Oportun Financial Corp 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations For more information about terms and abbreviations used in this report see the “ Glossary ” at the end of Part II of this report. An index to our management's discussion and analysis follows: Topic Overview 38 Key Financial and Operating Metrics 40 Seasonality 42 Historical Credit Performance 41 Results of Operations 43 Fair Value Estimate Methodology for Loans Receivable at Fair Value 48 Non-GAAP Financial Measures 49 Liquidity and Capital Resources 54 Critical Accounting Policies and Significant Judgments and Estimates 56 Recently Issued Accounting Pronouncements 57 The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (this “MD&A”) is intended to help the reader understand our results of operations and financial condition. This MD&A is provided as a supplement to, and should be read together with, our audited consolidated financial statements and the related notes thereto and other disclosures included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this MD&A, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the information contained in Part I, Item 1A. “Risk Factors” of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in this MD&A. Overview We are a financial technology company and digital banking platform driven by our mission to provide inclusive, affordable financial services that empower our members to build a better future. By intentionally designing our products with our members in mind, we are focused on realizing our vision to deliver a complete set of financial solutions that meet the needs of hardworking people, from borrowing and banking to savings, investing and more. We take a holistic approach to serving our members and view it as our purpose to responsibly meet their current capital needs, help grow our members’ financial profiles, increase their financial awareness and put them on a path to a financially healthy life. In our 16-year lending history, we have extended more than $12.0 billion in responsible credit through more than 4.9 million loans and credit cards . We have been certified as a Community Development Financial Institution ("CDFI") by the U.S. Department of the Treasury since 2009. With our acquisition of Hello Digit, Inc. ("Digit") on December 22, 2021, we believe we now have a strong competitive advantage over other fintechs and neobanks. As a combined company, we can now offer access to a comprehensive suite of digital banking products, offered either directly or through partners, including lending, savings and investing powered by A.I. and tailored to each member's goals. Digit began with a savings product and the intent to apply A.I. to make financial health effortless for everyone. Following the success of the initial savings product, Digit has now expanded its offering to bank account and investment products. Since 2015, Digit members have saved over $7.2 billion towards their rainy day fund and other savings goals and paid down more than $330.0 million in debt. Our financial products allow us to meet our members where they are and assist them with their overall financial health, resulting in opportunities to present multiple relevant products to our members. Our credit products include personal loans, secured personal loans and credit cards. Our digital banking products include digital banking, automated savings, long-term investing and retirement savings. Consumers are able to become members and access our products through our digital banking app — the Digit app — and the Oportun.com website, which are our primary channels for onboarding and serving members. Our personal loan products are also available over the phone or through over 480 retail locations, which includes 258 of our Lending as a Service partner locations. Credit Products Personal Loans - Our personal loan is a simple-to-understand, affordable, unsecured, fully amortizing installment loan with fixed payments throughout the life of the loan. We charge fixed interest rates on our loans, which vary based on the amount disbursed and applicable state law, with a cap of 36% annual percentage rate (“APR”) in all cases. As of December 31, 2021 , for all active loans in our portfolio and at time of disbursement, the weighted average term and APR at origination was 35 months and 32.4%, respectively. The average loan size for loans we originated in 2021 was $3,357. Our loans do not have prepayment penalties or balloon payments, and range in size from $300 to $11,000 with terms of 11 to 52 months. Generally, loan payments are structured on a bi-weekly or semi-monthly basis to coincide with our members' receipt of their income. As part of our underwriting process, we verify income for all applicants and only approve loans that meet our ability-to-pay criteria. As of December 31, 2021, we originate unsecured personal loans in 12 states through state licenses and in 26 states through our partnership with MetaBank, N.A. Secured Personal Loans - In April 2020, we launched a personal installment loan product secured by an automobile, which we refer to as secured personal loans. Our secured personal loans range in size from $2,525 to $20,000 with terms ranging from 21 to 64 months. The average loan 38 size for secured personal loans we originated in 2021 was $7,003. As of December 31, 2021, for all active loans in our portfolio and at time of disbursement, the weighted average term and APR at origination was 46 months and 29.6%, respectively. As part of our underwriting process, we verify income for all applicants and only approve loans that meet our ability-to-pay criteria. Our secured personal loans are currently offered in California, Texas and Florida, and we are in the process of expanding to other states. Credit Cards - We lau nched Oportun® Visa® Credit Card, issued by WebBank, Member FDIC, in December 2019, and offer credit cards in 45 states as of December 31, 2021. Credit lines on our credit cards range in size from $300 to $1,000 with an APR between 24.9% to 29.9%. The average APR of the outstanding credit card receivables was 29.8% as of December 31, 2021. The average credit line for credit cards activated in 2021 was $898. Digital Banking Products Digit Savings – Our Digit Savings product is designed to understand a member’s cash flows and save the right amount on a regular basis to effortlessly achieve savings goals. Digit Direct – Our Digit Direct product offers intelligent budgeting across bills, savings and spending via a checking account, offered through a bank partner, and members can have Digit be their primary banking relationship. Digit Investing and Digit Retirement – Our Digit investment and retirement products are a longer-term savings solution via an A.I.-driven portfolio allocation into low-cost investments based upon risk-tolerance. Our long-term investment solutions automatically allocates our members' savings into low-cost risk-adjusted portfolios held in brokerage accounts or tax-advantaged IRAs. Since 2020, our members have invested $36 million into long-term goals through low-cost ETF portfolios. The investment products include a general investing account and a retirement account for our members’ longer term goals, utilizing smart recommendations to invest savings in risk-adjusted portfolios. Lending as a Service Beyond our core direct-to-consumer lending business, we believe that we can leverage our proprietary credit scoring and underwriting model to partner with other consumer brands. Our first strategic partner for this Lending as a Service model was DolEx Dollar Express, Inc. (“DolEx”). In this partnership, DolEx markets loans and enters borrower applications into Oportun’s system, and Oportun underwrites, originates and services the loans. In July 2021, we signed Barri Financial Group as a Lending as a Service partner, which we launched in several locations in October 2021. In January of 2022, we announced our first all-digital Lending as a Service partnership with Sezzle, a leading provider of Buy Now Pay Later (“BNPL”) financing options. When deployed, Oportun will be available as a checkout option, through Sezzle, for larger purchases, which we believe will allow us to reach more new members. We believe we will be able to offer Lending as a Service to additional partners, and expand our membership base. Capital Markets Funding To fund our growth at a low and efficient cost, we have built a diversified and well-established capital markets funding program, which allows us to partially hedge our exposure to rising interest rates or credit spreads by locking in our interest expense for up to three years. Over the past eight years, we have executed 17 bond offerings in the asset-backed securities market, the last 14 of which include tranches that have been rated investment grade. We issued two- and three-year fixed rate bonds which have provided us committed capital to fund future loan originations at a fixed Cost of Debt. We are also party to a whole loan sale program whereby we sell a percentage of our loans to a third-party financial institution. In addition to our whole loan sale program, we also have a $600.0 million Personal Loan Warehouse facility with a term through September 2024 and a $150.0 million Credit Card Warehouse facility with a term through December 2023 which also helps to fund our receivables growth. Digit Acquisition On December 22, 2021, we completed our acquisition of Digit. Digit is a digital banking platform that provides automated savings, investing and banking tools. Digit members can keep and integrate their existing bank accounts into the platform, or they can make Digit their primary banking relationship by opening new accounts via Digit’s bank partner. By acquiring Digit, Oportun further expands its A.I. and digital capabilities, adding to its services to provide consumers a holistic offering built to address their financial needs. The total consideration we provided for Digit was approximately $205.3 million, comprised of $73.2 million in equity and $132.1 million in cash, subject to customary adjustments. The total consideration as reported herein differs from the amounts previously disclosed due to changes in the underlying value of the stock between the date the of the definitive agreement and the closing of the acquisition . The number of shares of Company common stock comprising the stock portion of the consideration was determined using the stock price as of the signing of the definitive agreement. We acquired 100% of the outstanding stock of Digit, and Digit is now our wholly-owned subsidiary. The cash consideration was funded with a $116.0 million Acquisition Financing facility. Digit started as a savings platform that connects to members’ checking accounts and analyzes their income and spending patterns to find amounts that can safely be set aside towards savings goals. Digit calculates these amounts by identifying upcoming bills and regular spending habits to ensure optimal amounts are flagged for savings and transferred to savings accounts. The funds in these saving accounts are owned by Digit members and are not the assets of the Company. Therefore, these funds are not included in the Consolidated Balance Sheets. Retail Network Optimization Consistent with our retail network optimization plan, during the first quarter of 2021, we closed 136 retail locations and reduced a portion of the employee workforce who managed and operated these retail locations. In addition, for the twelve months ended December 31, 2021, we incurred $11.2 million in expenses related to the retail location closures. In the first quarter of 2021, we recognized $1.6 million related to severance and 39 benefits related to the store closures which represents all severance and benefits related costs to be incurred related to the retail network optimization plan. The income statement impact for the twelve months ended December 31, 2021 was $12.8 million and was recorded through General, administrative and other on the Consolidated Statements of Operations. As the initial retail network optimization plan was substantially completed in the third quarter, there were no significant expenses incurred for the three months ended December 31, 2021. Key Financial and Operating Metrics We monitor and evaluate the following key metrics in order to measure our current performance, develop and refine our growth strategies, and make strategic decisions. For a presentation of the actual impact of the election of the fair value option for the periods presented in the financial statements included elsewhere in this report, please see the next section, "Non-GAAP Financial Measures". The Fair Value Pro Forma information is presented in that section because it is non-GAAP presentation. The following table and related discussion set forth key financial and operating metrics for our operations as of and for the years ended December 31, 2021 and 2020. For similar financial and operating metrics and discussion of our 2020 results compared to our 2019 results, refer to Part II. Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2020 as filed with the SEC on February 23, 2021 (File No. 001-39050). As of or for the Year Ended December 31, (in thousands of dollars, except CAC) 2021 2020 Key Financial and Operating Metrics Members (1) 1,479,660 651,600 Products (2) 1,545,463 651,600 Aggregate Originations $ 2,295,012 $ 1,347,994 30+ Day Delinquency Rate 3.9 % 3.7 % Annualized Net Charge-Off Rate 6.8 % 9.8 % Return on Equity 8.9 % (9.4) % Adjusted Return on Equity 14.7 % (3.0) % Other Metrics Number of Loans Originated 753,474 449,362 Customer Acquisition Cost $ 155 $ 199 Average Daily Principal Balance $ 1,756,170 $ 1,701,665 Owned Principal Balance at End of Period $ 2,272,864 $ 1,639,626 Managed Principal Balance at End of Period $ 2,583,462 $ 1,895,410 Operating Efficiency 74.6 % 67.4 % Adjusted Operating Efficiency 67.3 % 61.1 % (1) The Member metric reported as of December 31, 2020 is our previously defined Active Customer metric. (2) Products presented as of December 31, 2020 represents one product per member as we did not have members with multiple products at that time. See “ Glossary ” at the end of Part II of this report for formulas and definitions of our key performance metrics. Members Members as of December 31, 2021 grew to 1.5 million, as compared to 0.7 million as of December 31, 2020 . This increase was primarily driven by the acquisition of Digit and its members, as well as the increase in application volume and the growth of our credit card and secured personal loan products due to investments in d igital marketing, direct mail and referral programs. 40 Products Products as of December 31, 2021, grew to 1.5 million, compared to the 0.7 million Products we had as of December 31, 2020. This increase was primarily driven by the acquisition of Digit and its four digital banking products: Digit Savings, Digit Investing, Digit Retirement and Digit Direct. Combined with Oportun's unsecured personal loans, secured personal loans and credit cards, these seven products comprise our product offerings. Aggregate Originations Aggregate Originations increased to $2.30 billion for the year ended December 31, 2021 from $1.35 billion for the year ended December 31, 2020, representing a 70.3% increase. The increase is primarily driven by an increased number of applications due to higher demand. We originated 753,474 and 449,362 loans for the years ended December 31, 2021 and 2020, respectively. 30+ Day Delinquency Rate Our 30+ Day Delinquency Rate remained relatively flat at 3.9% and 3.7% as of December 31, 2021 and 2020, respectively, due to the effectiveness of our collections tools and payment options that have helped our borrowers manage through the pandemic as well as tighter underwriting criteria for loans originated since the pandemic began . Annualized Net Charge-Off Rate Annualized Net Charge-Off Rate for the years ended December 31, 2021 and 2020 was 6.8% and 9.8%, respectively. Net charge-offs decreased due to the overall improvement in the economy, the impact of stimulus payments to consumers as well as the effectiveness of our A.I.-driven underwriting models, collections tools and payment options that have helped our borrowers manage through the pandemic. Return on Equity and Adjusted Return on Equity For the year ended December 31, 2021 and 2020, Return on Equity was 8.9% and (9.4)%, respectively, and Adjusted Return on Equity was 14.7% and (3.0)%, respectively. The increases in Return on Equity and Adjusted Return on Equity are primarily due to higher net income. Net income was higher due to lower credit losses and increased fair value of our loan portfolio due to improved credit outlook. For a reconciliation of Return on Equity to Adjusted Return on Equity, see “Non–GAAP Financial Measures—Fair Value Pro Forma.” Historical Credit Performance Our A.I.-driven credit models enable us to originate loans with low and stable loss rates. Our Annualized Net Charge-off Rate ranged between 7% and 9% from 2011 to 2019 and was 9.8% in 2020, a modest variance above this range during the pandemic. Due to credit tightening in response to the COVID-19 pandemic and government stimulus payments our Annualized Net Charge-Off Rate decreased to 6.8% in 2021. However, we anticipate this rate will return to levels consistent with performance in pre-pandemic years. Consistent with our charge-off policy, we evaluate our loan portfolio and charge a loan off at the earlier of when the loan is determined to be uncollectible or when loans are 120 days contractually past due or 180 days contractually past due in the case of credit cards. . In addition to monitoring our loss and delinquency performance on an owned portfolio basis, we also monitor the performance of our loans by the period in which the loan was disbursed, generally years or quarters, which we refer to as a vintage. We calculate net lifetime loan loss rate by 41 vintage as a percentage of original principal balance. Net lifetime loan loss rates equal the net lifetime loan losses for a given year through December 31, 2021 divided by the total origination loan volume for that year. The below chart and table shows our net lifetime loan loss rate for each annual vintage of our personal loan product since we began lending in 2006, excluding loans originated from July 2017 to August 2020 under a loan program for borrowers who did not meet the qualifications for our core loan origination program. 100% of those loans were sold pursuant to a whole loan sale agreement. We have managed to stabilize cumulative net loan losses since the financial crisis that started in 2008. We even achieved a net lifetime loan loss rate of 5.5% during the peak of the recession in 2009. The evolution of our credit models has allowed us to increase our average loan size and commensurately extend our average loan terms. Cumulative net lifetime loan losses for the 2015, 2016, 2017, and 2018 vintages increased partially due to the delay in tax refunds in 2017 and 2019, the impact of natural disasters such as Hurricane Harvey, and the longer duration of the loans. The 2018 and 2019 vintages are increasing due to the COVID-19 pandemic. Year of Origination 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Dollar weighted average original term for vintage in months 9.3 9.9 10.2 11.7 12.3 14.5 16.4 19.1 22.3 24.2 26.3 29.0 30.0 32.0 Net lifetime loan losses as of December 31, 2021 as a percentage of original principal balance 7.7 % 8.9 % 5.5 % 6.4 % 6.2 % 5.6 % 5.6 % 6.1 % 7.1 % 8.0 % 8.2 % 10.0 %* 10.0 %* 4.2 %* Outstanding principal balance as of December 31, 2021 as a percentage of original amount disbursed — % — % — % — % — % — % — % — % — % — % 0.1 % 1.6 % 14.3 % 51.8 % * Vintage is not yet fully mature from a loss perspective. Seasonality Our quarterly results of operations may not necessarily be indicative of the results for the full year or the results for any future periods. Our business is highly seasonal, and the fourth quarter is typically our strongest quarter in terms of loan originations. For the three months ended December 31, 2021, our business exhibited growth in originations and revenue and improved profitability. Prior to the pandemic, we historically experienced a seasonal decline in credit performance in the fourth quarter primarily attributable to competing demand of our borrowers' available cash flow around the holidays. General increases in our borrowers’ available cash flow in the first quarter, including from cash received from tax refunds, temporarily reduces our borrowers’ borrowing needs. We experienced this seasonal trend in 2021, consistent with years prior to the COVID-19 pandemic. The economic impact of COVID-19 disrupted these seasonal trends in March 2020 and for the remainder of 2020. 42 Results of Operations The following tables and related discussion set forth our Consolidated Statements of Operations for the years ended December 31, 2021 and 2020. For a discussion regarding our operating and financial data for the year ended December 31, 2020, as compared to the same period in 2019, refer to Part II, Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2020, as filed with the SEC on February 23, 2021 (File No. 001-39050). Years Ended December 31, (in thousands of dollars) 2021 2020 Revenue Interest income $ 575,839 $ 545,466 Non-interest income 50,943 38,268 Total revenue 626,782 583,734 Less: Interest expense 47,669 58,368 Total net decrease in fair value (48,632) (190,306) Net revenue 530,481 335,060 Operating expenses: Technology and facilities 139,564 129,795 Sales and marketing 116,882 89,375 Personnel 115,833 106,446 Outsourcing and professional fees 57,931 47,067 General, administrative and other 37,480 20,471 Total operating expenses 467,690 393,154 Income (loss) before taxes 62,791 (58,094) Income tax expense (benefit) 15,377 (13,012) Net income (loss) $ 47,414 $ (45,082) Total revenue Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % Revenue Interest income $ 575,839 $ 545,466 $ 30,373 5.6 % Non-interest income 50,943 38,268 12,675 33.1 % Total revenue $ 626,782 $ 583,734 $ 43,048 7.4 % Percentage of total revenue: Interest income 91.9 % 93.4 % Non-interest income 8.1 % 6.6 % Total revenue 100.0 % 100.0 % Interest income. Total interest income increased by $30.4 million, or 5.6%, from $545.5 million for 2020 to $575.8 million for 2021. The increase is primarily attributable to growth in our Average Daily Principal Balance, which grew from $1.70 billion for 2020 to $1.76 billion for 2021 , an increase of 3.2%. The increase is due to growth in our portfolio as a result of higher application volume due to increased demand and due to 2020 originations being depressed as a result of the COVID-19 pandemic. Interest income was also favorably impacted by an increase in portfolio yield of 72 basis points in the year ended December 31, 2021 compared to the year ended December 31, 2020 due to growth in originations to new members who generally receive higher APRs than returning members. Non-interest income. Total non-interest income increased by $12.7 million, or 33.1%, from $38.3 million for 2020 to $50.9 million for 2021. This increase is primarily due to increased gain on loans sold of $6.4 million, or 31.7% under our whole loan sale programs due to an increase in loans sold resulting from higher origination volume. The increase in non-interest income is also due to $4.2 million of increased fees related to our credit card portfolio, $3.0 million increase related to MetaBank, N.A. documentation fees and $0.9 million attributed to Digit subscription income for the last ten days of 2021 after the acquisition, partially offset by decreased servicing fees of $2.0 million for the year ended December 31, 2021, due to the reduction in our serviced portfolio of sold loans due to lower sale volume since the onset of the COVID-19 pandemic and our decision to sell 10% versus 15% of originated loans. See Note 2 , Summary of Significant Accounting Policies , and Note 13 , Revenue , of the Notes to the Consolidated Financial Statements included elsewhere in this report for further discussion on our interest income, non-interest income and revenue. 43 Interest expense Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % Interest expense $ 47,669 $ 58,368 $ (10,699) (18.3) % Percentage of total revenue 7.6 % 10.0 % Cost of Debt 3.1 % 4.1 % Leverage as a percentage of Average Daily Principal Balance 88.5 % 83.8 % Interest expense. Interest expense decreased by $10.7 million, or 18.3%, from $58.4 million for 2020 to $47.7 million for 2021. We financed approximately 88.5% of our loans receivable through debt for 2021 as compared to 83.8% for 2020 , and our Average Daily Debt Balance increased from $1.43 billion to $1.55 billion for 2021 , an increase of 9.0%. We have continued to improve our Cost of Debt as we have been able to refinance at lower interest rates and increase the size of our securitizations. In 2022, we expect our interest expense to increase as we borrow to fund our portfolio growth and interest rates increase. See Note 2 , Summary of Significant Accounting Policies , and Note 9 , Borrowings , in the Notes to the Consolidated Financial Statements included in this report for further information on our Interest expense and our Secured Financing and asset-backed notes. Total net decrease in fair value Net decrease in fair value reflects changes in fair value of Fair Value Loans and Fair Value Notes on an aggregate basis and is based on a number of factors, including benchmark interest rates, credit spreads, remaining cumulative charge-offs and borrower payment rates. Increases in the fair value of loans increase Net Revenue. Conversely, decreases in the fair value of loans decrease Net Revenue. Increases in the fair value of asset-backed notes decrease Net Revenue. Decreases in the fair value of asset-backed notes increase Net Revenue. We also have derivative instruments related to our bank partnership program with MetaBank, N.A. Changes in the fair value of the derivative instrument are reflected in the total fair value mark-to-market adjustment below. Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % Fair value mark-to-market adjustment: Fair value mark-to-market adjustment on fair value loans $ 57,044 $ (25,548) $ 82,592 * Fair value mark-to-market adjustment on asset-backed notes 15,408 2,137 13,271 * Fair value mark-to-market adjustment on derivatives (3,097) — (3,097) Total fair value mark-to-market adjustment 69,355 (23,411) 92,766 * Charge-offs, net of recoveries on loans receivable at fair value (119,413) (166,895) 47,482 * Excess interest - credit card performance fee 1,426 — 1,426 * Total net decrease in fair value $ (48,632) $ (190,306) $ 141,674 * Percentage of total revenue: Fair value mark-to-market adjustment 11.1 % (4.0) % Charge-offs, net of recoveries on loans receivable at fair value (19.1) % (28.6) Total net decrease in fair value (8.0) % (32.6) % Discount rate 6.94 % 6.85 % Remaining cumulative charge-offs 9.60 % 10.03 % Average life in years 0.86 0.80 * Not meaningful Net decrease in fair value. Net decrease in fair value for 2021 was $48.6 million. This amount represents a total fair value mark-to-market increase of $69.4 million, and $119.4 million of charge-offs, net of recoveries on Fair Value Loans. The total fair value mark-to-market adjustment consists of a $57.0 million mark-to-market adjustment on Fair Value Loans due to (a) a decrease in remaining cumulative charge-offs from 10.03% as of December 31, 2020 to 9.60% as of December 31, 2021 due to improving credit trends, (b) an increase in average life from 0.80 years as of December 31, 2020 to 0.86 years as of December 31, 2021, partially offset by (c) an increase in the discount rate from 6.85% as of December 31, 2020 to 6.94% as of December 31, 2021 caused by higher interest rates. The $15.4 million mark-to-market adjustment on Fair Value Notes is due to rising rates and widening asset-backed securitization spreads. In 2022, we expect net decrease in fair value to be lower due to faster growth in new loans leading to increased losses. 44 Charge-offs, net of recoveries Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % Total charge-offs, net of recoveries $ 119,413 $ 166,895 $ (47,482) (28.5) % Average Daily Principal Balance 1,756,170 1,701,665 54,505 3.2 % Annualized Net Charge-Off Rate 6.8 % 9.8 % Charge-offs, net of recoveries. Our Annualized Net Charge-Off Rate decreased to 6.8% for the year ended December 31, 2021 from 9.8% for the year ended December 31, 2020. Net charge-offs for the year ended December 31, 2021 decreased primarily due to the overall improvement in the economy, the impact of stimulus payments to consumers as well as the effectiveness of our A.I.-driven underwriting models, collections tools and payment options that have helped our borrowers manage through the pandemic . Consistent with our charge-off policy, we evaluate our loan portfolio and charge a loan off at the earlier of when the loan is determined to be uncollectible or when loans are 120 days contractually past due or 180 days contractually past due in the case of credit cards. In 2022, we expect growth in new loan originations and our loan portfolio overall to lead to higher charge-offs. Operating expenses Operating expenses consist of technology and facilities, sales and marketing, personnel, outsourcing and professional fees and general, administrative and other expenses. Operating expenses include $50.1 million and $21.9 million related to new products for the years ended December 31, 2021 and 2020, respectively. Technology and facilities Technology and facilities expense is the largest segment of our operating expenses, representing the costs required to build our A.I.-enabled digital platform, and consisting of three components. The first component comprises costs associated with our technology, engineering, information security, cybersecurity, platform development, maintenance, and end user services, including fees for software licenses, consulting, legal and other services as a result of our efforts to grow our business, as well as personnel expenses. The second includes rent for retail and corporate locations, utilities, insurance, telephony costs, property taxes, equipment rental expenses, licenses and fees and depreciation and amortization. Lastly, the third category includes all software licenses, subscriptions, and technology service costs to support our corporate operations, excluding sales and marketing. Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % Technology and facilities $ 139,564 $ 129,795 $ 9,769 7.5 % Percentage of total revenue 22.3 % 22.2 % Technology and facilities . Technology and facilities expense increased by $9.8 million, or 7.5%, from $129.8 million for 2020 to $139.6 million for 2021. The increase is primarily due to $7.9 million service costs related to higher usage of software and cloud services, $3.5 million of increased depreciation commensurate with growth in internally developed software, $2.1 million in usage of India off-shoring services and other temporary contractors to supplement staffing related to new product investment and $3.4 million increase in salaries and benefits due to the increase in headcount. These increases were partially offset by the $3.7 million lower impairment charge related to fixed assets and system development costs associated with our direct auto product recorded in 2020 that were not present in 2021, $1.8 million lower office rent associated with retail locations that were closed as a result of the retail network optimization plan earlier in 2021 and $1.4 million lower expense due to higher capitalization of internally developed software in 2021 compared to 2020. Sales and marketing Sales and marketing expenses consist of two components and represent the costs to acquire our members. The first component is comprised of the expense to acquire a member through various paid marketing channels including direct mail, digital marketing and brand marketing. The second component is comprised of the costs associated with our telesales, lead generation and retail operations, including personnel expenses, but excluding costs associated with retail locations. Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars, except CAC) 2021 2020 $ % Sales and marketing $ 116,882 $ 89,375 $ 27,507 30.8 % Percentage of total revenue 18.6 % 15.3 % Customer Acquisition Cost (CAC) $ 155 $ 199 $ (44) (22.1) % Sales and marketing. Sales and marketing expenses to acquire our members increased by $27.5 million, or 30.8%, from $89.4 million for 2020 to $116.9 million for 2021. To grow our Aggregate Originations, we increased our investment in marketing initiatives by $33.8 million across various 45 marketing channels, including direct mail, digital advertising, lead aggregators and our referral programs. This increase was partially offset by $8.0 million lower personnel-related costs as a result of the implementation of our retail network optimization plan that began in the first quarter of 2021. As a result of our increased number of loans originated during the year ended December 31, 2021, our CAC decreased by 22.1%, from $199 for the year ended December 31, 2020 to $155 for the year ended December 31, 2021. Personnel Personnel expense represents compensation and benefits that we provide to our employees, and include salaries, wages, bonuses, commissions, related employer taxes, medical and other benefits provided and stock-based compensation expense for all of our staff with the exception of our telesales, lead generation, and retail operations which are included in sales and marketing expense and technology which is included in technology and facilities expense. Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % Personnel $ 115,833 $ 106,446 $ 9,387 8.8 % Percentage of total revenue 18.5 % 18.2 % Personnel . Personnel expense increased by $9.4 million, or 8.8%, from $106.4 million for 2020 to $115.8 million for 2021, primarily driven by a $9.5 million increase in compensation expense due to a 14.2% increase in U.S. headcount and merit increases. Outsourcing and professional fees Outsourcing and professional fees consist of costs for various third-party service providers and contact center operations, primarily for the sales, customer service, collections and store operation functions. Our contact centers located in Mexico and our third-party contact centers located in Colombia and Jamaica provide support for the business including application processing, verification, customer service and collections. We utilize third parties to operate the contact centers in Colombia and Jamaica and include the costs in outsourcing and other professional fees. Professional fees also include the cost of legal and audit services, credit reports, recruiting, cash transportation, collection services and fees and consultant expenses. Direct loan origination expenses related to application processing are expensed when incurred. In addition, outsourcing and professional fees include any financing expenses, including legal and underwriting fees, related to our Fair Value Notes. Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % Outsourcing and professional fees $ 57,931 $ 47,067 $ 10,864 23.1 % Percentage of total revenue 9.2 % 8.1 % Outsourcing and professional fees . Outsourcing and professional fees increased by $10.9 million, or 23.1%, from $47.1 million for 2020 to $57.9 million for 2021. The increase is primarily attributable to $11.3 million in debt financing fees and expenses related to asset-backed securitizations, $5.4 million increase in credit report expense due to higher application volume and $4.6 million of higher professional service costs related to credit card and bank partnership programs and expenses associated with our bank charter application. These increases were partially offset by a $5.3 million decrease related to ceasing legal collection on defaulted loans beginning in August 2020, $2.9 million lower outsourced service costs due to the decline in contact center outsourced headcount that was needed as a result of the uncertainty around the COVID-19 pandemic and $1.5 million in lower legal fees. General, administrative and other General, administrative and other expense includes non-compensation expenses for employees, who are not a part of the technology and sales and marketing organization, which include travel, lodging, meal expenses, political and charitable contributions, office supplies, printing and shipping. Also included are franchise taxes, bank fees, foreign currency gains and losses, transaction gains and losses, debit card expenses, litigation reserve, expenses associated with our retail network optimization plan and acquisition-related costs. Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % General, administrative and other $ 37,480 $ 20,471 $ 17,009 83.1 % Percentage of total revenue 6.0 % 3.5 % General, administrative and other . General, administrative and other expense increased by $17.0 million, or 83.1%, from $20.5 million for 2020 to $37.5 million for 2021, primarily due to our retail network optimization expenses of $11.2 million related to the retail location closures and $1.6 million related to severance and benefits related to the retail location closures. The increase was also attributable to $10.0 million of transaction and integration related expenses as a result of the Digit acquisition and a $3.3 million impairment charge recognized on a right-of-use asset related to our leased office space in San Carlos, California due to management's decision to move toward a remote-first work environment. These increases were partially offset by an $8.8 million decrease in litigation reserve relative to prior year and decreases in travel expenses due to travel restrictions and remote working arrangements resulting from the COVID-19 pandemic. Income taxes 46 Income taxes consist of U.S. federal, state and foreign income taxes, if any. For the years ended December 31, 2021 and 2020 we recognized tax expense (benefit) attributable to U.S. federal, state and foreign income taxes. Year Ended December 31, 2021 vs. 2020 Change (in thousands of dollars) 2021 2020 $ % Income tax expense (benefit) $ 15,377 $ (13,012) $ 28,389 218.2 % Percentage of total revenue 2.5 % (2.2) % Effective tax rate 24.5 % 22.4 % Income tax expense (benefit) . Income tax expense increased by $28.4 million or 218.2%, from a benefit of $13.0 million for 2020 to an expense of $15.4 million for 2021, primarily as a result of a pretax loss for the year ended December 31, 2020. See Note 2 , Summary of Significant Accounting Policies , and Note 14 , Income Taxes , of the Notes to the Consolidated Financial Statements included elsewhere in this report for further discussion on our income taxes. 47 Fair Value Estimate Methodology for Loans Receivable at Fair Value Summary Fair value is an electable option under GAAP to account for any financial instruments, including loans receivable and debt. It differs from amortized cost accounting in that loans receivable and debt are recorded on the balance sheet at fair value rather than on a cost basis. Under the fair value option credit losses are recognized through income as they are incurred rather than through the establishment of an allowance and provision for losses. The fair value of instruments under this election is updated at the end of each reporting period, with changes since the prior reporting period reflected in the Consolidated Statements of Operations as net decrease in fair value which impacts Net Revenue. Changes in interest rates, credit spreads, realized and projected credit losses and cash flow timing will lead to changes in fair value and therefore impact earnings. These changes in the fair value of the Fair Value Loans may be partially offset by changes in the fair value of the Fair Value Notes, depending upon the relative duration of the instruments. Fair Value Estimate Methodology for Loans Receivable at Fair Value We calculate the fair value of Fair Value Loans using a model that projects and discounts expected cash flows. The fair value is a function of: • Portfolio yield; • Average life; • Prepayments (or principal payment rate for our credit card receivables); • Remaining cumulative charge-offs; and • Discount rate. Portfolio yield is the expected interest and fees collected from the loans as an annualized percentage of outstanding principal balance. Portfolio yield is based upon (a) the contractual interest rate, reduced by expected delinquencies and interest charge-offs and (b) late fees, net of late fee charge-offs based upon expected delinquencies. Origination fees are not included in portfolio yield since they are generally capitalized as part of the loan’s principal balance at origination. Average life is the time-weighted average of expected principal payments divided by outstanding principal balance. The timing of principal payments is based upon the contractual amortization of loans, adjusted for the impact of prepayments, Good Customer Program refinances, and charge-offs. Prepayments are the expected remaining cumulative principal payments that will be repaid earlier than contractually required over the life of the loan, divided by the outstanding principal balance. For credit card receivables we estimate principal payment rates which are the expected amount and timing of principal payments over the life of the receivable. Remaining cumulative charge-offs is the expected net principal charge-offs over the remaining life of the loans, divided by the outstanding principal balance. Discount rate is the sum of the interest rate and the credit spread. The interest rate is based upon the interpolated LIBOR/swap curve rate that corresponds to the average life. The credit spread is based upon the credit spread implied by the whole loan purchase price at the time the flow sale agreement was entered into, updated for observable changes in the fixed income markets, which serve as a proxy for how a whole loan buyer would adjust their yield requirements relative to the originally agreed price. Our internal valuation committee includes members from our risk, legal, finance, capital markets and operations departments and provides governance and oversight over the fair value pricing and related financial statement disclosures. Additionally, this committee provides a challenge of the assumptions used and outputs of the model, including the appropriateness of such measures and periodically reviews the methodology and process to determine the fair value pricing. Any significant changes to the process must be approved by the committee. It is also possible to estimate the fair value of our loans using a simplified calculation. The table below illustrates a simplified calculation to aid investors in understanding how fair value may be estimated using the last eight quarters: • Subtracting the servicing fee from the weighted average portfolio yield over the remaining life of the loans to calculate net portfolio yield; • Multiplying the net portfolio yield by the weighted average life in years of the loans receivable, which is based upon the contractual amortization of the loans and expected remaining prepayments and charge-offs to calculate net cash flow; • Subtracting the remaining cumulative charge-offs from the net portfolio yield to calculate the net cash flow; • Subtracting the product of the discount rate and the average life from the net cash flow to calculate the gross fair value premium as a percentage of loan principal balance; and • Subtracting the accrued interest and fees as a percentage of loan principal balance from the gross fair value premium as a percentage of loan principal balance to calculate the fair value premium as a percentage of loan principal balance. 48 The table below reflects the application of this methodology for the eight quarters since January 1, 2020, on loans held for investment. The data for the three months ended December 31, 2021 in the table below represents all of our credit products. The data for the three months ended September 30, 2021 in the table below represents our secured and unsecured loan portfolio. For prior quarters, the data in the table below represents only our unsecured personal loan portfolio which was the primary driver of fair value during those periods. Three Months Ended Dec 31, 2021 Sep 30, 2021 Jun 30, 2021 Mar 31, 2021 Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Weighted average portfolio yield over the remaining life of the loans 30.14 % 30.35 % 30.28 % 30.25 % 30.17 % 30.50 % 30.78 % 30.74 % Less: Servicing fee (5.00) % (5.00) % (5.00) % (5.00) % (5.00) % (5.00) % (5.00) % (5.00) % Net portfolio yield 25.14 % 25.35 % 25.28 % 25.25 % 25.17 % 25.50 % 25.78 % 25.74 % Multiplied by: Weighted average life in years 0.859 0.761 0.769 0.778 0.796 0.775 0.797 0.903 Pre-loss cash flow 21.60 % 19.26 % 19.43 % 19.64 % 20.03 % 19.75 % 20.54 % 23.25 % Less: Remaining cumulative charge-offs (9.60) % (7.53) % (7.59) % (8.60) % (10.03) % (10.61) % (12.73) % (14.56) % Net cash flow 12.00 % 11.73 % 11.84 % 11.04 % 10.00 % 9.14 % 7.81 % 8.69 % Less: Discount rate multiplied by average life (5.96) % (4.96) % (5.03) % (5.17) % (5.45) % (6.07) % (7.04) % (11.54) % Gross fair value premium (discount) as a percentage of loan principal balance 6.04 % 6.77 % 6.81 % 5.87 % 4.55 % 3.07 % 0.77 % (2.85) % Less: Accrued interest and fees as a percentage of loan principal balance (1.03) % (0.90) % (0.87) % (0.92) % (1.06) % (1.15) % (1.35) % (1.11) % Fair value premium (discount) as a percentage of loan principal balance 5.01 % 5.87 % 5.94 % 4.95 % 3.49 % 1.92 % (0.58) % (3.96) % Discount Rate 6.94 % 6.52 % 6.54 % 6.65 % 6.85 % 7.84 % 8.84 % 12.78 % The illustrative table included above is designed to assist investors in understanding the impact of our election of the fair value option. Non-GAAP Financial Measures We believe that the provision of non-GAAP financial measures in this report, including Fair Value Pro Forma information, Adjusted EBITDA, Adjusted Net Income, Adjusted EPS, Adjusted Operating Efficiency and Adjusted Return on Equity, can provide useful measures for period-to-period comparisons of our core business and useful information to investors and others in understanding and evaluating our operating results. However, non-GAAP financial measures are not calculated in accordance with United States generally accepted accounting principles, or GAAP, and should not be considered as an alternative to any measures of financial performance calculated and presented in accordance with GAAP. There are limitations related to the use of these non-GAAP financial measures versus their most directly comparable GAAP measures, which include the following: ▪ Other companies, including companies in our industry, may calculate these measures differently, which may reduce their usefulness as a comparative measure. ▪ These measures do not consider the potentially dilutive impact of stock-based compensation. ▪ During the last three quarters of 2020 we excluded COVID-19 related expenses in our adjustments to derive Adjusted Net Income and Adjusted EBITDA. As of January 1, 2021, COVID-19 expenses are no longer being excluded from Adjusted Net Income or Adjusted EBITDA because our business practices have been updated to operate in the current environment. ▪ Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements. ▪ Although the fair value mark-to-market adjustment is a non-cash adjustment, it does reflect our estimate of the price a third party would pay for our Fair Value Loans or our Fair Value Notes. ▪ Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us. Reconciliations of non-GAAP to GAAP measures can be found below. 49 Fair Value Pro Forma We previously elected the fair value option to account for all Fair Value Loans held for investment and all Fair Value Notes issued on or after January 1, 2018. In order to facilitate comparisons to prior periods, we have provided below unaudited financial information for the year ended December 31, 2020 on a pro forma basis, or the Fair Value Pro Forma, as if we had elected the fair value option since our inception for all loans originated and held for investment and all asset-backed notes issued. Upon adoption of ASU 2019-05, effective January 1, 2020, we elected the fair value option on all remaining loans that had previously been measured at amortized cost. Accordingly, for the years ended December 31, 2021 and 2020, we did not have any loans receivable measured at amortized cost. Therefore, there are no Fair Value Pro Forma adjustments related to assets or revenue as of and for the years ended December 31, 2021 and 2020. As of January 1, 2021, we no longer have any Fair Value Pro Forma adjustments as there are no longer any amortized cost balances. However, on a Fair Value Pro Forma basis, the year ended December 31, 2020 includes Fair Value Pro Forma adjustments related to our asset-backed notes at amortized cost. Fair Value Pro Forma Consolidated Statements of Operations Data: Year Ended December 31, 2021 (1) Year Ended December 31, 2020 Period-to-period Change in FVPF (1) (in thousands) As Reported As Reported FV Adjustments FV Pro Forma $ % Revenue: Interest income $ 575,839 $ 545,466 $ — $ 545,466 $ 30,373 5.6 % Non-interest income 50,943 38,268 — 38,268 12,675 33.1 % Total revenue 626,782 583,734 — 583,734 43,048 7.4 % Less: Interest expense 47,669 58,368 (889) 57,479 (9,810) (17.1) % Net decrease in fair value (48,632) (190,306) 667 (189,639) 141,007 74.4 % Net revenue 530,481 335,060 1,556 336,616 193,865 57.6 % Operating expenses: Technology and facilities 139,564 129,795 — 129,795 9,769 7.5 % Sales and marketing 116,882 89,375 — 89,375 27,507 30.8 % Personnel 115,833 106,446 — 106,446 9,387 8.8 % Outsourcing and professional fees 57,931 47,067 — 47,067 10,864 23.1 % General, administrative and other 37,480 20,471 — 20,471 17,009 83.1 % Total operating expenses 467,690 393,154 — 393,154 74,536 19.0 % Income (loss) before taxes 62,791 (58,094) 1,556 (56,538) 119,329 211.1 % Income tax expense (benefit) 15,377 (13,012) 682 (12,330) 27,707 224.7 % Net income (loss) $ 47,414 $ (45,082) $ 874 $ (44,208) $ 91,622 207.3 % (1) Beginning in 2021 we are no longer including any Fair Value Pro Forma adjustments because all loans originated and held for investment and asset-backed notes issued are recorded at fair value. Therefore, the year ended December 31, 2021 is presented on a GAAP basis and the year ended December 31, 2020 includes Fair Value Pro Forma adjustments related to our asset-backed notes at amortized cost. Fair Value Pro Forma Consolidated Balance Sheet Data: December 31, 2021 (1) December 31, 2020 Period-to-period Change in FVPF (1) (in thousands) As Reported As Reported FV Adjustments FV Pro Forma $ % Cash and cash equivalents $ 130,959 $ 136,187 $ — $ 136,187 $ (5,228) (3.8) % Restricted cash 62,001 32,403 — 32,403 29,598 91.3 % Loans receivable 2,386,807 1,696,526 — 1,696,526 690,281 40.7 % Other assets 366,858 143,935 — 143,935 222,923 154.9 % Total assets 2,946,625 2,009,051 — 2,009,051 937,574 46.7 % Total debt 2,159,687 1,413,694 — 1,413,694 745,993 52.8 % Other liabilities 183,057 128,729 682 129,411 53,646 41.5 % Total liabilities 2,342,744 1,542,423 682 1,543,105 799,639 51.8 % Total stockholder's equity 603,881 466,628 (682) 465,946 137,935 29.6 % Total liabilities and stockholders' equity $ 2,946,625 $ 2,009,051 $ — $ 2,009,051 $ 937,574 46.7 % (1) Beginning in 2021 we are no longer including any Fair Value Pro Forma adjustments because all loans originated and held for investment and asset-backed notes issued are recorded at fair value. Therefore, the balances as of December 31, 2021 are presented on a GAAP basis and the balances as of December 31, 2020 include Fair Value Pro Forma adjustments related to our asset-backed notes at amortized cost. 50 Adjusted EBITDA Adjusted EBITDA is a non-GAAP financial measure defined as our net income (loss), adjusted for the impact of our election of the fair value option and further adjusted to eliminate the effect of certain items as described below. We believe that Adjusted EBITDA is an important measure because it allows management, investors and our Board to evaluate and compare our operating results, including our return on capital and operating efficiencies, from period-to-period by making the adjustments described below. In addition, it provides a useful measure for period-to-period comparisons of our business, as it removes the effect of taxes, certain non-cash items, variable charges and timing differences. • We believe it is useful to exclude the impact of income tax expense (benefit), as reported, because historically it has included irregular income tax items that do not reflect ongoing business operations. • We believe it is useful to exclude the impact of depreciation and amortization and stock-based compensation expense because they are noncash charges. • We believe it is useful to exclude the impact of certain non-recurring charges, such as expenses associated with a litigation reserve, our retail network optimization plan, impairment charges and acquisition and integration related expenses because these items do not reflect ongoing business operations. During the last three quarters of 2020 we excluded COVID-19 expenses in our adjustments to derive Adjusted EBITDA. As of January 1, 2021, COVID-19 expenses are no longer being excluded from Adjusted EBITDA because our business practices have been updated to operate in the current environment. • We also reverse origination fees for Fair Value Loans, net. We recognize the full amount of any origination fees as revenue at the time of loan disbursement in advance of our collection of origination fees through principal payments. As a result, we believe it is beneficial to exclude the uncollected portion of such origination fees, because such amounts do not represent cash that we received. • We also reverse the fair value mark-to-market adjustment because it is a non-cash adjustment as shown in the table below. Components of Fair Value Mark-to-Market Adjustment - Fair Value Pro Forma (in thousands) Year Ended December 31, 2021 2020 Fair value mark-to-market adjustment on Fair Value Loans $ 57,044 $ (25,548) Fair value mark-to-market adjustment on asset-backed notes 15,408 2,804 Fair value mark-to-market adjustment on derivatives (3,097) — Total fair value mark-to-market adjustment - Fair Value Pro Forma $ 69,355 $ (22,744) The following table presents a reconciliation of net income (loss) to Adjusted EBITDA for the years ended December 31, 2021 and 2020 as if the fair value option had been in place since inception for all loans held for investment and all asset-backed notes: Year Ended December 31, Adjusted EBITDA (in thousands) 2021 2020 Net income (loss) $ 47,414 $ (45,082) Adjustments: Fair Value Pro Forma net income adjustment (1) — 874 Income tax expense (benefit) 15,377 (12,330) COVID-19 expenses (2) — 4,632 Depreciation and amortization 23,714 20,220 Impairment (3) 3,324 3,702 Stock-based compensation expense 18,857 19,488 Litigation reserve — 8,750 Retail network optimization expenses 12,828 — Acquisition and integration related expenses 10,648 — Origination fees for Fair Value Loans, net (15,836) (900) Fair value mark-to-market adjustment (69,355) 22,744 Adjusted EBITDA (4) $ 46,971 $ 22,098 (1) Beginning in 2021 we are no longer including any Fair Value Pro Forma adjustments because all loans originated and held for investment and asset-backed notes issued are recorded at fair value. (2) As of January 1, 2021, COVID-19 expenses are no longer being excluded from Adjusted EBITDA because our business practices have been updated to operate in the current environment. (3) The impairment charge in 2021 was recognized on a right-of-use asset related to our leased office space in San Carlos, California due to management's decision to move toward a remote-first work environment. The impairment charge in 2020 was recognized on fixed assets and system development costs associated with our direct auto product. (4) For the year ended December 31, 2021, Adjusted EBITDA includes a pre-tax impact of $28.8 million, related to the launch of new products and services (such as secured personal loans, credit card, bank partnership and expenses associated with our bank charter application). For the year ended December 31, 2020, Adjusted EBITDA included a pre-tax impact of $18.2 million related to the launch of new products and services (such as direct auto and credit card). 51 Adjusted Net Income (Loss) We define Adjusted Net Income (Loss) as our net income (loss), adjusted for the impact of our election of the fair value option, and further adjusted to exclude income tax expense (benefit), stock-based compensation expenses and certain non-recurring charges. We believe that Adjusted Net Income (Loss) is an important measure of operating performance because it allows management, investors, and our Board to evaluate and compare our operating results, including our return on capital and operating efficiencies, from period to period. • We believe it is useful to exclude the impact of income tax expense (benefit), as reported, because historically it has included irregular tax items that do not reflect our ongoing business operations. • We believe it is useful to exclude the impact of certain non-recurring charges, such as expenses associated with a litigation reserve, our retail network optimization plan, impairment charges and acquisition and integration related expenses, because these items do not reflect ongoing business operations. During the last three quarters of 2020 we excluded COVID-19 related expenses in our adjustments to derive Adjusted Net Income. As of January 1, 2021, COVID-19 expenses are no longer being excluded from Adjusted Net Income because our business practices have been updated to operate in the current environment. • We believe it is useful to exclude stock-based compensation expense because it is a non-cash charge. • We include the impact of normalized statutory income tax expense by applying the income tax rate noted in the table. The following table presents a reconciliation of net income (loss) to Adjusted Net Income (Loss) for the years ended December 31, 2021 and 2020 as if the fair value option had been in place since inception for all loans held for investment and all asset-backed notes: Year Ended December 31, Adjusted Net Income (Loss) (in thousands) 2021 2020 Net income (loss) $ 47,414 $ (45,082) Adjustments: Fair Value Pro Forma net income adjustment (1) — 874 Income tax expense (benefit) 15,377 (12,330) COVID-19 expenses (2) — 4,632 Impairment (3) 3,324 3,702 Stock-based compensation expense 18,857 19,488 Litigation reserve — 8,750 Retail network optimization expenses 12,828 — Acquisition and integration related expenses 10,648 — Adjusted income (loss) before taxes 108,448 (19,966) Normalized income tax expense (benefit) 29,715 (5,738) Adjusted Net Income (Loss) (4) $ 78,733 $ (14,228) Income tax rate (5) 27.4 % 28.7 % (1) Beginning in 2021 we are no longer including any Fair Value Pro Forma adjustments because all loans originated and held for investment and asset-backed notes issued are recorded at fair value. (2) As of January 1, 2021, COVID-19 expenses are no longer being excluded from Adjusted Net Income because our business practices have been updated to operate in the current environment. (3) The impairment charge in 2021 was recognized on a right-of-use asset related to our leased office space in San Carlos, California due to management's decision to move toward a remote-first work environment. The impairment charge in 2020 was recognized on fixed assets and system development costs associated with our direct auto product. (4) For the year ended December 31, 2021, Adjusted Net Income includes an after-tax impact of $17.4 million, related to the launch of new products and services (such as secured personal loans, credit card, bank partnership and expenses associated with our prior bank charter application). For the year ended December 31, 2020, Adjusted Net Income includes an after-tax impact of $14.2 million, related to the launch of new products and services (such as direct auto and credit card). (5) Income tax rate for the year ended December 31, 2021 is based on a normalized statutory rate and the year ended December 31, 2020, is based on the effective tax rate. Adjusted Earnings Per Share (“Adjusted EPS”) Adjusted Earnings Per Share is a non-GAAP financial measure that allows management, investors and our Board to evaluate the operating results, operating trends and profitability of the business in relation to diluted adjusted weighted-average shares outstanding post initial public offering. In addition, it provides a useful measure for period-to-period comparisons of our business, as it considers the effect of conversion of all convertible preferred shares as of the beginning of each annual period. 52 The following table presents a reconciliation of Diluted EPS to Diluted Adjusted EPS for the years ended December 31, 2021 and 2020. For the reconciliation of net income (loss) to Adjusted Net Income (Loss), see the immediately preceding table “Adjusted Net Income (Loss).” Year Ended December 31, (in thousands, except share and per share data) 2021 2020 Diluted earnings (loss) per share $ 1.56 $ (1.65) Adjusted EPS Adjusted Net Income (Loss) $ 78,733 $ (14,228) Basic weighted-average common shares outstanding 28,191,610 27,333,271 Weighted average effect of dilutive securities: Stock options 1,375,915 — Restricted stock units 755,669 — Diluted adjusted weighted-average common shares outstanding 30,323,194 27,333,271 Adjusted Earnings (Loss) Per Share $ 2.60 $ (0.52) Adjusted Return on Equity We define Adjusted Return on Equity as annualized Adjusted Net Income (loss) divided by average stockholders’ equity. Average stockholders’ equity is an average of the beginning and ending stockholders’ equity balance for each period. Before January 1, 2021, we previously defined Adjusted Return on Equity as annualized Adjusted Net Income divided by average Fair Value Pro Forma total stockholders’ equity. Average Fair Value Pro Forma stockholders’ equity is an average of the beginning and ending Fair Value Pro Forma stockholders’ equity balance for each period. We believe Adjusted Return on Equity is an important measure because it allows management, investors and our Board to evaluate the profitability of the business in relation to equity and how well we generate income from the equity available. The following table presents a reconciliation of Return on Equity to Adjusted Return on Equity for the years ended December 31, 2021 and 2020. For the reconciliation of net income (loss) to Adjusted Net Income (Loss), see the immediately preceding table “Adjusted Net Income (Loss).” As of or for the Year Ended December 31, (in thousands) 2021 2020 Return on Equity 8.9 % (9.4) % Adjusted Return on Equity Adjusted Net Income (Loss) $ 78,733 $ (14,228) Fair Value Pro Forma average stockholders' equity (1) $ 535,255 $ 476,474 Adjusted Return on Equity 14.7 % (3.0) % (1) Beginning in 2021 we are no longer including any Fair Value Pro Forma adjustments because all loans originated and held for investment and asset-backed notes issued are recorded at fair value. Therefore, the average stockholders' equity amount as of December 31, 2021 reflects the average of the GAAP stockholders' equity account as of December 31, 2020 and the GAAP stockholders' equity account as of December 31, 2021. 53 Adjusted Operating Efficiency We define Adjusted Operating Efficiency as total operating expenses adjusted to exclude stock-based compensation expense and certain non-recurring charges such as expenses associated with a litigation reserve, our retail network optimization plan, impairment charges and acquisition and integration related expenses divided by total revenue. During the last three quarters of 2020 we excluded COVID-19 related expenses in our adjustments to derive Adjusted Operating Efficiency. As of January 1, 2021, COVID-19 expenses are no longer being excluded from Adjusted Operating Efficiency because our business practices have been updated to operate in the current environment. We believe Adjusted Operating Efficiency is an important measure because it allows management, investors and our Board to evaluate how efficient we are at managing costs relative to revenue. The following table presents a reconciliation of Operating Efficiency to Adjusted Operating Efficiency for the years ended December 31, 2021 and 2020 : As of or for the Year Ended December 30, (in thousands) 2021 2020 Operating Efficiency 74.6 % 67.4 % Adjusted Operating Efficiency Total revenue $ 626,782 $ 583,734 Total operating expense 467,690 393,154 COVID-19 expenses (1) — (4,632) Impairment (2) (3,324) (3,702) Stock-based compensation expense (18,857) (19,488) Litigation reserve — (8,750) Retail network optimization expenses (12,828) — Acquisition and integration related expenses (10,648) — Total adjusted operating expenses $ 422,033 $ 356,582 Adjusted Operating Efficiency 67.3 % 61.1 % (1) As of January 1, 2021, COVID-19 expenses are no longer being excluded from Adjusted Operating Efficiency because our business practices have been updated to operate in the current environment. (2) The impairment charge in 2021 was recognized on a right-of-use asset related to our leased office space in San Carlos, California due to management's decision to move toward a remote-first work environment. The impairment charge in 2020 was recognized on fixed assets and system development costs associated with our direct auto product. Liquidity and Capital Resources To date, we fund the majority of our operating liquidity and operating needs through a combination of cash flows from operations, securitizations, secured borrowings and whole loan sales. We may also utilize other sources in the future. Our material cash requirements relate to funding our lending activities, our debt service obligations, our operating expenses, and investments in the long-term growth of the company. During 2021, available liquidity increased primarily due to increased borrowing capacity under secured financings, partially offset by a decrease in cash and cash equivalents. We generally target liquidity levels to support at least twelve months of our expected net cash outflows, including new originations, without access to new debt financing transactions or other capital markets activity. We expect the COVID-19 pandemic to continue to adversely impact our business, liquidity, and capital resources. Future decreases in cash flows from operations resulting from delinquencies, defaults, losses, would decrease the cash available for the capital uses described above. We may incur additional indebtedness or issue equity in order to meet our capital spending and liquidity requirements, as well as to fund growth opportunities that we may pursue. Cash and cash flows The following table summarizes our cash and cash equivalents, restricted cash and cash flows for the periods indicated: Year Ended December 31, (in thousands) 2021 2020 Cash, cash equivalents and restricted cash $ 192,960 $ 168,590 Cash provided by (used in) Operating activities 163,447 152,869 Investing activities (884,786) 16,379 Financing activities 745,709 (136,799) Our cash is held for working capital purposes and originating loans. Our restricted cash represents collections held in our securitizations and is applied currently after month-end to pay interest expense and satisfy any amount due to whole loan buyer with any excess amounts returned to us. 54 Operating Activities Our net cash provided by operating activities was $163.4 million and $152.9 million for the years ended December 31, 2021 and 2020, respectively. Cash flows from operating activities primarily include net income or losses adjusted for (i) non-cash items included in net income or loss, including depreciation and amortization expense, fair value adjustments, net, origination fees for loans at fair value, net, gain on loan sales, stock-based compensation expense, and deferred tax provision, net, (ii) originations of loans sold and held for sale, and proceeds from sale of loans and (iii) changes in the balances of operating assets and liabilities, which can vary significantly in the normal course of business due to the amount and timing of various payments. Investing Activities Our net cash provided by (used in) investing activities was $884.8 million and $16.4 million for the years ended December 31, 2021 and 2020, respectively. Our investing activities consist primarily of loan originations and loan repayments. We currently do not own any real estate. We invest in purchases of property and equipment and incur system development costs. Purchases of property and equipment, and capitalization of system development costs may vary from period to period due to the timing of the expansion of our operations, the addition of employee headcount and the development cycles of our system development. The change in our net cash provided by (used in) investing activities is primarily due to disbursements on originations of loans increasing by $830.4 million while repayments of loan principal only increased by $53.0 million for the year ended December 31, 2021 compared to the year ended December 31, 2020. The change our net cash provided by (used in) investing activities is also driven by our acquisition of Digit, net of acquirer's cash received of $111.7 million. Financing Activities Our net cash provided by (used in) financing act ivities was $745.7 million and $(136.8) million for the years en ded December 31, 2021 and 2020, respectively. For the year ended December 31, 2021, net cash provided by financing activities was primarily driven by the issuance of our Series 2021-A, 2021-B and 2021-C asset-backed securitizations and the borrowings under the Secured Financing facilities and Acquisition Financing. For the year ended December 31, 2020, net cash used in financing activities was primarily driven by repayments of borrowings of our Secured Financing facility and redemption of our Series 2017-A and 2017-B asset-backed notes, partially offset by borrowings on our Secured Financing facility. Sources of Funds Debt and Available Credit Asset-Backed Securitizations As of December 31, 2021, we had $1.65 billion of outstanding asset-backed notes. During 2021, we issued $1.38 billion of asset-backed securities with maturities ranging from 2 to 3 years. Our securitizations utilize special purpose entities (SPEs) which are also variable interest entities (VIEs) that meet the requirements to be consolidated in our financial statements. For more information regarding our asset-backed securitizations, see Note 9, Borrowings of the Notes to the Consolidated Financial Statements included elsewhere in this report. Our ability to utilize our asset-backed securitization facilities as described herein is subject to compliance with various requirements including eligibility criteria for the loan collateral and covenants and other requirements. As of December 31, 2021, we were in compliance with all covenants and requirements of all our asset-backed notes. Secured Financings As of December, 31, 2021 , we had Secured Financing facilities with warehouse lines of $750.0 million in the aggregate with undrawn capacity of $352.0 million. Our ability to utilize our Secured Financing facilities as described herein is subject to compliance with various requirements, including eligibility criteria for collateral, concentration limits for our collateral pool, and covenants and other requirements. Acquisition Financing On December 20, 2021, Oportun RF, LLC, a wholly-owned subsidiary of the Company issued a $116.0 million asset-backed floating rate variable funding note, and an asset-backed residual certificate, both of which are secured by certain residual cash flows from the Company's securitizations and guaranteed by Oportun, Inc. The note was used to fund the cash consideration paid for the acquisition of Digit and bears interest at a rate of one-month LIBOR plus 8.00%. The Acquisition Financing is structured to pay down based on an amortization schedule, with a final payment in October 2024. As of December 31, 2021, we were in compliance with all covenants and requirements per the Secured Financing facilities and Acquisition Financing. For more information regarding our Secured Financing facilities and Acquisition Financing, see Note 9, Borrowings of the Notes to the Consolidated Financial Statements included elsewhere in this report. Whole loan sales As of December 31, 2021, we have a whole loan sale flow agreement with an institutional investor through March 4, 2022, in which we agreed to sell at least 10% of our personal loan originations, with an option to sell an additional 5%, subject to certain eligibility criteria and minimum and maximum volumes. The o riginations of loans sold and held for sale during the year ended December 31, 2021 was $214.6 million . For further 55 information on the whole loan sale transactions, see Note 5, Loans Held for Sale of the Notes to the Consolidated Financial Statements included in this report. Bank Partnership Program and Servicing Agreement We entered into a bank partnership program with MetaBank, N.A. on August 11, 2020. In accordance with the agreements underlying the bank partnership program, Oportun has a commitment to purchase an increasing percentage of program loans originated by MetaBank based on thresholds specified in the agreements. Lending under the partnership was launched in August of 2021. Contractual Obligations and Commitments The material cash requirements for our contractual and other obligations primarily include those related our outstanding borrowings under our asset-backed notes, Acquisition Financing and Secured Financing, corporate and retail leases, and purchase commitments for technology used in the business. See Note 9, Borrowings and Note 16, Leases, Commitments and Contingencies of the Notes to the Consolidated Financial Statements included in this report for more information. Liquidity Risks We believe that our existing cash balance, anticipated positive cash flows from operations and available borrowing capacity under our credit facilities will be sufficient to meet our anticipated cash operating expense and capital expenditure requirements through at least the next 12 months. We do not have any significant unused sources of liquid assets. If our available cash balances are insufficient to satisfy our liquidity requirements, we will seek additional debt or equity financing. In a rising interest rate environment, our ability to issue additional equity or incur debt may be impaired and our borrowing costs may increase. If we raise additional funds through the issuance of additional debt, the agreements governing such debt could contain covenants that would restrict our operations and such debt would rank senior to shares of our common stock. The sale of equity may result in dilution to our stockholders and those securities may have rights senior to those of our common stock. We may require additional capital beyond our currently anticipated amounts and additional capital may not be available on reasonable terms, or at all. Critical Accounting Policies and Significant Judgments and Estimates Our Management's Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. In accordance with GAAP, we base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are more fully described in Note 2, Summary of Significant Accounting Policies , in our Notes to the Consolidated Financial Statements included elsewhere in this report, we believe the following critical accounting policies affect the more significant estimates, assumptions and judgments we use to prepare our consolidated financial statements. Fair Value of Loans Held for Investment We elected the fair value option for our Fair Value Loans. We primarily use a discounted cash flow model to estimate fair value based on the present value of estimated future cash flows. This model uses inputs that are not observable but reflect our best estimates of the assumptions a market participant would use to calculate fair value. The following describes the primary inputs that require significant judgment: • Remaining Cumulative Charge-offs - Remaining cumulative charge-offs are estimates of the principal payments that will not be repaid over the life of a loan held for investment. Remaining cumulative loss expectations are adjusted to reflect the expected principal recoveries on charged-off loans. Remaining cumulative loss expectations are primarily based on the historical performance of our loans but also incorporate adjustments based on our expectations of future credit performance and are quantified by the remaining cumulative charge-off rate. • Remaining Cumulative Prepayments - Remaining cumulative prepayments are estimates of the principal payments that will be repaid earlier than contractually required over the life of a loan held for investment. Remaining cumulative prepayment rates are primarily based on the historical performance of our loans but also incorporate adjustments based on our expectations of future borrower behavior and refinancings through our Good Customer Program. For credit card receivables we estimate the principal payment rate which is the amount of principal we expect to get repaid each month. • Average Life - Average life is the time weighted average of the estimated principal payments divided by the principal balance at the measurement date. The timing of estimated principal payments is impacted by scheduled amortization of loans, charge-offs, and prepayments. • Discount Rates - The discount rates applied to the expected cash flows of loans held for investment reflect our estimates of the rates of return that investors would require when investing in financial instruments with similar risk and return characteristics. Discount rates are based on our estimate of the rate of return likely to be received on new loans. Discount rates for aged loans are adjusted to reflect the market relationship between interest rates and remaining time to maturity. We developed an internal model to estimate the fair value of Fair Value Loans. To generate future expected cash flows, the model combines receivable characteristics with assumptions about borrower behavior based on our historical loan performance. These cash flows are then discounted 56 using a required rate of return that management estimates would be used by a market participant. We test the fair value model by comparing modeled cash flows to historical loan performance to ensure that the model is complete, accurate and reasonable for our use. We also engaged a third party to create an independent fair value estimate for the Fair Value Loans, which provides a set of fair value marks using our historical loan performance data and whole loan sale prices to develop independent forecasts of borrower behavior. Their model used these assumptions to generate expected cash flows which were then aggregated and compared to actual cash flows within an acceptable range. Our internal valuation committee provides governance and oversight over the fair value pricing calculations and related financial statement disclosures. Additionally, this committee provides a challenge of the assumptions used and outputs of the model, including the appropriateness of such measures and periodically reviews the methodology and process to determine the fair value pricing. Any significant changes to the process must be approved by the committee. As discussed above, our fair value model uses inputs that are not observable but reflect our best estimates of the assumptions a market participant would use to calculate fair value. For a summary of how these inputs have changed over the last eight quarters since January 1, 2020, refer to Fair Value Estimate Methodology for Loans Receivable at Fair Value in Item 7. " Management's Discussion and Analysis of Financial Condition and Results of Operations ". For more information regarding the potential impact that changes in these inputs might have on our "Net increase (decrease) in fair value" on our Consolidated Statements of Operations, please refer to Item 7A. , " Quantitative and Qualitative Disclosures About Market Risk " included elsewhere in this report. Business Combination Under the acquisition method of accounting, we recognize tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. We record the excess of the fair value of the purchase consideration over the value of net assets acquired as goodwill. The accounting for business combinations requires us to make significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing developed technology, member relationships and other identifiable intangible assets include future cash flows that we expect to generate from the acquired assets and the appropriate discount rate. If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, we could experience impairment charges which could be material. In addition, we have estimated the economic lives of certain acquired assets and these lives are used to calculate depreciation and amortization expense. If our estimates of economic lives change, depreciation or amortization expenses could be accelerated or slowed. Recently Issued Accounting Pronouncements See Note 2 , Summary of Significant Accounting Policies , of the Notes to the Consolidated Financial Statements included elsewhere in this report for a discussion of recent accounting pronouncements and future application of accounting standards. 57