Oportun Financial Corporation (OPRT) Q3 2022 Earnings Report, Transcript and Summary

Good evening, and welcome to Oportun Financial Third Quarter 2022 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Dorian Hare. Please go ahead.

Thanks, and hello everyone. With me today to discuss Oportun's third quarter 2022 results are Raul Vazquez, Chief Executive Officer; and Jonathan Coblentz, Chief Financial Officer and Administrative Officer. I will remind everyone on the call or webcast that some of the remarks made today will include forward-looking statements related to our business, future results of operations and financial positions, planned products and services, business strategy and plans and objectives of management for our future operations. Actual results may differ materially from those contemplated or implied by these forward-looking statements and we caution you not to place undue reliance on these forward-looking statements. A more detailed discussion of the risk factors that could cause these results to differ materially are set forth in our earnings press release and in our filings with the Securities and Exchange Commission under the caption Risk Factors, including our upcoming Form 10-Q filing for the quarter ended September 30, 2022. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events other than as required by law. Also on today's call, we will present both GAAP and non-GAAP financial measures, which we believe can be useful measures for the period-to-period comparisons of our core business and which will provide useful information to investors regarding our financial condition and results of operations. A full list of definitions can be found in our earnings materials available at the Investor Relations section on our website. Non-GAAP financial measures are presented in addition to and not as a substitute for financial measures calculated in accordance with GAAP. A reconciliation of non-GAAP to GAAP measures is included in our earnings press release, our third quarter 2022 financial supplement and the appendix section of the third quarter 2022 earnings presentation, all of which are available at the Investor Relations section of our website at investor.oportun.com. In addition, this call is being webcast and an archived version will be available after the call, along with the script of our prepared remarks. With that, I will now turn the call over to Raul.

Thanks, Dorian, and good afternoon, everyone. Thank you for joining us. Today, I'd like to discuss our third quarter financial performance followed by an update on how the macroeconomic environment is impacting Oportun and its members and close with an update on our strategic initiatives. Oportun delivered a strong profitable third quarter on an adjusted basis. Let me start with the following summary. We delivered revenue of $250 million, up 57% along with adjusted net income of $8.4 million or adjusted EPS of $0.25. Our annualized net charge off rate of 9.8% was in line with our prior guidance. And we are upwardly revising our full year 2022 revenue and adjusted EPS guidance. Let me now update you in more detail regarding what we saw in Q3, starting with credit. Credit is the most important metric in our business. On our prior earnings call, we shared that starting in July, we had initiated a set of actions including significantly tightening our underwriting standards to address the impact of inflation on our members. I'm pleased to inform you that, these actions are having their intended effect. We are continuing to reduce our exposure to new borrowers and increase our proportionate exposure to more profitable returning borrowers, who have already successfully repaid at least one loan to Oportun. In the third quarter, 28% of our loans were to new borrowers as compared to 44% in the second quarter and 51% in the first quarter. Early-stage delinquencies are trending downward. For instance, from July to September, our 15-to-29-day delinquencies declined from 2.1% to 1.8% and our 30-to-59-day delinquencies declined from 2.2% to 2.1%. These trends divide the usual seasonal patterns in delinquencies, which typically rise in the back half of the year. And our first payment defaults are now below 2019 pre-pandemic levels having come down from the 2% range to below 1%. So in summary, we are very pleased with the credit results from Q3 originations and we are setting ourselves up well for good credit performance in 2023. Now I'd like to update you on the other actions we have been taking. Starting with underwriting. We are introducing and leveraging new underwriting models that have and will continue to significantly improve our credit performance. For instance, we launched an updated version of our model specifically focused on underwriting our returning portfolio. We are also expanding the use of the bank transaction model we launched earlier this year, by giving more applicants the opportunity to share their data, providing a more complete snapshot of their current financial situation. We also launched a new direct marketing platform this quarter that we expect will be fully implemented by the end of the year. We expect this new platform to improve the risk levels of the direct mail program and enable additional digital channels, where we will be able to target customers based on their credit profile. Our funding and liquidity remain strong and in September, we bolstered them by raising additional capital with a new 4 year $150 million senior secured term loan. The investment community's confidence in Oportun was also just further validated by our closing last week of our fourth securitization of 2022. Our ability to complete these financings increases our capacity to fund future originations. Finally, we have made progress and continue to focus on a significant reduction of operating expense growth. We are reiterating our mandate for flat second half adjusted operating expenses versus the first half of the year by reducing sales and marketing costs and limiting headcount growth. As a proof point of achieving this objective, third quarter adjusted operating expense declined 3% sequentially, to define our typical seasonal patterns and adjusted operating efficiency improved by approximately 1,300 basis points year over year to 54%, our lowest level since our 2019 IPO. As you can see, we continue to take the necessary steps towards putting the company on the strongest possible footing and are committed to limiting expense growth in order to operate more efficiently in 2023. Shifting now to our long-term strategic priorities, let me update you on our progress on enhancing our platform capabilities, growing our members and increasing our multiproduct relationships. We are continuing to enhance our platform capabilities to meet the everyday financial needs of hardworking people. We are on-track to start testing our unified app this quarter that brings together all the digit savings, banking, investing products and Oportun credit products into a single mobile application. Digit's financial performance is exceeding our expectations and our overall integration continues to progress nicely. We ended the third quarter with 1.9 million members, up from 1.8 million at the end of last quarter, a 9% annualized growth rate. We are pleased with this pace of adding high quality new members to Oportun, given our lower marketing spend and decreased focus on acquiring new borrowers. Furthermore, in the third quarter, products grew at an annualized rate of 11%, faster than our member growth of 9% as members continue to increase their engagement with Oportun. Now let me update you on new product activities. As a reminder, we indicated on our prior earnings call that we would deliberately moderate growth in our secured personal loan and credit card products in the second half of this year, as part of our credit tightening actions. For our secured personal loan products, we ended the third quarter with $116 million in receivables, up from $100 million sequentially. Our credit card receivables grew at a similarly moderate pace to $131 million up from $119 million sequentially. We now have more than 200,000 members who have an Oportun branded credit card. Finally, we have also continued to make great progress with our Lending-as-a-Service partner channel, from which we can efficiently increase our applicant pool and selectively add high-quality new members, even while we tighten our credit standards. During the third quarter, we scaled our partner network to include 348 locations, up from 229 a year ago and we still expect to complete 2022 with over five hundred locations. Additionally, our partnership with Sezzle, a buy-now-pay-later company and our first digital Lending-as-a-Service relationship remains on track to launch this quarter. With that, I'd like to turn it over to Jonathan for additional details on our financial performance and our revised guidance. He will also take you through a technical accounting requirement that caused a non-cash $108 million write-off of goodwill that impacted our Q3 GAAP results.

Thanks, and good afternoon, everyone. As Raul mentioned, we're pleased with our third quarter results, which exemplify the resilience of Oportun’s business model under the current macroeconomic environment. In the third quarter, we generated $250 million of total revenue and $8.4 million of adjusted net income or $0.25 of adjusted EPS. Revenue upside and expense discipline enabled us to be profitable, while our prior guidance had indicated the expectation for a slight loss. Our aggregate originations were $634 million down 4% year-over-year, and modestly below the prior guidance of between $650 million and $675 million for the quarter. This reflects the credit tightening actions we initiated in July and our focus on high quality originations. Total revenue of $250 million was above the guidance range and up 57% year-over-year with upside reflecting lower than anticipated prepayments. We expect continued revenue growth into 2023 even as we keep the tighter underwriting standards. Net revenue was $147 million up 5% year-over-year. Net revenue improved from the prior year period due to higher total revenue, partially offset by higher interest expense and net charge offs as compared to last year. Interest expense of $27 million was up 152% year-over-year, primarily driven by increased debt issuance to fund our growth and the increase in our cost of debt to 3.9% versus 2.8% in the year ago period. At the end of the third quarter, 79% of our debt was fixed rate providing us with protection from rising interest rates. For our net change in fair value, we had a $76 million net decrease, which consisted mainly of current period charge offs of $72 million. For the mark-to-market, the fair value price of our loans decreased to 100.7% as of September 30 and resulted in a $41 million mark-to-market decrease. The $61 million mark-to-market increase in our asset back notes resulted from a 181 basis point decrease in the weighted average price to 92.9% due to the increase in interest rates and credit spreads during the quarter. Turning to expenses, we maintain strong expense discipline as we said we would on our prior call with adjusted operating expenses decreasing sequentially 3%. As Raul mentioned, we will continue to reduce our adjusted operating expense growth rate going forward and are on track to be flat in the second half versus the first half of this year. Our customer acquisition cost was $142 down 7% from the prior year period due to lower direct mail and online marketing expenditures partially offset by lower aggregate originations. We delivered adjusted net income of $8.4 million compared to $24 million in the prior year quarter and adjusted EPS of $0.25 versus $0.78 respectively. For the first three quarters of the year, combined, adjusted net income was $65 million, representing 23% year-over-year growth and adjusted EPS was $1.95, representing 11% year-over-year growth. As Raul mentioned, our GAAP results were impacted by a technical accounting requirement. Because our market capitalization remained below our tangible book value, we were required by GAAP to write-off $108 million of goodwill. Our GAAP net income and EPS were impacted by this non-cash charge. While the goodwill related to our acquisition of Digit, the write-down is not a reflection on Digit's financial performance, which as you heard Raul mentioned earlier, is exceeding our expectations. We have not impaired any of the other intangibles we acquired with Digit for this reason. Because this was a non-cash charge, it in no way affects the operations for future prospects of the company. Adjusted EBITDA was a $6.2 million loss in the third quarter, $24 million decrease compared to a gain of $18 million in the prior year quarter. For the 9 months of the year, adjusted EBITDA was $23 million flat to the prior year period. Adjusted return on equity was 6% versus 9% in the prior year quarter. For the last 12 months, adjusted ROE averaged 17%. Turning now to credit. Our third quarter results showed we managed our credit well to deliver outcomes in line with our prior guidance. Our annualized net charge off rate was 9.8%, compared to 5.5% in the prior year period. As a reminder, last year's charge off rate was abnormally low due to strong consumer balance sheets, including the impact of government stimulus amidst the pandemic. As of September 30, our 30 plus day delinquency rate was 5.4%, which was consistent with the increased charge-off trends we previously guided to. Regarding our capital and liquidity, as of September 30, total cash was $272 million. Additionally, net cash flow from operations for the third quarter was $68 million, up 44% year-over-year. Our debt-to-equity ratio was 5.2x and absent the impact of the non-cash goodwill impairment charge I just discussed; our debt-to-equity ratio would have been 4.3x. Also as of September 30, $382 million of our combined $750 million in warehouse lines was undrawn and available to fund our growth. We are well positioned to maintain our strong liquidity, while we selectively underwrite high quality loans in our tightened credit posture. We have maintained our track record of consistent access to the capital markets. Raul mentioned that we closed a 4-year $150 million senior secured term loan in September. It's important to emphasize that this new facility provides non-dilutive capital that supports the continued investment and growth in our business that we expect in 2023 and beyond, even under the tighter credit underwriting criteria we have adopted in the current environment. We also disclosed our fourth securitization of 2022, a $300 million asset backed note issuance, reaffirming our access to funding and investor support for our business model. Turning to our expectations for the rest of 2022, we remain focused on prudent profitable growth by tightening credit and continuing the cost discipline that Raul mentioned. In terms of guidance, our outlook for the fourth quarter is; aggregate originations of $650 million to $700 million, total revenue of $255 million to $260 million, adjusted net income of $8 million to $10 million and adjusted EPS of $0.24 to $0.30. Our updated guidance for the full year is, aggregate originations of $2.962 billion to $3.012 billion, total revenue of $946 million to $951 million, adjusted net income of $73 million to $75 million and adjusted EPS of $2.19 to $2.25. Going forward, our credit performance will be driven by two different portfolio dynamics. The loans we've been originating since July under significantly tighter credit standards and the loans originated prior to that. Let me start with the loans we've originated since July. The credit tightening is already having the desired effect of driving down our early-stage delinquencies and first payment defaults with performance trending better than 2019. You can see these trends in the additional slides we've included in our earnings presentation this quarter. With regard to the loans originated prior to July, the charge offs we expected to have in the fourth quarter will be almost entirely from these loans we originated prior to tightening. For the fourth quarter, we are guiding to 11.9% annualized net charge offs, plus or minus 25 basis points. For the full year, we are increasing our guidance by 30 basis points to 9.9% net charge offs, plus or minus 20 basis points. Approximately 12 basis points of the increase in rate for the full year is reflective of the denominator effect of credit tightening leading to reduced origination amounts and lower average daily receivables from our prior expectation. It's worth keeping in mind that this upward revision of full year guidance only represents $8 million more in charge-offs than previously expected, and even after these expected incremental charge offs, we are forecasting $8 million to $10 million in adjusted income for the fourth quarter. Additionally, because the average life of our portfolio is only 0.92 years, the portfolio will turn over more than once per year. This means that the loans we started originating under tighter credit standards in July will make up the vast majority of the portfolio by the second half of 2023. While we expect to have elevated loss rates into the fourth quarter of this year, our projection remains that losses will start decreasing in the first quarter of 2023, and return to our target 7% to 9% range by the third quarter of 2023. In summary, I'm pleased that we delivered another strong quarter, Oportun’s ninth consecutive profitable quarter and that we are in a position today to upwardly revise our 2022 profit outlook. With that, I will now turn it back over to Raul for some final comments before we open the line for questions.

Thanks, Jonathan. This quarter exceeded our expectations and I am confident that we will emerge from this challenging economic environment, a stronger company than ever before, just as Oportun did following the pandemic and the financial crisis. The resilience the company has and will continue to exhibit reflects the determination of our talented employees. Oportun will continue to deliver responsible, profitable growth on behalf of our shareholders. I look forward to reviewing our fourth quarter results and providing our outlook on 2023 when we next report in February. With that, operator, let's open up the line for questions.

[Operator Instructions] And our first question comes from Mark DeVries with Barclays.

I was hoping you could clarify kind of what's changed that gave you confidence for the new EPS guidance for the year? Is it primarily just what you are seeing on the credit side or are there other drivers there we should be aware of?

Yes, Mark. It's Jonathan. So I think it's a number of things. So first of all, when you take a look at the beat we delivered for 3Q, that was really driven by two things; One, we beat revenue by $5 million and that was largely driven by slower prepayment rates in the portfolio, which is not unexpected given the inflation that's occurring. And then second, we had very strong expense discipline. So as you heard both Raul and I comment, we actually reduced adjusted operating expenses by 3% quarter-over-quarter, which is about $4.6 million. So we feel good about those trends. The other thing is yields have gone up, which in the short-term is going to be beneficial relative to the mark-to-market.

Okay, great. And then could you just comment on what you are observing in the funding markets? How your execution may be impacted like your latest ABS deal, how did how did that compare to past execution? And any impact on your ability to kind of hit your target returns?

Sure. So we successfully closed our fourth securitization of the year on last Thursday. It was a $300 million amortizing offering and we were able to sell all the tranches from AA down to BB in a little over a week. So it was a very successful offering in the context of the current market. It certainly reflected current market interest rates and credit spreads, but that's one of the reasons we chose to do it on an amortizing basis. So it's not a long-term piece of funding. When you look overall at our cost of funds, it was about 3.9% for the quarter. And so we see that rising into the 4s next quarter. But overall, on a blended basis, that's very manageable. We continue to have our warehouse lines that are committed through the personal loan run through '24 and there's a lot of interest from investors in purchasing our whole loans, which could be another source of funding. So we feel very good about our ability to access the capital we need to fund and grow our business.

And just wanted to make sure, you don't have any debt covenants that are impacted at all by the goodwill impairment, do you?

No, no. We do not.

Our next question comes from Sanjay Sakhrani with KBW.

Two questions on the higher charge offs. Appreciate there is like pluses and minuses from the financial impact that net each other out. But I guess when we think about the first half of next year and the charge off rate being higher than that 7% to 9%, as a result of I guess the back book that you mentioned, Jonathan. Could you just give us some sort of cadence, as to how that migration should look because the fourth quarter was a little bit higher than what you thought it would be? And then secondly, maybe Raul, you could just talk anecdotally about what your customers are dealing with now with the macro environment, with inflation, higher rates, et cetera also and higher rates, et cetera. Also, less liquidity from some of the FinTech players, like the buy now pay later providers. Maybe could just give us more color on that. So, 2-part question on loss rates? Thanks.

Yes. So, Sanjay, I’ll take the first part. I think, our expectation continues to be the same as before from our prior earnings call that we expect Q1 losses to be lower than where they were are in Q4, and to continue to trend downward over the course of the year.

And I'll add a little bit to that, Sanjay. I'd say from a credit perspective, we're right where I expected us to be and right where I wanted us to be. And that has two components to it, as you put it right. We were very transparent in the last call that the back book was seeing the impact of inflation and that we did expect delinquencies to go up. We expected losses to go up and it hit their peak in Q4 as Jonathan just mentioned, then we'll start going down and we'll get back to the 7% to 9% range in the 2023 timeframe. But I'd also like to point out, we've started to provide some of the same transparency that we provided during the pandemic. So I'm really pleased with how effective our credit tightening actions are proving to be. If you look at page six of our earnings deck, you're going to see the early-stage delinquencies are declining, and that's consistent with our focus on quality of originations as opposed to quantity. And then first payment defaults are now below pre pandemic levels. So we think we're setting ourselves up very well for a good 2023 from a credit perspective, right? Revenue was up $90 million year-over-year total revenue, and we know that's going to be a run rate going into 2023. So that higher revenue run rate, the lower losses that we would expect in 2023 combined with the expense discipline, we think is setting us up really, really well for 2023. Let me pause there and see if you have any other questions on credit before I answer the second question that you posed. Sanjay?

No, I think you can continue, probably.

Okay. So in terms of what we're seeing, both from a competition perspective and from a consumer perspective. In terms of competition, we continue to be a very attractive provider of credit in particular to our returning customer base. So I'm pleased with the demand that we're seeing there. I'm pleased with the credit performance that we're seeing. So I'd say from a competition perspective, we still know that by capping our rates at 36% and below, we're going to be one of the most attractive providers of credit. Our net promoter score is still 79. So I really like where we're at. From a consumer perspective, it's really the things that we've talked about in the past. They're just feeling the impact of inflation. Higher rents, gas have started to move up again a tiny bit. So we continue to be very, very focused on that repeat customer who's demonstrated success with our loans. And once the economy starts to stabilize a bit more and we start to see inflation coming back down, that's when we'll start to focus on originations again to new borrowers.

And just to follow up on the second part of that second question, you don't feel like there's an impact from diminished to liquidity from some of these providers? Because a lot of what we've been hearing from the FinTechs and the buy now pay later providers is they're pulling back, right? You don't feel like that's had an impact on your customers?

I mean, I think when others pull back, it makes us more attractive as a provider of credit. In terms of the impact on the customer themselves it's really hard to know. We're dealing with the customers that come to us for credit. They don't necessarily talk about the experience that they're having with other providers of credit.

Okay. Great. And just last one on the efficient the expenses and the efficiency ratio improving so much. I mean, that was great. I mean, I'm just trying to think how sustainable that is in this backdrop. Maybe you could just talk about the pluses and minuses of that efficiency ratio remaining here and how we should think about it on a go-forward basis? Thanks.

Sure. We are very committed to keeping expenses as flat as we can. Even as we go into 2023, we recognize that over the last few years, we made investments in headcount as we were building out our credit card product, as we were building out the secured an eleven product and then certainly when we made the Digit acquisition. So we feel that the organization is right-sized today. So we really feel that we can go ahead and support this higher revenue base with the headcount that we have today. So we actually think that, our on posture on expenses is very sustainable.

Our next question comes from Rick Shane with JPMorgan.

Thanks everybody for taking my questions this afternoon. I really appreciate the clarity in terms of the delinquency trends. Can we take a quick look at Slide 7? And I'd like to put this in context of a couple of things. So obviously, the first half of the year, first payment defaults were pretty significantly elevated. We can see the impact here of the tighter underwriting. Given the timeline of loans and when first payments are due, is it a weekly or bi-weekly? I'm trying to understand, how quickly the tighter underwriting comes through on this chart, since you provided on a weekly basis, or on a bi weekly basis?

Sure. So your right when you look at the beginning of 2022, that was really reflecting the stimulus that consumers had, right, our ability to go ahead and lean into the new states. And then as the economy started to change, then we started to drive this down as we kept tightening. I'd say, when you look at that Page 7 and you look at the page before Rick, we are already starting to see some of those first payment defaults bleed into those early delinquency buckets. You can see that the current percentage of the portfolio has been going up right from the end of July to the end of August to the end of September. At the same time, we are seeing one-to-seven-day delinquencies come down and 8 to 14 are pretty stable. That's not usually what happens at this time of the year. So we're defining seasonal trends. So we already feel that we're starting to see the impact of that tighter underwriting and those improved first payment defaults in those early stage delinquencies. And you could see it in the 15 to 29 as well, which went from 2.1% to 1.8%.

Got it. Okay. And that's helpful. And context I'm really interested in is, when we look at this first payment default chart, I'm curious if there was a sort of static tightening of underwriting or that as you moved through the quarter month-over-month, it became increasingly tighter. And the reason I'm most interested in this is that, if we look for the guidance for the fourth quarter, on a seasonal basis, it looks like you are tightening again. And that's what I really want to understand how should we think of this as three portfolios, the back book, the third quarter book and what's happening now in the fourth quarter in terms of even tighter underwriting?

No, I don't think of it as three portfolios. I really think of it as two. At a high-level, it is that back book. And then the portfolio that we're building with this tighter underwriting. It's not really, if you were to look at page seven again, it's not really one tightening action. Thankfully, we've got a underwriting engine that allows us to make changes quickly and then allows us to continue to make adjustments based on what we're seeing. So what happen is that our team internally will look at opportunities, say to tie in within the returning portfolio, and then they'll look at opportunities to tie in within the new portfolio, and then they'll start to look at it within different loan sizes. So it's not necessarily a reflection of we've got to tie in more and more and more. It's a question of just being able to sequence the work and being able to make the best decisions possible. But we very much think of it as two books. There's not say, additional tightening that's coming in Q4 that's reflected in that guidance.

And I apologize for my peers who are waiting to ask questions, but I just want to clarify this. Is it fair to say that what you just described is that perhaps by the end of September, underwriting was tighter than it was perhaps at the end of July, that there was that progression within the quarter?

Yes. I think that would be fair. Rick, because I really appreciate the question. I think one way to look at the difference, say in Q4, the two ways to look at the difference in Q4 originations is number 1, we're very focused on quality of originations, not quantity. We could certainly originate more than the 675 million that we've guided to. But we think that in this environment it makes the most sense for us to demonstrate, again, the efficacy of our underwriting engine and to position ourselves for lower losses in 2023 so that way we can go ahead and keep improving the profitability of our business. So that would be the first in quality over quantity. The second is, if you look at the new borrower percentage where we talked about Q1 being 51%, Q2 being 44%, and Q3 being 28%, it means that origination volume that normally we would make to new borrowers, we're choosing not to make a lot of that volume today. We're choosing to pick the highest quality borrowers within that new borrower population. And that just means that we're going to have less originations coming from that group. So I would characterize it more as a deliberate choice on our part to focus on that high quality returning portfolio and picking the best new borrowers as opposed to what I think was a great question on your part. So it's really that as opposed to say, incremental tightening that we expect to have in these last two months.

And look, I agree the market is clearly going to judge you on the credit performance over the loan growth at this point.

Our next question comes from David Scharf with JMP.

Actually, everything's pretty much been asked already of that was on my list, but maybe a little more kind of thematic or strategic question for you, Raul. Rick is 100% correct. Nobody's paying a whole lot of attention to your origination volumes at this point. But as you think about ultimately what the guideposts are? Some of the guideposts that you need to see before you restart that origination engine. Is it more in -- is it more meeting in certain internal metrics such as bringing visibility into losses to within that 7% to 9% percent range? Or are you more attuned to macro and internal conditions even if you are meeting those internal targets, just given how much uncertainty is out there?

Thanks for the question, David. I'd say, it's both. So we are absolutely looking at our internal metrics. We want to look at those first payment defaults. We want to see the performance on the early delinquency buckets that we shared with you. We want to see 30 plus delinquency rate get back to our historical levels. But at the same time, from a macro environment, the two things we are really looking at are inflation and unemployment. So let's say, for the sake of argument that the internal numbers we are getting to the ranges that we wanted to, but there was still the uncertainty and dynamic elements in the macro environment. We really wouldn't start to open up at that point too much, because we'd be concerned about potentially starting to open up and having the environment deteriorate some more. And then we'd be having to catch-up and we'd regret that decision. So it's really a combination of the two and what we'd really like to see is, we'd really like to see our internal numbers get better. We'd like to see inflation start to come down and we'd like to continue to see stability from an unemployment perspective. If we get kind of green lights across those three things, that's when we will be very comfortable starting to open back up and taking advantage of the growth opportunity that still is in front of us.

I think you've just basically defined the definition of expression once bitten twice shy, and there is no reason to move on any false questions. Actually, given particularly unemployment which we are still not seeing it move. Arguably, we still have more headwind ahead of us to the extent it's a lagging indicator. Maybe a follow-up too on Rick's kind of questioning along sort of Q4 versus Q3, magnitude of tightening or what you are seeing. It sounded like the revenue guide in the fourth quarter that went up as well as the revenue beat in the third quarter was not entirely pricing related, but it was lower prepayment rates. Now Jonathan said that was to be expected, but in the same breath said, it was a contributor to revenue coming in ahead of guidance. So is the prepayment rate coming in even slower than you anticipated? I mean, is that one more kind of cautious indicator that -- is keep tamping down the original nation outlook near-term?

David, it's Jonathan. I don't know that the prepayment rate relates to the origination outlook, at least we don't see it that way. What I meant to say was that, the rates we are seeing as we saw for the rest of the quarter were lower than at the time that we guided, right? And so, we factor that in now, and that's why one of the reasons among others why we expect to see higher revenue for the fourth quarter.

Got it. Yes. No, I just meant that on high-quality payment rates were one more negative indicator on consumer liquidity and payment patterns.

I wouldn't think of it say as a negative indicator, David. This is Raul. there are times where someone's got a $60 payment, $65 payment and they'll go ahead and make an $80 payment, right? And we are happy to take that payment because if that member pays off their loan early, we may still have a need for capital and we are happy to then give them a repeat loan. I think what we're just seeing right now is people are managing their money carefully. So we don't necessarily think that lower prepayment penalty indicates stress. We think it just indicates prudent management on our member’s part. And the prepayment just ended up being lower than we would've expected. And that creates a benefit for us in Q3, and it's going to create a benefit in Q4. So we don't think of that as a negative and it doesn't necessarily impact how we think about originations. The origination level for us is really about, again, that quality. How do we focus on the repeat borrower? How do we make sure that the bulk of our marketing is for that repeat borrower? So that, as you put it and as Rick put it right, we can deliver what we think investors are looking for right now, which is really having a strong degree of controlling command over credit outcomes.

Got it. Maybe just one last one. On capital, obviously you've highlighted both your success in recent accessing the debt capital markets as well as kind of your overall degree of liquidity. I mean, given your shares at a significant discount to book, as well as a putting on the brakes a little bit on the magnitude of origination activity. A any comments on further buybacks that you could discuss? It seems like you're in that paradigm as well as still being free cash flow positive there aren't many other uses for the capital.

Well, in this very unique environment, we think it makes sense to really be careful with our capital, right? I mean, the Fed clearly is indicating that they're going to continue to take action to try to bring inflation back down. So we think the most prudent thing to do today is to hold onto our capital until we see things stabilize a bit more from a macroeconomic perspective. To your point, David, we absolutely believe the company is undervalued. We've increased profit guidance, so we're hopeful that having now nine consecutive profitable quarters increasing guidance, and certainly demonstrating these early credit results that we're showing are going to go ahead and strengthen the confidence that investors have in our ability to navigate this environment. We're not planning to do buybacks now, but we'll continue to monitor the macro environment and our stock price and figure out if there is a moment in which we in the boards think that that's the best use of capital.

Our next question comes from John Hecht with Jefferies.

Hi John. We can't hear you.

I apologize for that. It was a question dovetailing on some of the other topics you've already addressed, but just thinking about the tightening and the -- they call it the new book as or forward book as opposed to the back book. Like how do we think about the difference in characteristics? I mean, of you did tell us that there's going to be more recurring customers, but you maybe I'm asking like what did you change in underwriting and then how will that affect the mix of secured, versus unsecured, versus card over the next few quarters? And anything that I might do to yield overall as well.

Yes. So the way that I would characterize say that the new book versus the back book is the book is -- that the number one difference is absolutely the mix of returning borrowers versus new borrowers. We have sought over the last few calls to give you a sense of what that mixes look like. When we expanded to thirty new states, through the MetaBank partnership, it just gave us a fantastic opportunity to acquire new borrowers. This was obviously before the war, before rates started moving up. There was still quite a bit of capital that people had just based on the stimulus measures. So it made sense for us to have new borrowers represent 51% of the loans we were making. And then as we started to reduce that, we went to 44% and now you see us at 28%. So I'd say that is the number one difference, John, between the back book and this new book. And because you've known us for years, you know that, that returning borrower is someone who has fantastic credit performance, a lower CAC. You also saw us report lower CAC this quarter. It's the most profitable and most proven part of the portfolio. So we think it makes sense to really focus on that borrower today, that would be the biggest difference in terms of the books.

And then you mentioned Meta. Maybe talk -- you guys have -- you've always had lots of new products in developing channels. Maybe can you talk about how Meta is doing or any changes to different channels or kind of what you are doing in terms of tightening is across the board just marginally or anything to kind of highlight with respect to the channels that you are using to grow?

Sure. So from a channel perspective, part of the tightening that the risk team also does is partnering with the marketing team and focusing on those channels that have the highest risk outcomes associated with them. So one of them for example is direct mail, because you get to select who you are going to send the mail to. It's very easy to shift that channel to more of a turning portfolio. So we have focused direct mail on the returning population. Some of the online channels where you don't certainly have that degree of pre-selection whether that's say keyword advertising or being on some of the online locations. Those are places where we have cut back, because historically we have seen much more of new borrower. Selection take place or acquisition is a better way to put it. So I'd say that, it hasn't been say channel-by-channel focus. It's been really again trying to focus on getting that mix that, we were looking for, that's really been what we have been focused on. From a product perspective, we showed last quarter and it continues to be true that, we are really focused on the unsecured personal loan product. That is the profitable engine of this business. We continue to believe in our multiproduct strategy. But right now, we are not focused on growing credit cards. We are not focused on growing the secured personal loan book. We have got those groups really focused on servicing and collections, and any elements of kind of the product infrastructure that can be improved in this environment.

Our next question comes from Hal Goetsch with Loop Capital.

Since the first derivative of improvement is being seen in the fourth quarter origination guidance. I know we are not -- we're still dealing with the tightening that's already happened. It implies originations to be down 20% or so. But the first derivative of improvement in early losses, delinquencies, first paid default is already improving. What would it take for you guys next year to turn back on some of that marketing spend came down quite significantly. I just want to know what normal really is. Because it appears to me this is, that's not a normal level. I want to kind of know where that might sell out next year.

Yes. Thanks for the questions, Hal, and thanks for the kind words about the quarter. We felt really good about the quarter. We thought we delivered a strong quarter given the environment. When it comes down to what would we need to see? We're really focused on inflation. We'd like to see inflation come back down. We'd like to see our borrowers have a little bit more money left over right after every paycheck. And we'd like to see the unemployment rate continue to be pretty low. We know that if we have a strong job market for our borrower, and they've got some money left over after every paycheck that they're then going to be current, because we know our borrowers want to pay us back when they don't. It's because they're having challenges. So just seeing us get back to a more normal economy with kind of lower inflation and strong job prospects. That's really what we need to see before we start to lean back into marketing and starting to look for more new borrower volume.

Our next question comes from Sanjay Sakhrani with KBW.

Hey, thanks. I just had a couple of follow up questions, more numbers related. I guess, Jonathan, on the debt costs, I know you did a couple of offerings, how should we think about those costs going forward? I'm just trying to think about like maybe a net interest margin or something. I think it, we calculate it to be 26%. Should that go higher as you invest or as you've sort of use some of those costs, sort of the debt to fund the loans.

You're asking if net interest margin will be higher in the future?

Yes. Like how should we think about NIM going forward?

Yes. So it's a balance of things. Obviously, the cost of funds component is going to creep up, right? We're at 3.9% for the third quarter, but it'll be higher in the fours for next quarter. And from a NIM perspective, we've taken pricing actions and we're looking at more opportunity there. So I do think we'll see NIM decline somewhat, but that it should come back later next year as more of the pricing actions flow through the portfolio.

Just add a little to that. Certainly, NIM is something that we're focused on to Jonathan's point, we continue to ask the team to look for opportunities to increase our yield, whether that's in origination fee or if there are areas where we can charge more from an interest rate perspective. We're looking for every opportunity. That said, right, we're also focused on reducing the expenses and the rest of the P&L. One of the reasons that we're so focused on driving losses down is we know if we can go ahead and reduce charge offs, that's going to help us with the overall profitability of the business. And then we spend a lot of time talking about OpEx because that is something that is absolutely in our control. And we're -- I'm pleased with the discipline that the team has shown. And just want to be really clear, because we hinted at this a couple of times, but we expect to take this discipline into 2023. So this is not just a question of second half expenses relative to first half. We're going to roll into 2023 with the same mentality from an OpEx perspective of very little hiring, making sure that the marketing expenses are earned by the credit performance, and again looking for the environment. So you are absolutely right. We are focused on NIM, but we are also looking at those other big expense lines in the P&L, and really focused on improving the overall adjusted net income performance of the company.

And just to add one thing, to Raul, we talked about the 1300 basis point year-over-year improvement in our operating efficiency. If you compare that relative to the revenue yield, it's about 4, right? So when you think about the 26% number, you mentioned for NIM, while OpEx is obviously below that, we got 4 better on that yield equation just by the OpEx changes we have made already. And if we stay flat as Raul has said, we would then and revenue continues to grow, then it's even more.

No, I appreciate that. And maybe we can just talk offline sort of the cadence of that, but I just wanted to make sure I understood that. And then just second question is on the impairment charge. Understanding sort of a technicality with the market cap and the book value. So should we think about that impairment charge as, in the unfortunate event that market cap continues to decline for whatever reason, right? Like does that impairment charge come back or -- ROE level set at some point? I'm just trying to think about the forward impact.

No, it's one and done.

Okay.

It's a very strict GAAP rule. And so if in the future we are trading well above tangible book value, we don't kept to write-up goodwill. And we have written off all the goodwill we had, so there is nothing more that would -- there would be no future write downs.

This concludes our question-and-answer session. I would like to turn the conference back over to Raul Vazquez for any closing remarks.

Just want to thank everyone once again for joining us on today's call, and we look forward to speaking with you again soon. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.