31, 2022 and 2023 was $649.9 million and $653.0 million, respectively.
Capped Call Transactions
The Company used $58.5 million of the net proceeds from the Notes to enter into privately negotiated capped call instruments (“Capped Calls”) with certain financial institutions. The Capped Calls each have an initial strike price of $285.26 per share, subject to certain adjustments, which corresponds to the initial conversion price of the Notes. The Capped Calls each have an initial cap price of $400.36 per share. The Capped Calls cover, subject to anti-dilution adjustments, 2.3 million shares of common stock. The Capped Calls are expected to reduce the potential dilution to common stock upon any conversion of Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of converted Notes, as the case may be, in the event the market price per share of common stock, as measured under the terms of the Capped Call, is greater than the strike price of the Capped Call, with such reduction and/or offset subject to a cap. If, however, the market price per share of the common stock, as measured under the terms of the Capped Call, exceeds the cap price of the Capped Calls, there would be dilution and/or there would not be an offset of such potential cash payments, in each case, to the extent that such market price per share of the common stock exceeds the cap price of the Capped Calls. The Capped Calls expire on August 15, 2026, subject to earlier exercise.
155
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The Capped Calls were determined to be freestanding financial instruments that meet the criteria for classification in equity; as such the Capped Calls were recorded as a reduction of additional paid-in capital within stockholders’ equity.
The following table summarizes the aggregate amount of maturities of all borrowings as of December 31, 2023:
| December 31, 2023 | |||||
| 2024 | $ | ||||
| 2025 | |||||
| 2026 | |||||
| 2027 | |||||
| 2028 | |||||
| Thereafter | |||||
| Total | $ | ||||
11. Stockholders' Equity
Common Stock Reserved for Future Issuance
In December 2020, the Company's amended and restated certificate of incorporation became effective, which authorizes the issuance of 700,000,000 shares of common stock with a par value of $0.0001 per share. Shares of common stock reserved for issuance, on an as-converted basis, are as follows:
| December 31, | December 31, | ||||||||||
| 2022 | 2023 | ||||||||||
| Options issued and outstanding | |||||||||||
RSUs outstanding | |||||||||||
PRSUs outstanding | |||||||||||
| Shares available for future issuance under 2020 plan | |||||||||||
Shares available for issuance under ESPP | |||||||||||
| Total | |||||||||||
Share Repurchase Program
In February 2022, the Board of Directors authorized the Company to purchase up to $400.0 million of common stock of the Company. The Company may repurchase shares from time to time through open market purchases, in privately negotiated transactions or by other means, including through the use of trading plans intended to qualify under Rule 10b5-1. The repurchase program does not obligate the Company to acquire any particular amount of its common stock, and may be suspended or terminated by the Company at any time at its discretion without prior notice.
The Company records share repurchases on the settlement date. Repurchased shares are subsequently retired and returned to the status of authorized but unissued. The Company’s policy for share retirements is to allocate the excess between par value and the repurchase price, including costs and fees, to additional paid-in capital. During the year ended December 31, 2023, the Company made no repurchases of common stock. As of
156
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
December 31, 2023, $222.1 million remains available for future purchases of our common stock under the share repurchase program.
Equity Incentive Plans
In 2012, the Company adopted the Equity Incentive Plan (“2012 Equity Incentive Plan”) authorizing the granting of incentive stock options (“ISOs”) and non-statutory stock options (“NSOs”) to eligible participants.
Under the 2012 Equity Incentive Plan, the exercise price of an ISO and NSO shall not be less than 100 % of the estimated fair value of the shares on the date of grant, as determined by the Board of Directors. The exercise price of an ISO granted to a 10 % stockholder shall not be less than 110 % of the estimated fair value of the shares on the date of grant, as determined by the Board of Directors. Options generally vest over four years and are exercisable for up to 10 years after the date of grant if the employee provides service to the Company for at least three years .
In October 2020, our Board of Directors adopted, and in November 2020 our Board of Directors amended and our stockholders approved, our 2020 Equity Incentive Plan which was effective on December 14, 2020. The Company terminated the 2012 Equity Incentive Plan immediately prior to effectiveness of the 2020 Equity Incentive Plan with respect to the grant of future awards. However, our 2012 Equity Incentive Plan continues to govern the terms and conditions of the outstanding awards granted under our 2012 Equity Incentive Plan.
The 2020 Equity Incentive Plan authorizes granting of ISOs, NSOs, stock appreciation rights, restricted stock, restricted stock units, or RSUs, and performance awards. In addition, the 2020 Equity Incentive Plan also includes any shares subject to awards granted under our 2012 Equity Incentive Plan that, on or after December 15, 2020, expire or otherwise terminate without having been exercised or issued in full, are tendered to or withheld by us for payment of an exercise price or for satisfying tax withholding obligations, or are forfeited to or repurchased by us due to failure to vest. The maximum number of shares that may be added to the 2020 Equity Incentive Plan pursuant to outstanding awards under the 2012 Equity Incentive Plan is 15,000,000 shares. The number of shares available for issuance under our 2020 Equity Incentive Plan also includes an annual increase on the first day of each fiscal year beginning with 2021 in an amount equal to the lesser of 15,000,000 shares or 5 % of the outstanding shares of our common stock on the last day of our immediately preceding fiscal year.
In connection with the Company’s acquisition of Prodigy, the Company assumed the Prodigy Software, Inc. 2015 Stock Incentive Plan (the “Prodigy Plan”), under which certain unvested options under the Prodigy Plan were assumed by the Company. The assumed options are subject to the same terms and conditions that were applicable to them under the Prodigy Plan, except that (i) the assumed options relate to shares of Upstart’s common stock, and (ii) the number of shares of Upstart’s common stock was the result of an adjustment based upon a ratio as described further in the Registration Statement on Form S-8 filed with the SEC on April 16, 2021.
157
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Stock Options
The following table summarizes stock option activity for the year ended December 31, 2023:
| Number of Options | Weighted-Average Exercise Price Per Share | Weighted-Average Remaining Contractual Life (years) | Aggregate Intrinsic Value | ||||||||||||||||||||
| Balances at December 31, 2022 | $ | $ | |||||||||||||||||||||
| Options granted | |||||||||||||||||||||||
| Options exercised | ( | ||||||||||||||||||||||
| Options cancelled and forfeited | ( | ||||||||||||||||||||||
| Balances at December 31, 2023 | |||||||||||||||||||||||
| Options exercisable – December 31, 2023 | |||||||||||||||||||||||
| Options vested and expected to vest – December 31, 2023 | $ | $ | |||||||||||||||||||||
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the fair value of the Company’s stock as of December 31, 2023. The aggregate intrinsic value of options exercised for the year ended December 31, 2021, 2022 and 2023 was $1,391.7 million, $157.3 million, and $28.9 million respectively. The weighted-average grant date fair value of options granted during the year ended December 31, 2021, 2022 and 2023 was $62.06 , $15.60 , and $8.19 per share, respectively. The total fair value of options vested for the year ended December 31, 2021, 2022 and 2023 was $23.5 million, $23.2 million, and $34.7 million, respectively.
As of December 31, 2023, total unrecognized stock-based compensation expense related to unvested stock options was $40.6 million, which is expected to be recognized over a remaining weighted-average period of 2.5 years.
158
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
In May 2021, the Company amended an employee stock option agreement which resulted in a modification of the vesting of a certain number of option shares. The Company valued the amended stock options as of the modification date. Based on the Black-Scholes option pricing model, incremental stock-based compensation expense of $4.4 million resulting from the modification was recognized during the year ended December 31, 2021. The amendment had no
Restricted Stock Units
The Company grants RSUs to employees and nonemployees. RSUs vest upon satisfaction of a service-based condition, which is generally satisfied over to four years . The following table summarizes RSU activity for the year ended December 31, 2023:
| Number of Shares | Weighted-Average Grant Date Fair Value Per Share | ||||||||||
| Unvested at December 31, 2022 | $ | ||||||||||
| RSUs granted | |||||||||||
| RSUs vested | ( | ||||||||||
| RSUs cancelled and forfeited | ( | ||||||||||
| Unvested at December 31, 2023 | $ | ||||||||||
As of December 31, 2023, total unrecognized stock-based compensation expense related to outstanding unvested RSUs was $150.1 million, which is expected to be recognized over a remaining weighted-average period of 2.0 years.
Restricted Stock
In connection with the Prodigy acquisition in April 2021, 82,201 shares of the Company’s restricted stock with a fair value of $10.1 million were issued to certain Prodigy employees. The restricted stock is subject to transfer restrictions and a repurchase option and is contingent upon the employees' continued employment with the Company. The restricted stock is subject to restrictions which lapse on a quarterly basis over two years from the time of the Prodigy acquisition, refer to Note 7. Acquisitions for further information. During the year ended December 31, 2023, 10,271 shares of restricted stock with a weighted-average grant date value of $123.33 per share fully lapsed and there was no unrecognized stock-based compensation expense as of December 31, 2023.
Performance-based Restricted Stock Units
On February 24, 2023, the Company’s Compensation Committee of the Board of Directors approved the cancellation of PRSUs that may be settled for 687,500 shares of the Company’s common stock granted to an executive in February 2022.
At the time the PRSUs were granted, the PRSUs were intended to be the executive’s primary compensation through calendar year 2029 so that, in connection with the grant of the PRSUs, the executive’s cash compensation was limited to the amount necessary to allow the executive to participate in the broad-based employee benefits generally applicable at the Company. In reaching its decision to cancel the PRSUs, the Compensation Committee extensively considered the purpose of the PRSUs and determined that the grant no longer provided the intended retention and incentive value to the executive. After considering various alternatives and the pros and cons of such alternatives and consulting with its external advisors, the Compensation Committee believed it was in the best interest of the Company and its stockholders to cancel the PRSUs in exchange for the reinstatement of the executive’s cash compensation, including the executive’s annual base salary and eligibility to participate in the
159
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Company’s 2023 Executive Bonus Plan with an annual target bonus opportunity equal to 75 % of the executive’s annual base salary.
Compensation expense associated with the PRSUs was recognized using the straight-line attribution method for each of the nine vesting tranches over the respective derived service period. The weighted-average grant date fair value using the Monte Carlo simulation was $68.76 per share. The Company recognizes stock-based compensation expense for awards subject to market-based vesting conditions regardless of whether these conditions will be achieved or not, and stock-based compensation expense for any such awards is not reversed if the market condition is not met. The cancellation of the grant was treated by the Company as a settlement for no consideration and remaining unrecognized compensation expense of $39.0 million associated with the grant was accelerated and recorded by the Company as part of engineering and product development expense on the consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2023.
2020 Employee Stock Purchase Plan
Our ESPP provides for consecutive six-month offering periods. The offering periods are scheduled to start on the first trading day on or after February 15 and August 15 of each year. The ESPP permits participants to purchase shares in the amount of 85 % of the lower of the fair market value of our shares of common stock on the first trading day of the offering period or on the exercise date. During the year ended December 31, 2023, 459,459 shares of common stock were purchased under the ESPP.
As of December 31, 2023, total unrecognized stock-based compensation expense related to the ESPP was immaterial .
Fair Value of Awards Granted
In determining the fair value of stock-based awards, the Company uses a Black-Scholes option-pricing model for its options granted and ESPP purchase rights and a Monte Carlo simulation model for its PRSUs. The inputs used for estimating the fair values of options granted, ESPP purchase rights and PRSUs granted during the period include:
Fair Value of Common Stock–The fair value of the Company’s common stock is determined by the closing price, on the date of grant, of its common stock, which is traded on the Nasdaq Global Select Market.
Expected Term–The expected term represents the period that the Company’s stock options and ESPP purchase rights are expected to be outstanding. We estimate the expected term based on the simplified method, which is the weighted-average time to vesting and the contractual maturity. The expected term for PRSUs is the simulation term, the time period from the valuation date to the end of the performance measurement period.
Volatility–Because the Company has not had an active trading market for its common stock for a sufficient period of time, the expected volatility is estimated based on the average volatility for comparable publicly-traded companies, over a period equal to the expected term of the stock option grants.
Risk-free Interest Rate–The risk-free interest rate assumption is based on the U.S. Treasury zero coupon issues in effect at the time of grant for periods corresponding with the expected term of the option.
Dividends–The Company has never paid dividends on its common stock and does not anticipate paying dividends on common stock for the foreseeable future. Therefore, the Company uses an expected dividend yield of zero .
160
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
The following assumptions were used to estimate the fair value of options granted:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Expected term (in years) | |||||||||||||||||
| Expected volatility | |||||||||||||||||
| Risk-free interest rate | |||||||||||||||||
| Dividend yield | |||||||||||||||||
The following assumptions were used to estimate the fair value of the February 2022 PRSUs granted:
| Expected term (in years) | |||||
| Expected volatility | |||||
| Risk-free interest rate | |||||
| Dividend yield | |||||
The following assumptions were used to estimate the fair value of ESPP purchase rights:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Expected term (in years) | |||||||||||||||||
| Expected volatility | |||||||||||||||||
| Risk-free interest rate | |||||||||||||||||
| Dividend yield | |||||||||||||||||
Stock-Based Compensation
The Company recorded stock-based compensation in the following expense categories in its consolidated statements of operations and comprehensive income (loss) for employees and nonemployees:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Sales and marketing | $ | $ | $ | ||||||||||||||
| Customer operations | |||||||||||||||||
| Engineering and product development | |||||||||||||||||
| General, administrative, and other | |||||||||||||||||
| Total | $ | $ | $ | ||||||||||||||
12. Leases
The Company’s operating leases expire between 2027 and 2029 and are primarily for its corporate headquarters in San Mateo, California and Columbus, Ohio, as well as additional office space in Columbus, Ohio and Austin, Texas. Certain leases have rent abatement, escalating rent payment provisions, lease renewal options,
161
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
and tenant allowances. Rent expense is recognized on a straight-line basis over the non-cancelable lease term, except when it is reasonably certain that the renewal option will be exercised.
During the year ended December 31, 2023, the Company entered into an amendment to partially terminate a portion of its leased office space in Columbus, Ohio. In connection with the amendment, the Company removed the extension option from the lease term as it was no longer reasonably certain to exercise such option. The Company also incurred a one-time termination fee of $7.0 million. The transaction was accounted for as a lease modification, which resulted in a decrease of the ROU asset and lease liability of $19.9 million and $21.2 million, respectively, and an immaterial gain on partial termination within other income (expense) on the consolidated statements of operations and comprehensive income (loss).
In connection with the Company’s lease agreements, letters of credit were issued on behalf of the Company for the benefit of the landlord in an aggregate amount of $3.4 million. The letters of credit are secured by certificates of deposit which are included in restricted cash on the consolidated balance sheets.
As of December 31, 2023, future minimum lease payments are as follows:
| Operating Leases | |||||
| 2024 | $ | ||||
| 2025 | |||||
| 2026 | |||||
| 2027 | |||||
| 2028 | |||||
| Thereafter | |||||
| Total undiscounted lease payments | |||||
| Less: Present value adjustment | ( | ||||
| Operating lease liabilities | $ | ||||
The Company did no t have any material finance leases as of December 31, 2022 and had no finance leases as of December 31, 2023. The Company’s operating lease expense consists of rent and variable lease payments. Variable lease payments such as common area maintenance and parking fees, were included in operating expenses. Rent expense for the Company’s short-term leases was immaterial for the years presented. Operating lease expense was as follows:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Rent expense | $ | $ | $ | ||||||||||||||
| Variable lease payments | $ | $ | $ | ||||||||||||||
162
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Supplemental cash flow and non-cash information related to the Company’s operating leases was as follows:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Cash paid for amounts included in the measurement of lease liabilities | $ | $ | $ | ||||||||||||||
| Right-of-use assets capitalized | |||||||||||||||||
| Adjustments to operating lease right-of-use assets due to modification and other reassessment events | $ | $ | $ | ( | |||||||||||||
Supplemental balance sheet information related to the Company’s operating leases was as follows:
| December 31, | |||||
| 2023 | |||||
| Weighted-average remaining lease term (in years) | |||||
| Weighted-average discount rate | |||||
13. Commitments and Contingencies
Commitments
The Company has loan purchase obligations under the Company’s loan agreements with certain lending partners. These lending partners retain ownership of the loans facilitated through Upstart’s platform for three days or longer (the “holding period”) after origination, as required under the respective agreements. The Company has committed to purchase the loans at the conclusion of the required holding period. As of December 31, 2022 and 2023, the total loan purchase commitment included outstanding principal balance of $17.8 million and $36.6 million, respectively.
Contingencies
Accounting for contingencies requires the Company to use judgment related to both the likelihood of a loss and the estimate of the amount or range of loss. The Company records a loss contingency when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company discloses material contingencies when it believes a loss is not probable but reasonably possible and may voluntarily provide information on additional contingencies.
From time to time the Company is subject to, and it is presently involved in, various litigation and legal proceedings arising from the ordinary course of business activities, the outcome of which the Company cannot reasonably determine. Other than the class actions and derivative actions described below, the Company does not believe that it is presently a party to any litigation of which the outcome would individually, or taken together, have a material adverse effect on our business, operating results, cash flows, or financial condition. As of December 31, 2022 and 2023, no loss contingency has been recorded in connection with legal proceedings.
Indemnifications
In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to vendors, directors, officers and other parties with respect to certain matters. In addition, the Company has entered into indemnification agreements with directors and certain officers and employees that will require the Company,
163
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. No demands have been made upon the Company to provide indemnification under such agreements, and thus, there are no claims that the Company is aware of that could have a material adverse effect on the Company’s consolidated financial statements.
Repurchases
Under the terms of the loan purchase and loan servicing agreements between the Company and institutional investors, as well as in agreements with investors in securitizations and pass-through certificate transactions, the Company may, in certain circumstances, become obligated to repurchase loans from such institutional investors. Generally, these circumstances include the occurrence of verifiable identity theft, the failure of sold loans to meet the terms of certain loan-level representations and warranties that speak as of the time of origination or sale, the failure to comply with other contractual terms with the institutional investors, or a violation of the applicable federal, state, or local lending laws.
The maximum potential amount of future payments associated under this obligation is the outstanding balances of the loans sold to the institutional investors, which at December 31, 2022 and 2023 is $15,551.1 million and $12,208.1 million, respectively. Actual payments made relating to the Company’s repurchase and indemnification obligations were immaterial.
The Company did not have material contingent liabilities related to future loan repurchase obligations as of December 31, 2022 and 2023. These amounts are included in accrued expenses and other liabilities on the Company’s consolidated balance sheets.
Legal
On May 13, 2022, a purported class action lawsuit was filed in the United States District Court, Northern District of California, captioned Ward v. Upstart Holdings, Inc., et al., Case No. 5:22-cv-02856-BLF (N.D. Cal.) against the Company, the Company’s Chief Executive Officer, and Chief Financial Officer alleging, among other things, that the defendants made false and/or misleading statements or omissions about the Company’s business, operations, and prospects in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 promulgated thereunder, as well as Section 20(a) of the Exchange Act. The Ward lawsuit claimed unspecified damages and legal fees.
Between May 19, 2022 and June 22, 2022, two additional related purported class action lawsuits were filed in the United States District Court, Northern District of California, captioned Plymouth County Retirement Association v. Upstart Holdings, Inc., et al., Case No. 3:22-cv-02973-WHO (N.D. Cal.) and Zhang v. Upstart Holdings, Inc., et al., Case No. 3:22-cv-03668-JD (N.D. Cal.). On July 7, 2022, a related purported class action lawsuit was filed in the United States District Court, Southern District of Ohio, captioned Handelsbanken Fonder AB v. Upstart Holdings, Inc., et al., Case No. 2:22-cv-02706-SDM-EPD (S.D. Ohio). The Zhang, Plymouth County, and Handelsbanken Fonder actions named the same defendants and made similar allegations to those in the Ward action.
On July 11, 2022, plaintiffs in the Zhang and Plymouth County actions filed notices voluntarily dismissing their lawsuits without prejudice. On July 12, 2022, motions to appoint lead plaintiff and lead counsel were filed in both the Ward action and the Handelsbanken Fonder action. On July 26, 2022, plaintiff in the Ward action filed a notice voluntarily dismissing his lawsuit without prejudice, and on July 27, 2022, plaintiff in the Handelsbanken Fonder action filed a notice voluntarily dismissing its lawsuit without prejudice.
On July 26, 2022, an additional lawsuit was filed in United States District Court, Southern District of Ohio, captioned Crain v. Upstart Holdings, Inc. et al., Case No. 2:22-cv-02935-ALM-EPD (S.D. Ohio) against the Company, the Company’s Chief Executive Officer, and Chief Financial Officer. The Crain lawsuit makes
164
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
allegations similar to those in the Handelsbanken Fonder action and alleges that the defendants made false and/or misleading statements or omissions about the Company’s business, operations, and prospects in violation of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, as well as Section 20(a) of the Exchange Act. The Crain lawsuit claims unspecified damages and legal fees. On August 16, 2022, the court appointed a lead plaintiff and approved lead counsel in the Crain action. On December 5, 2022, the lead plaintiff filed a consolidated amended complaint, which names the same defendants as the previous complaint, along with two Company executives, as well as Third Point LLC and its CEO and Third Point Ventures LLC and its managing partner (also a former Upstart board member). The consolidated amended complaint brings the same claims as the previous complaint but adds a claim under Section 20A of the Exchange Act. On February 24, 2023, the Upstart defendants filed a motion to dismiss the consolidated amended complaint. On September 29, 2023, the Court issued an order, granting in part and denying in part the Upstart defendants’ motion. On November 7, 2023, the Upstart defendants filed a motion for reconsideration, which has now been fully briefed and is awaiting decision by the Court. The Company believes the remaining claims in the Crain action are without merit and intends to defend itself vigorously.
On July 28, 2022, a derivative lawsuit was filed in United States District Court, Southern District of Ohio, captioned OConnor v. Huber et al., Case No. 2:22-cv-02961-EAS-KAJ (S.D. Ohio). The OConnor action includes allegations similar to those in the Crain complaint, and names as defendants each of the Company’s current board members and its Chief Financial Officer. The Company is named as a nominal defendant. The OConnor action includes claims for violation of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, unjust enrichment, and waste of corporate assets. The OConnor action seeks unspecified monetary damages and an accounting from the individual defendants. The OConnor action also seeks unspecified corporate governance and internal procedure modifications, punitive damages, and legal fees.
On October 7, 2022, a second derivative lawsuit was filed in United States District Court, Southern District of Ohio, captioned Chung v. Huber et al., No. 2:22-cv-03620-MHW-CMV (S.D. Ohio). The Chung action includes allegations similar to those in the OConnor complaint, and names as defendants each of the Company’s current board members, a former board member, and its Chief Financial Officer. The Company is named as a nominal defendant. The Chung action includes claims for violation of Section 10(b), 14(a), and 21D of the Exchange Act, breach of fiduciary duties, unjust enrichment, abuse of control, gross mismanagement, and waste of corporate assets. The Chung action seeks unspecified monetary damages, restitution, and attorney’s fees and costs from the individual defendants. It also seeks corporate governance and internal procedure modifications.
On December 12, 2022, in response to a joint motion by the parties, the Court consolidated the OConnor and Chung matters, appointed co-lead counsel, and stayed the consolidated case until resolution of the related Crain securities class action.
On February 3, 2023, a third derivative lawsuit was filed, in the United States District Court, District of Delaware, captioned Hsu v. Girouard, et al., 1:23-cv-00132-UNA (D. Del.). The Hsu action includes allegations similar to those in the consolidated derivative matter pending in Ohio, and names as defendants each of the Company’s current board members, a former board member, and its Chief Financial Officer. The Company is named as a nominal defendant. The Hsu action includes claims for violation of Section 14(a) of the Exchange Act as well as breach of fiduciary duties, and seeks unspecified monetary damages, restitution, and attorney’s fees and costs from the individual defendants. It also seeks corporate governance and internal procedure modifications. On February 16, 2023, in response to a joint stipulation and proposed order submitted by the parties, the Court stayed the Hsu action until resolution of the related Crain securities class action.
On March 8, 2023, a fourth derivative lawsuit was filed, in the United States District Court, District of Delaware, captioned Sornchai et al. v. Girouard, et al., 1:23-cv-00253-MN (D. Del). The Sornchai action includes allegations similar to those in the consolidated derivative matter pending in Ohio, and names as defendants each of the Company’s current board members, a former board member, its Chief Financial Officer, and a Company executive. The Company is named as a nominal defendant. The Sornchai action includes claims for violations of
165
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
Sections 10(b), 14(a) and 21D of the Exchange Act, breach of fiduciary duties, breach of fiduciary duty through misappropriation of material non-public information, and unjust enrichment, and seeks unspecified monetary damages, restitution, and attorney’s fees and costs from the individual defendants. It also seeks corporate governance and internal procedure modifications. On March 24, 2023, in response to a joint stipulation and proposed order submitted by the parties, the Court stayed the Sornchai action until resolution of the related Crain securities class action.
On April 5, 2023, a fifth derivative lawsuit was filed, in the Court of Chancery of the State of Delaware, captioned Okhai v. Girouard, et al., C.A. No. 2023-0401-SG (Del. Ch.). The Okhai action includes allegations similar to those in the consolidated derivative matter pending in Ohio, and names as defendants the Company’s current board members, two former board members, its Chief Financial Officer, and two current or former Company executives, as well as Third Point LLC and Third Point Ventures LLC. The Okhai action includes claims for breach of fiduciary, aiding and abetting such alleged breaches, and unjust enrichment, and seeks equitable and/or injunctive relief, restitution, and attorney’s fees and costs from the individual defendants. On August 3, 3023, in response to a motion to stay by the defendants in the Okhai action, the Court stayed the Okhai action until resolution of the motion to dismiss in the related Crain securities class action. Following the issuance of the September 29, 2023 order on the motion to dismiss in the related Crain securities class action, on November 16, 2023, in response to a joint stipulation and proposed order submitted by the parties, the Court stayed the Okhai action until resolution of a motion for reconsideration of the September 29, 2023 order on the motion to dismiss in the related Crain securities class action.
On October 13, 2023, a sixth derivative lawsuit was filed, in the Court of Chancery of the State of Delaware, captioned Romanyshyn v. Girouard, et al., C.A. No. 2023-1029-SG (Del. Ch.). The Romanyshyn action includes allegations similar to those in the consolidated derivative matter pending in Ohio, and names as defendants current and former directors and Company executives, as well as Third Point LLC and its CEO, and Third Point Ventures LLC. The Romanyshyn action includes claims for breach of fiduciary, and seeks unspecified monetary damages, restitution, and attorney’s fees and costs from the individual defendants. It also seeks corporate governance and internal procedure modifications. On November 3, 2023, in response to a joint stipulation and proposed order submitted by the parties, the Court stayed the Romanyshyn action until resolution of the motion to stay in the related Okhai derivative action.
On October 24, 2023, a seventh derivative lawsuit was filed, in the Court of Chancery of the State of Delaware, captioned Agarwal v. Girouard, et al., C.A. No. 2023-1075-SG (Del. Ch.). The Agarwal action includes allegations similar to those in the consolidated derivative matter pending in Ohio, and names as defendants current and former directors and Company executives, as well as Third Point LLC and its CEO, and Third Point Ventures LLC. The Agarwal action includes claims for breach of fiduciary, and seeks unspecified monetary damages, restitution, and attorney’s fees and costs from the individual defendants. It also seeks corporate governance and internal procedure modifications. On November 3, 2023, in response to a joint stipulation and proposed order submitted by the parties, the Court stayed the Agarwal action until resolution of the motion to stay in the related Okhai derivative action.
Given the uncertainty of litigation described above, the preliminary stage of the cases, and the legal standards that must be met for, among other things, class certification and success on the merits, the Company cannot estimate the reasonably possible loss or range of loss that may result from these actions.
14. Income Taxes
Income before income taxes consisted entirely of income from domestic operations of $133.7 million for the year ended December 31, 2021. Loss before income taxes consisted entirely of losses from domestic operations of, $109.1 million and $240.0 million for the calendar year ended December 31, 2022 and 2023, respectively. Income tax (benefit) expense included in the statements of operations and comprehensive income (loss) consisted of the following:
166
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Current: | |||||||||||||||||
| Federal | $ | $ | $ | ||||||||||||||
| State | |||||||||||||||||
| Total current tax expense | |||||||||||||||||
| Deferred: | |||||||||||||||||
| Federal | ( | ||||||||||||||||
| State | ( | ( | |||||||||||||||
| Total deferred tax expense | ( | ( | |||||||||||||||
| Total (benefit) provision for income taxes | $ | ( | $ | ( | $ | ||||||||||||
Income tax expense differed from the amount computed by applying the Federal statutory income tax rate of 21% to net income (loss) before income taxes for the year ended December 31, 2023 as a result of the following:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Federal tax at statutory rate | $ | $ | ( | $ | ( | ||||||||||||
| State income taxes, net of federal tax benefit | ( | ( | |||||||||||||||
| Stock-based compensation | ( | ( | |||||||||||||||
| Research and development credit | ( | ( | ( | ||||||||||||||
| PPP loan forgiveness (CARES Act) | |||||||||||||||||
| Change in valuation allowance | |||||||||||||||||
| Tax return to tax provision adjustment | ( | ( | |||||||||||||||
| Section 162(m) limitation | |||||||||||||||||
| Other | |||||||||||||||||
| (Benefit) provision for income taxes | $ | ( | $ | ( | $ | ||||||||||||
The tax effects of temporary differences that gave rise to significant portions of the Company’s deferred tax assets and liabilities related to the following:
167
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| December 31, | |||||||||||
| 2022 | 2023 | ||||||||||
| Deferred tax assets: | |||||||||||
| Net operating loss carryforwards | $ | $ | |||||||||
| Capitalized research and experimental expenditures | |||||||||||
| Research and development credits | |||||||||||
| Operating lease liabilities | |||||||||||
| Stock-based compensation | |||||||||||
| Convertible debt transactions | |||||||||||
| Accruals and reserves | |||||||||||
| Investment in partnerships | |||||||||||
| Amortization | |||||||||||
| Other | |||||||||||
| Total deferred tax assets | |||||||||||
| Less: valuation allowance | ( | ( | |||||||||
| Deferred tax assets – net of valuation allowance | |||||||||||
| Deferred tax liabilities: | |||||||||||
| Right of use asset | |||||||||||
| Servicing rights | |||||||||||
| Interest receivables | |||||||||||
| Intangible assets | |||||||||||
| Depreciation | |||||||||||
| Investment in partnerships | |||||||||||
| Total deferred tax liabilities | |||||||||||
| Net deferred tax liabilities | $ | $ | |||||||||
Management believes that, based on available evidence, both positive and negative, it is more likely than not that the deferred tax assets will not be utilized, and as such the Company maintains a full valuation allowance at December 31, 2023. The valuation allowance increased by $55.2 million for the year ended December 31, 2023 primarily as a result of current year activities and the capitalization of research and experimental activities.
As of December 31, 2023, the Company had approximately $1,069.2 million and $1,528.1 million of federal and state (post-apportioned) net operating losses (NOL), that will begin to expire in 2035 and 2034, respectively. The Company also has Federal and California research and development tax credits of $49.8 million and $21.7 million, respectively. The Federal research credits will begin to expire in 2032 and the California research credits have no expiration date. The Internal Revenue Code (“IRC”) limits the amount of NOL carryforwards that a company may use in a given year in the event of certain cumulative changes in ownership over a three-year period as described in Section 382 of the IRC. Utilization of NOL carryforwards and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. The Company performed an ownership analysis and identified ownership changes in prior years, as defined under IRC Section 382 and 383, however neither resulted in a material limitation that will reduce the total amount of NOL carryforwards and credits that can be utilized.
168
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
A reconciliation of the beginning and ending balances of gross unrecognized tax benefits is as follows:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Balance at beginning of year | $ | $ | $ | ||||||||||||||
| Additions for tax positions of prior years | |||||||||||||||||
| Tax positions related to the current year | |||||||||||||||||
| Balance at end of year | $ | $ | $ | ||||||||||||||
If recognized, all of the unrecognized tax benefits would not impact the effective tax rate due to the valuation allowance against certain deferred tax assets. As of December 31, 2023, the Company had $22.2 million unrecognized income tax benefits and there was an increase of $3.7 million to the Company’s unrecognized tax benefits during the year. The Company does not anticipate any significant increases or decreases to unrecognized tax benefits during the next twelve months. The Company’s policy is to classify interest and penalties associated with unrecognized tax benefits as income tax expense. The Company had no interest or penalty accruals associated with uncertain tax benefits in its consolidated balance sheet and consolidated statement of operations and comprehensive income (loss) for the tax year ended December 31, 2023.
The Company files income tax returns in the U.S. Federal jurisdiction and various state and local jurisdictions. The Company is not currently under examination by income tax authorities in federal, state, or local jurisdictions. However, because the Company has net operating losses and credits carried forward in several jurisdictions, certain items attributable to closed tax years are still subject to adjustment by applicable taxing authorities through an adjustment to tax attributes carried forward to open years. All tax returns will remain open for examination by the federal and most state taxing authorities for three years and four years, respectively, from the date of utilization of any net operating loss carryforwards or research and development credits.
15. Net Income (Loss) Per Share
Basic net income (loss) per common share is based on the weighted-average common shares outstanding during the relevant year. Diluted net income (loss) per share is based on the weighted-average common shares outstanding during the relevant year adjusted for the dilutive effect of share-based awards and convertible debt. Basic and diluted net income (loss) per share are computed independently for each year presented, which involves the use of different weighted-average share count figures. As a result, and after factoring the effect of rounding to the nearest cent per share, the sum of each fiscal quarter-to-date basic and diluted net income (loss) per share may not equal year-to-date basic and diluted net income (loss) per share.
For years in which the Company reports net losses, basic and diluted net loss per share are the same because potentially dilutive common shares are not assumed to have been issued if their effect is anti-dilutive.
169
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Numerator: | |||||||||||||||||
| Net income (loss) | $ | $ | ( | $ | ( | ||||||||||||
| Denominator: | |||||||||||||||||
| Weighted-average common shares outstanding used to calculate net income (loss) per share, basic | |||||||||||||||||
| Weighted-average effect of dilutive securities | |||||||||||||||||
| Weighted-average common shares outstanding used to calculate net income (loss) per share, diluted | |||||||||||||||||
| Net income (loss) per share, basic | $ | $ | ( | $ | ( | ||||||||||||
| Net income (loss) per share, diluted | $ | $ | ( | $ | ( | ||||||||||||
The following securities were excluded from the computation of diluted net income (loss) per share for the years presented, due to their anti-dilutive effect. These amounts represent the number of instruments outstanding at the end of each respective year:
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2022 | 2023 | |||||||||||||||
| Options to purchase common stock | |||||||||||||||||
| Unvested RSUs | |||||||||||||||||
| Convertible debt | |||||||||||||||||
| Purchase rights committed under the ESPP | |||||||||||||||||
| Unvested PRSUs | |||||||||||||||||
| Total | |||||||||||||||||
16. Reorganization Expenses
On January 31, 2023, the Company implemented a plan of reorganization (the “January 2023 Plan”). The January 2023 Plan was designed to reduce operating costs, streamline operations and return the Company to profitability. As part of the January 2023 Plan, the Company reduced its workforce by approximately 20 %, or 365 employees, and suspended development of its small business loan product.
170
Upstart Holdings, Inc.
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Share and Per Share Data and Ratios, or as Noted)
17. Subsequent Events
The Company has evaluated events that have occurred through the filing date of this Annual Report on Form 10-K. Based on its evaluation, other than any items recorded or disclosed within the consolidated financial statement and related notes, including as discussed below, the Company has determined no subsequent events were required to be recognized or disclosed.
On February 9, 2024, the Company signed an agreement with an investor to sell a pool of Upstart-powered core personal loans with an aggregate outstanding principal amount of $299.7 million. The total consideration in exchange for the loans include cash, and a right to receive additional cash amounts if credit performance of the loan pool is in line or exceeds initial expectations. In case of credit underperformance, the Company is obligated to make cash payments to the purchaser over time, subject to a certain cap. The Company plans to account for this sale under ASC 860, Transfers and Servicing.
On February 13, 2024, the Company obtained a waiver for breach in certain covenants related to the UAWT Warehouse Credit Facility for the January 2024 collection period and paid down $15.3 million of the outstanding advance on the credit facility.
171
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
a.Evaluation of Disclosure Controls and Procedures
Our management, with the participation and supervision of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2023, our disclosure controls and procedures were designed and function effectively to provide reasonable assurance that information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
b.Inherent Limitations on Effectiveness of Disclosure Controls and Procedures
Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of disclosure controls and procedures must reflect the fact there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Due to inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
c.Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Rules 13a-15(d) and 15d-15(d) under the Exchange Act) that occurred during the year ended December 31, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
d.Management’s Annual Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. Our management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on its evaluation under the framework in Internal Control - Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2023.
172
The effectiveness of our internal control over financial reporting as of December 31, 2023 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which appears in Part II, Item 8 of this Annual Report on Form 10-K.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Upstart Holdings, Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Upstart Holdings, Inc. and subsidiaries (the “Company”) as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2023, of the Company and our report dated February 15, 2024, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
173
/s/ Deloitte & Touche LLP
San Francisco, California
February 15, 2024
ITEM 9B. OTHER INFORMATION
(c) Securities Trading Plans
From time to time, some of the Company’s executive officers or directors may determine that it is advisable to diversify their investments for personal financial planning reasons or may seek liquidity for other reasons and may sell shares of common stock of the Company. To effect such sales, from time to time, some of the Company’s executive officers or directors may enter into trading plans that are designed to comply with the Company’s Insider Trading Policy and intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
During the quarter ended December 31, 2023, the following officer (as defined in Rule 16a-1(f) of the Exchange Act) of the Company has adopted a contract, instruction or written plan for the sale of securities of the Company intended to satisfy the affirmative defense conditions of Rule 10b5–1(c) of the Exchange Act:
Name and title of officer: Natalia Mirgorodskaya , Corporate Controller
Date of adoption : November 30, 2023
Duration of the trading arrangement: Through August 31, 2024 or earlier if all transactions under the trading arrangement are completed
Aggregate number of securities to be sold from time to time: up to 13,688 shares
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We maintain a Code of Ethics that incorporates our code of ethics applicable to all employees, including all directors and executive officers. Our Code of Ethics is published on our Investor Relations website at ir.upstart.com under “Governance.” We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding amendments to, or waiver from, a provision of the Company’s Code of Ethics by posting such information on the website address and location specified above.
The remaining information required by this item is incorporated by reference to the definitive Proxy Statement for our 2024 Annual Meeting of Stockholders, which will be filed with the SEC no later than 120 days after December 31, 2023.
ITEM 11. EXECUTIVE COMPENSATION
The remaining information required by this item will be set forth in our Proxy Statement and is incorporated herein by reference. The Proxy Statement will be filed with the SEC no later than 120 days after December 31, 2023.
174
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item will be set forth in our Proxy Statement and is incorporated herein by reference. The Proxy Statement will be filed with the SEC no later than 120 days after December 31, 2023.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item will be set forth in our Proxy Statement and is incorporated herein by reference. The Proxy Statement will be filed with the SEC no later than 120 days after December 31, 2023.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Our principal accountant is Deloitte & Touche, LLP. The information required by this item will be set forth in our Proxy Statement and is incorporated herein by reference. The Proxy Statement will be filed with the SEC no later than 120 days after December 31, 2023.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
We have filed the following documents as part of this Annual Report on Form 10-K:
1. Consolidated Financial Statements
2. Financial Statement Schedules
Financial statement schedules have been omitted because they are not required, not applicable, not present in amounts sufficient to require submission of the schedule, or the required information is shown in the Consolidated Financial Statements or Notes thereto.
| Page | |||||
Report of Independent Registered Public Accounting Firm (PCAOB ID: 34) | |||||
| Financial Statements: | |||||
3. Exhibits
The exhibits listed below are filed as part of this Annual Report on Form 10-K or are incorporated herein by reference, in each case as indicated below.
EXHIBIT INDEX
175
Incorporated by Reference | ||||||||||||||||||||||||||||||||
| Exhibit Number | Description | Form | File No. | Exhibit | Filing Date | |||||||||||||||||||||||||||
| 3.1 | 10-K | 001-39797 | 3.1 | February 18, 2022 | ||||||||||||||||||||||||||||
| 3.2 | 8-K | 001-39797 | 3.2 | November 18, 2022 | ||||||||||||||||||||||||||||
| 4.1 | S-1/A | 333-249860 | 4.1 | December 4, 2020 | ||||||||||||||||||||||||||||
| 4.2 | S-1 | 333-249860 | 4.2 | November 6, 2020 | ||||||||||||||||||||||||||||
| 4.3 | 10-K | 001-39797 | 4.3 | February 16, 2023 | ||||||||||||||||||||||||||||
| 4.4 | 8-K | 001-39797 | 4.1 | August 20, 2021 | ||||||||||||||||||||||||||||
| 4.5 | 8-K | 001-39797 | 4.2 | August 20, 2021 | ||||||||||||||||||||||||||||
| 10.1+ | S-1/A | 333-249860 | 10.1 | December 4, 2020 | ||||||||||||||||||||||||||||
| 10.2+ | 10-Q | 001-39797 | 10.1 | November 12, 2021 | ||||||||||||||||||||||||||||
| 10.3+ | S-1/A | 333-249860 | 10.3 | November 6, 2020 | ||||||||||||||||||||||||||||
| 10.4+ | S-1/A | 333-249860 | 10.4 | December 4, 2020 | ||||||||||||||||||||||||||||
| 10.5+ | S-1/A | 333-249860 | 10.5 | December 4, 2020 | ||||||||||||||||||||||||||||
| 10.6+ | S-8 | 333-255270 | 4.4 | April 16, 2021 | ||||||||||||||||||||||||||||
| 10.7+ | 8-K | 001-39797 | 10.1 | November 18, 2022 | ||||||||||||||||||||||||||||
| 10.8+ | 10-K | 001-39797 | 10.7 | February 18, 2022 | ||||||||||||||||||||||||||||
10.9+ | 10-K | 001-39797 | 10.10 | February 16, 2023 | ||||||||||||||||||||||||||||
| 10.10 | S-1 | 333-249860 | 10.8 | November 5, 2020 | ||||||||||||||||||||||||||||
| 10.11 | 10-Q | 001-39797 | 10.3 | November 12, 2021 | ||||||||||||||||||||||||||||
10.12^ | S-1/A | 333-249860 | 10.16 | December 7, 2020 | ||||||||||||||||||||||||||||
10.13^ | S-1/A | 333-249860 | 10.17 | December 7, 2020 | ||||||||||||||||||||||||||||
10.14 | 8-K | 001-39797 | 10.1 | August 20, 2021 | ||||||||||||||||||||||||||||
| 21.1* | ||||||||||||||||||||||||||||||||
176
Incorporated by Reference | ||||||||||||||||||||||||||||||||
| Exhibit Number | Description | Form | File No. | Exhibit | Filing Date | |||||||||||||||||||||||||||
| 23* | ||||||||||||||||||||||||||||||||
| 24.1 | Power of Attorney (included in the signature page hereto). | |||||||||||||||||||||||||||||||
| 31.1* | ||||||||||||||||||||||||||||||||
| 31.2* | ||||||||||||||||||||||||||||||||
| 32.1* | ||||||||||||||||||||||||||||||||
97.1* | ||||||||||||||||||||||||||||||||
| 101.INS* | Inline XBRL Instance Document | |||||||||||||||||||||||||||||||
| 101.SCH* | Inline XBRL Taxonomy Extension Schema Document | |||||||||||||||||||||||||||||||
| 101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |||||||||||||||||||||||||||||||
| 101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document | |||||||||||||||||||||||||||||||
| 101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document | |||||||||||||||||||||||||||||||
| 101.PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |||||||||||||||||||||||||||||||
—————
* Filed herewith.
+ Indicates management contract or compensatory plan.
^ Portions of this exhibit (indicated by asterisk) have been excluded because such information is both (i) not material and (ii) would be competitively harmful if publicly disclosed.
ITEM 16. FORM 10-K SUMMARY
None.
177
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: February 15, 2024
| Upstart Holdings, Inc | |||||||||||
| By: | /s/ Dave Girouard | ||||||||||
| Dave Girouard | |||||||||||
| Chief Executive Officer and Director | |||||||||||
| (Principal Executive Officer) | |||||||||||
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dave Girouard, Sanjay Datta and Scott Darling, and each of them, as his or her true and lawful attorney-in-fact and agent with full power of substitution and resubstitution, for such individual in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully for all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or the individual’s substitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report on Form 10-K has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Signature | Title | Date | ||||||
| /s/ Dave Girouard | Chief Executive Officer and Director | February 15, 2024 | ||||||
| Dave Girouard | (Principal Executive Officer) | |||||||
| /s/ Sanjay Datta | Chief Financial Officer | February 15, 2024 | ||||||
| Sanjay Datta | (Principal Financial Officer) | |||||||
| /s/ Natalia Mirgorodskaya | Corporate Controller | February 15, 2024 | ||||||
| Natalia Mirgorodskaya | (Principal Accounting Officer) | |||||||
| /s/ Sukhinder Singh Cassidy | Director | February 15, 2024 | ||||||
| Sukhinder Singh Cassidy | ||||||||
| /s/ Kerry Cooper | Director | February 15, 2024 | ||||||
| Kerry Cooper | ||||||||
178
| /s/ Paul Gu | Director | February 15, 2024 | ||||||
| Paul Gu | ||||||||
| /s/ Mary Hentges | Director | February 15, 2024 | ||||||
| Mary Hentges | ||||||||
| /s/ Jeff Huber | Director | February 15, 2024 | ||||||
| Jeff Huber | ||||||||
| /s/ Ciaran O’Kelly | Director | February 15, 2024 | ||||||
| Ciaran O’Kelly | ||||||||
| /s/ Hilliard C. Terry III | Director | February 15, 2024 | ||||||
| Hilliard C. Terry III | ||||||||
179
Exhibit 21.1
SUBSIDIARIES OF THE REGISTRANT
Name of Subsidiary | Jurisdiction of Incorporation | |||||||
Upstart Network, Inc. | Delaware | |||||||
Upstart Loan Trust | Delaware | |||||||
Upstart Loan Trust 2 | Delaware | |||||||
| Upstart Auto Warehouse Trust | Delaware | |||||||
Exhibit 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement Nos. 333-269863, 333-262867, 333-255270 and 333-251388 on Form S-8 of our reports dated February 15, 2024, relating to the financial statements of Upstart Holdings, Inc. and the effectiveness of Upstart Holdings, Inc.’s internal control over financial reporting appearing in this Annual Report on Form 10-K for the year ended December 31, 2023.
/s/ Deloitte & Touche LLP
San Francisco, California
February 15, 2024
Exhibit 31.1
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO
EXCHANGE ACT RULES 13a-14(a) AND 15d-14(a),
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Dave Girouard, certify that:
1. I have reviewed this Annual Report on Form 10-K of Upstart Holdings, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: February 15, 2024
| UPSTART HOLDINGS, INC. | ||||||||
| By: | /s/ Dave Girouard | |||||||
| Name: | Dave Girouard | |||||||
| Title: | Chief Executive Officer (Principal Executive Officer) | |||||||
Exhibit 31.2
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
PURSUANT TO
EXCHANGE ACT RULES 13a-14(a) AND 15d-14(a),
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Sanjay Datta, certify that:
1. I have reviewed this Annual Report on Form 10-K of Upstart Holdings, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: February 15, 2024
| UPSTART HOLDINGS, INC. | ||||||||
| By: | /s/ Sanjay Datta | |||||||
| Name: | Sanjay Datta | |||||||
| Title: | Chief Financial Officer (Principal Financial Officer) | |||||||
Exhibit 32.1
CERTIFICATIONS OF PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Dave Girouard, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report on Form 10-K of Upstart Holdings, Inc. for the year ended December 31, 2023 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents, in all material respects, the financial condition and results of operations of Upstart Holdings, Inc.
| Date: February 15, 2024 | By: | /s/ Dave Girouard | ||||||
| Name: | Dave Girouard | |||||||
| Title: | Chief Executive Officer and President | |||||||
(Principal Executive Officer) | ||||||||
I, Sanjay Datta, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report on Form 10-K of Upstart Holdings, Inc. for the year ended December 31, 2023 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents, in all material respects, the financial condition and results of operations of Upstart Holdings, Inc.
| Date: February 15, 2024 | By: | /s/ Sanjay Datta | ||||||
| Name: | Sanjay Datta | |||||||
| Title: | Chief Financial Officer | |||||||
| (Principal Financial Officer) | ||||||||
Exhibit 97.1
UPSTART HOLDINGS, INC.
COMPENSATION RECOVERY POLICY
Adopted on August 29, 2023
Upstart Holdings, Inc. (the “Company”) is committed to strong corporate governance. As part of this commitment, the Company’s Board of Directors (the “Board”) has adopted this clawback policy called the Compensation Recovery Policy (the “Policy”). The Policy is intended to further the Company’s pay-for-performance philosophy and to comply with applicable law by providing for the reasonably prompt recovery of certain executive compensation in the event of an Accounting Restatement (as defined below).
The Policy is intended to comply with Section 10D of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with Exchange Act Rule 10D-1 and with the listing standards of the national securities exchange (the “Exchange”) on which the securities of the Company are listed. The Policy shall be interpreted in a manner that is consistent with the requirements of Section 10D of the Exchange Act, Exchange Act Rule 10D-1 and with the listing standards of the Exchange, including any interpretive guidance provided by the Exchange.
In summary, the Policy provides rules related to the reasonably prompt recovery of certain incentive-based compensation received by Covered Executives (as defined below). The application of the Policy to Covered Executives is not discretionary, except to the limited extent provided below, and applies without regard to whether a Covered Executive was at fault.
Persons Covered by the Policy
The Policy is binding and enforceable against all “Covered Executives,” which means all individuals who are or were ever designated as an “officer” by the Board in accordance with Exchange Act Rule 16a-1(f) (a “Section 16 Officer”). Each Covered Executive will be required to sign and return to the Company an acknowledgement that such Covered Executive will be bound by the terms and comply with the Policy. The failure to obtain such acknowledgement shall have no impact on the applicability or enforceability of the Policy.
Administration of the Policy
The Compensation Committee (the “Committee”) of the Board has full delegated authority to administer the Policy. The Committee is authorized to interpret and construe the Policy and to make all determinations necessary, appropriate, or advisable for the administration of the Policy. In addition, if determined in the discretion of the Board, the Policy may be administered by the independent members of the Board or another committee of the Board made up of independent members of the Board, in which case all references to the Committee shall be deemed to refer to the independent members of the Board or the other Board committee. All determinations of the Committee shall be final and binding and shall be given the maximum deference permitted by law.
Accounting Restatements Requiring Application of the Policy
If the Company is required to prepare an accounting restatement due to the material noncompliance of the Company with any financial reporting requirement under the securities laws, including any required accounting restatement to correct an error in previously issued financial statements that is material to the previously issued financial statements, or that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period (an “Accounting Restatement”), then the Committee must determine what compensation, if any, must be recovered.
Compensation Covered by the Policy
The Policy applies to certain Incentive-Based Compensation (certain terms used in this Section are defined below) that is Received on or after October 2, 2023 (the “Effective Date”), during the Covered Period while the Company has a class of securities listed on a national securities exchange. Such Incentive-Based Compensation is considered “Clawback Eligible Incentive-Based Compensation” if the Incentive-Based Compensation is Received by a person after such person became a Covered Executive and the person served as a Section 16 Officer at any time during the performance period for the Incentive-Based Compensation. The Incentive-Based Compensation that must be recovered is the amount of Clawback Eligible Incentive-Based Compensation that exceeds the amount of Clawback Eligible Incentive-Based Compensation that otherwise would have been Received had such Clawback Eligible Incentive-Based Compensation been determined based on the restated amounts (such compensation, as computed without regard to any taxes paid, the “Excess Compensation,” is referred to in the listings standards as “erroneously awarded incentive-based compensation”).
To determine the amount of Excess Compensation for Incentive-Based Compensation based on stock price or total shareholder return, where it is not subject to mathematical recalculation directly from the information in an Accounting Restatement, the amount must be based on a reasonable estimate of the effect of the Accounting Restatement on the stock price or total shareholder return upon which the Incentive-Based Compensation was Received and the Company must maintain documentation of the determination of that reasonable estimate and provide such documentation to the Exchange.
“Incentive-Based Compensation” means any compensation that is granted, earned, or vested based wholly or in part upon the attainment of a Financial Reporting Measure. For the avoidance of doubt, no compensation that is potentially subject to recovery under the Policy is earned until the Company’s right to recover under the Policy has lapsed. The following items of compensation are not Incentive-Based Compensation under the Policy: salaries, bonuses paid solely at the discretion of the Compensation Committee or Board that are not paid from a bonus pool that is determined by satisfying a Financial Reporting Measure, bonuses paid solely upon satisfying one or more subjective standards and/or completion of a specified employment period, non-equity incentive plan awards earned solely upon satisfying one or more strategic measures or operational measures, and equity awards for which the grant is not contingent upon achieving any Financial Reporting Measure performance goal and vesting is contingent solely upon completion of a specified employment period (e.g., time-based vesting equity awards) and/or attaining one or more non-Financial Reporting Measures.
“Financial Reporting Measures” are measures that are determined and presented in accordance with the accounting principles used in preparing the Company’s financial statements, and any measures that are derived wholly or in part from such measures. Stock price and total shareholder return are also Financial Reporting Measures. A Financial Reporting Measure need not be presented within the financial statements or included in a filing with the Securities and Exchange Commission.
Incentive-Based Compensation is “Received” under the Policy in the Company’s fiscal period during which the Financial Reporting Measure specified in the Incentive-Based Compensation award is attained, even if the payment, vesting, settlement or grant of the Incentive-Based Compensation occurs after the end of that period. For the avoidance of doubt, the Policy does not apply to Incentive-Based Compensation for which the Financial Reporting Measure is attained prior to the Effective Date.
“Covered Period” means the three completed fiscal years immediately preceding the Accounting Restatement Determination Date. In addition, Covered Period can include certain transition periods resulting from a change in the Company’s fiscal year. The Company’s obligation to recover Excess Compensation is not dependent on if or when the restated financial statements are filed.
“Accounting Restatement Determination Date” means the earliest to occur of: (a) the date the Board, a committee of the Board, or one or more of the officers of the Company authorized to take such action if Board action is not required, concludes, or reasonably should have concluded, that the Company is required to prepare an Accounting Restatement; and (b) the date a court, regulator, or other legally authorized body directs the Company to prepare an Accounting Restatement.
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Repayment of Excess Compensation
The Company must recover Excess Compensation reasonably promptly and Covered Executives are required to repay Excess Compensation to the Company. Subject to applicable law, the Company may recover Excess Compensation by requiring the Covered Executive to repay such amount to the Company by direct payment to the Company or such other means or combination of means as the Committee determines to be appropriate (these determinations do not need to be identical as to each Covered Executive). These means may include:
(a)requiring reimbursement of cash Incentive-Based Compensation previously paid;
(b)seeking recovery of any gain realized on the vesting, exercise, settlement, sale, transfer, or other disposition of any equity-based awards;
(c)offsetting the amount to be recovered from any unpaid or future compensation to be paid by the Company or any affiliate of the Company to the Covered Executive, including payments of severance that might otherwise be due in connection with an Covered Executive’s termination of employment;
(d)cancelling outstanding vested or unvested equity awards; and/or
(e)taking any other remedial and recovery action permitted by law, as determined by the Committee.
The repayment of Excess Compensation must be made by a Covered Executive notwithstanding any Covered Executive’s belief (whether or not legitimate) that the Excess Compensation had been previously earned under applicable law and therefore is not subject to clawback.
In addition to its rights to recovery under the Policy, the Company or any affiliate of the Company may take any legal actions it determines appropriate to enforce a Covered Executive’s obligations to the Company or to discipline a Covered Executive. Failure of an Covered Executive to comply with their obligations under the Policy could lead to (without limitation) termination of that Covered Executive’s employment for cause for failure to comply with a Company policy, institution of civil proceedings, reporting of misconduct to appropriate governmental authorities, reduction of future compensation opportunities or change in role. The decision to take any actions described in the preceding sentence shall not be subject to the approval of the Committee and can be made by the Board, any committee of the Board, or any duly authorized officer of the Company or of any applicable affiliate of the Company. For avoidance of doubt, the decisions of the Company to terminate the employment of a Covered Executive are independent of determinations under this Policy. For example, if a Covered Executive was involved in activities that led to an Accounting Restatement, the Company’s decision as to whether to not to terminate such Covered Executive’s employment would be made under its employment arrangements with such Covered Executive and the requirement to apply this no-fault and non-discretionary clawback policy should bear no weight on whether any such termination was or was not a termination for cause (other than in a circumstance where the termination of employment was due to the Covered Executive’s failure to comply with their obligations under the Policy).
Limited Exceptions to the Policy
The Company must recover the Excess Compensation in accordance with the Policy except to the limited extent that the conditions set forth below are met, and the Committee determines that recovery of the Excess Compensation would be impracticable:
(a)The direct expense paid to a third party to assist in enforcing the Policy would exceed the amount to be recovered. Before reaching this conclusion, the Company must make a reasonable attempt to recover such Excess Compensation, document such reasonable attempt(s) to recover, and provide that documentation to the Exchange; or
(b)Recovery would likely cause an otherwise tax-qualified retirement plan, under which benefits are broadly available to employees of the Company, to fail to meet the legal requirements as such.
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Other Important Information in the Policy
The Policy is in addition to the requirements of Section 304 of the Sarbanes-Oxley Act of 2002 that are applicable to the Company’s Chief Executive Officer and Chief Financial Officer, as well as any other applicable laws, regulatory requirements, rules, or pursuant to the terms of any existing Company policy or agreement providing for the recovery of compensation.
Notwithstanding the terms of any of the Company’s organizational documents (including, but not limited to, the Company’s bylaws), any corporate policy or any contract (including, but not limited to, any indemnification agreement), neither the Company nor any affiliate of the Company shall indemnify or provide advancement for any Covered Executive against any loss of Excess Compensation. Neither the Company nor any affiliate of the Company shall pay for or reimburse insurance premiums for an insurance policy that covers potential recovery obligations. In the event the Company is required to recover Excess Compensation from a Covered Executive who is no longer an employee pursuant to the Policy, the Company shall be entitled to seek such recovery in order to comply with applicable law, regardless of the terms of any release of claims or separation agreement such individual may have signed. The Committee or Board may review and modify the Policy from time to time.
If any provision of the Policy or the application of any such provision to any Covered Executive is adjudicated to be invalid, illegal or unenforceable in any respect, such invalidity, illegality or unenforceability shall not affect any other provisions of the Policy or the application of such provision to another Covered Executive, and the invalid, illegal or unenforceable provisions shall be deemed amended to the minimum extent necessary to render any such provision or application enforceable.
The Policy shall terminate and no longer be enforceable when the Company ceases to be listed issuer within the meaning of Section 10D of the Exchange Act.
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