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spk00: 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.
spk01: Thank you, Natalia, and good morning, everyone. Thank you all for joining us. Earlier this morning, GreenSky issued a press release announcing results for its fourth quarter and full year 2020 ended December 31st, 2020. You can access this press release on the investor relations section of the GreenSky website. In addition, we have posted our fourth quarter and full year 2020 earnings presentation, which we will refer to in today's call. Today you will hear prepared remarks from David Zalek, our Chairman and Chief Executive Officer, and Andrew Kang, our Executive Vice President and Chief Financial Officer. We are also joined by Jerry Benjamin, our Vice Chairman and Chief Administrative 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 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 this morning, 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 March 10, 2021, and on the Investor Relations page of our website. At this time, I will turn the call over to David.
spk03: 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 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, lead 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. 2020 was also a pivotal year for us in which we set out on a critical strategy to diversify our funding. As a result, we now have increased capacity and multiple sources of liquidity, which allows us to support our growth objectives, optimize profitability, and help manage liquidity risk into the future. In 2020, we completed over $1 billion of new funding initiatives, and since year end, that momentum has continued with the recent completion of a new $1 billion forward flow sale agreement with the leading life insurance company earlier this month. The agreement brings yet another new funding partner to our ecosystem and supports our ability to grow transaction volumes into 2022. Included in the agreement was an initial sale of approximately $135 million in assets, which was incremental to four one-year commitments. Andrew will provide additional details on our overall state of funding, but I'm delighted that our funding is the strongest and most diverse it has ever been in the history of our company. On slide four, GreenSky has enabled $28 billion of transactions for over 3.7 million consumers, and 2020 transaction volumes of $5.5 billion reflect the resilience of our business during the past year, despite the impacts and the restrictions related to our elective healthcare businesses. In 2020, we were pleased to be able to increase the average ticket size of our transactions by over 10% compared to the prior year, which also helped drive the growth in our year-end servicing portfolio by over 30% from what it was two years ago. Turning to slide five of the presentation, we continue to believe our high-quality program consumers and their strong credit performance is a key differentiator for GreenSky. Our weighted average FICO score of borrowers at the time of application was 781 in Q4. Thirty-day-plus delinquencies observed at the end of the fourth quarter were just under 1%, compared to 1.38% at the end of fourth quarter of 2019, reflecting a nearly 40 basis point improvement compared to a year ago and an improvement compared to the third quarter of 2020, outperforming typical seasonal trends. These metrics reflect the positive credit nature of our consumers who represent homeowners actively pursuing the improvement of their highest valued asset. and the performance of our service portfolio reflects the investments GreenSky has made in technology, process, and operations that allow us to differentiate credit quality at time of origination and as we service the portfolio throughout the life of the Loves. As we've shared with you before, I'd like to update you on the small portion of our portfolio that continues to receive COVID-19 disaster assistance. As of the end of the year, approximately 0.8% of the total loans serviced on our platform remained in payment deferral status related to COVID-19. Some of the borrowers that were impacted by this hardship did result in a loss, but with a peak of 4% who received disaster assistance, less than 0.3% charged off in 2020. Although the overall impact of these losses is yet to be determined in 2021, we continue to see positive trends. Our borrowers are continuing to exit payment deferral at a faster rate than those requesting new enrollments, and less than 0.5% of loans in our servicing portfolio remain in deferral at the end of February. We are optimistic that the assistance our consumers receive through continuing federal stimulus support and the hopeful expeditious reopening of our economy will prevent meaningful opportunity on our performance for the remainder of the year. Turning to slide six, GreenSky has demonstrated a proven track record of maintaining a very high-quality consumer base for many years, and we have achieved a greater than 30% CAGR on transaction volumes and revenues prior to 2020 without sacrificing on quality. At the end of the fourth quarter, 80% of borrowers at time of application had a weighted average FICO score in excess of 700, and 40% had scores in excess of 780. Not only have we shown strong credit performance historically, but we've also been successful in maintaining the quality of new originations in a challenging 2020 without sacrificing credit. While GreenSky has limited actual exposure to credit risk, our originations benefits our business as we earn incentive payments in our bank waterfall when loans perform better than expected. Additionally, the quality of loans originated on GreenSky's platform remain important to our funding partners, which has allowed us to maintain and expand existing relationships and add new banks and institutional investors to the GreenSky program. On slide seven, the size of the target addressable market for our core domestic home improvement and elective health care verticals exceeds $600 billion per year. This combined with the superior consumer experience and seamless technology platform we provide to our merchants are key differentiators, making GreenSky the market leader in our core home improvement business and a strong disruptor in elective healthcare financing. Focusing on home improvement, we recently renewed our partnership with the Home Depot and have added a significant number of new merchants to our platform. By way of example, The Q4 merchant additions included a $25 million a year regional HVAC contractor, two regional roofing contractors who combined annual revenue in excess of $85 million, and a new $30 million a year regional window and door contractor, and many others. Of the new relationships added in Q4, approximately 75% of those merchants represent a migration from our competitors and an increase in GreenSky's market share. Overall, our home improvement business was resilient through the fourth quarter, despite ongoing supply chain disruptions, which increased cycle times for many larger home improvement projects. However, I believe that we will begin to see improvements in these delays and disruptions and a return to more normal project timelines as the pace of business normalizes in 2021. Our Green Sky Patient Solutions business also continues to be well-positioned to benefit from a significant recovery in pent-up demand in the coming year. Although the fourth quarter and full-year transaction volumes were still adversely impacted by COVID-19-related shutdowns in elective healthcare procedures, we expect to see solid growth in our patient solution business as the year progresses. Our growth strategy is focused on specific high-growth verticals such as non-invasive cosmetics, large-ticket dentistry, and LASIK vision corrections. One such early win already this year was successfully establishing an integrated financing solution with LaserAway, a leader in aesthetic dermatology, with 67 clinics nationwide. As a technology-driven operator, they were delighted with GreenSky's API capabilities to deliver a seamless financing experience for their patients, and we expect partnerships like these will support the growth and recovery of our elective healthcare business in 2021. Turning to slide eight, GreenSky continues to generate outstanding lifetime value to customer acquisition cost metrics due to our focus on larger merchants and maintaining the lowest account acquisition costs among our FinTech competitors. The chart on the left shows that we have achieved a 53% CAGR in the number of merchants with over 10 million of annual transaction volume since 2015. On the right, you can see that our transaction volume include merchants that have been with us for many years. As trusted partners, we have shared in their successful growth of their business and in GreenSky's transaction volume over the years. During the fourth quarter alone, we added over 1,000 new merchants to the GreenSky platform, many of whom left our competitors and came to GreenSky via inbound inquiries as they seek to gain access to our patented proprietary platform. Throughout 2020, we talked with you about our focus on increasing merchant productivity, and in Q4, our average merchant ticket size increased by 10% compared to the prior year, while we also observed meaningful growth in the average monthly transaction volume per merchant originated on our platform. This is another important example of the disciplined execution of our team on key strategic goals to increase the scale and resiliency of our transaction volumes. Before I turn the call over to Andrew to go through the details of our fourth quarter and full year 2020 performance, as well as to update you on our 2021 guidance, let me briefly recap our 10x9x30 plan that we shared with you at our Investor Day in early January. Our strategic plan calls for transaction volumes approaching $10 billion, revenues of approximately $900 million, and a long-term sustainable adjusted EBITDA margin targeting an excess of 30% by 2025. We believe this plan has upside as it does not include additional platform innovations and strategic projects in our pipeline. We will periodically be updating our plan for additional stair steps in growth as we launch new initiatives coming out of successful pilots and sharing specific details supporting such incremental growth expectations. Thank you for your interest in GreenSky, and I'll now turn the call over to Andrew.
spk04: 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 forecast 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. I mentioned this previously on our investor day, but in the fourth quarter, we completed $685 million in loan sales at significantly improved pricing, which more closely reflects our bank funding costs. We also amended our warehouse credit facility to increase the committed capacity to $555 million and increase the advance rate, establishing a more efficient funding structure as we temporarily warehouse those loan participations prior to sale. With our existing bank partner capacity and successful rollout of our loan sales program, GreenSky's funding is the strongest it has ever been in the history of the company. Importantly, current market dynamics today continue to show strong demand for our assets from both banks and institutional investors, and we continue to have active dialogue with new and existing partners interested in adding to our bank commitments as well as participating in our loan sales. With attractive economics, these additional sources of funding will allow us to grow our business while maintaining and improving our margins. Turning to slide 11, our net income was $23 million in the fourth quarter compared to $5 million in the same quarter in 2019. Let me walk through the key drivers of these results. Starting with revenues, Green Skies reported fourth quarter total revenue of $129 million compared to $136 million in the fourth quarter of 2019. Q4 transaction fee revenue reflected the benefit of a 40 basis point increase in the transaction fee rate compared to the same quarter in the prior year, across $1.3 billion of new transaction volume in the quarter. For the year, GreenSky's total revenues were $526 million, reflecting a 30 basis point increase in transaction fee rate over the prior year which largely offset the decrease in volumes in 2020. I will go into more detail on the cost of revenue and financial guarantee expense in a moment, but I also want to highlight the efficiency of our operating expenses for the year. Excluding non-cash and non-recurring items, our operating expenses were flat year over year with incremental expenses related to investments in new products and innovations funded through those efficiencies. expense control continues to be a strict focus for us in 2021 as we ensure the most efficient path toward growth and realize the true scalability of our operations. It is worth noting that our 2020 results are consistent or better than what we provided during our investor day. Our net income is higher than originally estimated, largely due to better-than-expected revenue of $6 million, as well as an additional $4 million favorable variance driven by December bank waterfall activity that resulted in $2.4 million lower cost of revenue and $1.5 million favorable impact to our financial guarantee expense. Turning to slide 12, our full year average transaction fee rate for the year was 7.1% and 7.2% in Q4, or 40 basis points higher than the same period last year. The higher transaction fee, year over year reflects the continued demand for promotional financing products with higher transaction fees in our home improvement business. We were also highly successful in working with our merchants on new and innovative products that supported higher close rates toward the end of the year and into 2021. On the right, the trend in APR on new originations also continued to increase quarter over quarter, with strong demand for deferred interest products which have higher corresponding yields. While there was a 20 basis point decrease in total portfolio APR in the fourth quarter compared to the prior year, the elevated transaction fees more than offset the decline and resulted in an improvement to overall revenue generation when taking into account both transaction fee rate and collateral APR collectively. On slide 13, transaction fee rates and the multi-year history of recurring merchant utilization on our platform, that David described earlier together drove transaction fee revenue of $393 million for the year. Servicing fees from our $9.5 billion portfolio contributed approximately 22% of total revenues for the year with the average servicing fee rate increasing to 1.23% from 1.14% compared to the prior year. As a result, actual cash servicing fees received in 2020 were up 23% compared to 2019. Shifting now to the cost of revenue. Cost of revenue was $79 million for the quarter compared to $70 million in 2019. We inferred $29.7 million in loan sale costs in the fourth quarter, which were offset by a $12.6 million reduction in bank waterfall costs. For the year, cost of revenue increased to $307.9 million, primarily due to $72 million in loan sale costs and $10.7 million in non-cash sales facilitation expense. This was also offset by a $23 million decrease in our bank waterfall costs compared to 2019. As you can see, for the quarter and for the year, our loan sale activities have results that benefit our bank waterfall costs that I will go into more detail in a moment. Origination expenses as a percentage of transaction volume were lower for the quarter while servicing-related expenses increased $2 million year-over-year, but as a percentage of the average servicing portfolio, these costs remain flat. This is particularly remarkable when taking into account the volatility in consumer behavior and uncertainty of credit during 2020, and it continues to highlight GreenSky's cost discipline and the agile nature of our operations and investments in technology to service the loans on our platform. Over the last few quarters, we have highlighted the positive trends within our bank waterfall costs and specifically the improvements attributed to stronger incentive payments. Overall bank waterfall costs, 26% in the fourth quarter compared to a year ago, were $13 million lower in 2020 compared to 2019. On the right, we show the components that make up our bank waterfall costs. FCR expense for the quarter was $85 million, or 7% lower compared to the same quarter in the prior year, and total ending FCR liability was $185 million at the end of the year, or $21 million lower than a year ago. Lastly, incentive payments were $6 million higher in Q4 versus the prior year, reducing the cost of revenue and reflecting the combined benefit of lower charge-off rates and lower bank margin. As we discussed in Q3, loan sales costs make up an important component of our cost of revenue. To remind everyone, GreenSky's business model has always been focused on the lifetime profitability of each vintage of originations. And as we described in our investor day, while fully loaded funding costs are recognized up front with loan sales, over the life of our vintage originations and current sale economics, these costs are equivalent to our historical bank funding costs. Loan sales expense was $29.7 million in the quarter, which reflects the realized expense on assets sold as well as the mark-to-market expense on loan receivables held for sale on our balance sheet at the end of the quarter. Beginning in Q3, we also began recognizing a non-cash mark-to-market expense on future sale facilitation commitments for assets not on GreenSky's balance sheet. This non-cash item for the quarter was $7.6 million benefit due to improved pricing execution in the fourth quarter compared to the $18 million expense recognized in Q3. For the full year, the non-cash mark-to-market expense was less than $11 million. While we incur an upfront expense on our loan sales, keep in mind they also reduce FCR expense otherwise incurred in our bank waterfall in future periods and mitigate risk and incentive payment variability due to charge-offs. It is also important to note that our loan sale costs vary based on the loan product mix that is sold and taken into concert with transaction fees earned at the loan product level. Our loan sales maintain a lifetime contribution margin of greater than 5% consistent with our historical cost of funds. Turning to slide 15, the financial guarantee expense for the fourth quarter represented a benefit of $23.5 million. You will recall that under our adoption of CECL, the escrow we put aside on behalf of our bank partners represent the main component of the financial guarantee expense. While historically our ongoing bank partners have used little to no escrow, the CECL methodology requires us to estimate the expense as though our loan portfolios were in runoff. The loan sales in Q4 had the impact of reducing our model escrow usage, and as a result, the related financial guarantee liability. This resulted in the recognition of a significant financial guaranteed benefit during the fourth quarter of 2020. Prior to the fourth quarter, we adjusted EBITDA for CECL expense as a non-cash item. However, we now estimate certain model scenarios show small amounts of cash escrow usage might reasonably occur. As a result, we have discontinued our adjustment of this as a non-cash item and EBITDA recognized a cumulative reduction to EBITDA for prior quarter adjustments and further simplified our financial reporting. Said another way, there is a $0 EBITDA adjustment for CECL for full year 2020, as well as in our 2021. Turning now to guidance on slide 16, we are on track to achieve transaction volumes of $6.2 to $6.5 billion or approximately 15% growth year over year, and our estimated revenue remains at approximately $584 million. we are revising our net income estimate to break even for the year based on two primary reasons. First, while there is still uncertainty in the post-COVID recovery of the consumer and improvement in the macroeconomic environment, the trends we are seeing through the end of last year and into the first couple months of 2021 lead us to believe incentive payment performance as a result of lower charge-offs will be better than our prior estimates. Second, we expect additional improvements in 2021 loan sale costs anchored by the new billion-dollar forward flow agreement that we announced today. Together, these two trends combine for a $40 million benefit to net income at the midpoint of our revised guidance. We are also revising adjusted EBITDA higher, which reflects the benefits and the cost of revenue that I just described, but also takes into account that we are no longer adjusting EBITDA for the financial guarantee expense. As a result, we are revising our adjusted EBITDA to $45 to $55 million and adjusted EBITDA margin to between 8% and 10% per year. Once we have finished recognizing the remaining impacts from the pandemic and have reached a steady state in our diversified funding model, which we believe will be by 2022, reported gap net income and adjusted EBITDA are estimated to reflect sustainable adjusted margins exceeding 30%. Before moving to Q&A, I wanted to offer some additional assumptions and transparency on how to model key inputs underlying our 2021 guidance on revenue and cost of revenue. Here, we provide a range for transaction fees, servicing fees, and interest and other income, as well as cost of funds and servicing and originations costs. Thank you for the opportunity to discuss our fourth quarter and full year 2020 financial results and for your ongoing interest in Green Skies. Operator, this completes our prepared remarks, and we are now ready to take questions.
spk00: At this time, if you would like to ask a question, please press star, then the number one on your telephone keypad. Again, to ask a question, please press star, then the number one. We will pause for just a moment to compile the Q&A roster. Your first question is from the line of John Davis with Raymond James.
spk06: 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 21 to 22, and explicitly those kind of pandemic costs that you think more or less will come out of? 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.
spk04: Sure. As I mentioned, I think the two main components and the revision upward are around an improving charge-off estimate for the year as well as the mark-to-market cost. 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, you know, ongoing improvement. You can see part of our performance related to delinquencies are 40 basis points better year over year. 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 the shift in 2021 expectations.
spk03: 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 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 2019, and also in 2021, we'll start seeing the benefit of that. So we're literally changing the funding model and diversifying it, which is what's creating this optic and 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.
spk06: 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 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? I just kind of want to understand the play of how you guys think about stimulus. Obviously, it's going to fit on the credit side.
spk03: Yeah, 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, 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. They're being helped by the stimulus. I think the data bears it out. The data shows that people who are getting stimulus are actually paying off debt and saving money.
spk06: Right. I should note there was a potential headwind from stimulus just from people not needing to borrow as much. That makes sense. Okay. And then I guess last one for me, it's just topical with kind of 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 up front or the funding costs. just at a high level. I know it's complicated when you get in the weeds, but just, you know, good, bad, neutral. If rates were to continue to rise, just make commentary there. Thanks, guys.
spk04: Sure. Let me comment first on the funding cost piece. So I think, you know, obviously we're focused on watching, you know, the expected change in interest rates down the road. I would say that, you know, predominantly our bank waterfall costs are anchored off of the short end of the curve, and based on where they've 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, You know, 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 type 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.
spk03: Yeah. 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 rate is driven by hyperinflation or a deep recession, that's one thing. But changes in long-term interest rate expectations does not impact our margin. As interest rates 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.
spk06: Okay. All right. Thanks, guys.
spk00: Your next question is from the line of Aaron Saganovich with Citi.
spk05: Hi. Thanks for the question. Maybe you could just talk a little bit about the consumer demand. It looks like you have pretty solid expected growth for 2021 in how you're seeing that trending over the past few months.
spk03: 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. And certainly supply chain is making progress, catching up. But the consumer demand is certainly there.
spk05: Okay. And then the FCR expense was lower year over year. Was that primarily related to loan sales in the quarter? I was trying to understand the movements there.
spk04: Yes, that was primarily due to the diversified funding model. So, again, as we incur costs on loan sales, We have said that it does have an offsetting benefit to our bank waterfall costs, and 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 FCR 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. Okay.
spk00: Thank you. Your next question is from the line of Bill Ryan with CompassPoint.
spk07: 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 return going down with low interest rate environment? And then second, you know, 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 kind of draw a correlation, if you will, between the delinquencies and the credit losses to better calculate incentive income? Thanks.
spk04: So, thank you. I'll start with the component, 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 kind of 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 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've continued 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 kind of target to represent in terms of loan sale costs, with probably some upside given that there continues to be some strong demand from our partners in 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 a 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. And I think the best kind of early indicator of that is the delinquency metric that we've provided historically. So 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 of economics. But we'll try and work with you on that to see if we can dissect it with what information is out there.
spk07: 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, You know, if you're kind of trying to adjust it to an apples to apples comparison a year ago with deferrals and its impact on delinquencies, you know, is there a way or a number that you can kind of directionally give us on that as well? Thanks.
spk03: 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.
spk04: 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 kind of 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.
spk08: Thank you.
spk00: Your next question is from the line of Rob Wildhack with Autonomous Research.
spk02: Good morning, guys. I wanted to ask about your commentary that the escrow could be used going forward. In the slides, you talk 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?
spk04: Sure. I'll try and take that one. So as I mentioned, our escrow utilization forecast is based on a non, I would say, 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. So I think, you know, 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 in a material amount, but the guidance that we are applying is that, you know, it is either a cash or non-cash expense based on a, again, runoff forecast, and if we see you know, any amount of cash utilization, whether it's, you know, small, we are going to apply the guidance of not adjusting it back into our EBITDA. So it's kind of a binary.
spk03: Yeah, let me add to that. So this is really all about accounting treatment. It's not a change in cash. So, for example, Rob, if we have a bank sell a portfolio, and in order to facilitate the sale, the escrow is used, what that means is all of the escrow is for any bank, can't be added back in EBITDA. So Cecil and Gap strikes again.
spk02: Okay, thanks. So is it fair to say then, Andrew, just to kind of 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?
spk03: No, it's not really that. If we've got a small bank that just can't originate anymore, 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.
spk02: Well, okay. Thank you.
spk04: Yeah, and I just said it's not any one of those things. It can be a combination of the different components that I mentioned. So it's definitely not related to kind of 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.
spk00: Your final question is from the line of Chris Donette with Piper Sandler.
spk08: Good morning. Thanks for taking my questions. I 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 had a promotional event in the first quarter. So I'm wondering if that's something that we should expect in 21 with, you know, 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?
spk03: So, what we see is certainly stability in the take rate. Our expectation is that, in terms of our modeling, is we assume it'll be a little bit lower and kind of 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. And just as a data point on Q1, every year we have some volume-based marketing funds and rebates that we pay in Q1. And so that is arbitrarily making Q1 look different. And so I think we can maybe try to show that with and without the marketing fund. So 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?
spk08: Yeah, it does. Just didn't want to be surprised if there was anything that the – yeah, your comments put it in context here. And then – go ahead, Andrew.
spk04: I was just going to add that, you know, on the take rate, we have seen – we mentioned that, you know, the end of 2020 into 2021, we've seen higher, you know, take rate. given the mix of consumer demand. We are, you know, outside of the rebates that we just discussed, we do think over the course of the year 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.
spk08: Okay. Got it. And 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 looks like HVAC was down about 36% year on year. Just wondering, and we've talked about this before, but first kind of retrospectively, any callouts on HVAC for the fourth quarter? And then just wondering what the weather in the first quarter, if that changed anything on activity for HVAC, particularly in some regions like Texas, or just curious.
spk04: 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 focus and stress 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 kind of what you're seeing in our business other than the fact that there's just, you know, some seasonal changes and, you know, we're looking to ramp up both in both categories.
spk03: I would add to that. What we're seeing in every category, certainly in home improvement and, for that matter, elective health care, is, um, uh, good leading indicators for growth in every category of our business. So, you know, for, uh, for us, we're getting, we're gaining market share, we're getting bigger, we're getting more merchants, um, and we're seeing in every segment of our business, uh, growth year over year.
spk08: Okay. And on elect, yeah, yeah. That's what I was going to say. Elective healthcare, anything you, you point us to like, um, It's a 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. I mean, is this a coiled spring or is it something that's going to be gradual?
spk03: So 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's going to get elective medical procedures. We saw that. We saw so many of our amazing healthcare providers, you know, they went from, you know, 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. We've got many more in the pipeline. So 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 a steady progression in the trends we're seeing so far.
spk08: Okay. Thanks, David.
spk03: Thank you.
spk00: Fair enough for the questions. I will turn the call back over to CEO David Zalek for any closing remarks.
spk03: 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.
spk00: This concludes the Marine Sky fourth quarter 2020 financial results conference call. Thank you for your participation. You may now disconnect.
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