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spk08: Good morning and welcome to GreenSky's third quarter 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.
spk02: Thank you, Tiffany, and good morning, everyone. Thank you all for joining us. After the close of market trading hours yesterday, GreenSky issued a press release announcing results for its third quarter ended September 30th, 2020. You can access this press release on the investor relations section of the Green Sky website. In addition, we have posted our third quarter earnings presentation, which we will refer to during today's call. Today you will hear prepared remarks from David Zalek, our Chairman and Chief Executive Officer, Jerry Benjamin, our Vice Chairman and Chief Administrative Officer, and Andrew Kang, our Executive Vice President and Chief Financial Officer. Before we begin, let me remind you that our presentation and discussions will include forward-looking statements. These are statements that are based on current assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from those projected. We will disclaim any obligation to update any forward-looking statements except as required by law. Information about these risks and uncertainties is included in our press release issued yesterday as well as in our filings with regulators. We also will be discussing non-GAAP financial measures on today's call. These non-GAAP measures are not intended to be considered in isolation from, a substitute for, or superior to our GAAP results, and we encourage you to consider all measures when analyzing GreenSky's performance. These non-GAAP measures are described and reconciled to their GAAP counterparts in the presentation materials, the press release dated November 9, 2020, and on the investor relations page of our website. Lastly, I wanted to mention that we will be hosting a Virtual Investor Day on January 12, 2021, where members of the GreenSky senior management team will be presenting key elements of the company's strategy. Logistical details will be sent out in early December. At this time, I'd like to turn the call over to David.
spk03: Thanks, Tom. Good morning, everyone, and thank you for joining us. It's good to be with you today to review our third quarter 2020 results. Let me begin by welcoming two new GreenSky executives. Tom, thanks for kicking off today's call. We're excited for you to join the team and looking forward to your contributions going forward. I'm also pleased to welcome Andrew Kang, our new Chief Financial Officer. As you know, Andrew joins GreenSky with over 20 years of financial services experience, and I know he'll do a great job and that you will enjoy getting to know Andrew. I also want to take this opportunity to thank Rob Partlow for his service to GreenSky for the past six years and for his ongoing leadership. GreenSky had a very productive third quarter, from multiple new IT product innovations to software releases enhancing our mobile user experience to successfully executing on initiatives to diversify and fortify our funding, all while continuing to deliver strong results despite the challenges and headwinds of this year. Turning to slide five, our third quarter operating results and key business metrics reflect strong resiliency of demand in our core home improvement business. We are also excited about the prospects of our elective healthcare business after the shutdowns which occurred earlier this year. In addition, as announced a few weeks ago, we have completed more than $2.5 billion in funding in the third quarter, which we will touch on more in a moment. Our transaction volume for the quarter was over $1.5 billion, down 10% from approximately $1.6 billion in the third quarter of 2019. Importantly, we continue to make solid progress within the year, with Q3 volume up 9% sequentially compared to the second quarter of 2020. This quarter continues to reflect headwinds related to our elective healthcare business, which was dramatically and negatively impacted as a result of the mandated COVID-19 shutdowns early this year. We feel optimistic that our patient solutions transaction volume will begin to regain momentum as elective healthcare procedures nationally continue to restore. Our transaction fee rate for the quarter was 7.3%, up 40 basis points when compared to the third quarter of 2019. reflecting continued demand for certain loan products offered by merchants and consumer preference for promotional financing. We are happy to report that our overall servicing portfolio grew 9% year-over-year to $9.5 billion. As we continue to generate new transaction volume, our servicing portfolio continues to grow and provide attractive recurring fee revenue that contributes to GreenSky's overall profitability. Total revenue for the quarter was $142 million, or 7% lower than Q2 of the prior year. However, when adjusting for the $16.4 million of servicing access recognized in 2019, comparable third quarter revenue was 4% higher than the prior year. This was driven by stronger transaction fee rates coupled with the higher servicing fee revenue due to the growth of our servicing portfolio and higher average servicing fees. GreenSky reported a strong third quarter adjusted EBITDA of $38.7 million, up 17% from the third quarter of 2019. Similarly, adjusted EBITDA margin was 27%, up from 22% last year. These improvements were driven by stronger incentive payments in the quarter and reflect the continued strong credit performance of the portfolio. The recurring revenue nature of GreenSky's technology business model, coupled with our industry-leading customer acquisition costs combined to continue to deliver highly attractive adjusted EBITDA margins. In a few minutes, Jerry will walk you through our key operating metrics, our key addressable markets, and trends impacting our business. And then Andrew will provide a detailed review of the quarter's operating results. Turning to slide six, I want to quickly update you on three key topics. The ongoing impacts related to COVID-19, the diversification of our funding model, and an early look at our fourth quarter and full year 2021 expectations. First, as we continue to navigate COVID-19, we are committed to helping our consumers, merchants, bank partners, and teammates navigate this challenging environment and to continue to focus on the safety of all our Green Sky associates and their families. We continue to benefit from our investments in our GreenSky technology infrastructure, and I continue to be gratified by the innovation of our talented workforce. As a result, substantially all of our workforce continues to work remotely while providing world-class loan servicing and customer service levels to our bank partners, merchants, and GreenSky program consumer borrowers. Next, funding diversification. We announced last month the completion of $875 million in funding initiatives, including the sale of approximately $775 million in loan participations in September and October. As you know, we've been planning these asset sales for some time, and despite the extreme market volatility witnessed earlier this year, I'm proud of our team for successfully completing these transactions and demonstrating the follow-through on diversifying our funding model. We also announced last month that GreenSky entered into a new long-term bank partner relationship, our largest in the last two years. The $600 million per year commitment over the next three years will support the growth of our elective healthcare business. And as we develop this new relationship, we hope to include new products over time. The addition of this new bank partner demonstrates the continued attractiveness of our bank waterfall model as a cornerstone of GreenSky's established funding ecosystem. and we continue to advance discussions, both our existing and new prospective bank partners, to help strengthen our overall funding. Turning now to an early look at our fourth quarter of 2020 and full year 2021. For the upcoming fourth quarter, taking into effect both the ongoing economic impacts from COVID-19 and abnormal seasonality patterns, we expect to see transaction volume in the fourth quarter to contribute approximately one quarter of our full year 2020 volume of $5.4 billion. technology teams are making tremendous progress on our deep new product roadmap delivering continued innovations for both our merchants and consumers we're seeing strong momentum in new high quality additions to our existing robust merchant network and both home improvement and elective healthcare and our disciplined underwriting and the strong credit performance of the green sky loan portfolios will continue to drive our long-term profitability through these and other ongoing initiatives Absent any unexpected COVID-related setbacks, we anticipate the green sky will deliver mid-teen transaction volume growth in 2021. After the impact of the pandemic and as the associated macro effects normalize in 2021, we anticipate adjusted EBITDA margins to trend toward 25% on a sustainable basis. I'll now turn it over to Jerry.
spk00: Thank you, David, and good morning. GreenSky has now enabled 26 billion of transactions for approximately 3.6 million consumers, with the size of our loan servicing portfolio now approximating 9.5 billion. With consumers spending considerably more time in their homes, our core home improvement vertical has continued to demonstrate strong resilience with, as David mentioned, transaction volumes largely holding steady throughout the third quarter and improving in September when compared to August. We continue to believe that the strong homeowner credit bias present in our loan servicing portfolio represents an important differentiator when contrasting the GreenSky program with most other consumer loan portfolios. We are very pleased with GreenSky's third quarter credit performance, continuing the consistently improving trends that we've now witnessed over the past five quarters. As we discussed with you in our first and second quarter earnings calls, 100% of the GreenSky Bank funding partners agreed in mid-March to offer voluntary payment deferrals for any GreenSky program borrower requesting COVID-19 assistance. Less than 1% of the balances of the company's total servicing portfolio were in payment deferral in response to COVID-19 assistance requests at the end of the third quarter, reflecting a significant improvement from approximately 4% at the end of June. With a relatively low rate of payment deferrals compared with other consumer loan programs out in the market, we remain cautiously optimistic with respect to the ultimate performance of our relatively small COVID-19 hardship deferral portfolio. Turning to slide eight of the presentation, our dollar credit weighted average FICO score of consumers at origination was 784, and the credit quality of the consumer's super prime loan servicing portfolio remains exceptional. At the end of the quarter, 87% of borrowers had an origination weighted average FICO in excess of 700, and 39% had scores in excess of 780. 30-day plus delinquencies observed at the end of the third quarter were a mere 1.04% compared to 1.29% at the end of the third quarter of 2019, reflecting a 25 basis point improvement compared to a year ago. Turning to slide nine. The APR on our new originations continue to increase quarter over quarter as our deferred interest rate promotional financing products continue to outperform. As a result, the overall billed APR of third quarter portfolio originations increased 30 basis points to 13.3%. In conjunction with higher portfolio yields, the recent demand has also continued to keep transaction fee rates elevated for the third quarter at 7.3%. Although we could see the benefit from demand generated by consumer behavior, which we believe is partially a result of uncertainty of the pandemic, we expect the transaction fee rates will normalize to our historic trend of approximately 7% over time. On slide 10, as of September 30th, we had a robust network of approximately 16,000 merchants on GreenSky's patented technology platform. As mentioned on last quarter's call, over the past year, we've continued to focus on merchant quality. While we plan to not only add high-quality merchants, we also expect to generate increased productivity for merchants that have been part of Greencast's ecosystem for many years. We hope to proactively partner with each of these merchants to successfully grow their businesses. With COVID-19 persisting, the partnerships we cultivate with our merchants have never been more important. In order for our merchants to better adapt to their customers' financing needs in the current economic environment, we queried our merchants and developed a whole suite of new promotional loan product offerings responsive to merchant input received. These product innovations continue to be exceptionally well received. Let me provide a little more color on our home improvement and patient solutions businesses. We continue to compete within vast markets, the domestic home improvement market exceeding $400 billion per year. Moreover, today's aging housing stock, currently 39 years old on average, bodes extremely well for the long-term home improvement spending trends. Our home improvement business overall continued to see strong resiliency during the quarter, notwithstanding some of the merchants reporting select COVID-19-related supply chain disruptions, impacting total cycle times for job completions within their businesses. While we believe GreenSky to be the market leader in home improvement finance, we continue to enhance our product offerings, add larger merchants that meet all our customer satisfaction, credit, and productivity targets, and invest in advancing the effectiveness of our risk management processes. And advances in medical technologies and the aging U.S. population will continue to drive attractive annual elective health care market growth. Although we believe our patient solutions business to already be a top three player as of the end of 2019, our elective healthcare business had a challenging quarter as the impact of COVID-19 continued to significantly impact the number of elective procedures performed and as a result, related transaction volumes. However, as David mentioned, we expect to see material growth in this business and our latest strategic bank alliance is already serving as a significant catalyst. I'd like to briefly touch on slide 11, which shows the effectiveness of our sales and marketing spends as a percentage of revenue, which continues to outperform peers and highlights the efficiency of leveraging GreenSky's deep merchant network and the loyalty of our merchants and their enthusiasm for our technology platform. We believe GreenSky is extremely well positioned to capture additional market share as economic conditions restore and normalize. The quality of both our servicing portfolio and of the loans facilitated for our funding partners remains exceptional. With that, I'll turn it over to Andrew so he can take you through the details of our third quarter 2020 financial performance. Andrew?
spk06: Thank you, Jerry and David, for the kind welcome, and good morning, everyone. I am very excited to be with you all today to share GreenSky's third quarter financial results. Turning to slide 12, GreenSky's reported third quarter total revenue was $142 million, or 7% lower year over year. While transaction fee revenue was down 5% as a result of the lower volume in the quarter, we benefited from the 40 basis points increase in the transaction fee rate in Q3. Servicing revenue for the quarter was $27 million, but if we adjust for the non-cash changes in servicing assets, including the $16 million in Q3 2019, servicing revenue for the third quarter 2020 was 16% higher year over year. This was driven by a higher servicing fee rate of approximately 1.19% in Q3 and by the larger average service portfolio balance. Cost of revenue was $92 million for the quarter, reflecting an increase of $27 million year over year. This change was due to four primary factors. First, servicing costs were higher for the quarter as you would expect due to the growth in the service portfolio, and the costs associated with our loan participation sold as well as held for sale as of September 30th were also higher. However, these costs were offset by lower quarterly origination costs and strong incentive payment performance, which drove a sharp decline in the fair value change in the FCR liability. I will go into more detail on the components of cost of revenue shortly. The financial guarantee expense for the quarter or the non-cash impact of CECL improved by $1.4 million due to the improvement in our COVID-19 assistance portfolio that we described earlier. Our operating profit on a GAAP basis of $9 million was most significantly impacted by the timing of the accounting recognition related to assets held for sale. When you adjust for non-cash items, our adjusted EBITDA grew 17% and EBITDA margin increased by 23%. This was a result of stable operating costs, positive credit performance, and strong bank waterfall margins. Turning to slide 13. Total revenue for the first nine months of the year was $397 million and was in line with 2019. The average transaction fee rate for the year through the first nine months was 7.12% or 28 basis points higher than the same period last year. As Jerry mentioned earlier, we have had strong demand for promotional products with attractive transaction fees in our home improvement business this year. And we continue to work with our product teams and our merchants to find additional ways to optimize transaction fees for these desirable financing solutions. Servicing fees have contributed 22% of total revenues for the year with the average servicing fee rate having increased to 1.25% from 1.15% for the nine months ended. As a reminder, after adjusting for the non-cash servicing asset book in Q3 2019, servicing revenue was up 33% for the first nine months of the year. Turning to slide 14, I would like to dive deeper into the cost of revenue, which has been and continues to be an important component of GreenSky's profitability. As I mentioned earlier, the total cost of revenue for the third quarter was $92 million. Let me go into a little bit more detail on how that cost breaks down. First, looking at the cost of revenue table on the left, actual dollar origination expense was lower for the quarter, driven in part by lower volume, but also benefiting from ongoing operational efficiencies. Servicing related expenses increased year over year, but it is important to note that as a percentage of the average service portfolio, these expenses have remained flat. This highlights our continued operational cost discipline while managing through the pandemic and it demonstrates the agile and highly scalable nature of our operations and highlights the effectiveness of our investments in technology. Moving down the table, over the last several quarters, we have highlighted the improving trends within the fair value change in the FCR liability, and specifically the improving trends attributed to stronger incentive payments. This quarter was no different in reflecting this positive trend. The fair value change in the FCR liability was $21 million for the quarter, down 51% from $43 million a year ago. Shifting to the table on the right side of the slide, I wanted to break down the components of the fair value change in the FCR liability. The strong improvement year over year was driven by significantly higher incentive payments received from our bank waterfall, which increased to $58 million, representing a 68% increase from a year ago. This increase, again, reflects one of the most significant drivers of our profitability for the quarter and can be attributed to the strong demand of our promotional products, our strong credit performance, and the low interest rate environment. The total FCR liability, which, as you know, is the liability on our balance sheet for future finance charge reversals, was $187 million for the quarter, and the FCR expense was $84 million. It is important to note that both the quarterly expense and the total ending FCR balance were both very stable year over year. To complete the reconciliation of the total cost of revenue, we should also discuss the cost associated with the loan participation sales as part of our diversified funding model. Back on the table to the left of the slide, loan and loan participation sales costs were $31.8 million in the quarter, which reflect the realized discounts on loan participation sold in the quarter, as well as the discount on loan receivables held for sale on our balance sheet at the end of the quarter. The gross cost of revenue including these loan participation sales costs was $74 million or 3.1% as a percentage of the average service portfolio. Taking into account this impact, the gross cost of revenue is flat to the comparable cost from a year ago. As we previously announced, the asset sales completed in September and October were executed at approximately 95% of principal balance. The $31.8 million cost this quarter in combination with the $10.8 million cost in Q2 2020 approximate the related cost of the sales and the assets held for sale remaining on our balance sheet. New for this quarter, we also recognize the non-cash mark-to-market on future loan participation purchase commitments not on GreenSky's balance sheet at quarter end. This is different in nature from the mark-to-market recognition for loans either sold or on GreenSky's balance sheet at the end of the quarter. As a result, the $18 million non-cash item was an adjustment on our third quarter EBITDA. The mark-to-market represents the fair value of our agreement to facilitate loan sales for a bank partner, which was recorded based on a mark on September 30th. We adjust for this non-cash item because what is ultimately realized and recognized will depend on the structure and pricing for the future transactions at that time. Turning to slide 15, at the end of Q3, we increased our bank waterfall commitments with our existing partners to $8.3 billion, of which approximately $1.5 billion of commitments were unused at the end of the quarter. We also expect another $2.1 billion in revolving capacity to become available in the next 12 months through the pay down of existing balances. Since the end of June, three of our existing bank partners have renewed $3.7 billion in commitments, and an existing bank partner expanded their commitment by an incremental $100 million. The overall commitments, significant available capacity, and our renewing partners clearly demonstrate the ongoing strength of our bank commitments and reflect the strong demand in the current market. We touched on this earlier, and I wanted to mention that the new $600 million per year up to $1.8 billion in total commitment over an initial three-year term facilitating our elective healthcare business. This new funding capacity will be instrumental in supporting the growth of that vertical. As part of our diversified funding strategy, we completed the first of a series of expected asset sales, which create incremental capacity for future transaction volume growth. Together with our very strong bank waterfall commitments, we have ample funding for growth while protecting our lifetime margins. Furthermore, we are encouraged by the heightened interest and demand from bank and non-bank investors for our products. Before I conclude, I want to highlight that as part of our Investor Day, we plan to provide additional details on how to dimension the mix of our funding in the coming year, as well as the associated costs. Thank you for the opportunity to discuss the quarter's financial results and for your interest in GreenSky. Operator, this completes our prepared remarks, and we are now ready to take questions.
spk08: At this time, if you would like to ask a question, please press star, then the number 1 on your telephone keypad. Again, that is star one. We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Michael Young with Truist Security.
spk01: Good morning.
spk03: Good morning.
spk06: Thanks for taking the question. I wanted to start maybe just higher level on the credit performance piece. It looks like you guys have maybe tightened the FICO box a little bit over the last couple quarters, and credit performance has been really strong. Do you think that going into 2021, you may kind of loosen the standards back a little bit or mean revert, and that may be supportive of that kind of mid-teens transaction growth you expect?
spk03: Great question. So let me start by saying that the credit performance we're reporting now is not really impacted by any changes to our credit standards over the last six months. Obviously, it takes longer than that to show performance. We certainly were very mindful about the unknowns of April, but we do expect to have a more normal environment, we hope, over the coming months and quarters than sort of what we've seen the last year.
spk06: And do you see anything thus far that would make you think that the outlook for credit performance would change? I think that's been a big driver of kind of the improvement in the FCR liability, et cetera. I think a lot of banks are expecting more kind of fallout potentially if there is some early next year. So just curious if you have any outlook on that.
spk03: We're cautiously optimistic. Before COVID, we were experiencing our best credit performance. which was really driven by our analytics and optimization, not by changing approval rates. This is pre-COVID. So there are certainly headwinds of the unknown of what happens next in the economy if there's another shutdown, if there's a lack of benefits and support for people who've been impacted. But we've also got a lot of tailwinds as it relates to credit performance, and that's the optimization that we benefited from really for the last year, including now. So we're cautiously optimistic.
spk06: Hi, this is Andrew. The one thing I'd add to just for context is, you know, it's more point-in-time comment, but if you reflect on the delinquency performance for the quarter, it was down year over year, and that does include the population of loans that have come out of COVID deferral. So we are seeing people come out of payment assistance and remain current on their balances. So I think it's more of a point in time comment, but I think that's also a good reflection. Okay. And if I could just sneak in one last one, just on the 4Q, or I guess the full year 2020 guidance on transaction volumes, I guess that implies a fairly lower rate of transaction volumes in the fourth quarter.
spk01: Is there some, you know, is that just seasonal softness maybe, or is that, you know, COVID cases kind of creeping back up and expecting some, you know, lower amount of economic activity? Just anything you can provide there would be helpful.
spk03: Yeah, the first thing is, you know, remember healthcare was not long ago over 10% of our business. And it's now, because of a couple months ago, gone down to much closer to 0% of our business. So that's the biggest contributing factor to the headwind in overall growth. Now that doctor's offices are reopened and we're hoping for more stable economic environment and the need for elective procedures is obviously still there. So we expect that to be a tailwind rather than a headwind going into next year. But certainly we're between seasonality, the distractions of what's going on, and it's going to take us some number of months to rebuild healthcare. That's a reflection of those elements.
spk00: Yeah, it's probably worth noting we expect the fourth quarter volumes expressed as sort of a piece of the whole year to be very consistent with 2019, same percentage of the year's productivity. In Q4, we know in the home improvement business, few consumers want contractors in their home between Thanksgiving, Christmas, and New Year's. We can't believe with the advent of COVID, workers will be more embraced in people's homes. So similar seasonality to prior year.
spk07: OK, thanks.
spk08: Your next question comes from the line of Steven Wald with Morgan Stanley.
spk04: Hey, good morning, and welcome, Andrew. Maybe in picking up where we were just sort of talking about the seasonal guidance and the transaction volumes being lower, it seems like the health care piece is you're not sort of banking on that rebounding anytime soon, particularly with the potential for second wave disruptions. But that with the forward flow agreement, that's something we should be thinking of as a 21 event as things normalize or people go back to the doctor's office and consider elective procedures. But as far as the home improvement piece, I heard you, Jerry, pointing out probably not an incremental, probably less demand for having people in the home. But it seemed almost like, and correct me if I'm getting this wrong, that third quarter had maybe a little bit of an ebb in terms of activity as people started coming out of their houses. uh then maybe if they were to go back in that there would be some kind of offset to the seasonal weakness i'm kind of curious how you're thinking about the push and pull of people potentially spending more time at home but obviously wanting to limit exposure if they're trying to see loved ones around the holidays how should we think about the ramp maybe from 4q back into the summer months in 2021 because the mid-teens volume that you're talking about for growth implies that things don't pick up perhaps until well into next year
spk03: Well, we're certainly going to be conservative, number one. Number two, it will take time to rebuild health care. We continue to believe that over time, health care will be as large, if not larger, than our home improvement business, which is why the announcement of that strategic funding was very exciting for us. As it relates to home improvement, You know, what we've seen is just tremendous demand. There's lots of noise in the market. There are supply chain challenges. There are companies that are having trouble with labor. But for us, Q4 and Q1 tend to be the slowest of the year. So there is a ramp, but We're certainly being careful as we think about how long it'll take to ramp up healthcare and how long it'll take for the supply to catch up to the demand in home improvement.
spk04: Understood. And maybe switching to some of the other pieces of the sort of forward look. So you put the adjusted EBITDA as you're coming through the pandemic as being more sustainable at 25%. And I think we had previously understood that to be sort of in the 25 to upwards of low 30s. I'm kind of curious, like what's shifted? Perhaps as you've looked at shifting the model towards a more balanced between the waterfall and an originate-to-sell model, how that's shifted your thinking about the economics of the business and sort of what gets you to that 25% versus prior comments?
spk03: Yeah, so I think something that's important is our expectation going forward certainly, is that from what we've seen, there's incredible demand on the bank side. We've seen that accelerate. So that's certainly very encouraging for us. You've seen a bunch of renewals. You've seen expansion. You've seen even a new $1.8 billion relationship. We also are very interested in having diversification, and we believe that the two types of funding go hand in hand. One kind has complexities of FCR. The other kind has a very different kind of timing. But the way we look at it is that our expectation going forward is that the net present value, the present value of the economics for Green Sky, are the moral equivalent. So from our perspective, ample funding and abundance of funding is very important, and having great economics Time for first. Andrew.
spk06: Thanks, David. I think just tagging on, you know, when we think of, you know, mid-20s EBITDA margins, I think, you know, we are taking into account, you know, additional uncertainty as to how the macroeconomic plays out. We're taking into account, you know, some of the growth trends that we're anticipating. I would say that in a more sustainable long-term manner, we are still pointing to high 20s, 30% EBITDA margin target. But I think our forward view for 2021 would be in a transition to that, taking into account some of the uncertainties that we're still waiting to play out.
spk04: appreciate all that if i could just squeeze in a quick follow-up here it seems like from the way you guys are talking about it your base case assumption at a high level is almost things do get a little bit worse before they get better i just want to make sure i'm understanding like what the essential underlying assumptions are so we can sort of measure them against as conditions develop is that generally how you're thinking or is it sort of base case um among some of the others that we've seen in this in the space talking about a gradual recovery from here is is there are we hearing that right
spk06: I wouldn't say that it's going to get worse before it gets better. I think we've alluded to the fact that we think Q4 will be consistent from a percentage of the year basis as last year. And there will be seasonality impacts specific to that. I think from there, I think the trend continues to build on the momentum we've seen as we continue to come out of the pandemic and as different operational pieces of the company continue to stabilize and normalize. whether that's elective health care or that supply chain for home improvement. But I wouldn't say, you know, I wouldn't characterize it necessarily as it gets worse before it gets better. I'd say that we're trending upward from here.
spk00: Yeah, I would just echo David's earlier comment. Historically, the second and third quarter are the highest in terms of productivity. The spring weather comes and people are starting to do work around the home outside. Typically, the second and third quarter is 26%, 27% of the full year. So the seasonality that David spoke to really is more akin to what we'll see the rebound, not us believing that things are going to get worse before they get better. Understood.
spk04: Appreciate it.
spk00: Surely.
spk08: Your next question comes from the line of Aaron Saganovich with Citi.
spk06: Thanks. In terms of the reduction of your underperforming merchant partners, it looks like they came down a couple thousand versus the prior quarter. Are you done with this exercise? And did that have any impact on the transaction volume for the quarter? And what proportion of transactions did these merchants represent?
spk03: Yeah. We are substantially done with that. And what we're really referring to are micro merchants. And so it's a headline number, but the merchants that we called were contributing almost no volume, like a loan a quarter. And we just concluded that there's too much risk and volatility and management required and it isn't profitable. We're certainly interested in great merchants and great relationships, but it's got to work for everybody. So that had no meaningful impact whatsoever. Something that's very important is in terms of what we're seeing in the market is we've had a string of great successes in winning new merchants, taking merchants from competition. So we're very excited about the prospects for continued growth into next year.
spk00: Just to add a little context to David's comment, I mentioned earlier we're really competing in a vast market. This is a $400 billion annual domestic market. We've got 16,000 merchants on the platform. I think you've heard us say in the past there are about 155,000 home improvement contractors that do more than a million dollars of revenue domestically. In our 16,000 merchant roster, we've only got about 5,500 that fall in that category. So while we're the largest player in this marketplace, we've got tremendous growth potential to penetrate further. And to David's point, we're interested in doing business with those merchants where we can be a material vendor and we can put the resources forth both to provide the merchant management and help them grow their business.
spk06: Thanks. That's helpful, Kyle. I appreciate that. Congrats on the new bank financing for the elective healthcare. How did that process work? Did you specifically search out bank funding just for elective healthcare, or was this something that the bank partner just, for whatever reason, preferred to have that protocol?
spk00: As you've heard us say in the past, we maintain an ongoing pipeline of banks. We're in dialogue all the time with banks. This relationship came together perhaps a little bit more quickly than prior relationships, but not inconsistent with our history, and we continue to maintain a lengthy pipeline of interested parties. So it's a great opportunity, a lot of enthusiasm, and as David said, we expect this to be a catalyst in restoring our elective business on a rapid basis.
spk03: I think it's also fair to say that this particular financial institution has a unique interest in healthcare. So it was a very exciting strategic fit for both parties.
spk05: Okay.
spk06: And your other bank partnerships, they're not specific to any vertical, they're across the whole level?
spk03: It depends by bank partner. As the company grew, it was originally only home improvement. Some of our banks have expanded into healthcare. This is certainly the first one that started with healthcare.
spk06: Got it. Okay. Thank you.
spk08: Our next question comes from the line of John Davis with Raymond James.
spk06: Hey, good morning. This is Matt on for John. Thank you for taking the questions. So to start, curious how volume trended throughout the quarter. I think you said flat in June. So considering 3Q is down 10%, any commentary there? Was it all just weakening some elective healthcare or maybe any October trends you can give us? I know you mentioned September was better than August and expect improvement in 4Q.
spk03: Yeah, so for us, it's primarily elective health care. That was certainly the primary driver. We definitely saw in the market, you know, some delays associated with whether it's supply chain or election noise. But for Green Sky, this was really a story about the diminishment of our elective health care business.
spk00: Yeah, to David's point, it had approximated 10% of originations, Q4-19, so that would have implied, you know, on an annual basis, $500, $500, $600 million a year that went to largely a negligible balance this year as the shutdowns occurred nationwide. So this was much a story about not having that elective health care vertical contributing.
spk05: OK, thank you. And then it appears the take rate went up year over year. It was better than expected. Is there any noted change in merchant behavior and promotional activity given the drop in rates?
spk06: Have you seen more merchants maybe shift more to interest-free financing rather than promotional rate at all?
spk03: No, what we've seen is historically take rates, you know, obviously the take rate is much higher this quarter than it was same quarter last year, but 20 basis points less than prior quarter. And I would caution anyone about, we say this when take rates are going up and we say this when take rates are going down, they're typically give or take 20, 30 basis points around 700 basis points. And they've been that way for almost all of our $26 billion of origination. The thing that we want to remind people when take rate is at the peak of the season or at the drop of the year, that our economics are neutral. If you said to me, would you prefer a business that has 8% transaction fee or 6% transaction fee, I'd say, which business is doubling? That's what matters. And the reason I say that is Green Sky's present value of cash flow, profit, is neutral if it's a 6% product or an 8% product. It certainly pleases people who focus on GAAP, but obviously we're very focused on long-term present value of cash flow. And the answer to your question is there's natural seasonal volatility. Some merchants want a 12-month promotion. Some merchants want an 18-month promotion. Which category is running promotions that cost a little bit more? Which ones that cost a little bit less? For Green Sky, it's neutral.
spk06: Okay. Thanks. And then the last one for me, I feel like those are new focus on the healthcare going forward, but it wasn't really talked about much last quarter. Clearly you have some financing and historically you bought the second, get the third percent of the business. So where do you see going from here? I know it kind of, you said it went to zero this quarter, but now you have about $1.8 billion in financing for the next few years. So is there any detail about the mix of elective healthcare over time? Thanks guys.
spk00: Yeah, we clearly look for the business to restore back to 10% of originations. The denominator effect takes place as that home improvement business grows. That becomes larger, obviously. But we were there Q4-19. We'll get back there in the not-too-distant future. That would be a good objective to get back there over the next four to six quarters if possible. But certainly there's ample market demand and enthusiasm in the sales force and in the provider network. But to move it into the teens and approximately higher when you've got a home improvement business growing as rapidly as ours is, That's a bit of a task, so we'll watch it grow over time. And as David said, over the long haul, this business should be as large, if not larger, than our home improvement business.
spk06: Okay. Thank you guys so much.
spk08: The next question comes from the line of Vincent Kantek with Stevens.
spk06: Hey, good morning. Thanks very much for taking my questions. Just wanted to follow up again on the transaction volume and understanding that there's the elective healthcare piece and taking that out. It's still, I mean, being down 20% year-over-year and down 19% quarter-to-quarter still seems like a big number. Just wondering if maybe we just focus on the home improvement side, how much Is the performance or is the guidance year over year and quarter over quarter? And is it just a delay? So should we expect, say, the first quarter of 21 to make that up where we will just sort of shift it from the fourth quarter to first quarter because of COVID or other delays in completing jobs?
spk00: Thank you. There were a couple assertions in there. buried in the question, so let me sort of unpack that just a bit to make sure we're not talking over each other. As David commented, we had an elective healthcare business that basically drew up to negligible levels in calendar 20. So that was at a run rate of 500 to 600 million of originations. When you take that out of the equation and look at the home improvement on an apples and apples basis, you're not seeing anything that's remotely down 20%. So that assertion of that math just doesn't work. Happy to hop offline with you and sort of back into some numbers, but the preface, I think, is off there. As we look into 21, as we mentioned, we have seasonality taking place. Fourth quarter is always our softest quarter. It's just the nature of the consumer behavior around the holidays. Q1 is our second thinnest quarter. Merchants take a breather. They plan their year. They have their sales contacts. They do their planning. And then the weather breaks and things start picking up dramatically in the spring and into the summer. As I mentioned, if we take the year and look at that sort of on a four-quarter pie, Q2, Q3, 26%, 27% of annual originations happening in those two quarters. So the seasonality is what we'll sort of lead into. We don't expect that things are going to get worse. That's not in our baseline assumption. We expect that supply chains will normalize. We feel very, very good about the demand for the home improvement products. We're talking to our merchants on a daily basis. David touched on also briefly, merchants have been cautious in spending during the election cycle in terms of marketing and the fear that their messages have been lost. Media prices have really been driven up, so you'll see those merchants come out next year and start marketing again, consistent with prior periods. So we're expecting that double-digit sort of mid-teens kind of growth and origination that's a byproduct of the home improvement growth with restoration in the elective healthcare business.
spk03: Yeah, David, I just want to clarify or correct, I think, a comment that you made. Transaction volume for the quarter was down 10%, not 20%. And just remind everyone that not long ago, elective healthcare was 10% of our business. So we're very excited about the durability of our home improvement business as well as the momentum that we're seeing. And we're providing directional guidance as to how we think the overall business will continue to grow nicely next year.
spk06: Okay. Thank you for that. Yeah, I was just – sorry, I was meeting the fourth quarter – 20 implied guidance, but that's helpful. So the elective healthcare, that was 500 to 600 million and a quarter. And so I guess that would be more like a third of your originations. Sorry, just trying to clarify.
spk03: It was 500 to 600 million annual run rate. Not long ago, it was over 10% of our business.
spk06: Gotcha. Okay. Makes sense. Thank you. Separate question, I just wanted to clarify on the loan participation sales and the fair value mark on that. Maybe if you can go into more detail of what that is and what changes that fair value mark over time. I know that's non-cash, but just trying to understand that in more detail. Is that sort of like the FCR or the financial guarantee? I'm just trying to understand the mechanics. Thank you. Sure. So if you're referring to the line item mark-to-market on sales facilitation obligations of $18 million, that, as I described, is related to a fair value assessment of an obligation we have to help facilitate loan sales for a bank partner. So those are not on GreenSky's balance sheet, and they are not a cash item. Directionally, I think the way you can think about it is The fair value mark is consistent with the other side of the fence, which is I'm calling the recognized or realized gain or loss on sales and or receivables that are on GreenSky's balance sheet. So the fair value assessment is reflective of what has happened. I would say directionally we are adjusting it as a non-cash item because ultimate recognition of those facilitation obligations are sometime in the future and they will be dependent on the structure which may be different and price which may be different relative to what we recognize as part of green skies balance sheet so that's that's the primary differentiator between those two items okay gotcha but it's not um like say a guarantee or a certain level of performance uh guarantee it is okay okay understood thanks very much Thank you.
spk08: Your next question comes from the line of Rob Wildhack with Autonomous Research.
spk05: Good morning, guys. Can you give some additional details about that sales facilitation obligation? Why didn't these loans fit or stay in the waterfall? And what's the dollar amount of loans you're obligated to sell? Any additional color you could provide there would be helpful.
spk06: Sure. Hi, Rob. It's not necessarily a FIT type assessment. These are loans originated by a bank partner held on their balance sheet. As part of our agreement with them, we have an obligation to sell those loans after a certain period of time. And so we're reflecting that fair value mark as part of that obligation. But it is not representative of what is what is available or eligible for the SPV. In fact, you know, some of those loans could go into the SPV into the future. Some of those loans could be transacted in an alternate way. It's simply an arrangement we have with one of our bank partners to help facilitate originations and ultimately sell them as a solution for that funding.
spk00: Okay. Nothing worth jumping in, Rob. As David mentioned, The super regional banks are flush with cash. We're seeing escalating demand for our portfolios. We're getting calls on a daily basis from existing and prospective bank partners looking for assets. So in the case of the loans held for sale on the balance sheet that Andrew just referenced... And that's not our balance sheet. Right, on the bank's balance sheet. If those move to a bank that would work with us, with us servicing the loan, on a waterfall basis, for instance, the mark that we're taking would be restored. So to Andrew's point, we don't know what the ultimate outcome is of that trade. There could be no mark required. This is a conservative estimate is what it is.
spk05: Okay, got it. And then, you know, just on the funding more broadly, you know, zooming out a little bit, is there an ideal mix that you're targeting between waterfall and whole loan sales?
spk06: Andrew, why don't you touch on that? Sure, absolutely. And we'll obviously talk a little bit more about this in January, but I think really the idea here is we're not establishing the sales as some strict percentage or concentration of funding. I think the whole point of diversification was to optimize. As Jerry mentioned, we are seeing a significant amount of demand across are capable channels of funding so not only from bank partners but also in the securitization market or through other sales to institutional investors we will use all those opportunities to best optimize i would say that you know just directionally it's probably something like 20 at least from my seat today, that would be expected to be sold. But I would caution that because I think it could be higher or lower based on other attractive funding that we'll see materialize.
spk05: Okay, that's really helpful. And just if I could ask one quick one, Jerry, you mentioned that the $18 million mark this quarter was a conservative estimate, and I you know, appreciate that. Is there a possibility that that could ultimately get worse when you realize the sale?
spk00: If money markets were to perversely move, but just given where we've been and the normalization that's taking place as people have sort of begun to understand and absorb COVID, that wouldn't be a likely trend, as I sit here today.
spk07: Okay, thank you.
spk06: Heading on, all things being equal, we expect that execution to improve over time. As we do more of those transactions, we get more recognition in the market. Again, all things being equal, that should improve.
spk00: It's not worth mentioning, everything that we've sold here to four has been with servicing retained, so we continue to enjoy the income stream post-sale.
spk05: That's really helpful. Thanks, guys.
spk08: Your next question comes from the line of Chris Donat with Piper Sandler.
spk01: Hi. Good morning, everyone. Thanks for taking my question. Wanted to ask one around the home improvement categories on your slide number 10. And maybe I'm trying to dig too deep into this. But relative to the second quarter, looks like you saw improvement in windows and doors and weaker on HVAC. And I'm just wondering if there's anything notable there. It didn't sound like the merchant, like your discontinued merchants were a factor, but we've got a bunch of cross-currents like weather, the pandemic, the stimulus package.
spk04: I'm just wondering anything you'd call out as far as better demand for window originations, but maybe a little weaker on HVAC?
spk03: Yeah, so part of it, there's definitely very specific supply chain challenges, particularly for HVAC. And there were earlier supply chain challenges for windows that seems to have restored. So I think there's lots of moving parts. But what we're seeing is sort of a general view from the merchants that we've interviewed. They expect that absent a new lockdown, they expect sort of their supply chains to be cleaned up by Christmas. And we're certainly seeing a lot of engagement and enthusiasm in new merchant sign-ups. But I think in terms of what you're referencing, Chris, just a lot of noise and distraction in the market, whether it's supply chain or labor or election. So there's nothing related to either merchant attrition or merchant termination that we've seen. we've seen continued strong ads of large strategic merchants. Okay. And then just while I'm asking on that, just to double check, like nothing related to the stimulus package that happened more in the second quarter timeframe that impacted.
spk01: And the reason I'm asking that is just if we get another stimulus package, if we would expect any any notable impact on your business. But it doesn't seem like there was much of one. Is that fair to say?
spk03: That is correct. In fact, I would say that the stimulus, you know, if you think about, you know, our home improvement business, these are average FICO 770, average income $125,000, average debt to income 20-something percent, 23%. Generally, these are not the borrowers that are going to be as motivated by stimulus. Now, there is a slice of that population that certainly is going to appreciate getting an extra $600 a week. What we see is that has more impact on payment than it does on the demand by origination. If your HVAC system is broken, you need a new HVAC system. Certainly, windows and doors is more of a a want and a need, we have not seen as close a correlation on demand connected to benefits or incentive payments from the government as we have more of an acceleration on payments.
spk01: Got it. OK. Thanks very much, David.
spk03: Chris, good talking to you again. It's been too long.
spk01: Yeah.
spk08: Your next question comes from the line of Bill Ryan with CompassPoint.
spk06: My question has been answered. Thank you. Thank you, Bill.
spk08: Your next question comes from the line of Reggie Smith with JPMorgan.
spk01: Hey, good morning, guys. Thanks for squeezing me in. I had a quick question, and if this is too detailed, we can take it offline, but I was curious. You know, one of the things I've been struggling to model is that FCR expense. I get that the liability is somewhat dictated by the size of the portfolio. I know that ratio has kind of come down in the last couple of quarters, but how should we think about that FCR expense over the next few quarters? And then I had a follow-up question on the – I guess the gain, the loss on sale piece, but we can come back to that. But just to get the first question, the FCR expense, how should we think about that? That ratio has bounced around quite a bit for the last couple of quarters.
spk06: Thank you for the question. So it has bounced around for the past few quarters. I think directionally we would expect it to remain pretty stable going forward, keeping in mind some impacts of seasonality.
spk00: as well but we can um certainly take that offline uh when we when we catch up uh we can try and dive a little deeper into that for you i want to highlight for you one of the benefits of the asset sales that andrew highlighted although there was a discount realized we shed the fcr with respect to those assets so that piece of the portfolio that went bye-bye there is no fcr going forward so while andrew's suggesting the P&L trend looked stable going forward, which I would concur with, we would expect, based on the mix of how we're funding our business, to mimic on the FCR side. If we had more funding coming from capital markets and less from waterfall, for instance, there'd be less FCR liability to establish.
spk01: Sure. Got that. Understood. And then I guess just to drill in on that $32 million expense, I think you guys said that... That includes, I guess, expected discounts on loans that are held that haven't been sold yet. Is that correct? And if so, should we expect that number to decline? Was it almost a pull forward there, or is 32 like a good kind of go forward? It is a pull forward. So you would expect that to come down?
spk06: Well, so the 32 includes loans that have not been sold yet. So it's a mark-to-market on receivables held on our balance sheet that will be sold in the future.
spk01: Got it. And that relates to the $500 or so million that shows up as held? That's right. Got it. Okay.
spk06: It's a combination of that balance you just mentioned as well as what was actually sold in the quarter.
spk01: What was actually sold. Correct. Got it. Got it, got it, got it. Okay, that makes sense, that makes sense. I was going to ask, and you guys kind of, I think, touched on it, but I was hoping to get within the home improvement space, if there were any pockets of strength to call out. It looks like windows and doors were a relative bright spot, but maybe if you could talk about some of the weaker areas so that we could maybe understand where things could kind of snap back next year, and if that kind of makes sense.
spk03: Hey, Reggie. Great to catch up. You know, actually, look, we saw a lot of volatility over the last couple of months in windows and doors and HVAC. Certainly the larger projects were more complicated and had more moving parts. But what we're really seeing is a great deal of demand, and from everything we can see, the leading indicators are very encouraging across the board.
spk01: Okay, understood. All right, cool. Well, thank you for squeezing me in, and we'll catch up afterwards. Good talking to you guys. Thank you.
spk07: Thank you. Thank you.
spk08: There are no further questions in queue. I will now turn the conference back over to Mr. David Zalek, CEO, for closing remarks.
spk03: Thank you. Thank you everyone for your questions. Our consolidated third quarter 2020 results were highlighted by continued durability of our home improvement business, renewed optimism for patient solutions, and strong adjusted EBITDA growth of 17%. As mentioned in my initial remarks, our ongoing focus on product innovation Merchant productivity and credit quality, along with our recently expanded and strong sources of funding, positions us very well for future success. Thank you again for joining us today. Please stay healthy and safe, and we look forward to speaking with you in January on our Virtual Investor Day. Thank you.
spk08: Thank you for participating in GreenSky's third quarter 2020 financial results conference call. You may now disconnect. THE END
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