GREENSKY, INC. (United States dollars in thousands, except per share data and unless otherwise indicated) You should read the following discussion and analysis of our financial condition and results of operations together with our Unaudited Condensed Consolidated Financial Statements and related notes included elsewhere in this Form 10-Q, as well as the Audited Consolidated Financial Statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in theGreenSky, Inc. 2019 Form 10-K filed with theSecurities and Exchange Commission onMarch 2, 2020 ("2019 Form 10-K"). This discussion and analysis contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various important factors, including those set forth under Part II, Item 1A "Risk Factors" in this Form 10-Q. Organization GreenSky, Inc. (or the "Company," "we" or "our") was formed as aDelaware corporation onJuly 12, 2017 . The Company was formed for the purpose of completing an initial public offering ("IPO") of its Class A common stock and certain Reorganization Transactions, as further described in the 2019 Form 10-K, in order to carry on the business ofGreenSky Holdings, LLC ("GS Holdings ") and its consolidated subsidiaries.GS Holdings , a holding company with no operating assets or operations, was organized inAugust 2017 . OnAugust 24, 2017 ,GS Holdings acquired a 100% interest inGreenSky, LLC ("GSLLC"), aGeorgia limited liability company, which is an operating entity. Common membership interests ofGS Holdings are referred to as "Holdco Units." OnMay 24, 2018 , the Company's Class A common stock commenced trading on the Nasdaq Global Select Market in connection with its IPO. Executive Summary Covid-19 Pandemic OnMarch 11, 2020 , theWorld Health Organization designated the novel coronavirus disease (referred to as "COVID-19") as a global pandemic. In the second half ofMarch 2020 , the impact of COVID-19 and related actions to mitigate its spread within theU.S. began to impact our consolidated operating results. As ofNovember 9, 2020 , the date of filing this Quarterly Report on Form 10-Q, the duration and severity of the effects of COVID-19 remain unknown. Likewise, neither do we know the duration and severity of the impact of COVID-19 on members of the GreenSky ecosystem - our merchants,Bank Partners , and GreenSky program borrowers - or our associates. In addition to instituting a Company-wide work-at-home program to ensure the safety of all GreenSky associates and their families, we formed a GreenSky Continuity Team that is tasked with communicating to employees on a regular basis regarding such efforts as planning for contingencies related to the COVID-19 pandemic, providing updated information and policies related to the safety and health of all GreenSky associates, and monitoring the ongoing crisis for new developments that may impact GreenSky, our work locations and/or our associates. Our GreenSky Continuity Team is generally following the requirements and protocols as published by theU.S. Centers for Disease Control and Prevention and theWorld Health Organization , as well as state and local governments. As of the date of this filing, we have not begun to lift the actions put in place as part of our business continuity strategy, including work-at-home requirements and travel restrictions, and we do not believe that these protocols have materially adversely impacted our internal controls or financial reporting processes. OnMarch 27, 2020 , the President ofthe United States signed into law the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"). The CARES Act, among other things, includes provisions relating to direct economic assistance to American workers, refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, technical corrections to tax depreciation methods for qualified improvement property and temporary relief from certain troubled debt restructuring provisions. While we do not believe the impacts of the CARES Act were material during the three and nine months endedSeptember 30, 2020 , we continue to examine both the direct and indirect impacts that the CARES Act, and additional government relief measures, may have on our business, including impacts associated with the expiration of select CARES Act provisions. 50 -------------------------------------------------------------------------------- Table of
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The following are anticipated key impacts of COVID-19 on our business and response initiatives taken by the Company, in coordination with our network partners, to mitigate such impacts: Transaction Volume. Our transaction volume began to be impacted significantly by COVID-19 inmid-March 2020 and continued to be impacted through the third quarter. For the three and nine months endedSeptember 30, 2020 , our transaction volume decreased 10% and 6%, respectively, compared to the three and nine months endedSeptember 30, 2019 . Compared to the second quarter 2020, volumes for the third quarter were 9% higher which is partially due to the seasonality we have historically observed. Consumer spending behavior has been significantly impacted by the COVID-19 pandemic, principally due to restrictions on "non-essential" businesses, issuances of stay-at-home orders, increased unemployment, uncertainties about the extent and duration of the pandemic and consumers' concerns with allowing merchant service providers into their home. To the extent this change in consumer spending behavior continues, we expect transaction volume to decline relative to the prior year. We expect any declines in transaction volume to reduce our transaction fees relative to 2019. In order for our merchants to better adapt to their customers' financing needs in the current economic environment, we collaborated with our merchants and, in response to their input, developed a suite of new promotional loan product offerings, primarily additional reduced rate and deferred interest loan products. The extent to which our home improvement merchants have remained open for business has varied across merchant category and geographical location within theU.S. The majority of elective healthcare providers had been temporarily closed nationwide due to state and local restrictions, prohibiting the performance of elective healthcare procedures and reducing our elective healthcare transaction volumes from mid-March through September to de minimis levels. Portfolio Credit Losses. We entered the COVID-19 pandemic with historically strong credit performance and we believe our home improvement sector super-prime program borrowers, in particular, in concert with our focus on promotional credit, are strongly resilient. To maintain our strong credit position in this uncertain economic environment, we continue to emphasize our super-prime promotional loan programs with our merchants. Additionally, in partnership with ourBank Partners , GreenSky program borrowers impacted by COVID-19who requested hardship assistance have received temporary relief from payments. As ofSeptember 30, 2020 , less than 1% of the total servicing portfolio was in payment deferral. While our measures have thus far been effective in mitigating substantial credit losses, we anticipate increased portfolio credit losses in the fourth quarter of 2020 and into 2021 as compared to the prior periods. The timing and extent of these future portfolio credit losses is not yet know given the ongoing COVID-19 pandemic. These potential credit losses would reduce our incentive payments from ourBank Partners . We also provide limited protection to theBank Partners through our restricted escrow accounts. Increases in credit losses have the effect of reducing our incentive payments fromBank Partners , thereby (absent any other factors) increasing our fair value change in finance charge reversal expense, which is a component of cost of revenue. In addition, for our loan receivables held for sale atSeptember 30, 2020 , estimated credit losses are reflected in the value at which the loan receivables are recorded. As the impact of COVID-19 continues to persist and evolve, GreenSky remains committed to serving GreenSky program borrowers and ourBank Partners and merchants, while caring for the safety of our associates and their families. The potential impact that COVID-19 could have on our financial condition and results of operations remains highly uncertain. For more information, refer to Part II, Item 1A "Risk Factors" and, in particular, "- The global outbreak of the novel coronavirus, or COVID-19, has caused severe disruptions in theU.S. economy, and may have an adverse impact on our performance and results of operations." 51 -------------------------------------------------------------------------------- Table of
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Key Developments Specific key developments during the third quarter include: Funding Diversification. GreenSky continues to actively diversify its funding to include a combination of commitments fromBank Partners and alternative funding structures with one or more institutional investors, financial institutions and other sources. •We completed a critical component for the GreenSky program to accomplish alternative funding structures by entering into a series of agreements (collectively, the "Facility Bank Partner Agreements") inMay 2020 with an existing Bank Partner, to provide a framework for the programmatic sale of loan participations and/or whole loans by that Bank Partner to third parties, including to the previously-announced special purpose vehicle sponsored by the Company (the "SPV"). The SPV uses financing under an asset-backed revolving credit facility, established pursuant to a warehouse credit agreement entered into by the SPV inMay 2020 with the lenders party thereto from time to time (the "Lenders"), andJPMorgan Chase Bank, N.A . ("JPMorgan") as administrative agent, to finance purchases by the SPV of participations in loans originated through the GreenSky program (the "SPV Facility"). •In September andOctober 2020 , GreenSky executed a total of$875 million in various funding initiatives, including the sale of approximately$775 million in loan participations or whole loans to institutional asset managers, financial institutions andBank Partners (including a loan sale to a new bank partner) and an increase in an existing Bank Partner's funding commitment of$100 million . A portion of these transactions included the sale of participations previously purchased by the SPV, and the related proceeds from the sale of such participations were used to pay down amounts previously borrowed under the SPV Facility, which allowed additional purchases of participations to be financed through the SPV Facility. •We continue to work with multiple institutional investors, financial institutions or other financing sources on whole loan and loan participations sales programs (collectively, "New Institutional Financings") and expect to complete one or more additional transactions in the first half of 2021. Depending on the magnitude and timing of future sales, the SPV Facility could facilitate substantial incremental GreenSky program loan volume. •InOctober 2020 , we entered into a new long-term$600 million per year bank funding partnership, totaling up to$1.8 billion in the initial three-year term, for our elective healthcare vertical. Third Quarter and Year-to-date 2020 Results Notwithstanding the impact of COVID-19 thus far on our 2020 transaction volumes, we achieved strong results in our key business metrics and financial measures as of and for the three and nine months endedSeptember 30, 2020 : Business Metrics •Transaction volume (as defined below) was$1.48 billion during the three months endedSeptember 30, 2020 compared to$1.64 billion during the three months endedSeptember 30, 2019 , a decrease of 10%. Transaction volume was$4.21 billion during the nine months endedSeptember 30, 2020 compared to$4.46 billion during the nine months endedSeptember 30, 2019 , a decrease of 6%; •Total revenue of$142.0 million during the three months endedSeptember 30, 2020 decreased 7% from$153.5 million during the three months endedSeptember 30, 2019 . Total revenue of$396.8 million during the nine months endedSeptember 30, 2020 increased 0.04% from$396.7 million during the nine months endedSeptember 30, 2019 ; •The outstanding balance of loans serviced by our platform totaled$9.55 billion as ofSeptember 30, 2020 compared to$8.76 billion as ofSeptember 30, 2019 , an increase of 9%; •Incentive payments we receive from ourBank Partners , which favorably impact our cost of revenue, increased 68% and 76% during the three and nine months endedSeptember 30, 2020 , respectively, 52 -------------------------------------------------------------------------------- Table of
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compared to the same periods in 2019 due to the combination of lower agreed-upon Bank Partner portfolio yield and strong credit performance across the portfolio, offset by the decrease in incentive payments associated with participated loans purchased by the SPV (which ceased earning incentive payments upon purchase); •We maintained a strong consumer profile. GreenSky program borrowers with credit scores over 780 comprised 39% of the loan servicing portfolio as ofSeptember 30, 2020 , and over 87% of the loan servicing portfolio as ofSeptember 30, 2020 consisted of GreenSky program borrowers with credit scores over 700; and •The 30-day delinquencies as ofSeptember 30, 2020 were 1.04%, an improvement of 25 basis points overSeptember 30, 2019 . The delinquency rate includes accounts that received COVID-19 assistance that are no longer in payment deferral. Less than 1% of the total loans serviced by our platform as ofSeptember 30, 2020 were in deferral status as of that date, compared to 4% at the end of the second quarter of 2020. Financial Measures We had net income of$5.2 million during the nine months endedSeptember 30, 2020 compared to net income of$90.7 million during the nine months endedSeptember 30, 2019 . The lower earnings in the 2020 period was primarily due to: •$28.4 million non-cash charge to financial guarantee expense in the nine months endedSeptember 30, 2020 period in accordance with the provisions of ASU 2016-13 (referred to as "CECL"), which we adopted onJanuary 1, 2020 . Refer to "Three and Nine Months EndedSeptember 30, 2020 and 2019-Financial guarantee" in this Part I, Item 2 as well as Note 1 and Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for additional discussion of our financial guarantee. •During the first quarter of 2020, we terminated our program related to transferring our rights to Charged-Off Receivables (as defined in Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1), for which we recognized a$22.9 million gain in the nine months endedSeptember 30, 2019 . To the extent that we do not transfer our rights to Charged-Off Receivables in the future, we expect to benefit from the retained recoveries over time to achieve overall higher cash returns and recognize recoveries as collected. •During the third quarter of 2020, we recognized an$18.3 million mark-to-market expense related to sales facilitation obligations which is reflected in cost of revenue. •During the first three quarters of 2020, sales, general administrative and compensation and benefits cost increased$7.2 million , reflecting increases in credit reserves on loans receivable held for sale, higher IPO litigation costs and$1.6 million increase in stock-based compensation expense. For additional information, see Results of Operations within this Item 2. Adjusted EBITDA (as defined below) of$38.7 million during the three months endedSeptember 30, 2020 increased from$33.1 million during the three months endedSeptember 30, 2019 . Adjusted EBITDA of$95.6 million during the nine months endedSeptember 30, 2020 increased from$81.3 million during the nine months endedSeptember 30, 2019 . Information regarding our use of Adjusted EBITDA, a non-GAAP measure, and a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP (as defined below) measure, is included in "Non-GAAP Financial Measure." Seasonality. Historically, our business has generally been subject to seasonality in consumer spending and payment patterns. We cannot yet predict the impacts of COVID-19 on the seasonality of our business for the remainder of 2020 or future periods. Given that our home improvement vertical is a significant contributor to our overall revenue, our revenue growth generally has been higher during the second and third quarters of the year as the weather improves, the 53 -------------------------------------------------------------------------------- Table of
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residential real estate market becomes more active and consumers begin home improvement projects. During these periods, we have typically experienced increased loan applications and, in turn, transaction volume. Conversely, our revenue growth generally has been relatively slower during the first and fourth quarters of the year, as consumer spending on home improvement projects tends to slow leading up to the holiday season and through the winter months. As a result, the volume of loan applications and transactions has also tended to slow during these periods. Historically, the elective healthcare vertical has been susceptible to seasonality during the fourth quarter of the year, as the licensed healthcare providers take more vacation time around the holiday season. During this period, the volume of elective healthcare procedures and our resulting revenue have typically been slower relative to other periods throughout the year. Our seasonality trends may vary in the future as we introduce our program to new industry verticals and become less concentrated in the home improvement industry. The origination related and finance charge reversal components of our cost of revenue also have been subject to these same seasonal factors, while the servicing related component of cost of revenue, in particular customer service staffing, printing and postage costs, has not been as closely correlated to seasonal volume patterns. As transaction volume increases, the transaction volume related personnel costs, as well as costs related to credit and identity verification, among other activities, increase as well. Further, finance charge reversal settlements are positively correlated with transaction volume in the same period of the prior year. As prepayments on deferred interest loans, which trigger finance charge reversals, typically are highest towards the end of the promotional period, and promotional periods are most commonly 12, 18 or 24 months, finance charge reversal settlements follow a similar seasonal pattern as transaction volumes over the course of a calendar year. Lastly, we historically have observed seasonal patterns in consumer credit, driven to an extent by income tax refunds, which results in lower charge-offs during the second and third quarters of the year. Credit improvement during these periods has a positive impact on the incentive payments we receive from ourBank Partners . Conversely, during the first and fourth quarters of the year, when credit performance is comparably lower, our incentive payment receipts are negatively impacted, which in turn has a negative impact on our cost of revenue. Non-GAAP Financial Measure In addition to financial measures presented in accordance withUnited States generally accepted accounting principles ("GAAP"), we monitor Adjusted EBITDA to manage our business, make planning decisions, evaluate our performance and allocate resources. We define "Adjusted EBITDA" as net income (loss) before interest expense, taxes, depreciation and amortization, adjusted to eliminate equity-based compensation and payments and certain non-cash and non-recurring expenses. We believe that Adjusted EBITDA is one of the key financial indicators of our business performance over the long term and provides useful information regarding whether cash provided by operating activities is sufficient to maintain and grow our business. We believe that this methodology for determining Adjusted EBITDA can provide useful supplemental information to help investors better understand the economics of our platform. Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, the analysis of other GAAP financial measures, such as net income. Some of the limitations of Adjusted EBITDA include: •It does not reflect our current contractual commitments that will have an impact on future cash flows; •It does not reflect the impact of working capital requirements or capital expenditures; and •It is not a universally consistent calculation, which limits its usefulness as a comparative measure. Management compensates for the inherent limitations associated with using the measure of Adjusted EBITDA through disclosure of such limitations, presentation of our financial statements in accordance with GAAP and reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measure, net income, as presented below. 54 --------------------------------------------------------------------------------
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Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Net income $ 2,811 $ 44,075 $ 5,247 $ 90,669
Interest expense(1) 6,775 5,634 18,289 18,200
Income tax expense (benefit) 197 1,533 799 (3,528)
Depreciation and amortization 2,973 1,955 8,180 5,117
Equity-based compensation expense(2) 4,338 3,781 11,318 9,724
Change in financial guarantee liability(3) (2,382) (320) 26,274 (36)
Servicing asset and liability changes(4) 368 (16,174) (1,370) (24,809)
MTM on sales facilitation obligations(5) 18,262 - 18,262 -
Discontinued charged-off receivables
program(6) - (7,921) - (22,703)
Transaction and non-recurring expenses(7) 5,367 549 8,625 8,672
Adjusted EBITDA $ 38,709 $ 33,112 $ 95,624 $ 81,306
(1)Includes interest expense on our term loan. Interest expense on the SPV
Facility and its related loans receivables held for sale are excluded from the
adjustment above as such amounts are a component of cost of revenue in our
on-going business.
(2)Includes equity-based compensation to employees and directors, as well as
equity-based payments to non-employees.
(3)Includes non-cash charges related to our financial guarantee arrangements
with our ongoing Bank Partners , which are primarily a function of new loans
facilitated on our platform during the period increasing the contractual escrow
balance and the associated financial guarantee liability.
(4)Includes the non-cash changes in the fair value of servicing assets and
servicing liabilities related to our servicing assets associated with Bank
Partner agreements and other contractual arrangements. 2019 amounts have been
updated to be consistent with the Company's 2020 presentation in accordance with
our Non-GAAP policy.
(5)MTM on sales facilitation obligations reflects changes in the fair value in
the embedded derivative for sales facilitation obligations. The changes in fair
value are recognized as a mark-to-market expense in cost of revenue for the
period.
(6)Includes the amounts related to the now discontinued program of transferring
our rights to charged-off receivables to third parties. 2019 amounts have been
updated to be consistent with the Company's 2020 presentation in accordance with
our Non-GAAP policy.
(7)For the three and nine months ended September 30, 2020 , includes professional
fees and other costs associated with our strategic alternatives review process
and IPO related litigation, as well as increased costs resulting from the
COVID-19 pandemic. For the three months ended September 30, 2019 , includes legal
fees associated with IPO related litigation. For the nine months ended September
30, 2019 , includes the following: (i) legal fees associated with IPO related
litigation of $959 thousand , (ii) one-time tax compliance fees related to filing
the final tax return for the Former Corporate Investors associated with the
Reorganization Transactions of $160 thousand , and (iii) lien filing expenses
related to certain Bank Partner solar loans of $621 thousand .
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Business Metrics
We review a number of operating and financial metrics to evaluate our business,
measure our performance, identify trends, formulate plans and make strategic
decisions, including the following.
Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Transaction Volume
Dollars (in millions) $ 1,475 $ 1,644 $ 4,205 $ 4,464
Percentage decrease (10) % (6) %
Loan Servicing Portfolio
Dollars (in millions, at end of period) $ 9,547 $ 8,763 $ 9,547 $ 8,763
Percentage increase 9 % 9 %
Cumulative Consumer Accounts
Number (in millions, at end of period) 3.57 2.85 3.57 2.85
Percentage increase 25 % 25 %
Transaction Volume. We define transaction volume as the dollar value of loans
facilitated on our platform during a given period. Transaction volume is an
indicator of revenue and overall platform profitability and has grown
substantially in the past several years.
Loan Servicing Portfolio. We define our loan servicing portfolio as the
aggregate outstanding consumer loan balance (principal plus accrued interest and
fees) serviced by our platform at the date of measurement. Our loan servicing
portfolio is an indicator of our servicing activities. Our loan servicing
portfolio includes loan receivables held for sale by the SPV as of September 30,
2020 . The average loan servicing portfolio for the three months ended September
30, 2020 and 2019 was $9,475 million and $8,488 million , respectively. The
average loan servicing portfolio for the nine months ended September 30, 2020
and 2019 was $9,325 million and $7,959 million , respectively.
Cumulative Consumer Accounts. We define cumulative consumer accounts as the
aggregate number of consumer accounts approved on our platform since our
inception, including accounts with both outstanding and zero balances. Although
not directly correlated to revenue, cumulative consumer accounts is a measure of
our brand awareness among consumers, as well as the value of the data we have
been collecting from such consumers since our inception. We may use this data to
support future growth by cross-marketing products and delivering potential
additional customers to merchants that may not have been able to source those
customers themselves.
Factors Affecting our Performance
Network of Merchants and Transaction Volume. We have a robust network of
approximately 16,000 merchants, upon which we derive our transaction volumes.
Our revenues and financial results are heavily dependent on our transaction
volume, which represents the dollar amount of loans funded on our platform and,
therefore, influences the fees that we earn and the per-unit cost of the
services that we provide. Our transaction volume depends on our ability to
retain our existing platform participants, add new participants and expand to
new industry verticals. We engage new merchants through both direct sales
channels and affiliate channel partners, such as manufacturers, software
companies and other entities that have a network of merchants that would benefit
from consumer financing. Once onboarded, merchant relationships are maintained
and grown by direct account management, as well as regular product enhancements
that facilitate merchant growth.
Bank Partner Relationships; Other Funding. "Bank Partners " are the federally
insured banks that originate loans under the consumer financing and payments
program that we administer for use by merchants on behalf of such banks in
connection with which we provide point-of-sale financing and payments technology
and related marketing, servicing, collection and other services (the "GreenSky
program" or "program"). Our ability to generate and increase transaction volume
and expand our loan servicing portfolio is, in part, dependent on (a) retaining
our existing Bank Partners and having them renew and expand their commitments,
(b) adding new Bank Partners , and/
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or (c) adding complementary funding arrangements to increase funding capacity. Our failure to do so could materially and adversely affect our business and our ability to grow. A Bank Partner's funding commitment typically has an initial multi-year term, after which the commitment is either renewed (typically on an annual basis) or expires. While no assurance is given that any of the current funding commitments of ourBank Partners will be renewed, sinceJune 30, 2020 we have had threeBank Partners' funding commitments renewed for an additional year for an aggregate of$3.76 billion . As ofSeptember 30, 2020 , we had aggregate funding commitments from our ongoingBank Partners of approximately$8.1 billion , of which approximately$1.5 billion was unused. These funding commitments are "revolving" and replenish as outstanding loans are paid down. As a result of loan pay downs, we anticipate approximately$2.1 billion of additional funding capacity will become available in the next 12 months. As we add newBank Partners , their full commitments are typically subject to a mutually-agreed-upon onboarding schedule. As previously disclosed, inOctober 2020 , GreenSky entered into a new long-term$600 million per year bank funding partnership, totaling up to$1.8 billion in the initial three-year term, for its elective healthcare vertical. This new Bank Partner commitment is based on loan funding per year and is not a revolving commitment that replenishes as outstanding loans are paid down. In addition to customary expansion of commitments from existingBank Partners and the periodic addition of newBank Partners to our funding group, we have diversified the funding for loans originated by ourBank Partners to also include alternative structures with institutional investors, financial institutions and other financing sources. To that end, as noted above under "Executive Summary," inMay 2020 , the Company entered into theFacility Bank Partner Agreements with an existing Bank Partner, to provide a framework for the programmatic sale of loan participations and whole loans by the Bank Partner to third parties, including to the SPV. In addition, we established the SPV Facility with JPMorgan to finance purchases by the SPV of participations in loans originated through the GreenSky program. Further, in September andOctober 2020 , the Company executed a total of$875 million in various funding initiatives, including the sale of loan participations or whole loans to institutional asset managers, financial institutions andBank Partners (including a loan sale to the new Bank Partner) and an increase to an existing Bank Partner's funding commitment by$100 million . A portion of these transactions included the sale of participations previously purchased by the SPV, and the related proceeds from the sale of such participations were used to pay down amounts previously borrowed under the SPV Facility, which allowed additional purchases of participations to be financed through the SPV Facility. We continue to work with multiple institutional investors, financial institutions and other financing sources on New Institutional Financings and expect to complete one or more additional transactions in the first half of 2021. Depending on the magnitude and timing of future sales, the SPV Facility could facilitate substantial incremental GreenSky program loan volume. If we do not timely consummate New Institutional Financings, or if the funding commitments from ourBank Partners and New Institutional Financings (should they be consummated) are not sufficient to support expected originations, it would limit our ability for loans to be originated or our ability to generate revenue at or above current levels. Performance of the Loans our Bank Partners Originate. While ourBank Partners bear substantially all of the credit risk on their wholly-owned loan portfolios, Bank Partner credit losses and prepayments impact our profitability in the following ways: •Our contracts with ourBank Partners entitle us to incentive payments when the finance charges billed to borrowers exceed the sum of an agreed-upon portfolio yield, a fixed servicing fee and realized credit losses. This incentive payment varies from month to month, primarily due to the amount of realized credit losses. •With respect to deferred interest loans, the GreenSky program borrowers are billed for interest throughout the deferred interest promotional period, but the GreenSky program borrowers are not obligated to pay any interest if the loans are repaid in full before the end of the promotional period. We are obligated to remit this accumulated billed interest to ourBank Partners to the extent the loan principal balances are paid off within the promotional period (each event, a finance charge reversal or "FCR") even though the interest billed to the GreenSky program borrowers is reversed. Our maximum FCR liability is limited to the gross amount of finance charges billed during the promotional period, offset by (i) the collection of incentive 57 -------------------------------------------------------------------------------- Table of
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payments from ourBank Partners during such period, (ii) proceeds received from transfers of Charged-Off Receivables, and (iii) recoveries on unsold charged-off receivables. Our profitability is impacted by the difference between the cash collected from these items and the cash to be remitted on a future date to settle our FCR liability. Our FCR liability quantifies our expected future obligation to remit previously billed interest with respect to deferred interest loans. •Under our Bank Partner agreements, if credit losses exceed an agreed-upon threshold, we make limited payments to ourBank Partners . Our maximum financial exposure is contractually limited to the escrow that we establish with each Bank Partner, which represented a weighted average target rate of 2.2% of the total outstanding loan balance as ofSeptember 30, 2020 . Cash set aside to meet this requirement is classified as restricted cash in our Unaudited Condensed Consolidated Balance Sheets. As ofSeptember 30, 2020 , the financial guarantee liability associated with our escrow arrangements recognized in accordance with ASU 2016-13 represents over 90% of the contractual escrow that we have established with each Bank Partner. •Under a certain Bank Partner agreement, the first credit losses that occur on a specific pool of loans result in payments to the Bank Partner from our credit support fund. Our maximum financial exposure for such loans is contractually limited to cash within the credit support fund, and any escrow established at the Bank Partner. The credit support fund represents a weighted average target rate of 2.0% of the total loans subject to the credit support fund. Cash set aside to meet this requirement will be classified as restricted cash in our Unaudited Condensed Consolidated Balance Sheets. As ofSeptember 30, 2020 , the financial guarantee liability associated with our credit support fund recognized in accordance with ASU 2016-13 represents 100% of the credit support fund established with the Bank Partner. Performance of Loan Participations. We bear substantially all of the credit risk of loan receivables held for sale, however, our intent is that our holding period for such loan receivables is fairly brief. For further discussion of our sensitivity to the credit risk exposure of ourBank Partners , see Part I, Item 3 "Quantitative and Qualitative Disclosures About Market Risk-Credit risk." InJanuary 2020 , ourBank Partners also became subject to ASU 2016-13, which may affect how they reserve for losses on loans. General Economic Conditions and Industry Trends. Our results of operations are impacted by the relative strength of the overall economy and its effect on unemployment, consumer spending behavior and consumer demand for our merchants' products and services. As general economic conditions improve or deteriorate, the amount of consumer disposable income tends to fluctuate, which, in turn, impacts consumer spending levels and the willingness of consumers to take out loans to finance purchases. Specific economic factors, such as interest rate levels, changes in monetary and related policies, market volatility, consumer confidence and, particularly, unemployment rates, also influence consumer spending and borrowing patterns. In addition, trends within the industry verticals in which we operate affect consumer spending on the products and services our merchants offer in those industry verticals. For example, the strength of the national and regional real estate markets and trends in new and existing home sales impact demand for home improvement goods and services and, as a result, the volume of loans originated to finance these purchases. In addition, trends in healthcare costs, advances in medical technology and increasing life expectancy are likely to impact demand for elective medical procedures and services. Refer to "Executive Summary" above for a discussion of the expected impacts on our business from the COVID-19 pandemic. Components of Results of Operations There were no significant changes to the components of our results of operations as disclosed in Part II, Item 7 of our 2019 Form 10-K, except as noted below. Financial guarantee. Upon our adoption of the provisions of ASU 2016-13 onJanuary 1, 2020 , our financial guarantee liability associated with our escrow arrangements with ourBank Partners was recognized in accordance with ASC 326, Financial Instruments-Credit Losses (CECL). Changes in the financial guarantee liability each period as measured under CECL are recorded as non-cash charges in the statement of operations. 58 -------------------------------------------------------------------------------- Table of Contents Results of Operations Summary Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Revenue Transaction fees$ 107,538 $ 112,782 $ (5,244) (5) %$ 299,199 $ 305,195 $ (5,996) (2) % Servicing 27,446 40,626 (13,180) (32) % 87,210 90,577 (3,367) (4) % Interest and other 7,039 121 6,918 5,717 % 10,433 907 9,526 1,050 % Total revenue 142,023 153,529 (11,506) (7) % 396,842 396,679 163 - % Costs and expenses Cost of revenue (exclusive of depreciation and amortization shown separately below) 92,346 65,278 27,068 41 % 229,442 180,099 49,343 27 % Compensation and benefits 21,683 21,799 (116) (1) % 66,158 61,891 4,267 7 % Property, office and technology 4,143 3,909 234 6 % 12,242 12,648 (406) (3) % Depreciation and amortization 2,973 1,955 1,018 52 % 8,180 5,117 3,063 60 % Sales, general and administrative 11,614 8,657 2,957 34 % 30,068 22,843 7,225 32 % Financial guarantee (302) 1,117 (1,419) N/M 28,354 4,035 24,319 603 % Related party 350 670 (320) (48) % 1,304 1,795 (491) (27) % Total costs and expenses 132,807 103,385 29,422 28 % 375,748 288,428 87,320 30 % Operating profit 9,216 50,144 (40,928) (82) % 21,094 108,251 (87,157) (81) % Other income (expense), net (6,208) (4,536) (1,672) 37 % (15,048) (21,110) 6,062 (29) % Income before income tax expense (benefit) 3,008 45,608 (42,600) (93) % 6,046 87,141 (81,095) (93) % Income tax expense (benefit) 197 1,533 (1,336) (87) % 799 (3,528) 4,327 N/M Net income$ 2,811 $ 44,075 $ (41,264) (94) %$ 5,247 $ 90,669 $ (85,422) (94) % Less: Net income attributable to noncontrolling interests 1,850 29,349 (27,499) (94) % 3,487 60,728 (57,241) (94) % Net income attributable to GreenSky, Inc.$ 961 $ 14,726 $ (13,765) (93) %$ 1,760 $ 29,941 $ (28,181) (94) % Earnings per share of Class A common stock Basic$ 0.01 $ 0.24 $ 0.03 $ 0.50 Diluted$ 0.01 $ 0.23 $ 0.02 $ 0.46 Three and Nine Months EndedSeptember 30, 2020 and 2019 Total Revenue During the three and nine months endedSeptember 30, 2020 , total revenue decreased$11.5 million , or 7%, and increased$0.2 million , or 0.04%, respectively, compared to the same periods in 2019. Transaction fees During the three and nine months endedSeptember 30, 2020 , transaction fees decreased 5% and 2%, respectively, compared to the same periods in 2019. These decreases were primarily due to a decrease in transaction volume, which declined 10% and 6%, respectively. Additionally, price concessions for a significant merchant group reduced transaction fees by$2.4 million during the nine months endedSeptember 30, 2020 compared to$3.7 million offered to the same merchant group during the same period in 2019. The impact of lower transaction volume was also mitigated by an increase in the transaction fees earned per dollar originated ("transaction fee rate") which were 7.29% during the three months endedSeptember 30, 2020 compared to 6.86% during the same period in 2019, and 7.12% during the nine months endedSeptember 30, 2020 compared to 6.84% during the same period in 2019. The year over year transaction fee rate increases are primarily related to the mix of promotional terms of loans originated on our platform. Loans with lower interest rates, longer stated maturities and longer promotional periods generally carry relatively higher transaction fee rates. Conversely, 59 -------------------------------------------------------------------------------- Table of
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loans with higher interest rates, shorter stated terms and shorter promotional periods generally carry relatively lower transaction fee rates. With the onset of the COVID-19 pandemic, our merchants shifted originations to more promotional loans, which resulted in the upward shift in the transaction fee rate. In addition, the mix of loans offered by merchants generally varies by merchant category, and is dependent on merchant and consumer preference. Therefore, shifts in merchant mix have a direct impact on our transaction fee rates. Servicing During the three months endedSeptember 30, 2020 , servicing revenue decreased$13.2 million , or 32%, compared to the same period in 2019, which was primarily attributable to the$0.8 million decrease in the fair value of our servicing asset in 2020, as compared to the 16.4 million increase in the fair value of our servicing asset during the same period in 2019, which offset the impact of the 12% increase in the average servicing portfolio and higher contractual servicing fee rate of 1.19%, compared to 1.14% during the same period of 2019. During the nine months endedSeptember 30, 2020 , servicing revenue decreased$3.4 million , or 4%, compared to the same period in 2019, which was primarily attributable to the$0.1 million decrease in the fair value change in our servicing asset in 2020, as compared to the$25.3 million increase in the fair value change in our servicing asset during the same period in 2019, which offset the increase in the average loan servicing portfolio of 17%, combined with the receipt of higher fixed servicing fees associated with increases to the contractual fixed servicing fees for certainBank Partners in the second half of 2019. The average servicing fee increased to 1.25% of the average loan servicing portfolio for the nine months endedSeptember 30, 2020 from 1.09% in the same period in 2019. Interest and other During the three and nine months endedSeptember 30, 2020 , interest income increased$6.9 million and$9.5 million , respectively, compared to the same periods in 2019, which was primarily attributable to 2020 interest income from loan receivables held for sale due to the purchase of participations in loans by the SPV. Cost of Revenue (exclusive of depreciation and amortization expense) Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Origination related$ 7,271 $ 9,828 $ 19,823 $ 25,677 Servicing related 13,158 11,834 38,299 33,259 Fair value change in FCR liability 21,832 43,616 110,386 121,163 Loan and loan participation sales costs 31,823 - 42,672 - Mark-to-market on sales facilitation obligations 18,262 - 18,262 $ - Total cost of revenue (exclusive of depreciation and amortization expense)$ 92,346 $ 65,278 $ 229,442 $ 180,099 Origination related Origination related expenses typically include costs associated with our customer service staff that supports Bank Partner loan originations, credit and identity verification, loan document delivery, transaction processing and customer protection expenses. During the three and nine months endedSeptember 30, 2020 , origination related expenses decreased 26% and 23%, respectively, compared to the same periods in 2019, commensurate with our 10% and 6% period over period, respectively, decrease in transaction volume. The lower expenses were largely driven by lower customer protection expenses of$1.6 million and$4.5 million during the three and nine months endedSeptember 30, 2020 , respectively, compared to the same periods in 2019, which are incurred when the Company determines that a merchant did not fulfill its obligation to the end consumer and compensates a Bank Partner for the applicable portion of the loan principal balance. 60 -------------------------------------------------------------------------------- Table of
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Servicing related Servicing related expenses are primarily reflective of the cost of our personnel (including dedicated call center personnel), printing and postage. During the three and nine months endedSeptember 30, 2020 , servicing related expenses increased 11% and 15%, respectively, compared to the same periods in 2019, which resulted from our 12% and 17% period over period, respectively, average loan servicing portfolio growth. The increases in servicing related expenses associated with the increases in loans serviced were primarily for personnel costs within our customer service, collections and quality assurance functions. Fair value change in FCR liability The following table reconciles the beginning and ending measurements of our FCR liability and highlights the activity that drove the fair value change in FCR liability included in our cost of revenue. Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Beginning balance$ 198,755 $ 164,979 $ 206,035 $ 138,589 Receipts(1) 62,631 43,233 166,939 114,287 Settlements(2) (95,706) (68,838) (295,848) (191,049) Fair value changes recognized in cost of revenue(3) 21,832 43,616 110,386 121,163 Ending balance$ 187,512 $ 182,990 $ 187,512 $ 182,990 (1)Includes: (i) incentive payments fromBank Partners , which is the surplus of finance charges billed to borrowers over an agreed-upon portfolio yield, a fixed servicing fee and realized net credit losses, (ii) cash received from recoveries on previously charged-off Bank Partner loans, and (iii) the proceeds received from transferring our rights to Charged-Off Receivables attributable to previously charged-off Bank Partner loans. We consider all monthly incentive payments fromBank Partners during the period to be related to billed finance charges on deferred interest products until monthly incentive payments exceed total billed finance charges on deferred products, which did not occur during the periods presented. (2)Represents the reversal of previously billed finance charges associated with deferred payment loan principal balances that were repaid within the promotional period. The three and nine months endedSeptember 30, 2020 also includes$4.3 million and$24.3 million , respectively, of billed finance charges not yet collected on participations in loans held by the SPV, which were paid to the Bank Partner in full as of the participation purchase dates. (3)A fair value adjustment is made based on the expected reversal percentage of billed finance charges (expected settlements), which is estimated at each reporting date. The fair value adjustment is recognized in cost of revenue in the Unaudited Condensed Consolidated Statements of Operations. Further detail regarding our receipts is provided below for the periods indicated. Three Months Ended Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Incentive payments$ 57,525 $ 34,167 $ 155,737 $ 88,569 Proceeds from Charged-Off Receivables transfers(1) - 7,921 - 22,703 Recoveries on unsold charged-off receivables(2) 5,106 1,145 11,202 3,015 Total receipts$ 62,631 $ 43,233 $ 166,939 $ 114,287 (1)We collected recoveries on previously charged-off and transferred Bank Partner loans on behalf of our Charged-Off Receivables investors of$6.2 million and$5.6 million during the three months endedSeptember 30, 2020 and 2019, respectively, and$17.4 million and$16.2 million during the nine months endedSeptember 30, 2020 and 2019, respectively. These collected recoveries are excluded from receipts, as they do not impact our fair value change in FCR liability. (2)Represents recoveries on previously charged-off Bank Partner loans. The decrease of$21.8 million , or 50%, in the fair value change in FCR liability recognized in cost of revenue during the three months endedSeptember 30, 2020 compared to the same period in 2019 was primarily a function of higher performance fees (attributable to lower charge-offs and lower bank margin) which more than 61 -------------------------------------------------------------------------------- Table of
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offset the impact of the growth of the FCR Liability, net of settlements. In addition, there were no sales of Charged-Off Receivables in the three months endedSeptember 30, 2020 compared to proceeds of$7.9 million in the same period in 2019. The decrease of$10.8 million , or 9% in the fair value change in FCR liability recognized in cost of revenue during the nine months endedSeptember 30, 2020 compared to the same period in 2019, was primarily a function of higher performance fees (attributable to lower charge-offs and lower bank margin) which more than offset the impact of the FCR Liability, net of settlements. In addition, there were no sales of Charged-Off Receivables in the nine months endedSeptember 30, 2020 compared to proceeds of$22.7 million in the same period in 2019. Excluding the impact of the proceeds from Charged-Off Receivables transfers, the decreases in the fair value change in FCR liability were 58% and 23% for the three and nine months endedSeptember 30, 2020 , respectively, relative to our 9% and 9% growth in the loan servicing portfolio, respectively, as we benefited from a 68% and 76% increase in incentive payments resulting from the combination of lower interest rates and lower Bank Partner portfolio credit losses. Loan and loan participations sales costs These amounts primarily include interest expense on the SPV Facility, lower of cost or fair value adjustments on our SPV Participations, certain fees and the amortization of deferred debt issuance costs incurred in connection with obtaining the SPV Facility. We had no such costs in 2019 as the program began in the second quarter of 2020. During the three and nine months endedSeptember 30, 2020 , the loan and loan participations sales costs were$31.8 million and$42.7 million , respectively, inclusive of$19.7 million realized discount on SPV loan participation sales. As the Facility Bank Partner Agreements and the SPV Facility are new arrangements beginning in the second quarter of 2020, there were no SPV related expenses during the three and nine months endedSeptember 30, 2019 . Mark-to-market on sales facilitation obligations The mark-to-market on sales facilitation obligations reflects the changes in the fair value in the embedded derivative for SPV loan participation commitments and are recognized as a mark-to-market in cost of revenue for the period. During both the three and nine months endedSeptember 30, 2020 , the mark-to-market on sales facilitation obligations were$18.3 million . As the first sales facilitation obligations were entered into in the third quarter of 2020, there were no such amounts during the three and nine months endedSeptember 30, 2019 . See Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for further information. Compensation and benefits For the three months endedSeptember 30, 2020 , compensation and benefits expense decreased$0.1 million , or 1%, compared to the same period in 2019 as a result of lower salary expense of$1.1 million , partially offset by a$0.5 million increase in stock-based compensation expense and a$0.3 million decrease in capitalized IT costs. During the nine months endedSeptember 30, 2020 , compensation and benefits expense increased$4.3 million , or 7%, compared to the same period in 2019 as a result of higher salary expense of$3.6 million due to an increase in headcount and a$1.6 million increase in stock-based compensation expense. The increase was offset by a$0.9 million increase in capitalized IT costs during the same period. Property, office and technology During the three months endedSeptember 30, 2020 , property, office, and technology expense increased$0.2 million , or 6%, compared to the same period in 2019. The increase is primarily due to a$0.8 million increase 62 -------------------------------------------------------------------------------- Table of
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in software, hardware and hosting costs, partially offset by a$0.5 million decrease in consulting expenses associated with additional technology process innovation costs in the 2019 period. During the nine months endedSeptember 30, 2020 , property, office, and technology expense decreased$0.4 million , or 3%, respectively, compared to the same period in 2019. The decrease is primarily due to a$1.7 million decrease in consulting expenses, offset by the increases in software, hardware and hosting costs of$1.1 million and facility related costs of$0.3 million . Depreciation and amortization During the three and nine months endedSeptember 30, 2020 , depreciation and amortization expense increased$1.0 million , or 52%, and$3.1 million , or 60%, respectively, compared to the same periods in 2019 primarily driven by increases in capitalized internally-developed software in 2019 and prior periods. Sales, general and administrative During the three and nine months endedSeptember 30, 2020 , sales, general and administrative expense increased$3.0 million , or 34%, and$7.2 million , or 32%, respectively, compared to the same periods in 2019 primarily related to (i) provision for losses for loan receivables held for sale of$0.4 million and$4.3 million , respectively; (ii) professional fees related to litigation and compliance matters of$3.2 million and$5.1 million , respectively; and (iii) advisory and insurance costs of$0.4 million and$1.2 million , respectively. These increases were offset by decreases in trade show attendance, advertising fees, recruiting and marketing related travel expenses largely related to impacts of the COVID-19 pandemic. Financial guarantee During the three and nine months endedSeptember 30, 2020 , non-cash financial guarantee expense (benefit) recognized subsequent to our adoption of ASU 2016-13 onJanuary 1, 2020 totaled$(0.3) million and$28.4 million , respectively, representing the estimated change in the financial guarantee liability related to (i) our escrow financial guarantee expense (benefit) of$(2.3) million and$26.4 million , respectively, and (ii) our credit support fund financial guarantee expense of$2.0 million for both periods. As measured in accordance with the new standard, the decrease in the three month period is a result of sales of loan participations from our existing bank partner arrangements into an alternative funding strategy which is not subject to our financial guarantee. The increase in the financial guarantee liability during the nine months endedSeptember 30, 2020 was primarily associated with new Bank Partner loans facilitated during the period, which increased the required escrow balance, and, to a lesser degree, due to decreased expectations of Bank Partner loan credit performance under the current economic environment. See Note 1 and Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for additional information regarding the measurement of our financial guarantees under the new standard. Under this guidance, we are precluded from including future loan originations by ourBank Partners in measuring our financial guarantee liability. Consistent with the modeling of loan losses for any consumer loan portfolio assumed to go into "run-off," our recognized financial guarantee liability under this model represents a significant portion of the contractual escrow that we establish with each Bank Partner and typically increases each period, with a corresponding non-cash charge to the statement of operations, as new loans facilitated on our platform during the period increase the contractual escrow balance. Historically, our actual cash payments required under the financial guarantee arrangements have been immaterial for ongoing Bank Partner portfolios into which we continue originating loans, and we expect this to continue to be the case subject to the accuracy of our assumptions around the performance of the loan portfolios. During the three and nine months endedSeptember 30, 2019 , financial guarantee expenses recognized in accordance with legacy guidance in ASC 450, Contingencies, were$1.1 million and$4.0 million , respectively, representing expected escrow usage in future periods associated with Bank Partner loan credit performance that was determined to be probable of occurring. 63 -------------------------------------------------------------------------------- Table of
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Related party During the three and nine months endedSeptember 30, 2020 , related party expenses decreased$0.3 million , or 48%, and$0.5 million , or 27%, compared to the same periods in 2019, which was primarily due to fees incurred in the 2019 periods to a placement agent in connection with certain Charged-Off Receivables transfers, of which there were none in the 2020 periods. Other income (expense), net During the three months endedSeptember 30, 2020 , other expense increased$1.7 million , or 37%, compared to the same period in 2019. The increase was primarily due to the$1.1 million increase in interest expense from our incremental term loan entered intoJune 2020 (the 2020 Amended Credit Agreement) and a$0.6 million decrease in interest income. During the nine months endedSeptember 30, 2020 , other expense decreased$6.1 million , or 29%, compared to the same period in 2019. The decrease was primarily due to: (i) a decrease in other losses due to a remeasurement of the TRA liability of$6.4 million during 2019 and (ii) a decrease in interest income of$1.5 million . The decrease was offset by a net$1.9 million increase from the change in the fair value of our servicing assets and liabilities. Income tax expense (benefit) Income tax expense recorded during the three and nine months endedSeptember 30, 2020 of$0.2 million and$0.8 million reflected the expected income tax expense of$0.04 million and$0.34 million , respectively, on the net earnings for the periods related toGreenSky, Inc.'s economic interest inGS Holdings . The expected income tax expense for the three and nine months endedSeptember 30, 2020 was combined with$0.16 million and$0.46 million , respectively, of tax expense arising from discrete items, which primarily consisted of a stock-based compensation shortfall as a result of restricted stock award vesting during the period. Income tax expense (benefit) recorded during the three and nine months endedSeptember 30, 2019 reflected the expected income tax expense of$3.8 million and$7.7 million , respectively, on the net earnings for the periods related toGreenSky, Inc.'s economic interest inGS Holdings . Income tax expense during the three and nine months endedSeptember 30, 2019 was more than offset by$2.3 million and$11.2 million , respectively, of tax benefits arising from discrete items, which primarily included remeasurement of our net deferred tax assets of$0 million and$7.5 million , respectively, and warrant and stock-based compensation deductions of$2.0 million and$3.4 million , respectively. The decrease in income tax expense during the three months endedSeptember 30, 2020 as compared to the same period in 2019 was primarily related to a decrease in overall net earnings attributable toGreenSky, Inc.'s economic interest inGS Holdings compared to the 2019 period. The income tax expense during the nine months endedSeptember 30, 2020 as compared to the income tax benefit during the same period in 2019 was primarily related to more favorable discrete items in 2019 as compared to 2020, as a result of share-based compensation deductions and a remeasurement of deferred tax asset, which were offset by a decrease in overall net earnings attributable toGreenSky, Inc.'s economic interest inGS Holdings compared to the 2019 period. Net income attributable to noncontrolling interests Net income attributable to noncontrolling interests for the three and nine months endedSeptember 30, 2020 and 2019 reflects income attributable to the Continuing LLC Members for the entire periods based on their weighted average ownership interest inGS Holdings , which was 60.4% and 64.6% for the three months endedSeptember 30, 2020 and 2019, respectively, and 62.4% and 65.9% for the nine months endedSeptember 30, 2020 and 2019, respectively. 64 -------------------------------------------------------------------------------- Table of
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Financial Condition Summary Changes in the composition and balance of our assets and liabilities as ofSeptember 30, 2020 compared toDecember 31, 2019 were principally attributable to the following: •a$7.3 million decrease in cash and cash equivalents and restricted cash. See "Liquidity and Capital Resources" in this Part I, Item 2 for further discussion of our cash flow activity; •a$491.4 million increase in loan receivables held for sale, net, primarily due to the purchase of SPV Participations totaling$754.8 million during the nine months endedSeptember 30, 2020 ; •a$18.5 million decrease in the FCR liability primarily due to billed finance charges not yet collected on participations in loans held by the SPV, which were paid to the Bank Partner in full as of the participation purchase dates. This activity is analyzed in further detail throughout this Part I, Item 2; •the impact of ourJanuary 1, 2020 adoption of ASU 2016-13, which resulted in an additional financial guarantee liability of$118.0 million and a corresponding cumulative-effect adjustment to equity at the adoption date, including$32.2 million to retained earnings, net of the impact of a$10.4 million increase in deferred tax assets, and$75.4 million to noncontrolling interest. The estimated value of the financial guarantee increased an additional$28.4 million based on our subsequent measurement during the nine months endedSeptember 30, 2020 . See Note 1 and Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for further discussion of the new standard; •a$3.2 million increase in accounts payable primarily due to monthly settlements withBank Partners related to their portfolio activity; •a$12.8 million increase in the interest rate swap liability due to the significantly decreased interest rate environment. See Note 8 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for additional information; •a$3.8 million increase in transaction processing liabilities, which is reflective of the reduction in custodial in-transit loan funding requirements; •a$432.8 million increase in notes payable attributable to the new SPV Facility upon draw to fund loan purchases by the SPV; •a$68.8 million increase in the term loan attributable to the$75.0 million incremental term loan resulting from the 2020 Amended Credit Agreement; and •a decrease in total equity of$150.9 million primarily due to: (i) the measurement of our financial guarantee liability under ASU 2016-13, as discussed above, (ii) distributions of$48.6 million , which were primarily tax distributions, and (iii) other comprehensive loss of$11.6 million associated with our interest rate swap, as discussed above. These decreases were partially offset by share-based compensation of$11.3 million . Liquidity and Capital Resources We are a holding company with no operations and depend on our subsidiaries for cash to fund all of our consolidated operations, including future dividend payments, if any. We depend on the payment of distributions by our current subsidiaries, includingGS Holdings and GSLLC, which distributions may be restricted as a result of regulatory restrictions, state law regarding distributions by a limited liability company to its members, or contractual agreements, including agreements governing their indebtedness. For a discussion of those restrictions, refer to Part II, Item 1A "Risk Factors - Risks Related to Our Organizational Structure." In particular, the Credit Facility (as defined below) contains certain negative covenants prohibitingGS Holdings and GSLLC from making cash dividends or distributions unless certain financial tests are met. In addition, while there are exceptions to these prohibitions, such as an exception that permitsGS Holdings to pay our operating expenses, these exceptions apply only when there is no default under the Credit Facility. We currently anticipate that such restrictions will not impact our ability to meet our cash obligations. 65 -------------------------------------------------------------------------------- Table of
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Our principal source of liquidity is cash generated from operations. Our transaction fees are the most substantial source of our cash flows and follow a relatively predictable, short cash collection cycle. To the extent that the impact from the COVID-19 pandemic on consumer spending behavior results in a decline in our transaction volume compared to prior periods, our transaction fees would be similarly impacted. Our short-term liquidity needs primarily include setting aside restricted cash for Bank Partner escrow balances and interest payments onGS Holdings' Credit Facility, which consists of the term loan and revolving loan facility, funding the portion of the SPV Participations that is not financed by the SPV facility, and interest payments and unused fees on the SPV Facility, as defined and discussed in Note 7 to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1. Further, we do not anticipate any major capital expenditures. We currently generate sufficient cash from our operations to meet these short-term needs. In addition, we expect to use cash for: (i) FCR liability settlements, which are not fully funded by the incentive payments we receive from ourBank Partners , but for which$90.4 million is held for certainBank Partners in restricted cash as ofSeptember 30, 2020 , and (ii) sales facilitation obligations. Our$100 million revolving loan facility is also available to supplement our cash flows from operating activities to satisfy our short-term liquidity needs. As noted above under "Executive Summary," inMay 2020 , we established the SPV Facility to finance purchases by the SPV of participations in loans originated through the GreenSky program. The SPV Facility provides committed financing of$300.0 million , with an additional$200.0 million uncommitted accordion that was accessed inJuly 2020 . The Company currently expects that the SPV Facility will provide financing for approximately 70% (on average) of the principal balance for such participations, and the Company will fund the remainder. During the second and third quarter of 2020, the Company completed purchases of SPV Participations of$754.8 million . We expect that the Company will from time to time purchase participations in loans that have future funding obligations. Such future funding obligations will be funded by the Bank Partner that owns the loan; however, the Company will be required to purchase a participation in the future funding amount, which the Company would intend to finance through the SPV Facility at similar rates. As ofSeptember 30, 2020 , the SPV held$535.2 million of loan participations on its Balance Sheet, of which$432.8 million was financed through the SPV Facility. In addition, we expect the SPV to continue to conduct periodic sales of the loan participations or issue asset-backed securities to third parties, which sales or issuances would allow additional purchases to be financed at similar rates. Our most significant long-term liquidity need involves the repayment of our term loan upon maturity inMarch 2025 , which assuming no prepayments, will have an expected remaining unpaid principal balance of$444.6 million at that time, as well as the repayment of our revolving SPV Facility upon maturity inMay 2022 . Assuming no extended impact of the COVID-19 pandemic, we anticipate that our significant cash generated from operations will allow us to service this debt both for quarterly principal payments and the balloon payment at maturity. Should operating cash flows be insufficient for this purpose, we will pursue other financing options. We have not made any material commitments for capital expenditures other than those disclosed in the "Contractual Obligations" table in Part II, Item 7 of our 2019 Form 10-K, which did not change materially during the nine months endedSeptember 30, 2020 . Significant Changes in Capital Structure During the nine months endedSeptember 30, 2020 , we established the SPV Facility and amended our 2018 Amended Credit Agreement. See "Key Developments" above for further discussion on our funding diversification. During the nine months endedSeptember 30, 2019 , we purchased 8.7 million shares of Class A common stock at a cost of$102.2 million under our share repurchase program, which are held in treasury. See Note 11 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for further discussion of our treasury stock. 66 -------------------------------------------------------------------------------- Table of
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Cash flows
We prepare our Unaudited Condensed Consolidated Statements of Cash Flows using
the indirect method, under which we reconcile net income (loss) to cash flows
provided by operating activities by adjusting net income (loss) for those items
that impact net income (loss), but may not result in actual cash receipts or
payments during the period. The following table provides a summary of our
operating, investing and financing cash flows for the periods indicated.
Nine Months Ended
September 30,
2020 2019
Net cash provided by (used in) operating activities
$ (12,120) $
(10,921)
Net cash provided by (used in) financing activities
Cash and cash equivalents and restricted cash totaled$438.5 million as ofSeptember 30, 2020 , a decrease of$7.3 million fromDecember 31, 2019 . Restricted cash, which had a balance of$324.9 million as ofSeptember 30, 2020 compared to a balance of$250.1 million as ofDecember 31, 2019 , is not available to us to fund operations or for general corporate purposes. Cash flow activities for the nine months endedSeptember 30, 2020 consisted of$430.5 million of cash used for operating activities,$12.1 million of cash used for investing activities, and$435.3 million of cash provided by financing activities. Financing activity inflows were highlighted by proceeds from the SPV Facility, and proceeds from the term loan. The financing activity inflows were offset by outflows related to distributions toGS Holdings' members, payment of withholding taxes associated with stock option exercises, and repayments of the principal balance of our term loan and SPV Facility. Our restricted cash balances as ofSeptember 30, 2020 andDecember 31, 2019 were comprised primarily of four components: (i)$175.5 million and$150.4 million , respectively, which represented the amounts that we have escrowed withBank Partners as limited protection to theBank Partners in the event of certain Bank Partner portfolio credit losses or in the event that the finance charges billed to borrowers do not exceed the sum of an agreed-upon portfolio yield, a fixed servicing fee and realized credit losses; (ii)$90.4 million and$75.0 million , respectively, which represented an additional restricted cash balance that we maintained for certainBank Partners related to our FCR liability; (iii)$27.1 million and$24.7 million , respectively, which represented certain custodial in-transit loan funding and consumer borrower payments that we were restricted from using for our operations; and (iv)$31.9 million and$0.0 million , respectively, which represented temporarily restricted cash related to collections in connection with SPV Participations (which is released from restrictions in accordance with the terms of the SPV Facility). The restricted cash balances related to our FCR liability and our custodial balances are not included in our evaluation of restricted cash usage, as these balances are not held as part of a financial guarantee arrangement. See Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for additional information on our restricted cash held as escrow withBank Partners . Cash provided by operating activities Nine Months EndedSeptember 30, 2020 . Cash flows used in operating activities were$430.5 million during the nine months endedSeptember 30, 2020 . Net income of$5.2 million was adjusted favorably for certain non-cash items of$64.1 million , which were predominantly related to financial guarantee losses, depreciation and amortization, equity-based expense, and mark to market adjustment on loan receivables held for sale, partially offset by the fair value changes in servicing assets and liabilities and deferred tax benefit. The primary uses of operating cash during the nine months endedSeptember 30, 2020 were: (i) purchases of participations in loan receivables held for sale by the SPV and (ii) a decrease in billed finance charges on deferred interest loans that are expected to reverse in future periods driven by the settlements of billed finance charges on SPV Participations at the time of purchase by the SPV. Nine Months EndedSeptember 30, 2019 . Cash flows provided by operating activities were$125.4 million during the nine months endedSeptember 30, 2019 . Net income of$90.7 million was adjusted unfavorably for certain non-cash items of$6.2 million , which were predominantly related to depreciation and amortization, equity- 67 -------------------------------------------------------------------------------- Table of
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based expense, financial guarantee losses and fair value changes in servicing liabilities, partially offset by deferred tax benefit. Primary sources of operating cash during the nine months endedSeptember 30, 2019 were: (i) earnings, (ii) an increase in billed finance charges on deferred interest loans that are expected to reverse in future periods, (iii) an increase in accounts payable largely driven by Bank Partner settlements related to their portfolio activity and payables for price concessions to a significant merchant group, and (iv) an increase in transaction processing liabilities, which is reflective of the growth in custodial in-transit loan funding requirements and consumer borrower payments primarily driven by a Bank Partner addition at the end of 2018 and origination volume growth. These increases were offset by a use of cash associated with accounts receivable, which was largely commensurate with the increase in transaction volume. Cash used in investing activities Detail of the cash used in investing activities is included below for each period (dollars in millions). Nine Months Ended September 30, 2020 2019 Software$ 11.2 $ 8.8 Computer hardware 0.7 0.9 Leasehold improvements 0.1 0.7 Furniture 0.1 0.5 Purchases of property, equipment and software$ 12.1 $ 10.9 The$1.2 million higher spend on investing activities during the nine months endedSeptember 30, 2020 compared to the same period in 2019 was primarily related to an increase in capitalized costs associated with various internally-developed software projects, such as mobile application development and transaction processing, and was offset by lower hardware costs associated with higher infrastructure needs in the 2019 period and lower leasehold improvement costs. Cash used in financing activities Our financing activities in the periods presented consisted of equity and debt related transactions and distributions.GS Holdings makes tax distributions based on the estimated tax payments that its members are expected to have to make during any given period (based upon various tax rate assumptions), which are typically paid in January, April, June and September of each year. We had net cash provided by financing activities of$435.3 million during the nine months endedSeptember 30, 2020 compared to net cash used of$149.3 million during the same period in 2019. In the 2020 period, our proceeds of cash were primarily related to proceeds from the SPV Facility of$570.0 million , and proceeds from the term loan of$70.5 million . The net cash provided by financing activities was offset by net cash used for tax and non-tax distributions to members of$48.5 million and$2.5 million , respectively, payments under our TRA of$12.8 million , and repayments of the principal balance of our term loan (net of original issuance discount) and SPV facility of$3.2 million and$137.2 million , respectively. In the 2019 period, our use of cash was primarily related to: (i) our$104.3 million repurchase of Class A common stock, (ii) distributions of$23.2 million , (iii) payments under our TRA of$4.7 million , and (iv) equity activity of$14.2 million consisting of Class B common stock exchanges and option exercises. Borrowings See Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for further information about our borrowings, including the use of proceeds, as well as our interest rate swap. Term loan and revolving facility 68 -------------------------------------------------------------------------------- Table of
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OnMarch 29, 2018 ,GS Holdings amended itsAugust 25, 2017 Credit Agreement ("2018 Amended Credit Agreement"). The 2018 Amended Credit Agreement provides for a$400.0 million term loan, the proceeds of which were used, in large part, to settle the outstanding principal balance on the$350.0 million term loan previously executed under the Credit Agreement inAugust 2017 , and includes a$100.0 million revolving loan facility. The revolving loan facility also includes a$10.0 million letter of credit. The Credit Facility is guaranteed byGS Holdings' significant subsidiaries, including GSLLC, and is secured by liens on substantially all of the assets ofGS Holdings and the guarantors. Interest on the loans can be based either on a "Eurodollar rate" or a "base rate" and fluctuates depending upon a "first lien net leverage ratio." The 2018 Amended Credit Agreement contains a variety of covenants, certain of which are designed to limit the ability ofGS Holdings to make distributions on, or redeem, its equity interests unless, in general, either (a) its "first lien net leverage ratio" is no greater than 2.00 to 1.00, or (b) the funds used for the payments come from certain sources (such as retained excess cash flow and the issuance of new equity) and its "total net leverage ratio" is no greater than 3.00 to 1.00. In addition, during any period when 25% or more of our revolving facility is utilized,GS Holdings is required to maintain a "first lien net leverage ratio" no greater than 3.50 to 1.00. There are various exceptions to these restrictions, including, for example, exceptions that enable us to pay our operating expenses and to make certainGS Holdings tax distributions. The$400.0 million term loan matures onMarch 29, 2025 , and the revolving loan facility matures onMarch 29, 2023 . OnJune 10, 2020 , we entered into a Second Amendment to our Credit Agreement ("2020 Amended Credit Agreement"), which provided for an additional$75.0 million term loan ("incremental term loan"). The term loan and revolving loan facility under the 2018 Amended Credit Agreement and incremental term loan under the 2020 Amended Credit Agreement are collectively referred to as the "Credit Facility." The modified term loan and the incremental term loan are collectively referred to as the "term loan." The incremental term loan, incurs interest, due monthly in arrears, at an adjusted LIBOR, which represents the one-month LIBOR multiplied by the statutory reserve rate, as defined in the 2020 Amended Credit Agreement, with a 1% LIBOR floor, plus 450 basis points. The incremental term loan has the same security, maturity, principal amortization, prepayment, and covenant terms as the 2018 Amended Credit Agreement, maturing onMarch 29, 2025 . There was no amount outstanding under our revolving loan facility as ofSeptember 30, 2020 , which is available to fund future needs ofGS Holdings' business. We had drawn$1.0 million on our available letter of credit as ofSeptember 30, 2020 . SPV Facility OnMay 11, 2020 ,GS Investment entered into the SPV Facility to finance purchases by the SPV of 100% participation interests in loans originated through the GreenSky program. The SPV Facility provides a revolving committed financing of$300 million , and an uncommitted$200 million accordion that was accessed inJuly 2020 . There was$432.8 million outstanding under the SPV Facility as ofSeptember 30, 2020 . The SPV Facility is secured by the loan participations held by the SPV, and Lenders do not have direct recourse to the Company for any loans made under the SPV Facility. The interest rate on the SPV Facility is the applicable commercial paper conduit funding rate (or, if the Lenders do not fund their advances under the SPV Facility through commercial paper markets, 3-month LIBOR plus 0.50%) plus 2.50%. The SPV Facility matures onMay 10, 2022 . Expected Replacement of LIBOR The use of the London Interbank Offered Rate ("LIBOR") is expected to be phased out by the end of 2021. LIBOR is currently used as a reference rate for certain of our financial instruments, including our$475.0 million term loan under the 2020 Amended Credit Agreement and the related interest rate swap agreement, both of which are set to mature after the expected phase out of LIBOR. At this time, there is no definitive information regarding the future utilization of LIBOR or of any particular replacement rate; however, we continue to monitor the efforts of various parties, including government agencies, seeking to identify an alternative rate to replace LIBOR. We will work with our lenders and counterparties to accommodate any suitable replacement rate where it is not already provided under the terms of the financial instruments and, going forward, we will use suitable alternative reference rates for our financial instruments. We will continue to assess and plan for how the phase out of LIBOR will affect the Company; however, while the LIBOR transition could adversely affect the Company, we do not currently perceive any material risks and do not expect the impact to be material to the Company. 69 -------------------------------------------------------------------------------- Table of
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Tax Receivable Agreement Our purchase of Holdco Units from the Exchanging Members using a portion of the net proceeds from the IPO, our acquisition of the equity of certain of theFormer Corporate Investors , and any future exchanges of Holdco Units for our Class A common stock pursuant to the Exchange Agreement (as such terms are defined in the 2019 Form 10-K) are expected to result in increases in our allocable tax basis in the assets ofGS Holdings . These increases in tax basis are expected to increase (for tax purposes) depreciation and amortization deductions allocable to us and, therefore, reduce the amount of tax that we otherwise would be required to pay in the future. This increase in tax basis may also decrease gain (or increase loss) on future dispositions of certain assets to the extent tax basis is allocated to those assets.We and GS Holdings entered into a Tax Receivable Agreement ("TRA") with the "TRA Parties" (the equity holders of theFormer Corporate Investors , the Exchanging Members, the Continuing LLC Members and any other parties receiving benefits under the TRA, as those parties are defined in the 2019 Form 10-K), whereby we agreed to pay to those parties 85% of the amount of cash tax savings, if any, inUnited States federal, state and local taxes that we realize or are deemed to realize as a result of these increases in tax basis, increases in basis from such payments, and deemed interest deductions arising from such payments. Due to the uncertainty of various factors, the likely tax benefits we will realize as a result of our prior purchases and exchanges of Holdco Units or any future exchanges of Holdco Units for our Class A common stock pursuant to the Exchange Agreement, or the resulting amounts we are likely to pay out to the TRA Parties pursuant to the TRA are also uncertain. However, we expect that such payments will be substantial and may substantially exceed the tax receivable liability of$307.3 million as ofSeptember 30, 2020 . Because we are the managing member ofGS Holdings , which is the managing member of GSLLC, we have the ability to determine when distributions (other than tax distributions) will be made by GSLLC toGS Holdings and the amount of any such distributions, subject to limitations imposed by applicable law and contractual restrictions (including pursuant to our 2020 Amended Credit Agreement or other debt instruments). Any such distributions will be made to all holders of Holdco Units, including us, pro rata based on the number of Holdco Units. The cash received from such distributions will first be used by us to satisfy any tax liability and then to make any payments required under the TRA. We expect that such distributions will be sufficient to fund both our tax liability and the required payments under the TRA. In the event that we do not make timely payment of all or any portion of a tax benefit payment due under the TRA on or before a final payment date, LIBOR is the base for the default rate used to calculate the required interest. The TRA is anticipated to remain in effect after the expected phase out of LIBOR in 2021. See Part I, Item 2 "Liquidity and Capital Resources-Borrowings" for further discussion of the LIBOR phase out. Contingencies From time to time, we may become a party to civil claims and lawsuits in the ordinary course of business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred and the amount can be reasonably estimated, which requires management judgment. As ofSeptember 30, 2020 andDecember 31, 2019 , we did not record any provision for liability. Should any of our estimates or assumptions change or prove to be incorrect, it could have a material adverse impact on our consolidated financial condition, results of operations or cash flows. See Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for discussion of certain legal proceedings and other contingent matters. Contractual Obligations We have future obligations under various contracts relating to debt and interest payments and operating leases. During the nine months endedSeptember 30, 2020 , we entered into the Second Amendment to our Credit Agreement and an asset-backed revolving credit facility. See Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for additional information regarding changes to the Company's contractual obligations. 70
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Recently Adopted or Issued Accounting Standards See "Recently Adopted Accounting Standards" and "Accounting Standards Issued, But Not Yet Adopted" in Note 1 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for additional information. Critical Accounting Policies and Estimates The accounting policies and estimates that we believe are the most critical to an understanding of our results of operations and financial condition as disclosed in our Management's Discussion and Analysis of Financial Condition and Results of Operations as filed in our 2019 Form 10-K include those related to our accounting for finance charge reversals, servicing assets and liabilities, financial guarantees and income taxes. In the preparation of our Unaudited Condensed Consolidated Financial Statements as of and for the three and nine months endedSeptember 30, 2020 , there have been no significant changes to the accounting policies and estimates related to our accounting for finance charge reversals, servicing assets and liabilities and income taxes. OnJanuary 1, 2020 , we adopted the provisions of ASU 2016-13, which impacted our accounting for the contingent aspect of our financial guarantees. Historical periods prior toJanuary 1, 2020 continue to reflect the measurement of the contingent aspect of our financial guarantees under legacy guidance in ASC 450. Refer to Note 1 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for discussion of our adoption of ASU 2016-13 and its impact on our consolidated financial statements and for the revised accounting policy.
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