Q2 2020 On Deck Capital Inc Earnings Call
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Earnings Conference call.
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After relations.
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Thank you Carol good morning, everyone and welcome to Ondecks second quarter earnings call.
Joining me on the call. This morning, Noah Breslow, or Chief Executive Officer, Kim Brown, our Chief Financial Officer, and Nick Brown, our Chief risk Officer.
Our earnings release was issued last night and is available with our earnings presentation and financial data supplement in the Investor Relations section of our website.
Certain statements, including those related to our third quarter in second half 2020 outlook are forward looking statements. They are not Saxon are subject to material risks and uncertainties described in our FCC filings you.
These statements are based on currently available information and we undertake no duty to update them, except as required by law.
Today's discussion is also subject to the forward looking statement limitations in the earnings release, and our actual results could differ materially and adversely from those anticipated.
During this call will use terms to find in the earnings release and refer to non-GAAP financial measures for definitions and reconciliations to GAAP. Please refer to the non-GAAP tables in the earnings release and the appendix of the earnings presentation posted on our website.
With that I'll turn the call over to know.
Thank you, Steve and thank you all for joining us today.
Before we get into our second quarter highlights and financial results I want to make a few brief comments on last night's announcement regarding the acquisition the bond backed by a noble.
For anyone that may not have seen that announcement, we entered into a definitive agreement whereby a noble will acquire on Dec any transaction valued at $90 million with an approximate all in per share value of $1.38 cents for ondecks shareholders, which equates to about a 90% premium to our closing share price on July 27.
We're extremely excited about our combination with an over.
This transaction combines two businesses with complementary expertise and capabilities.
Both companies are pioneers and leveraging proprietary analytics and the digital experience to deliver financing to underserved small businesses and consumers.
Following an extensive review of our strategic options conducted over the last few months. We believe this is the best path forward for our customers employees and shareholders.
Joining forces with Inova and leveraging our collective scaling strength.
As long as our complementary portfolio products and brands provides the best opportunity for our long term success.
Together, the combined company sure innovative customer oriented cultures, and we believe shareholders of both firms will benefit from the substantial synergies expected to be realized as we integrate the businesses.
The transaction is anticipated to close later this year subject to ondecks shareholder approval and customary closing requirements.
During the pendency period, we remain committed to transparency with all stakeholders and focused on running our business what remains an unprecedented public health and economic environment.
Now turning to our second quarter's results.
We made significant progress executing the cobot response plan, we outlined during our first quarter earnings call over the last 90 days and we reported a second quarter profit.
On the call today I will provide you with an update on the progress we've made against our near term priorities.
Then I'll turn the call over Didnt, Nick to provide an update on our portfolio performance and discuss our strategy for growing originations.
After that Ken will walk you through our financial results and our progress with respect to funding and liquidity.
And finally before opening the call to questions I will discuss our second half objectives.
We dramatically curtailed originations of our core small business loan products in the second quarter.
Most states went into different degrees of locked out.
During this time, we focused on helping our customers and other small businesses managed to this unprecedented environment by facilitating paycheck protection program or PPP loans.
Your partnership with experienced SP, a lender banks.
We also reallocated team members from sales to payment support and collections functions in a comprehensive effort to maintain constructed hey relationships with our customers.
We worked with our customers to offer temporary payment reductions payment deferrals or term extensions at where appropriate to each situation.
Our actions on the customer side have increased the percentage of our customers and paying relationships and the large reduction in our delinquencies from peak levels.
Nick will go into greater detail on the shortly but our one plus delinquent loan balance improved from a peak of nearly $500 million in April to around $275 million. This week.
We also took actions to preserve liquidity and increased funding flexibility in the second quarter.
We amended our for U.S. warehouse facilities to receive temporary relief for cobot impacted loans and we received a waiver on our corporate line of credit.
In Canada, we paid off our credit Agricole facility and amended our facility with bank of Montreal.
And then Australia, we executed an amendment with credit Suisse.
And we continue to constructively work with our lending partners on further amendments as we adapt to this dynamic environment.
We also aggressively reduced costs and ultimately exceeded our targeted second quarter operating expense savings of $13 million.
This was accomplished through a temporary 90 day austerity program. We implemented early April in response to the uncertainty in the economy and the impact of co bid on our business.
Ken will go into more detail honest later, but given we now expect the journey back to our pre Kobin scale will take quarters instead of weeks or months, we decided to make permanent changes to reduce our expenses to better align with projected revenue.
In July we laid off approximately 20% of our U.S. staff.
This decision was difficult, but necessary for us to navigate the environments, we are going to be in for the next six to 12 months.
Finally, we began originating new term loans and lines of credit again in June after a brief pause in may.
We have a targeted and disciplined strategy to prudently originator products focused on shorter term loans in select states in industries that are reopened.
I'm encouraged by recent trends as we continue to grow application and approval volumes week over week.
With that I'm going to turn the call over generic but we'll be back to provide an update on our second half priorities before opening the call for questions.
Thank you know.
I'm glad to join this morning, and provide an update on our portfolio performance and discuss the strategy. We are following for wrapping origination.
For those reviewing our earnings presentation slide seven through nine provide some of the context to the trends that I will be discussing.
Delinquency in collection trends have continued to improve during the second quarter from their peak in April.
This improvement has been driven by improvement in industry is less impacted by the pandemic and then geographies that began to reopen early although most industries and geographies are seeing some improvement since may.
We are able to identify and analyze these trends because we track delinquencies. When they are one day past due which allows us to react more dynamically then if we were using industry standard views of 30 days plus past due.
As you can see on slide eight are totally U.S., one plus days past due balance which includes all customer on temporary payment reductions payment deferrals or term extension increase from prior quarter, but decline from its peak of 47% in may 243% at June Thirtyth and today sets.
Well below 40%.
And the percentage of delinquent loan balances on which we are collecting more than 25% of the normal payment has improved from approximately 30% at March 31st and 45% at April 30% to 62% as of June Thirtyth.
Collectability trends are also improving and we are deploying substantial additional internal resources to moving customers into paying status as the economy reopens, including putting merchants on specific payment plans.
That's cool that we have set company gold each month on improving the number of customers into paying relationship, which we have achieved in each month throughout the quarter.
The percentage of total U.S. customers, making a payment in the last seven days of at least 25% of the original contractual mouth.
Increased from a low 75% in April 17th to approximately 87% on June Thirtyth and approximately 88% this week.
Now getting into our allowance for credit losses.
Our allowance for credit losses increased $32 million as expected losses were realized in the portfolio paid down.
During the quarter, we had a slight reserve build on the existing portfolio due to a seasoning of accounts within the co. The debit stopped population.
And then increasing certainty of a more gradual recovery than initially estimated at the end of first quarter.
Accounts in this population are still not paying despite a range of collections efforts and offered and therefore are more likely to default slide nine depicts the composition of our reserve between the normal and each cobot subpopulation.
Overall, our portfolio delinquency trends and roll rates have been in line with our expectations.
And our net charge off rate has increased in line with expectations at delinquency on the earliest kobin impacted loans in our portfolio seasons into charge off.
As we mentioned during the first quarter call you cannot apply existing roll rates.
Through our delinquency buckets.
As illustrated in our financial data supplement as the loss expectations are different.
And finally, we are assuming global economic activity remains muted throughout the second half of 2020 with a slow recovery commencing in 2021.
In our allowance for credit losses, and well this is a slower recovery than previously forecast our belief in the quality bar delinquent customers and their desire to work through their situation.
To achieve full principal pay off has not changed since last quarter.
Now I will share some thoughts on or re entry strategy.
We have used they faced and prudent approach to grow our originations starting with the customers industry in geography, we have the best visibility yacht and our data shows our most resilient in this environment. Each credit strategy is tested with safe and sound credit and pricing strategies before.
Full rollout.
We're continuing to watch the rapidly changing climate and adapt as necessary.
Like an accordion, we can scale up or down in industries or geographies that are four are not performing.
What we have seen so far it's the demand is temporary due to cobot uncertainty and some overhang from the government stimulus programs, but we do feel confident our reentry approach in value proposition will allow us to prudently scale, our businesses, albeit on a slower pace because of the macro environment.
And more muted demand function.
And with that I'll turn the cat call over to Ken to walk through second quarter financial results and provide an update on our funding strategy.
Well, thank you Nick and good morning, everyone.
Nick said they'd like to provide some additional detailing our second quarter results, our funding and liquidity position and our outlook for the remainder of the year.
Second quarter net income was $2 million or four cents per diluted share significantly improved from $59 million net loss in the first quarter.
Included in this quarter's results are in that 6.4 million noncash goodwill impairment and a 2.8 million restructuring charge related to the actions we took to reduce ongoing costs.
Excluding these items and roughly $2 million of stock based compensation. Our adjusted net income was $13.6 million or 23 cents per diluted share count.
Compared to an adjusted net loss of $58 million last quarter.
Getting into some of the details.
Finance receivables and just the ended the quarter or just over $900 million a $390 million decrease from March 30, onest, reflecting a pullback in originations and strong portfolio collections.
Origination volume decrease about 90% sequentially to $66 million, reflecting our decision to temporarily suspend originating new term loans and lines of credit.
And the greater than expected, 30% portfolio contraction was driven in part by a high level of prepayments.
Gross revenue was $81 million down 27% from the prior quarter, largely due to portfolio and yield contraction.
Portfolio yield declined roughly 500 basis points sequentially, it's a 28.4% reflecting cobot related impacts.
Interest expense decreased to $10 million as debt balances declined commensurate with portfolio run off.
Our cost of funds rate improved 20 basis points from the prior quarter to 4.6%.
Driven primarily by the reduction in market interest rates in March.
Net interest income and net interest margin also declined.
Net interest margin was 21.5% a sequential decline of 610 basis points, reflecting the change in yield and negative carry on the excess liquidity we maintained.
Now turning to credits.
As a result of the trends that Nick discussed a provision for credit losses was $24 million.
84 million from the prior quarter, when we increased reserves for higher expected losses due to cope it.
The net charge off ratio increases expected to 20.9%.
As the earliest cobot impacted loans in our portfolio season and were charged off.
The 15, plus day delinquency ratio increased from 10.3% at March 31st% to 39.5% at June Thirtyth as Cogan impacted loans age. However, this ratio improved from its peak of 42% in may even with a declining loan portfolio in passing that did not.
And there.
As noted in Nick mentioned, the percentage of customers and paying relationships increased meaningfully while the balance of delinquent loans is significantly down from its peak.
As a result, the allowance for credit losses decreased $32 million from March 30, Onest, two 174 million at June Thirtyth.
Reflecting the realization of expected losses, and the portfolio pay down.
The reserve ratio increased modestly to just under 20%.
In line with portfolio trends and our updated loss expectations.
We made meaningful progress on operating expenses, which decreased $11 million from the first quarter 40 million, which included 2.8 million dollar restructuring charge.
Excluding that charge operating expenses decreased 14 million or 28% from the first quarter as we exceeded our targeted expense.
The temporary expense actions, we took in the quarter included an almost complete elimination of marketing spend.
Significant reduction in discretionary costs and broad based employee actions, including a hiring freeze the place one of employees on part time or furlough status and salary reductions.
This approach enabled us to act quickly and gave us maximum optionality, while preserving franchise value.
No I mentioned, we made the tough decision earlier this month to lay off approximately 20% of our U.S. staff, which resulted in the 2.8 million dollar restructuring charge, which has an expected payback period of approximately one quarter.
As a result of the continued decline in a market capitalization, we impaired the entire 11 million of goodwill that was recorded when we combined our Canadian business without a lost city during the second quarter of 2019.
Since we are a single segment company testing is done on a consolidated basis and as a result, we had a record this noncash charge.
However, since the goodwill is booked in our Canadian subsidiary $4.6 million. If it was attributable to non controlling interests, making the net impact to ondeck $6.4 million.
And finally, we did not record any income tax expense or benefit in the second quarter due to the continued uncertainties in our full year 2020 taxable income forecast.
Turning to the balance sheet.
There's no expansions preserving our liquidity was a top priority during the second quarter.
We manage both loan origination and operating cost outflows and made significant progress amending our debt facilities.
These amendments provided temporary relief on borrowing base requirements and portfolio performance test for a specified period.
And reduced facility advance rates.
Our debt balances continued to decline in line with portfolio collections, which are continued strong.
And there's no also mentioned we continue to have constructive dialogue with our lenders on potential future amendments.
Total cash and equivalents at quarter end was $150 million essentially unchanged from March 30, Onest, though the composition change with the proportion of restricted cash increasing primarily due to the higher balances related to be early amortization of our securitizations.
Debt outstanding decreased 364 million to 680 million as cash collected was primarily used to pay down debt.
Ondeck stockholders' equity increased to 217 million.
5 million from March 30, Onest and now represents 22% of assets.
Our debt to equity ratio also improved to three times at quarter end, reflecting our debt pay down.
Before I turn the call over to know for closing remarks, I want to share our thoughts on the near term outlook.
We are again not guiding to explicit revenue and income Rangers. However, as we execute on our second half 2020 priorities, we expect to reporting modest net loss in the third quarter, reflecting the following trends.
Lower revenue, reflecting continued albeit slower portfolio contraction.
It's stable net interest margin.
Provision for loan losses, consistent with increasing originations and portfolio quality trends.
Operating expenses around 40 million per quarter.
And as Nick mentioned this outlook assumes U.S. and global economic activity remains muted throughout the second half of 2020 with a slow recovery beginning in 2021.
With that I'll turn it back to know or for final comments before opening the call for questions.
Thanks, Ken.
I'm so proud of the way our team responded in the second quarter to this challenging environment, but one thing we know for sure is that could be 19 is going to be here longer than we all hoped.
Keith has continued to rise in many areas in the U.S. warding, many small businesses opening plans and increasing uncertainty for those businesses that have reopened.
While there will always be a need for online small business lending, we recognize the need to make more permanent business changes to adapt to this reality.
As a result, we have aligned or second half origination strategy and operating expense levels to fit our liquidity position and position us for success from the pandemic abates and the economy begins to recover.
Our second half 2020 priorities are focused on near term sustainability and positioning the company for a return to portfolio growth in 2021.
First we will prudently increased originations focusing on industries and geographies that will remain resilience given the current and expected environment.
And continue to improve collections from existing accounts and manage credit quality on new originations through active portfolio management.
Third increased automation and operating efficiency across the company and finally, we will continue to focus on maintaining ample liquidity in funding flexibility during this transitionary period.
Our business combination with the Nova will bring together to fin Tech leader to create a company with over $40 billion loans originated since inception.
A highly complementary portfolio of leading brands addressing the needs of underserved consumers and small businesses.
Leadership in leveraging advanced analytics and technology to make efficient lending decisions online.
And experienced management team and innovative culture increased scale and financial strength to whether the current environment and emerged stronger.
And significant shareholder value creation opportunities.
These strategic and financial benefits are compelling and we believe provide our customers employees and shareholders the best opportunity for growth and success.
With that we'll turn the call back over to Carol for your questions about the quarter.
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Our first question today comes from Stephen Walker from Morgan Stanley. Please go ahead.
Hey, Thanks, good morning, and congratulations on the deal guys.
Maybe just a quick a high level question about sort of the conversations you're having with your clients as we think about the go forward and condition on the ground. Obviously like you pointed out Noah this is going to be with us for a longer I'm curious.
Given what we're seeing with the complexion of the portfolio.
What your clients thoughts are on the extent to which stimulus is supporting them right now the extent to which the removal of that stimulus could drive further portfolio deterioration for you guys could you give us some comment there.
Yeah, no absolutely so.
The.
Sentiment, we're seeing I think as we go into the restart we actually just posted some customer stories on our website you know it isn't uncertain time for small businesses and I think the experience can't be simply distilled into a single.
Overwhelming sentiment because it really depends on where you are and what you do.
And so the government stimulus I think undoubtedly played a positive role in the second quarter in terms of helping customers in our portfolio eager to loans that we facility that traded ourselves through PPP.
Or others did helping them sort of maintain their businesses and their payroll. The during that time, we did see I think better collections in our back book than we expected.
Going forward, though I.
I don't think small businesses, our banking second round of government stimulus on if you saw the PPP fund still had a decent amount of their allocation left so demand for that particular type of stimulus I think abated.
But we are seeing just again some uncertainty in businesses as they reopen acid their levels of demand as they think about you know the growth investments required. So we are reopening originations not only with a focus on geography and industry, but also with a focus on existing customers, where we have that long history, we've seen their businesses in some cases over over.
A period as long as years, and and were able to make really sound lending decisions and we've sort of watch those customers have payment activity during the koby crisis, so, especially customers who have worked upon deck for a long time and have exhibited strong painted behavior during coated.
Is where we're starting in our restart and we'll throw them expand from there.
That's very helpful and maybe just one quick other one.
I noticed in the in the call last night with Inova I didn't see any specific number unless I missed something around the extent of the market that they're planning to take on the acquisition is just curious if you guys had a sense of where that might be shaking out or just the logic behind how to mark that at fair value at a specific point in time later this year given the.
Ever changing conditions on the ground affecting the book.
Of course, yes, no thats, a really important question, but we're not suited to answer it ourselves. This is really a question for a Nova is our management team, but certainly as as was mentioned on the call last night. They are strongly considering moving the portfolio to fair value.
Which is aligned with their accounting strategy.
Understood. Thanks.
Our next question comes from Eric Wasserstrom from GBM.
Thanks Scott.
Hi, Good morning, Thanks for taking my question, maybe on a similar loan of thought around and market conditions. I mean, I think one of the one of the things we've we've observed as many small businesses pivoting.
I'd say, we're primarily an in store model to.
Maybe a hybrid model to even if that our restaurant to pivot towards.
You know.
Primarily preparing for delivery and take out in that kind of thing.
Do you guys have any sense of how much.
Revenue recapture is occurring as as Youre your small business customers make that make that pivot.
Yes. Thanks, Eric This is no us so.
It's hard for us to peg the exact level of revenue recapture for our customers, but but I will say, 100% you are right on main street small business owners, especially if they were more brick and mortar are doing kind of anything and everything to go more digital and go more distanced.
So if we look at some of the customer experiences we've had in the restart and why small businesses are taking loans the folks who are growing either there in industries that are directly if you will benefiting from from the current conditions, there's a few industry that fit those criteria.
But a number of the use cases have been around buying inventory to support kind of E commerce or digital type revenue expansion for these businesses, while they're unable to operate in the normal course, so so I think the trend is absolutely there.
The level of revenue recapture I think really varies by the type of business and the industry there and so it's tough to generalize, but but I think all business owners are accelerating their plans to have a digital components, even if their brick and mortar business ultimately comes back to its former size.
The only other things that I would add to what no. It said is a lot of our customers are anticipating the in their local geography, they will be seeing consolidation I ease some of their competitors are having difficulties in the anticipate that competition being reduced but the.
Our nation is unknown in their mind as to the timing of when that will occur because of the support of the government stimulus programs that have allowed them to continue to operate beyond that which they would normally be able to survive.
Okay got it got it. Thank you for that and then one when deal related question no. What can you just walk us through the the milestones from from here that we should be we should be following towards the consummation of the deal.
I can do it at a very high level, Eric, but I'd, rather not respond too much about the deal the folks that this call is really on the second quarter earnings for Ondecks Standalone.
But this is a a really as a standard deal there's a stock component both companies are public.
And so a lot of these next steps are very customary.
In terms of a filing of a proxy and a shareholder vote to approve the deal on on Dec side.
And those are really the main domain milestones that we see otherwise it's a very straightforward.
Stock deal, there's the usual checks on anti trust, which we are you know.
Fairly confident will not much yield any issues.
And that's about it.
Okay, great. Thanks very much.
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Ask a question.
Your next question comes from Olefins withheld from JP Morgan.
Please go ahead.
Good morning, guys. Thanks for taking my question.
I'm curious to explore the elevated prepayments and it seems a little bit inconsistent with what we're seeing some other consumer categories, where I'm curious if there were any specific incentives that you guys were offering to drive those prepayments.
Yes, I'll I'll answer that in two ways, the first of which was.
I think most of our customers are saying that although it's still a lot of uncertainty ahead of them. They are seeing more certainty than when coated initially started.
And so those customers, who either receive PPP money or had fairly deep capital reserve as that certainty on their future increased their willingness to expand their capital to become current with their loans became go.
Operator, and as a result, we saw that that sentiment improvements resulted in payment improvement in our portfolio.
The second thing is is that a lot of the increase payments initially were coming for.
Early pay offs and that early payoff has started to level out over the last week or two and what we're seeing now is that it's mostly customers who are resuming their normal payment schedule. That's driving the improvements we are seeing some move.
In terms of how much of their original payment that they are paying moving from 25% to 50%, 50% to 70% et cetera, but the biggest changes from those that moved from a short term deferral to paying greater than 25%.
Okay. So looking ahead I guess given those funds do you feel like the evening.
Or the prepayments that you sign Kikuyu wear and.
Sort of a blip driven by happened that your other really hurt.
All of that relatively easily board.
Yeah, Hey at least based upon the trends for the last couple of weeks.
The early pay offs have increased and what we're seeing is is that overall the increase in collectability and payments that has been really strong in the last couple of weeks are being driven less by early pay offs and more by increasing percentages of payments within the paying population and some movement.
From non paying to above 25%.
Great. Thank you.
And Weve no further questions in queue at this time.
We would like to thank you for participating on today's call.
Concerning our conference call for today.
Correct.
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