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 39 Key Financial and Operating Metrics 41 Seasonality 44 Historical Credit Performance 42 Results of Operations 45 Fair Value Estimate Methodology for Loans Receivable at Fair Value 50 Non-GAAP Financial Measures 51 Liquidity and Capital Resources 54 Critical Accounting Policies and Significant Judgments and Estimates 57 Recently Issued Accounting Pronouncements 58 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 digital banking platform that puts our members’ financial goals within reach. With intelligent borrowing, savings, budgeting, and spending capabilities, we empower members with the confidence to build a better financial future . By intentionally designing our products to help solve the financial health challenges facing a majority of people in the U.S., we believe our business is well positioned for significant growth. 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 $15.5 billion in responsible credit through more than 6.3 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 Digit in 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. 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 Oportun Mobile 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 700 retail locations, which includes 590 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, 2022, for all active loans in our portfolio and at time of disbursement, the weighted average term and APR at origination was 38 months and 32.0%, respectively. The average loan size for loans we originated in 2022 was $4,189. Our loans do not have prepayment penalties or balloon payments, and range in size from $300 to $12,000 with terms of 12 to 60 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, 2022, we originate unsecured personal loans in 12 states through state licenses and in 30 states through our partnership with Pathward, N.A. (formerly known as 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 $18,000 with terms ranging from 27 to 63 months. The average loan size for secured personal loans we originated in 2022 was $8,304. As of December 31, 2022, for all active loans in our portfolio and at time of disbursement, the weighted average term and APR at origination was 49 months and 28.3%, respectively. As part of our underwriting process, we 39 evaluate the collateral value of the vehicle, 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, Florida, Arizona and New Jersey and we are in the process of considering expansion into 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, 2022 . Credit lines on our credit cards range in size from $300 to $3,000 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, 2022 . The average credit line for credit cards activated in 2022 was $834. Digital Banking Products Savings – Our 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. Our savings product utilizes mac hine learning to analyze a member’s transaction activity and build forecasts of the member’s future cash flows to make small, frequent savings decisions according to the member’s financial goals in a personalized manner. Members integrate their existing bank accounts into the platform or they can make Digit their primary banking relationship through a bank partner. After one year using the automated savings product, members have been able to increase their liquid savings by approximately 50%. Since 2015 Digit has helped members save more than $8.9 billion . Direct – Our Direct product offers a full checking account, through a bank partner, that intelligently organizes and budgets a member’s money across bills, savings, and spending. The bank account with a brain™, Direct leverages the same A.I. engine used for our savings product to automatically identify and organize recurring bills and guides spending to ensure members' savings goals are met, and that members know exactly what they can safely spend. This is on top of what members can expect from a traditional checking account, including a physical and virtual debit card to use for purchases and ATM withdrawals and checks. Investing and Retirement – Our 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 $66.6 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. The funds in these savings, checking, investing and retirement accounts are owned by members of our digital banking products and are not the assets of the Company. Therefore, these funds are not included in the Consolidated Balance Sheets. 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 and expand our member base. With our Lending as a Service model, our partner markets loans and enters borrower applications into our system and Oportun underwrites, originates and services the loans. Our first lending as a service partner was DolEx Dollar Express, Inc. with an initial launch in December 2020. In October of 2021, we launched another Lending as a Service partnership with Barri Financial Group in select locations. 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 which launched in the first quarter of 2023. Oportun is now 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 20 bond offerings in the asset-backed securities market, the last 17 of which include tranches that have been rated investment grade. We have 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. On July 22, 2022, we issued $400.0 million of amortizing asset-backed notes. On September 14, 2022, we entered into a credit agreement for a $150.0 million senior secured term loan, which was upsized and amended on March 10, 2023 to provide the ability to be able to borrow up to an additional $75.0 million. On March 10, 2023, we borrowed $20.8 million of Incremental Tranche A-1 Loans and intend to borrow an additional $4.2 million of Incremental Tranche A-2 Loans on or about March 27, 2023, which amount has been committed by the applicable lenders. We may borrow up to an aggregate additional amount of $50.0 million on an uncommitted basis, in two $25.0 million tranches, expected to be available, if provided by the applicable lenders, on or about April 21, 2023 and June 23, 2023, respectively. On November 3, 2022, we issued $300.0 million of amortizing asset-backed notes. Through March 4, 2022, we were also party to a whole loan sale program whereby we sold a percentage of our loans to a third-party financial institution. We allowed the whole loan sale program agreement to expire on its own terms. In March 2022, we participated in a securitization and sold loans through the issuance of amortizing asset-backed notes secured by a pool of our unsecured and secured personal installment loans. We also sold our share of the residual interest in the pool. The sold loans had an aggregate unpaid principal balance of approximately $227.6 million ("2022-1 transaction"). During 2022, we sold certain populations of our personal loans and credit card receivables that had an aggregate unpaid principal balance, including unpaid interest and fees, of approximately $66.2 million. In addition to possible future whole loan, structured or other loan sales, 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. On March 8, 2023, the Credit Card Warehouse facility 40 was amended, extending its term through December 2024 and reducing its commitment from $150.0 million to $120.0 million. Streamlining Operations On February 9, 2023, we announced that we are taking a series of measures to streamline our operations, including reducing the size of our corporate staff by 10%, impacting approximately 155 employees, and reducing our expenditures on external contractors. In relation to these and other personnel related activities, we expect to incur non-recurring, pre-tax charges of $6 to $7 million in the first quarter of 2023. These reductions are anticipated to result in annualized run-rate savings in compensation and benefits of approximately $38 million beginning in 2023. We have also identified certain non-personnel related operational efficiencies that are anticipated to result in annualized run-rate savings of $10 to $15 million beginning in 2023. Retail Network Optimization During the first quarter of 2022, we closed an additional 27 retail locations in April 2022 and reduce a portion of the workforce who manage and operate these retail locations. The income statement impact for the twelve months ended December 31, 2022 was $1.9 million, and was recorded through General, administrative and other on the Consolidated Statements of Operations . This amount included expenses related to the retail location closures and all severance and benefits-related costs. While we do not expect any significant additional expenses to be incurred related to these closures, we are continually evaluating the performance of retail and partner locations. During the first quarter of 2021, pursuant to our retail network optimization plan we closed 136 retail locations and reduced a portion of the employee workforce who managed and operated these retail locations. 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 . This amount included expenses related to the retail location closures and all severance and benefits-related costs. 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. 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, 2022 and 2021. For similar financial and operating metrics and discussion of our 2021 results compared to our 2020 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, 2021 as filed with the SEC on March 1, 2022. As of or for the Year Ended December 31, (in thousands of dollars) 2022 2021 Key Financial and Operating Metrics Members (1) 1,877,260 1,479,660 Products (1) 2,006,245 1,545,463 Aggregate Originations $ 2,922,871 $ 2,295,012 30+ Day Delinquency Rate 5.6 % 3.9 % Annualized Net Charge-Off Rate 10.1 % 6.8 % Return on Equity (13.5) % 8.9 % Adjusted Return on Equity 12.1 % 14.7 % Other Metrics Managed Principal Balance at End of Period $ 3,406,981 $ 2,583,462 Owned Principal Balance at End of Period $ 3,098,609 $ 2,272,864 Average Daily Principal Balance $ 2,740,318 $ 1,756,170 (1) The 1,479,660 Members and 1,545,463 Products reported as of December 31, 2021 reflect our previously defined and disclosed "Members" and "Products" metrics. Beginning January 1, 2022, we modified our definition of Members to reflect the long-term nature of our relationship with our members and modified our definition of Products to reflect multiproduct adoption by our members. See “ Glossary ” at the end of Part II of this report for formulas and definitions of our key performance metrics. 41 Members We define Members as borrowers with an outstanding or successfully paid off loan, originated by us or under a bank partnership program that we service, or individuals who have been approved for a credit card issued under a bank partnership program. Members also include individuals who have signed-up to use or are using any of our Savings, Direct, Investing and/or Retirement products. We view Members as an indication of growth of our business and our ability to establish long term relationships with the users of our products. Member growth is generally an indicator of future revenue, but is not directly correlated with revenue, since not all Members who sign up for one of our products fully utilize or continue to use our products. Members as of December 31, 2022 grew to 1.9 million, as compared to 1.5 million as of December 31, 2021 . This increase was due to the success in our marketing efforts during the year. Products Products refers to the aggregate number of personal loans and/or credit card accounts that our Members have had or been approved for that have been originated by us or through one of our bank partners. Products also include the aggregate number of digital banking products we offer as a result of our acquisition of Digit, including Savings, Direct, Investing and Retirement, that our Members use or have signed-up to use. We view Products as an indicator of the effectiveness of our member acquisition efforts and multiproduct adoption. Products as of December 31, 2022, grew to 2.0 million, compared to the 1.5 million Products we had as of December 31, 2021. This increase was due to growth in both our credit products and our digital banking products. Aggregate Originations Aggregate Originations increased to $2.92 billion for the year ended December 31, 2022 from $2.30 billion for the year ended December 31, 2021, representing a 27.4% increase. The increase is primarily driven by a growth in average loan size due to a focus on returning members with historically lower credit risk and a larger number of loans originated. We originated 764,516 and 753,474 loans for the years ended December 31, 2022 and 2021, respectively. The increase is primarily driven by an increased number of applications due to higher demand, partially offset by a reduction in our approval rate as we tightened credit. 30+ Day Delinquency Rate Our 30+ Day Delinquency Rate increased to 5.6% as of December 31, 2022 from 3.9% as of December 31, 2021. The increase reflects the higher mix of first-time borrowers and the return to pre-pandemic underwriting criteria later in 2021. In mid-2022, we took numerous actions to improve the credit performance on newly originated loans; including significantly tightening our underwriting standards for all borrowers, particularly for higher risk digital marketing channels, and adjusting loan size based on member free cash flow. We also focused lending towards existing and returning members to address rising delinquencies. Annualized Net Charge-Off Rate Annualized Net Charge-Off Rate for the years ended December 31, 2022 and 2021 was 10.1% and 6.8%, respectively. The increase is primarily driven by a higher mix of first-time borrowers in 2022 compared to 2021. In mid-2022, we took numerous actions to improve the credit performance on newly originated loans; including significantly tightening our underwriting standards for all borrowers, particularly for higher risk digital marketing channels, and adjusting loan size based on member free cash flow. We also focused lending towards existing and returning members to improve credit outcomes as existing and returning members historically have had lower loss rates. Further, due to credit tightening in response to the COVID-19 pandemic and government stimulus payments our Annualized Net Charge-Off Rate was lower in 2021. We anticipate that this rate may increase in 2023 due to the impact of inflation and other macroeconomic factors on members. Return on Equity and Adjusted Return on Equity For the year ended December 31, 2022 and 2021, Return on Equity was (13.5)% and 8.9%, respectively. The decrease in Return on Equity is primarily due to lower net income, primarily as a result of the goodwill impairment. For the year ended December 31, 2022 and 2021, Adjusted Return on Equity was 12.1% and 14.7%, respectively. The decrease in Adjusted Return on Equity is primarily due to lower Adjusted Net Income. Adjusted Net Income was lower due to higher credit losses, higher cost of funds and decreased fair value of our loan portfolio as a result of higher loss and discount rate assumptions. For a reconciliation of Return on Equity to Adjusted Return on Equity, see “Non–GAAP Financial Measures.” Historical Credit Performance 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. Our Annualized Net Charge-off Rate increased to 10.1% in 2022 primarily due to a higher mix of first-time borrowers in 2021 and the first half of 2022. In response to this increase, we tightened our credit underwriting standards and focused lending towards existing and returning members to improve credit outcomes. 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 and charge-off a credit 42 card account when it is 180 days contractually past due. 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 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, 2022 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. The 2021 vintage is running higher than prior vintages primarily due to a higher percentage of loan disbursements to new members. We have tightened credit and began reducing loan volumes to new and returning members in the third quarter of 2021 and reduced further in the second half of 2022. 43 Year of Origination 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 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 33.3 Net lifetime loan losses as of December 31, 2022 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 % 9.8 % 10.6 %* 7.5 %* 8.7 %* Outstanding principal balance as of December 31, 2022 as a percentage of original amount disbursed — % — % — % — % — % — % — % — % — % — % — % — % 2.2 % 14.5 % 50.6 % * 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, 2022, our business exhibited lower than typical originations due to our credit tightening. 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 2022, consistent with years prior to the COVID-19 pandemic. 44 Results of Operations The following tables and related discussion set forth our Consolidated Statements of Operations for the years ended December 31, 2022 and 2021. For a discussion regarding our operating and financial data for the year ended December 31, 2021, as compared to the same period in 2020, 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, 2021, as filed with the SEC on March 1, 2022. Years Ended December 31, (in thousands of dollars) 2022 2021 Revenue Interest income $ 876,114 $ 575,839 Non-interest income 76,431 50,943 Total revenue 952,545 626,782 Less: Interest expense 93,046 47,669 Total net decrease in fair value (218,842) (48,632) Net revenue 640,657 530,481 Operating expenses: Technology and facilities 216,120 139,564 Sales and marketing 110,033 116,882 Personnel 154,850 115,833 Outsourcing and professional fees 67,630 57,931 General, administrative and other 58,838 37,480 Goodwill impairment 108,472 — Total operating expenses 715,943 467,690 Income (loss) before taxes (75,286) 62,791 Income tax expense 2,458 15,377 Net income (loss) $ (77,744) $ 47,414 Total revenue Year Ended December 31, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % Revenue Interest income $ 876,114 $ 575,839 $ 300,275 52.1 % Non-interest income 76,431 50,943 25,488 50.0 % Total revenue $ 952,545 $ 626,782 $ 325,763 52.0 % Percentage of total revenue: Interest income 92.0 % 91.9 % Non-interest income 8.0 % 8.1 % Total revenue 100.0 % 100.0 % Interest income. Total interest income increased by $300.3 million, or 52.1%, from $575.8 million for 2021 to $876.1 million for 2022. The increase is primarily attributable to growth in our Average Daily Principal Balance, which grew from $1.76 billion for 2021 to $2.74 billion for 2022 , an increase of 56.0%. The increase was partially offset by a decrease in portfolio yield of 82 basis points in the year ended December 31, 2022 compared to the year ended December 31, 2021 driven by our tightening of credit underwriting standards and focusing lending towards existing and returning members in the second half of 2022. Existing and returning members generally receive lower APRs, but historically have lower loss rates compared to new members. Non-interest income. Total non-interest income increased by $25.5 million, or 50.0%, from $50.9 million for 2021 to $76.4 million for 2022. This increase is primarily due to $37.5 million attributable to Digit subscription income and $6.7 million increase in servicing revenue. This was partially offset by decreased gain on loans sold of $21.5 million under our whole loan sale programs due to the expiration of our whole loan sale agreement on March 4, 2022. 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. 45 Interest expense Year Ended December 31, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % Interest expense $ 93,046 $ 47,669 $ 45,377 95.2 % Percentage of total revenue 9.8 % 7.6 % Cost of Debt 3.7 % 3.1 % Leverage as a percentage of Average Daily Principal Balance 91.2 % 88.5 % Interest expense. Interest expense increased by $45.4 million, or 95.2%, from $47.7 million for 2021 to $93.0 million for 2022. We financed approximately 91.2% of our loans receivable through debt for 2022 as compared to 88.5% for 2021, and our Average Daily Debt Balance increased from $1.55 billion to $2.50 billion for 2022, an increase of 60.9%. Our Cost of Debt has increased due to increases in interest rates and wider credit spreads on our new asset-backed securitization issuances. We expect our interest expense to increase as benchmark interest rates rise and as we continue to fund our portfolio growth through debt. See Note 2, Summary of Significant Accounting Policies , and Note 9, Borrowings , in the Notes to the Consolidated Financial Statements included elsewhere in this report for further information on our Interest expense and our borrowings. Total net decrease in fair value Net increase (decrease) in fair value reflects changes in fair value of loans receivable held for investment and asset-backed 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 Pathward, 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, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % Fair value mark-to-market adjustment: Fair value mark-to-market adjustment on Loans Receivable at Fair Value $ (68,897) $ 57,044 $ (125,941) * Fair value mark-to-market adjustment on asset-backed notes 184,906 15,408 169,498 * Fair value mark-to-market adjustment on derivatives 3,702 (3,097) 6,799 Total fair value mark-to-market adjustment 119,711 69,355 50,356 * Charge-offs, net of recoveries on loans receivable at fair value (276,796) (119,413) (157,383) * Net settlements on derivative instruments (15,688) 1,426 (17,114) * Fair value mark on loans sold (1) (46,069) — (46,069) * Total net decrease in fair value $ (218,842) $ (48,632) $ (170,210) * Percentage of total revenue: Fair value mark-to-market adjustment 12.6 % 11.1 % Charge-offs, net of recoveries on loans receivable at fair value (29.1) % (19.1) Total net decrease in fair value (16.5) % (8.0) % Discount rate 11.48 % 6.94 % Remaining cumulative charge-offs 10.38 % 9.60 % Average life in years 1.00 0.86 * Not meaningful (1) The fair value mark-to-market adjustment on loans receivable at fair value shown for the year ended December 31, 2022, excludes $(46.1) million related to the cumulative fair value mark on loans sold as part of the structured and other loan sales in 2022. For details regarding the structured and other loan sales in 2022, refer to Note 5, Loans Held for Sale and Loans Sold of the Notes to the Consolidated Financial Statements included elsewhere in this report. Net decrease in fair value. Net decrease in fair value for 2022 was $218.8 million. This amount represents a total fair value mark-to-market increase of $119.7 million, and $276.8 million of charge-offs, net of recoveries on Loans Receivable at Fair Value. The total fair value mark-to-market adjustment consists of a $(68.9) million mark-to-market adjustment on Loans Receivable at Fair Value due to (a) an increase in remaining cumulative charge-offs from 9.60% as of December 31, 2021 to 10.38% as of December 31, 2022, (b) an increase in the discount rate from 6.94% as of December 31, 2021 to 11.48% as of December 31, 2022, partially offset by (c) an increase in average life from 0.86 years as of December 31, 2021 to 1.00 years as of December 31, 2022. The $184.9 million mark-to-market adjustment on asset-back notes is due to rising rates and widening asset-backed securitization spreads. The total net increase (decrease) in fair value for the year ended December 31, 2022 includes a $(46.1) million adjustment related to the fair value mark on loans sold as part of the structured and other loan sales in 2022. In 2023, we expect to continue to see volatility in fair value primarily as a result of macroeconomic conditions. 46 Charge-offs, net of recoveries Year Ended December 31, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % Total charge-offs, net of recoveries $ 276,796 $ 119,413 $ 157,383 131.8 % Average Daily Principal Balance 2,740,318 1,756,170 984,148 56.0 % Annualized Net Charge-Off Rate 10.1 % 6.8 % Charge-offs, net of recoveries. Our Annualized Net Charge-Off Rate increased to 10.1% for the year ended December 31, 2022 from 6.8% for the year ended December 31, 2021. Net charge-offs for the year ended December 31, 2022 increased primarily due to a higher mix of first-time borrowers in 2021 and the first half of 2022. In response to this increase, we tightened our credit underwriting standards and focused lending towards existing and returning members to improve credit outcomes in the second half of 2022. Further, due to credit tightening in response to the COVID-19 pandemic and government stimulus payments, our charge-offs were lower in 2021. 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 the loan is 120 days contractually past due and we charge-off a credit card account when it is 180 days contractually past due. Operating expenses Operating expenses consist of technology and facilities, sales and marketing, personnel, outsourcing and professional fees and general, administrative and other expenses. Technology and facilities Technology and facilities expense is the largest segment of our operating expenses, representing the costs required to build and maintain our A.I.-enabled digital platform, and consists 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 component 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 component includes all software licenses, subscriptions, and technology service costs to support our corporate operations, excluding sales and marketing. Year Ended December 31, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % Technology and facilities $ 216,120 $ 139,564 $ 76,556 54.9 % Percentage of total revenue 22.7 % 22.3 % Technology and facilities . Technology and facilities expense increased by $76.6 million, or 54.9%, from $139.6 million for 2021 to $216.1 million for 2022. The increase is primarily due to a $31.7 million increase in salaries and benefits due to the increase in headcount, a $27.2 million increase in service costs related to higher usage of software and cloud services which includes a $7.4 million increase attributable to Digit bank processing fees, $13.5 million incurred for India off-shoring services and other temporary contractors to supplement staffing related to new product investment and $11.5 million of increased depreciation commensurate with growth in internally developed software. These increases are partially offset by $8.0 million lower expense due to higher capitalization of internally developed software in 2022 compared to 2021 and $1.9 million lower office rent due to retail location closures in early 2021 and early 2022. We expect our technology and facilities expense may increase in 2023 compared to 2022 due to increased depreciation related to internally developed software and increased service costs due to higher usage of software and cloud services. 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, 2022 vs. 2021 Change (in thousands of dollars, except CAC) 2022 2021 $ % Sales and marketing $ 110,033 $ 116,882 $ (6,849) (5.9) % Percentage of total revenue 11.6 % 18.6 % Customer Acquisition Cost (CAC) $ 144 $ 155 $ (11) (7.1) % 47 Sales and marketing. Sales and marketing expenses to acquire our members decreased by $6.8 million, or 5.9%, from $116.9 million for 2021 to $110.0 million f or 2022. Our net decrease in marketing spend during the year ended December 31, 2022 was $14.8 million across various marketing channels, including digital advertising and direct mail. We decreased marketing spend as we shifted our strategy to focus lending towards existing and returning members to improve credit outcomes. The decrease in marketing spend was partially offset by an increase of $4.1 million related to outsourcing and professional fees primarily due to outsourced telesales FTEs as a result of an increase in demand for new applications and $2.7 million higher salaries and benefit costs due to increased headcount and increase in average compensation. As a result of our decreased marketing spend during the year ended December 31, 2022, our CAC decreased by 7.1%, from $155 for the year ended December 31, 2021 to $144 for the year ended December 31, 2022. We expect our sales and marketing expense to decrease in 2023 compared to 2022 as we maintain focus on our strategy to improve credit outcomes by focusing lending towards existing and returning members. 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 expenses and technology which is included in technology and facilities. Year Ended December 31, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % Personnel $ 154,850 $ 115,833 $ 39,017 33.7 % Percentage of total revenue 16.3 % 18.5 % Personnel . Personnel expense increased by $39.0 million, or 33.7%, from $115.8 million for 2021 to $154.9 million for 2022. $13.2 million of the increase is attributable to the Digit acquisition and the remaining increase is due to a 17.0% increase in U.S. headcount. We expect our personnel expense to decrease in 2023 compared to 2022 as a result of our recently announced plan to reduce headcount and streamline operations. 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. The costs related to our third-party contact centers located in Colombia, Jamaica and the Philippines are included in outsourcing and professional fees. These third-party contact centers provide business support, including application processing, verification, customer service and collections. 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 asset-backed notes. Year Ended December 31, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % Outsourcing and professional fees $ 67,630 $ 57,931 $ 9,699 16.7 % Percentage of total revenue 7.1 % 9.2 % Outsourcing and professional fees . Outsourcing and professional fees increased by $9.7 million, or 16.7%, from $57.9 million for 2021 to $67.6 million for 2022. The increase is primarily attributable to $7.5 million of higher professional service costs related to credit card programs and other consulting services and $3.3 million related to 84.2% growth in contact center outsourced FTEs as a result of an increase in demand for new applications and the new Philippines contact center. These increases were partially offset by a $3.4 million decrease in debt financing fees and expenses incurred on asset-backed notes issued in 2022 compared to asset-backed notes issued in 2021. We expect our outsourcing and professional fees to decrease in 2023 compared to 2022 as a result of our continued focus on cost cutting and streamlining operations. 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, retail network optimization expenses and Digit-related acquisition and integration expenses. Year Ended December 31, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % General, administrative and other $ 58,838 $ 37,480 $ 21,358 57.0 % Percentage of total revenue 6.2 % 6.0 % General, administrative and other . General, administrative and other expense increased by $21.4 million, or 57.0%, from $37.5 million for 2021 to $58.8 million for 2022, primarily due to an increase of $19.6 million of transaction and integration related expenses as a result of the Digit acquisition, $6.1 million of losses related to fraudulent loans, $2.7 million increase in litigation expense related to Digit CID litigation and $7.1 million increase in postage and printing expenses, travel expenses and other general and administrative expenses due to new products and services 48 and continuing growth of the business. These increases were partially offset by a $3.3 million decrease attributable to an impairment charge recognized in 2021 on a right-of-use asset related to our leased office space in San Carlos, California, not present in 2022 and a $10.9 million decrease in retail network optimization expenses incurred in the year ended December 31, 2022 compared to the year ended December 31, 2021. We expect our general, administrative and other expense to decrease in 2023 compared to 2022 as a result of our continued focus on cost cutting and strong expense discipline. Goodwill impairment Year Ended December 31, 2022 vs. 2021 Change (in thousands, except percentages) 2022 2021 $ % Goodwill impairment $ 108,472 $ — $ 108,472 * Percentage of total revenue 11.4 % — % Goodwill impairment. In response to a sustained decline in our share price primarily driven by macroeconomic conditions, we conducted a quantitative test of our goodwill as of September 30, 2022. As a result of this quantitative test, we identified an impairment to goodwill resulting in recognition of a $108.5 million non-cash goodwill impairment charge for the year ended December 31, 2022 . There were no goodwill impairment charges during the year ended December 31, 2021 . Income taxes Income taxes consist of U.S. federal, state and foreign income taxes, if any. For the years ended December 31, 2022 and 2021 we recognized tax expense attributable to U.S. federal, state and foreign income taxes. Year Ended December 31, 2022 vs. 2021 Change (in thousands of dollars) 2022 2021 $ % Income tax expense $ 2,458 $ 15,377 $ (12,919) 84.0 % Percentage of total revenue 0.3 % 2.5 % Effective tax rate (3.3) % 24.5 % Income tax expense . Income tax expense decreased by $12.9 million or 84.0%, from $15.4 million for 2021 to $2.5 million for 2022, primarily resulting from the tax benefits of the return-to-provision adjustments, generation of tax credits, and having lower pretax income for the year ended December 31, 2022 as a result of the goodwill impairment, which is non-deductible for income tax purposes. 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. 49 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 increase (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 Loans Receivable at Fair Value may be partially offset by changes in the fair value of the asset-backed 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 Loans Receivable at Fair Value 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 and credit cards 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 for personal loans 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. For personal loans, 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 cards, 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 and credit cards, divided by the outstanding principal balance. For personal loans, the discount rate is the sum of the interest rate and the credit spread. The interest rate is based upon the interpolated treasury curve rate that corresponds to the average life. The credit spread is based upon the credit spread implied by the loan purchase price at the time loans are sold, updated for observable changes in the fixed income markets, which serve as a proxy for how a potential loan buyer would adjust their yield requirements relative to the originally agreed price. For credit cards, the discount rate is the sum of our weighted average cost of funds and the spread implied by the personal loan discount rate. An implied spread is calculated by subtracting the weighted average borrowing cost of the Personal Loan Warehouse from the personal loan discount rate. This spread is then added to the weighted average borrowing cost of the Credit Card Warehouse to arrive at a discount rate for credit cards. 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. 50 The table below reflects the application of this methodology for the eight quarters since January 1, 2021, on loans held for investment. The data for the periods ending on or after 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, 2022 Sep 30, 2022 Jun 30, 2022 Mar 31, 2022 Dec 31, 2021 Sep 30, 2021 Jun 30, 2021 Mar 31, 2021 Weighted average portfolio yield over the remaining life of the loans 29.50 % 29.90 % 30.27 % 30.15 % 30.14 % 30.35 % 30.28 % 30.25 % Less: Servicing fee (5.00) % (5.00) % (5.00) % (5.00) % (5.00) % (5.00) % (5.00) % (5.00) % Net portfolio yield 24.50 % 24.90 % 25.27 % 25.15 % 25.14 % 25.35 % 25.28 % 25.25 % Multiplied by: Weighted average life in years 1.000 0.924 0.895 0.847 0.859 0.761 0.769 0.778 Pre-loss cash flow 24.50 % 23.01 % 22.61 % 21.30 % 21.60 % 19.26 % 19.43 % 19.64 % Less: Remaining cumulative charge-offs (10.38) % (11.67) % (11.25) % (10.37) % (9.60) % (7.53) % (7.59) % (8.60) % Net cash flow 14.12 % 11.34 % 11.37 % 10.93 % 12.00 % 11.73 % 11.84 % 11.04 % Less: Discount rate multiplied by average life (11.48) % (9.42) % (8.03) % (5.73) % (5.96) % (4.96) % (5.03) % (5.17) % Gross fair value premium (discount) as a percentage of loan principal balance 2.64 % 1.92 % 3.34 % 5.21 % 6.04 % 6.77 % 6.81 % 5.87 % Less: Accrued interest and fees as a percentage of loan principal balance (1.18) % (1.19) % (1.10) % (1.09) % (1.03) % (0.90) % (0.87) % (0.92) % Fair value premium (discount) as a percentage of loan principal balance 1.45 % 0.73 % 2.24 % 4.12 % 5.01 % 5.87 % 5.94 % 4.95 % Discount Rate 11.48 % 10.19 % 8.97 % 6.76 % 6.94 % 6.52 % 6.54 % 6.65 % 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 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. ▪ 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 loans receivable held for investment or our asset-backed 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. Adjusted EBITDA Adjusted EBITDA is a non-GAAP financial measure defined as our net income, 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 non-cash charges. 51 • We believe it is useful to exclude the impact of interest expense associated with the Company's Corporate Financing, as we view this expense as related to our capital structure rather than our funding. • 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. • We also reverse origination fees for Loans Receivable at Fair Value, 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 (in thousands) Year Ended December 31, 2022 2021 Fair value mark-to-market adjustment on loans receivable at fair value (1) $ (68,897) $ 57,044 Fair value mark-to-market adjustment on asset-backed notes 184,906 15,408 Fair value mark-to-market adjustment on derivatives 3,702 (3,097) Total fair value mark-to-market adjustment $ 119,711 $ 69,355 (1) The fair value mark-to-market adjustment on loans receivable at fair value shown for the year ended December 31, 2022, excludes $(46.1) million related to the cumulative fair value mark on loans sold as part of the structured and other loan sales in 2022. For details regarding the structured and other loan sales in 2022, refer to Note 5, Loans Held for Sale and Loans Sold of the Notes to the Consolidated Financial Statements included elsewhere in this report. The following table presents a reconciliation of net income (loss) to Adjusted EBITDA for the years ended December 31, 2022 and 2021 : Year Ended December 31, Adjusted EBITDA (in thousands) 2022 2021 Net income (loss) $ (77,744) $ 47,414 Adjustments: Income tax expense 2,458 15,377 Interest on corporate financing 5,987 — Depreciation and amortization 35,182 23,714 Impairment 108,472 3,324 Stock-based compensation expense 27,620 18,857 Litigation reserve 2,750 — Retail network optimization expenses 1,882 12,828 Acquisition and integration related expenses 29,682 10,648 Origination fees for loans receivable at fair value, net (26,845) (15,836) Fair value mark-to-market adjustment (119,711) (69,355) Adjusted EBITDA $ (10,267) $ 46,971 Adjusted Net Income We define Adjusted Net Income as our net income, adjusted to exclude income tax expense, stock-based compensation expenses and certain non-recurring charges. We believe that Adjusted Net Income 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. • 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. 52 The following table presents a reconciliation of net income (loss) to Adjusted Net Income for the years ended December 31, 2022 and 2021 : Year Ended December 31, Adjusted Net Income (in thousands) 2022 2021 Net income (loss) $ (77,744) $ 47,414 Adjustments: Income tax expense 2,458 15,377 Impairment 108,472 3,324 Stock-based compensation expense 27,620 18,857 Litigation reserve 2,750 — Retail network optimization expenses 1,882 12,828 Acquisition and integration related expenses 29,682 10,648 Adjusted income before taxes 95,120 108,448 Normalized income tax expense 25,682 29,715 Adjusted Net Income $ 69,438 $ 78,733 Income tax rate (1) 27.0 % 27.4 % (1) Income tax rates for the years ended December 31, 2022 and December 31, 2021, are based on a normalized statutory 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. The following table presents a reconciliation of Diluted EPS to Diluted Adjusted EPS for the years ended December 31, 2022 and 2021. For the reconciliation of net income (loss) to Adjusted Net Income, see the immediately preceding table “Adjusted Net Income.” Year Ended December 31, (in thousands, except share and per share data) 2022 2021 Diluted earnings (loss) per share $ (2.37) $ 1.56 Adjusted EPS Adjusted Net Income $ 69,438 $ 78,733 Basic weighted-average common shares outstanding 32,825,772 28,191,610 Weighted average effect of dilutive securities: Stock options 252,357 1,375,915 Restricted stock units 173,092 755,669 Diluted adjusted weighted-average common shares outstanding 33,251,221 30,323,194 Adjusted Earnings Per Share $ 2.09 $ 2.60 Adjusted Return on Equity We define Adjusted Return on Equity as annualized Adjusted Net Income divided by average stockholders’ equity. Average stockholders’ equity is an average of the beginning and ending 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 stockholders' equity and how efficiently we generate income from stockholders' equity. The following table presents a reconciliation of Return on Equity to Adjusted Return on Equity for the years ended December 31, 2022 and 2021. For the reconciliation of net income (loss) to Adjusted Net Income, see the immediately preceding table “Adjusted Net Income.” As of or for the Year Ended December 31, (in thousands) 2022 2021 Return on Equity (13.5) % 8.9 % Adjusted Return on Equity Adjusted Net Income $ 69,438 $ 78,733 Average stockholders' equity $ 575,740 $ 535,255 Adjusted Return on Equity 12.1 % 14.7 % 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. We believe Adjusted Operating Efficiency is an important measure because it allows management, investors and our Board to evaluate how efficiently we manage costs relative to revenue. The following table presents a reconciliation of Operating Efficiency to Adjusted Operating Efficiency for the years ended December 31, 2022 and 2021 : As of or for the Year Ended December 30, (in thousands) 2022 2021 Operating Efficiency 75.2 % 74.6 % Adjusted Operating Efficiency Total revenue $ 952,545 $ 626,782 Total operating expense 715,943 467,690 Impairment (108,472) (3,324) Stock-based compensation expense (27,620) (18,857) Litigation reserve (2,750) — Retail network optimization expenses (1,882) (12,828) Acquisition and integration related expenses (29,682) (10,648) Total adjusted operating expenses $ 545,537 $ 422,033 Adjusted Operating Efficiency 57.3 % 67.3 % 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, corporate financing and whole loan sales. We may utilize these or 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 2022, available liquidity increased primarily due to the closing of our Corporate Financing facility and the issuance of additional asset-backed securitizations. We generally target liquidity levels to support at least twelve months of our expected net cash outflows, including new originations, without access to our Corporate Financing facility or equity markets. Rising interest rates, credit trends and other macroeconomic conditions could continue to have an impact on market volatility which could 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. In addition to the $75.0 million that may be available under the recent amendment to the Corporate Financing facility and the associated warrants, 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) 2022 2021 Cash, cash equivalents and restricted cash $ 203,817 $ 192,960 Cash provided by (used in) Operating activities 247,875 163,447 Investing activities (1,171,548) (884,786) Financing activities 934,530 745,709 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. Operating Activities Our net cash provided by operating activities was $247.9 million and $163.4 million for the years ended December 31, 2022 and 2021, 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, goodwill impairment charges, 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 54 business due to the amount and timing of various payments. Investing Activities Our net cash used in investing activities was $1,171.5 million and $884.8 million for the years ended December 31, 2022 and 2021, respectively. Our investing activities consist primarily of loan originations and loan repayments. 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 used in investing activities is primarily due to disbursements on originations of loans increasing by $920.6 million while repayments of loan principal only increased by $289.0 million for the year ended December 31, 2022 compared to the year ended December 31, 2021. Our net cash used in investing activities for the year ended December 31, 2022, includes proceeds of $249.3 million related to a structured loan sale in the first quarter 2022 and other loan sales during the remainder of 2022. The change in our net cash used in investing activities is also driven by our acquisition of Digit, net of acquirer's cash received, of $111.7 million for the year ended December 31,2021. Financing Activities Our net cash provided by financing activities was $934.5 million and $745.7 million for the years ended December 31, 2022 and 2021, respectively. For the year ended December 31, 2022, net cash provided by financing activities was primarily driven the issuance of our Series 2022-A, Series 2022-2 and Series 2022-3 asset-backed notes and the borrowings under our Secured Financing facilities and Acquisition and Corporate Financing facilities, partially offset by repayments of borrowings on our Secured Financing facilities and scheduled amortization payments on our Acquisition Financing facility and our Series 2019-A, Series 2022-2 and Series 2022-3 asset-backed notes. For the year ended December 31, 2021, net cash provided by financing activities was primarily driven by the issuance of our Series 2021-A, Series 2021-B and Series 2021-C asset-backed notes and the borrowings under our Secured Financing facilities and Acquisition Financing, partially offset by redemptions of our Series 2018-A, Series 2018-B, Series 2018-C and Series 2018-D asset-backed notes and repayments of borrowings on our Secured Financing facility. Sources of Funds Debt and Available Credit Asset-Backed Securitizations As of December 31, 2022, we had $2.39 billion of outstanding asset-backed notes. During 2022, we issued $1.10 billion of asset-backed securities. Our securitizations utilize special purpose entities which are also variable interest entities (VIEs) that meet the requirements to be consolidated in our financial statements. For more information regarding our VIEs and asset-backed securitizations, see Note 4, Varia ble Interest Entities and 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, 2022, we were in compliance with all covenants and requirements of all our asset-backed notes. Secured Financings As of December, 31, 2022 , we had Secured Financing facilities with warehouse lines of $750.0 million in the aggregate with undrawn capacity of $430.0 million. On March 8, 2023, the Credit Card Warehouse facility was amended, reducing its commitment from $150.0 million to $120.0 million, thereby reducing the combined commitment to $720.0 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, our wholly-owned subsidiary, 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 our securitizations and guaranteed by Oportun, Inc. The note was used to fund the cash consideration paid for the acquisition of Digit. On May 24, 2022, and subsequently on July 28, 2022, pursuant to amended indentures, Oportun RF, LLC issued an additional $20.9 million and $9.1 million asset-backed floating rate variable funding notes, and asset-backed residual certificates, both of which are also secured by certain cash flows from our securitizations and guaranteed by Oportun, Inc., increasing the size of the facility to $119.5 million. The amendments also replaced the interest rate based on LIBOR with an interest rate based on SOFR plus 8.00%. The Acquisition Financing facility was scheduled to pay down based on an amortization schedule with a final payment in May 2024. Subsequently, on February 10, 2023, the Acquisition Financing facility was further amended, including among other things, revising the interest rate to SOFR plus 11.00% and adjusting the amortization schedule to defer $42.0 million in principal payments through July 2023, with final payment in October 2024. 55 Corporate Financing On September 14, 2022, we entered into an agreement to borrow $150.0 million of a senior secured term loan (the “Corporate Financing”). The term loan bears interest, payable in cash, at an amount equal to 1-month term SOFR plus 9.00%. The term loan is scheduled to mature on September 14, 2026, and is not subject to amortization. Certain prepayments of the term loan are subject to a prepayment premium. The obligations under the Credit Agreement are secured by our assets and certain of our subsidiaries guaranteeing the term loan, including pledges of the equity interests of certain subsidiaries that are directly or indirectly owned by us, subject to customary exceptions. On March 10, 2023 we upsized and amended our Corporate Financing facility to be able to borrow up to an additional $75.0 million. At closing and as part of the Incremental Tranche A-1, we borrowed $20.8 million and intend to borrow an additional $4.2 million in Incremental Tranche A-2 loans on or about March 27, 2023, which amount has been committed by the applicable lenders. We may borrow up to an aggregate additional amount of $50.0 million on an uncommitted basis in two $25.0 million additional Incremental Tranche B and Incremental Tranche C loans expected to be available, if provided by the applicable lenders, on or about April 21, 2023 and June 23, 2023, respectively. The term loan now bears interest at (a) an amount payable in cash equal to 1-month term SOFR plus 9.00% plus (b) an amount payable in cash or in kind, at the Company’s option, equal to 3.00%. As of December 31, 2022, we were in compliance with all covenants and requirements on our outstanding debt and available credit. For more information regarding our Secured Financing facilities and Acquisition Financing and Corporate Financing, see Note 9, Borrowings of the Notes to the Consolidated Financial Statements included elsewhere in this report. Structured Loan Sales In March 2022, we participated in a securitization and sold loans through the issuance of amortizing asset-backed notes secured by a pool of our unsecured and secured personal installment loans. We also sold our share of the residual interest in the pool. The sold loans had an aggregate unpaid principal balance of approximately $227.6 million. For further information on the structured loan sale transactions, see Note 5, Loans Held for Sale and Loans Sold of the Notes to the Consolidated Financial Statements included elsewhere in this report. Other Loan Sales During 2022, we entered into agreements to sell certain populations of its personal loans and credit card receivables that had an aggregate unpaid principal balance, including unpaid interest and fees, of approximately $66.2 million. For further information on these sales, see Note 5, Loans Held for Sale and Loans Sold of the Notes to the Consolidated Financial Statements included elsewhere in this report. Whole Loan Sales Through March 4, 2022, we had a commitment to sell to a third-party institutional investor 10% of our unsecured loan originations that satisfy certain eligibility criteria, and an additional 5% subject to certain eligibility criteria and minimum and maximum volumes. We chose not to renew the arrangement and allowed the agreement to expire on its terms on March 4, 2022. The originations of loans sold and held for sale during the year ended December 31, 2022 was $52.7 million. For further information on the whole loan sale transactions, see Note 5, Loans Held for Sale and Loans Sold of the Notes to the Consolidated Financial Statements included elsewhere in this report. Bank Partnership Program and Servicing Agreement We entered into a bank partnership program with Pathward, 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 Pathward 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. On the Second Amendment Closing Date, the Company borrowed $20.8 million of incremental term loans and intends to borrow an additional $4.2 million of Incremental Tranche A-2 Loans on or about March 27, 2023, which amount has been committed by the applicable lenders. Under the Amended Credit Agreement, the Company may borrow up to an aggregate additional amount of $50.0 million on an uncommitted basis, in two $25.0 million tranches, the Incremental Tranche B Loans and Incremental Tranche C Loans expected to be available, if provided by the applicable lenders, on or about April 21, 2023 and June 23, 2023, respectively. We anticipate that we will likely draw down these additional incremental commitments, however, given their uncommitted nature there can be no assurance that we will be able to access such additional capital. If our available cash balances are insufficient to satisfy our liquidity requirements, we will seek additional debt or equity financing and we may have to take additional actions to decrease expenses, curtail the origination of loans, and our ability to continue to support our growth and to respond to challenges could be impacted. 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 56 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 loans receivable held for investment. 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 loans receivable held for investment. 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 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. 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, 2021, 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 . Goodwill Impairment Goodwill is tested for impairment annually and more frequently if events and circumstances indicate that the asset might be impaired. We have a single reporting unit for the purpose of conducting the goodwill impairment assessment. A goodwill impairment charge is recognized for the amount that the carrying value, including goodwill, exceeds the fair value, limited to the total amount of goodwill. Factors that could lead to a future impairment include material uncertainties such as a significant reduction in projected revenues, a deterioration of projected financial performance, future acquisitions and/or mergers, and a decline in our market value as a result of a significant decline in our stock price. In response to a sustained decline in our share price primarily driven by macroeconomic conditions, we conducted a quantitative test of its goodwill as of September 30, 2022. We recognized a $108.5 million non-cash impairment charge for the year ended December 31, 2022. There were 57 no triggering events or goodwill impairment charges during the year ended December 31, 2021 (see Note 7 , Capitalized Software, Other Intangibles and Goodwill of the Notes to the Consolidated Financial Statements included elsewhere in this report for further details). 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. 58