GreenSky, Inc.
Q4 2020 Earnings Call Transcript

Published: 10 Mar 2021

[Operator:]

Good morning, and welcome to GreenSky’s Fourth Quarter and Full-Year 2020 Financial Results Conference Call. As a reminder, this event is streaming live on the GreenSky Investor Relations website, and a replay will be available on the same site approximately two hours after the completion of the call. We will begin with opening remarks and introductions. At this time, I would like to turn the call over to Tom Morabito, Vice President of Investor Relations. Mr. Morabito, you may begin.

[Tom Morabito:]

Thank you, Natalia, and good morning, everyone. Thank you all for joining us.

[David Zalik:]

Thanks, Tom. Good morning, everyone, and thank you for joining us to review our fourth quarter and full-year 2020 results. 2020 was a year where we witnessed the durability in the home improvement market, demonstrated the strength in which we operate in that market, and reinforced the underlying resiliency of GreenSky’s people and proprietary financial technology platform to service that market. GreenSky ended the year strong in transaction volume trends, and despite the unprecedented impacts of the pandemic, we delivered results in line with the prior year. Importantly, our fourth quarter results as well as the solid start to the New Year leads me to be optimistic about achieving our goals in 2021. Not without the challenges in 2020, we were able to grow our servicing portfolio to over $9.5 billion while maintaining the strength of GreenSky’s consumer base. Both full-year 2020 transaction volume and top line revenues were in line with the prior year despite the significant headwinds of the nationwide shutdown in business activities and the tremendous toll it took on everyday life.

[Andrew Kang:]

Thank you David, and good morning. Before I discuss our 2020 results and update our guidance for 2021, let me provide some additional details around GreenSky’s funding and liquidity. As David shared earlier, since year end we executed a $1 billion forward flow sale agreement with a leading life insurance company new to GreenSky’s ecosystem. In conjunction with establishing this forward flow, we also executed an initial sale of approximately $135 million to our new partner. This execution reflects a significant milestone in establishing new structural liquidity and reflects our continued focus on having a robust and diverse set of funding options to support our immediate and long term growth plans. It also demonstrates the successful first step of establishing a forward flow strategy that we set out to do before encountering headwinds in 2020. Our bank waterfall funding capacity also remains strong with approximately $2 billion of commitments unused entering 2021, and we expect another $2.6 billion in revolving capacity to become available in the next 12 months as outstanding loans pay down. Since the end of June, four of our existing bank partners have renewed $5.8 billion in commitments and an existing bank partner expanded their commitment by an incremental $100 million. The current and forecasted capacity under our bank funding combined with the new $1 billion forward flow arrangement allows us to be opportunistic and nimble with respect to our funding strategy in 2021.

[Operator:]

Your first question is from the line of John Davis with Raymond James.

[John Davis:]

Hey, good morning, guys. Andrew, maybe just wanted to quickly start on the margins since that’s where you kind of wrapped up. The 8% to 10%, nice to see a little bump there. But just - I want to better understand what gives you confidence that you go from, let’s call it 10% to 30% from 2021 to 2022, and explicitly those kind of pandemic costs that you think more or less will come out. I just want to understand the moving pieces, because obviously that’s a pretty big year-over-year ramp in the margin and pretty important to the forward EBITDA forecast.

[Andrew Kang:]

Sure. As I mentioned, I think the two main components in the revision upward are around an improving charge-off estimate for the year as well as the mark-to-market costs. So let me start by kind of touching on the first part. So when we provided our guidance on Investor Day, we noted that there was still a lot of uncertainty. We were still in the back half towards the end of 2020 as we were putting our estimates together. We’ve seen ongoing improvement. You can see part of our performance related to delinquencies are 40 basis points better year-over-year. We’re seeing positive trends in declining COVID-19 deferral status. We are seeing momentum and possibly some optimism around stimulus and vaccine-related reopening. So from a 2020 credit perspective, we knew that we were uncertain and conservative, and so we are bringing that forward based on the additional data we’ve seen in the past two or so months to improve our credit loss forecast for the year. The other main component is around our mark-to-market or loan sale costs. And as we noted previously, even at the end of last year, we saw strong momentum improving our mark-to-market costs relative to our initial sale in Q3. And that was even further solidified by the establishment of this billion-dollar forward flow agreement, which really anchors kind of the pricing for 2021. So those are the two largest components that are attributing to this shift in 2021 expectations.

[David Zalik:]

Let me add to that. Good morning, John. This is very much about the enhancement of our model of having a more diversified distribution of funding. What we’re doing in literally midstream is going from a bank waterfall model to a mixed model, and what that creates for about a two-year period is all this mark-to-market, which technically pulls forward all of that cost into current period. And as we start getting the benefit of everything that we’ve sold off, which was sold off at a discount far less than the transaction fee that we earned, but it still sold off at a discount in 2020 and 2019, and also in --sorry, in 2020 and 2021, we’ll start seeing the benefit of that. So we are literally changing the funding model and diversifying it, which is what’s creating this optic in this EBITDA margin. So we have confidence because it’s math, and we see how it normalizes by the time you get to year two, year three of this transition.

[John Davis:]

Okay, great. That’s super helpful. And then I just wanted to touch a little bit on stimulus impact. I think, Andrew, you mentioned that you have better - or expectations for better credit this year. But if I think about the potential impact on originations, did you see last year when stimulus hit that you had kind of a slowdown in originations as people had more cash and didn’t need to finance? Just kind of want to understand the play of how you guys are thinking about stimulus, obviously, benefit on the credit side?

[David Zalik:]

Yes. So the stimulus really helps the marginal borrower make payments. The stimulus doesn’t seem to correlate to more people wanting to do home improvement. You’re dealing with homeowners super prime that are spending $10,000 on a home improvement project. From what we can see in the data is that economies opening up, communities opening up is what stimulates home improvement projects. If you have marginal borrowers that get stimulus checks, they will default less often. So on the demand side, it’s, “Tell me where the market is open, and I can tell you where home improvement is growing.” And on the debt side, we have a narrow slice of marginal credit that are being helped by the stimulus. And I think the data bears it out. Like the data shows that people who are getting stimulus are actually paying off debt and saving money.

[John Davis:]

Right. No, that makes sense. I should know if there was a potential headwind from stimulus just from people not needing to borrow as much, if that makes sense?

[David Zalik:]

No.

[John Davis:]

Okay. And then, I guess, last one for me, just topical with kind of the move up in interest rates recently. So with this new diversified funding mix, maybe just at a high-level talk about how interest rates will play through the P&L, whether it’s the take rate upfront or the funding costs, just at a high level, I know it’s complicated when you get in the weeds, but just good, bad, neutral, if rates were to continue to rise, just any commentary there? Thanks, guys.

[Andrew Kang:]

Sure. Let me comment first on the funding cost piece. So I think, obviously, we’re focused on watching the expected change in interest rates down the road. I would say that predominantly our bank waterfall costs are anchored off of the short end of the curve. And based on where they have been historically and where they are today, our bank margin structure does have some capacity for movement upward before it actually begins to impact our cost of funds from our bank waterfall. I think from a loan sale perspective, we’re seeing strong demand across that segment today. And, in fact, one thing we didn’t highlight was the execution of a securitization that was done with our loans earlier this quarter. That also was received very successfully. And so I don’t think there is any immediate impact, at least in 2021 as we see it, on the funding side that would impact our profitability due to a raising rate environment. In terms of the take rate, I might let David comment. But my initial thought is that obviously the different types of products that we offer show a broad range of elasticity to the consumer. And I think that when we see rates move and we’re trying to adjust for that on the front end, I think we have a lot of optionality to ensure that we protect margin on that side as well. But, David, I don’t know if you have anything to add?

[David Zalik:]

Yes, as we’ve said for years now, when rates went up or rates went down, especially over the last couple of years, at the end of the day the consumer bears that cost. It doesn’t impact negatively origination growth simply by interest rate, so if the interest is driven by hyper inflation or a deep recession, that’s one thing, but changes in long term interest rate expectations does not impact our margin. As interest rate go up, consumers are expecting to pay a higher rate or getting a lesser benefit, and as interest rates go down, it’s the same thing.

[John Davis:]

Okay, all right. Thanks guys.

[Operator:]

Your next question is from the line of Arren Cyganovich with Cit.

[Arren Cyganovich:]

Hi, thanks for the question. Maybe if you’d just talk a little bit about the consumer demand - you know, it looks like you have pretty solid expected growth for 2021, and how you’re seeing that trending over the past few months.

[David Zalik:]

We’re seeing very strong consumer demand. We’re getting reports from our merchants that they’re off to a great start. We’re certainly seeing encouraging early results in our own data, and I think the biggest challenge is labor and supply chain. Certainly, supply chain is making progress catching up, but the consumer demand is certainly there.

[Arren Cyganovich:]

Okay, and then the SCR expense was lower year-over-year. Was that primarily related to loan sales in the quarter? I’m just trying to understand the movements there.

[Andrew Kang:]

Yes, that was primarily due to the diversified funding model. Again, as we incur costs on loan sales, we have said that it does have an offsetting benefit to our bank waterfall costs. Some of that is due to deferred rate loans - again, if they’re not put into the bank waterfall, then you don’t have that SCR expense. But overall, we are seeing that benefit come through 2020 and we expect that to be fairly consistent in the coming year as well.

[Arren Cyganovich:]

Okay, thank you.

[Operator:]

Your next question is from the line of Bill Ryan with Compass Point.

[Bill Ryan:]

Good morning and thanks for taking my questions. Just a couple things. On the third quarter call, you kind of talked about a 2.7% discount is what you would be selling loans to third parties at relative to par. You kind of gave some positive directional indicators in the conference call and even in the press release. Could you talk about what you’re seeing in that number, what are the key drivers - are required rates for return going down with a low interest rate environment? Then second, we talked about this in the past, but you give us the delinquency number as far as credit goes, but we really don’t have a credit loss rate number, which is one of the key drivers of the incentive income line item. Is that something that you are thinking about providing to us so that we can draw a correlation, if you will, between the delinquencies and the credit losses to better calculate incentive income? Thanks.

[Andrew Kang:]

Thank you. I’ll start with the components, just the breakdown of the discount. I think what we shared with you before, the 2.7 probably was around our investor day when we were comparing the lifetime profitability of bank waterfall versus our loan sales. I believe we said our bank waterfall was about 2.6 in cost, getting us to about a 5.3 to 5.4 contribution margin regardless of the source of liquidity. I’d say, just to try and answer your question, the 2.7 is what we continue to improve upon. What you’re seeing the benefit of in our 2021 view is that because we’ve now established a large forward flow agreement with equivalent pricing, we’re able to then take advantage of the expected costs we’d incur over the coming year. So really, the 2.7 is also a component of the different type of loans that we sell, but we think that’s still the appropriate target to represent in terms of loan sales costs with probably some upside, given that there continues to be some strong demand from our partners and doing more of those types of agreements, and also new and existing partners that we’re having active dialogue with. In terms of the question on credit loss, we understand that that’s an important piece of the assumption. We are building, as you can see, some additional granularity on how to model our projections. Credit loss is one that we haven’t specifically provided historically. We did show in our investor day kind of an historical view on credit losses. I think that’s probably the best place to start, and we’ll continue providing directional guidance relative to where we think that will play out. I think the best early indicator is the delinquency metric that we’ve provided historically. I think we’ll work with you to try and triangulate that, but at this point we have not provided a specific loss forecast embedded into the bank waterfall economics. We’ll try and work with you on that to see if we can dissect it with that information is out there.

[Bill Ryan:]

Okay, and just one follow-up to that. On the delinquency number that you give us at, what’s it, 99 basis points, and you talked about 0.8% of loans on deferral, if you were trying to adjust it to an apples-to-apples comparison with year ago, with deferrals and its impact on delinquencies, is there a way or a number that you can directionally give us on that as well? Thanks.

[David Zalik:]

I think it’s hard to compare apples to apples when, you’re right - we’re really talking about apples and oranges. But from our perspective, credit continues to outperform our expectations.

[Andrew Kang:]

The thing I’d add too is just from a timing perspective, we saw much of the decline in the deferral status occur in Q3 and in Q4, so when you fast forward to the end of the year, many of those accounts that have come out of deferral have now had 30 days or more to go into delinquency if that were the direction they were going, so I think David’s correct - it’s hard for us to actually pinpoint an exact number. But I do think directionally, even loans coming out of deferral are remaining healthier than we initially expected.

[Bill Ryan:]

Thank you.

[Operator:]

Your next question is from the line of Rob Wildhack with Autonomous Research

[Rob Wildhack:]

Good morning guys. I wanted to ask about your commentary that the escrow could be used going forward. In the slides, you chalked this up to funding diversification but that’s not really a new development this quarter, so one, why would you be tapping into escrow when the credit environment has gotten so much better over the past couple of quarters; and then two, what specifically has changed now, and really since the investor day, that led you to change and no longer make this adjustment to your EBITDA?

[Andrew Kang:]

Sure, I’ll try and take that one. As I mentioned, our escrow utilization forecast is based on, I would say, a non-practical runoff scenario, so you have to start with the fact that when we take into account the modeling, we assume that there are no additional originations in any of our bank waterfalls, and therefore we project some amount of pay down and escrow utilization in aggregate. When we model that going forward, there are a couple of components that I think can impact whether or not cash is used, and by the way, just to repeat, we don’t see large scale or material impacts of cash utilization - they’re very much on the margin, but they can be impacted by portfolios that are paying down faster or slower. They can be impacted by changes in credit, they can also be impacted in now the activity of loan sales, so as we sell loans, loans may or may not come in and out of our bank waterfall, and that will impact balances as well. I think to try and answer your question in a concise manner, I think our models show that in certain cases, we may show small utilization for certain bank partners - again, not a material amount, but the guidance that we are applying is that it is either a cash or non-cash expense based on a runoff forecast, and if we see any amount of cash utilization, whether it’s small, we are going to apply the guidance of not adjusting it back into our EBITDA, so it’s kind of a binary--

[David Zalik:]

Yes, let me add to that. This is really all about accounting treatment. It’s not a change in cash. For example, Rob, if we have a bank sell a portfolio and in order to facilitate the sale of the escrows used, what that means is all of the escrow can’t be--for any bank, can’t be added back in EBITDA, so CECL and GAAP strikes again.

[Rob Wildhack:]

Okay, thanks. Is it fair to say, then, Andrew, just to characterize what you said, that the loan sale activity and the fact that you’re selling more whole loans means that obviously fewer loans go into the waterfall, and that could trigger some payments to bank partners, maybe because they’re not getting the volume that they might have under the old model?

[Andrew Kang:]

No.

[David Zalik:]

No, it’s not really that. If we’ve got a small bank that just can’t originate any more, or we’ve had small banks sell and they need to exit the program, it’s that kind of small stuff that’s going to have a very modest escrow expense.

[Rob Wildhack:]

Okay, thank you.

[Andrew Kang:]

Yes, and I’d just add, it’s not any one of those things. It can be in combination of the different components that I mentioned, so it’s definitely not related to a lower bank waterfall capacity or anything like that. It’s just the ins and outs of loan sales is probably the simplest way to describe it.

[Operator:]

Your final question is from the line of Chris Donat with Piper Sandler.

[Chris Donat:]

Good morning, thanks for taking my questions. Wanted to ask one around the transaction fee rate and how you expect that to play out over the year. I know in prior years, it had been at times lower in the first quarter, and I think you’d had a promotional event in the first quarter, so I’m wondering if that’s something that we should expect in ’21 with--I know the guidance for the full-year on the transaction fee is around 7%, but should it be maybe below that in first quarter and then above it in later quarters?

[David Zalik:]

What we see is certainly stability in the take rate. Our expectation in terms of our modeling is we assume it will be a little bit lower and go back to its historical norm, but just a reminder, if the average take rate is 700 or 670, our margins are intact, because when the take rate is higher, there’s a higher interest rate or economic value of the portfolio. If the take rate is higher, then that’s offset by lower economic value. Just as a data point on Q1, every year we have some volume-based marketing funds and rebates that we pay in Q1, so that is arbitrarily making Q1 look different. I think we can maybe try to show that with and without the marketing funds. In reality, it’s an annualized expense, but we’re paying it and it’s earned after the year and we’re expensing it, paying it, and the cash comes out in Q1. Does that help, Chris?

[Chris Donat:]

Yes, it does. I just didn’t want to be surprised if there was anything, but yes, your comments put it in context here. Then--go ahead, Andrew?

[Andrew Kang:]

I was just going to add that on the take rate we have seen, we mentioned that the end of 2020, into 2021 we’ve seen higher take rate given the mix of consumer demand. We are--outside of the rebates that we just discussed, we do think over the course of the year that that probably normalizes a little bit more towards--around 7% is kind of what we’ve guided to, so I think that’s the best way for you to think about it without hopefully being surprised.

[Chris Donat:]

Okay, got it. Then just wanted to ask one question about mix - I get that windows are the most important part of the mix, but by our math it looks like HVAC was down about 36% year-on-year. Just wondering--and you’ve talked about this before, but first, retrospectively any call-outs on HVAC for the fourth quarter, and then I’m just wondering with the weather in the first quarter, if that changed anything on activity for HVAC, particularly in some regions like Texas. Just curious.

[Andrew Kang:]

I’d say that HVAC seasonally, just in general, has seen kind of a trend downward at the end of the year. I think that’s something that tends to get more focused and stressed around replacement and issues during the peak summer months, so I think seasonally HVAC tends to go down. We haven’t seen any major shifts in our merchant base; in fact, David mentioned earlier that we’ve added new merchants, both in HVAC and windows and doors, so I don’t think there’s anything underlying what you’re seeing in our business other than the fact that there’s just some seasonal changes and we’re looking to ramp up in both categories.

[David Zalik:]

I would add to that, what we’re seeing in every category, certainly in-home improvement and, for that matter, elective healthcare, are good leading indicators for growth in every category of our business. For us, we’re gaining market share, we’re getting bigger, we’re getting more merchants, and we’re seeing in every segment of our business growth year-over-year.

[Chris Donat:]

Okay, and on--

[Andrew Kang:]

[Chris Donat:]

Yes, that’s what I was going to say. Elective healthcare, anything you’d point us to? The combination of restrictions being lifted in states, but I guess there’s also a consumer comfort issue with being willing to go in and getting something scheduled is--I mean, is this a coiled spring or is it something that’s going to be gradual, do you think, with healthcare?

[David Zalik:]

It’s not going to be a one quarter we expect to be back. There’s certainly a lot of demand, but you’re right - when the state governments forcibly close medical offices and there’s fear and panic, nobody is going to get elective medical procedures. We saw that. We saw so many of our amazing healthcare providers, they went from employing hundreds of people and growing to literally being down 90%, in some cases 100% overnight. Now fortunately that didn’t last very long. We’re certainly seeing it come back. We’re seeing our business come back. We mentioned earlier today a great relationship with a large multi-state fantastic medical provider, and we’ve got many more in the pipeline. We do think long term over the next year or two this becomes a very important, material part of our business, and we certainly like the steady progression in the trends we’re seeing so far.

[Chris Donat:]

Okay, thanks David.

[David Zalik:]

Thank you.

[Operator:]

There are no further questions. I will turn the call back over to CEO David Zalik for any closing remarks.

[David Zalik:]

Thank you for your questions and thank you again for joining us today. Please stay healthy and safe, and we look forward to speaking with you in May when we discuss our first quarter 2021 results. Thank you again.

[Operator:]

This concludes the GreenSky fourth quarter 2020 financial results conference call. Thank you for your participation. You may now disconnect.