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 ofAugust 10, 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 all 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 six months endedJune 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. 48 -------------------------------------------------------------------------------- Table of
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The following are anticipated key impacts 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-19mid-March 2020 and continued to be impacted during the second quarter. For the three months endedJune 30, 2020 , our transaction volume decreased 14% compared to the second quarter of 2019 with each month's volumes as follows: •April 2020 volumes were 26% lower thanApril 2019 •May 2020 volumes were 16% lower thanMay 2019 •June 2020 volumes were approximately level withJune 2019 . 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 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 developed a suite of new promotional loan product offerings, primarily additional reduced rate and deferred interest loan products, responsive to the merchant input that we received. 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 June to de minimis levels. Portfolio Credit Losses. We entered the COVID-19 pandemic with historically strong credit performance and 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. AtJune 30, 2020 , approximately 4% of the balances of the portfolio we service were subject to payment deferrals. While we expect these measures to mitigate credit losses, we anticipate that higher unemployment rates, while partially offset by the effects of government stimulus measures such as the CARES Act, will ultimately result in increased portfolio credit losses in the second half of 2020 and first quarter of 2021 as compared to the prior periods. We 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. 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." Key Developments Specific key developments during the second 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. 49 -------------------------------------------------------------------------------- Table of
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•InMay 2020 , the Company put in place 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") with an existing Bank Partner,Synovus Bank , to provide a framework for the programmatic sale of loan participations and/or whole loans by the Bank Partner to third parties, including to the previously-announced special purpose vehicle sponsored by the Company (the "SPV"). In conjunction with the Facility Bank Partner Agreements,Synovus Bank extended its relationship with the Company by an additional three years. •InMay 2020 , the SPV entered into a Warehouse Credit Agreement with the lenders party thereto from time to time (the "Lenders"), andJPMorgan Chase Bank, N.A . ("JPMorgan") as administrative agent, to establish an asset-backed revolving credit facility to finance purchases by the SPV of participations in loans originated through the GreenSky program (the "SPV Facility"). •The SPV Facility initially provided committed financing of$300 million , with an additional$200 million uncommitted accordion that was accessed inJuly 2020 . •The Company currently expects that the SPV Facility will provide financing for approximately 70% of the principal balance of the purchased participations (on average), and the Company will fund the remainder. •During the second quarter of 2020, the SPV completed multiple purchases of participations in loans ("SPV Participations") totaling$431.0 million in the aggregate, of which$298.4 million was financed through the SPV Facility. InJuly 2020 , the SPV purchased additional loan participations totaling$284.0 million , in connection with the SPV's$200.0 million borrowing under the uncommitted accordion provided by the SPV Facility. •The assets of the SPV are not available to satisfy any obligation of the Company, and the Lenders will not have direct recourse to the Company for any loans made under the SPV Facility. •We expect the SPV to conduct periodic sales of the purchased participations or issue asset-backed securities to third parties, which sales or issuances would allow additional purchases of participations to be financed through the SPV Facility. To the extent that such sales occur, the SPV Facility could facilitate substantial incremental GreenSky program loan volume. •We continue to work with multiple institutional investors on whole loan and loan participations sales programs and forward flow financing arrangements (collectively, "New Institutional Financings"). We expect to close on one or more of these transactions in the second half of 2020. Amendment of Credit Agreement. InJune 2020 ,GS Holdings amended itsMarch 29, 2018 Credit Agreement (as amended, the "2020 Amended Credit Agreement") to increase the Company's borrowings under the Credit Facility in an aggregate principal amount of$75.0 million . The incremental term loan, priced at LIBOR plus 450 basis points, with a 1% LIBOR floor, has the same security, maturity, principal amortization, prepayment, and covenant terms as the existing term loan underGS Holdings' senior secured term loan facility and matures onMarch 29, 2025 . Strategic Alternatives Review Process. The Company's Board of Directors, working together with its senior management team and legal and financial advisors, completed the process, announced inAugust 2019 , to explore, review and evaluate a range of potential strategic alternatives focused on maximizing stockholder value. The Company's Board of Directors determined that the Company can best drive future value creation by executing on a growth plan that leverages a renewed focus on the Company's home improvement vertical, the cross marketing of complementary products to its consumer program borrowers, enhanced merchant productivity, scalability of operations, termination of the programmatic sale of charged-off receivables and funding diversification to support our continued profitable growth. Final Patent Approval. OnJuly 28, 2020 , the United States Patent and Trademark Office issued the Company's firstU.S. patent. Originally filed in 2014, the patent relates to our mobile application process and credit 50 -------------------------------------------------------------------------------- Table of
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decisioning model. This patent is an important recognition of a key component of our proprietary technology platform. Second Quarter Year-to-date 2020 Results Notwithstanding the impact of COVID-19 thus far on our 2020 transaction volumes, we achieved growth in the majority of our key business metrics and financial measures as of and for the three and six months endedJune 30, 2020 : •Transaction volume (as defined below) was$1.36 billion during the three months endedJune 30, 2020 compared to$1.58 billion during the three months endedJune 30, 2019 , a decrease of 14%. Transaction volume was$2.73 billion during the six months endedJune 30, 2020 compared to$2.82 billion during the six months endedJune 30, 2019 , a decrease of 3%; •Total revenue of$133.0 million during the three months endedJune 30, 2020 decreased 4% from$138.8 million during the three months endedJune 30, 2019 . Total revenue of$254.8 million during the six months endedJune 30, 2020 increased 5% from$243.2 million during the six months endedJune 30, 2019 ; •The outstanding balance of loans serviced by our platform totaled$9.38 billion as ofJune 30, 2020 compared to$8.19 billion as ofJune 30, 2019 , an increase of 15%; •Incentive payments we receive from ourBank Partners , which favorably impact our cost of revenue, increased 83% and 81% during the three and six months endedJune 30, 2020 , respectively, 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. For all loans originated on our platform during the six months endedJune 30, 2020 , the credit-line weighted average GreenSky program borrower credit score was 783. Furthermore, GreenSky program borrowers with credit scores over 780 comprised 38% of the loan servicing portfolio as ofJune 30, 2020 , and over 86% of the loan servicing portfolio as ofJune 30, 2020 consisted of GreenSky program borrowers with credit scores over 700; •The 30-day delinquencies as ofJune 30, 2020 were 0.74%, an improvement of 57 basis points overJune 30, 2019 . This measure does not include loans that are currently in payment deferral under COVID-19 hardship requests. Approximately 4% of the outstanding balance of loans serviced by our platform as ofJune 30, 2020 were in deferral status as of that date; and •Active merchants totaled 17,553 as ofJune 30, 2020 compared to 16,603 as ofJune 30, 2019 , an increase of 6%. We have a robust network of active merchants from which we derive our transaction volumes. We are focused on selectively adding high quality merchants to our network as well as working with our existing merchants to increase volumes facilitated on our platform. We had net income of$13.4 million during the three months endedJune 30, 2020 compared to net income of$39.2 million during the three months endedJune 30, 2019 . We had net income of$2.4 million during the six months endedJune 30, 2020 compared to net income of$46.6 million during the six months endedJune 30, 2019 . The lower earnings in the 2020 periods were primarily due to: •$28.7 million non-cash charge to financial guarantee expense in the six months endedJune 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 Six Months EndedJune 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. 51 -------------------------------------------------------------------------------- Table of
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•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$14.9 million gain in the six months endedJune 30, 2019 . To the extent that we do not transfer our rights to Charged-Off Receivables, we expect to benefit from the retained recoveries over time to achieve overall higher cash returns and recognize recoveries as collected. Adjusted EBITDA (as defined below) of$39.7 million during the three months endedJune 30, 2020 increased from$36.9 million during the three months endedJune 30, 2019 . Adjusted EBITDA of$58.9 million during the six months endedJune 30, 2020 increased from$48.8 million during the six months endedJune 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 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. 52 -------------------------------------------------------------------------------- Table of
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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 these
non-GAAP financial measures to the most directly comparable GAAP measure, net
income, as presented below.
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Net income $ 13,355 $ 39,193 $ 2,436 $ 46,594
Interest expense(1) 5,894 6,323 11,514 12,566
Income tax expense (benefit) 1,497 (4,466) 602 (5,061)
Depreciation and amortization 2,762 1,695 5,207 3,162
Equity-based compensation expense(2) 3,481 3,275 6,980 5,943
Change in financial guarantee liability(3) 10,248 (133) 28,656 284
Servicing asset and liability changes(4) 454 (8,469) 246 (7,999)
Discontinued charged-off receivables
program(5) - (7,427) - (14,782)
Transaction and non-recurring expenses(6) 2,025 6,907 3,258 8,123
Adjusted EBITDA $ 39,716 $ 36,898 $ 58,899 $ 48,830
(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)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.
(6)For the three and six months ended June 30, 2020 , includes professional fees
and other costs associated with our strategic alternatives review process, $307
thousand related to incremental technology costs associated with COVID-19, and
IPO related litigation. For the three and six months ended June 30, 2019 ,
includes legal fees associated with IPO related litigation. For the six months
ended June 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 Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Transaction Volume
Dollars (in millions) $ 1,358 $ 1,578 $ 2,729 $ 2,820
Percentage decrease (14) % (3) %
Loan Servicing Portfolio
Dollars (in millions, at end of period) $ 9,384 $ 8,191 $ 9,384 $ 8,191
Percentage increase 15 % 15 %
Active Merchants
Number (at end of period) 17,553 16,603 17,553 16,603
Percentage increase 6 % 6 %
Cumulative Consumer Accounts
Number (in millions, at end of period) 3.39 2.63 3.39 2.63
Percentage increase 29 % 29 %
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 $434 million of loan receivables held for sale by the SPV.
The average loan servicing portfolio for the three months ended June 30, 2020
and 2019 was $9,286 million and $7,884 million , respectively. The average loan
servicing portfolio for the six months ended June 30, 2020 and 2019 was $9,248
million and $7,691 million , respectively.
Active Merchants. We define active merchants as merchants that have submitted at
least one consumer application during the twelve months ended at the date of
measurement. Because our transaction volume is a function of the size,
engagement and growth of our merchant network, active merchants, in aggregate,
are an indicator of future revenue and profitability, although they are not
directly correlated. The comparative measures can also be impacted by
disciplined corrective action taken by the Company to remove merchants from our
program who do not meet our customer satisfaction standards.
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 Active Merchants and Transaction Volume. We have a robust network of
active 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, as well
as affiliate channel partners, such as manufacturers, software companies and
other entities that have a network of merchants that would benefit from
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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 existingBank Partners and having them renew and expand their commitments, (b) adding newBank Partners , and/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. No assurance is given that any of the current funding commitments of ourBank Partners will be renewed. As ofJune 30, 2020 , we had aggregate funding commitments from our ongoingBank Partners of approximately$8.0 billion , of which approximately$1.6 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$2.7 billion of additional funding capacity will become available through 2021. As we add newBank Partners , their full commitments are typically subject to a mutually-agreed-upon onboarding schedule. As previously disclosed, one of ourBank Partners adjusted its funding commitment effectiveApril 30, 2020 from$3 billion to$2 billion , which adjustment is reflected in the incremental funding capacity noted above. The adjustment of the Bank Partner's funding commitment had only a nominal impact on our current funding position, because the funding level by the Bank Partner at the time of the change was near the Bank Partner's maximum. In addition to customary expansion of commitments from existingBank Partners and the periodic addition of newBank Partners to our funding group, we are working to diversify the funding for loans originated by ourBank Partners to also include alternative structures with one or more institutional investors, financial institutions or other financing sources. To that end, as noted above under "Executive Summary," inMay 2020 , the Company entered into the Facility Bank Partner Agreements with an existing Bank Partner,Synovus Bank , to provide a framework for the programmatic sale of loan participations and/or 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. The SPV Facility provides committed financing of$300 million , with an additional$200 million uncommitted accordion which we accessed inJuly 2020 . During the second quarter of 2020, the SPV completed multiple purchases of loan participations totaling$431.0 million . InJuly 2020 , the SPV purchased additional loan participations totaling$284.0 million , in connection with the SPV's$200.0 million borrowing under the uncommitted accordion provided by the SPV Facility. We expect the SPV 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 through the SPV Facility. To the extent that such sales occur, the SPV Facility could facilitate substantial incremental GreenSky program loan volume. Additionally, we are continuing to work with multiple institutional investors on both a whole loan and loan participations sales program and forward flow financing arrangements. We would expect to close on one or more of these transactions in the second half of 2020. If we do not timely consummate forward flow arrangements or other alternative structures, or if the funding commitments from ourBank Partners and forward flow arrangements or other alternative structures (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 as follows: 55 -------------------------------------------------------------------------------- Table of
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•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, we bill the GreenSky program borrower for interest throughout the deferred interest promotional period, but the GreenSky program borrower is not obligated to pay any interest if the loan is 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 borrower 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 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 ofJune 30, 2020 . Cash set aside to meet this requirement is classified as restricted cash in our Unaudited Condensed Consolidated Balance Sheets. As ofJune 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. 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. 56 -------------------------------------------------------------------------------- Table of
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Results of Operations Summary
Three Months Ended June 30 , Six Months Ended June 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
Revenue
Transaction fees $ 101,777 $ 108,365 $ (6,588) (6) % $ 191,661 $ 192,413 $ (752) - %
Servicing 28,481 30,318 (1,837) (6) % 59,764 49,951 9,813 20 %
Interest and other 2,704 69 2,635 3,819 % 3,394 786 2,608 332 %
Total revenue 132,962 138,752 (5,790) (4) % 254,819 243,150 11,669 5 %
Costs and expenses
Cost of revenue (exclusive of
depreciation and amortization shown
separately below) 64,930 56,228 8,702 15 % 136,705 114,265 22,440 20 %
Compensation and benefits 22,041 20,459 1,582 8 % 44,475 40,092 4,383 11 %
Property, office and technology 4,244 4,512 (268) (6) % 8,266 8,926 (660) (7) %
Depreciation and amortization 2,762 1,695 1,067 63 % 5,207 3,162 2,045 65 %
Sales, general and administrative 8,590 7,302 1,288 18 % 18,678 14,555 4,123 28 %
Financial guarantee 10,248 1,696 8,552 504 % 28,656 2,918 25,738 882 %
Related party 477 589 (112) (19) % 954 1,125 (171) (15) %
Total costs and expenses 113,292 92,481 20,811 23 % 242,941 185,043 57,898 31 %
Operating profit 19,670 46,271 (26,601) (57) % 11,878 58,107 (46,229) (80) %
Other income (expense), net (4,818) (11,544) 6,726 (58) % (8,840) (16,574) 7,734 (47) %
Income before income tax expense
(benefit) 14,852 34,727 (19,875) (57) % 3,038 41,533 (38,495) (93) %
Income tax expense (benefit) 1,497 (4,466) 5,963 N/M 602 (5,061) 5,663 N/M
Net income $ 13,355 $ 39,193 $ (25,838) (66) % $ 2,436 $ 46,594 $ (44,158) (95) %
Less: Net income attributable to
noncontrolling interests 9,222 26,877 (17,655) (66) % 1,637 31,379 (29,742) (95) %
Net income attributable to GreenSky, Inc. $ 4,133 $ 12,316 $ (8,183) (66) % $ 799 $ 15,215 $ (14,416) (95) %
Earnings per share of Class A common
stock
Basic $ 0.06 $ 0.20 $ 0.01 $ 0.26
Diluted $ 0.06 $ 0.19 $ 0.01 $ 0.23
Three and Six Months Ended June 30, 2020 and 2019
Total Revenue
During the three and six months ended June 30, 2020 , total revenue decreased
$5.8 million , or 4%, and increased $11.7 million , or 5%, respectively, compared
to the same periods in 2019.
Transaction fees
During the three and six months ended June 30, 2020 , transaction fees decreased
6% and 0.4%, respectively, compared to the same periods in 2019. These decreases
were primarily due to a decrease in transaction volume, which declined 14% and
3%, respectively. Additionally, price concessions for a significant merchant
group reduced transaction fees by $2.4 million during the six months ended June
30, 2020 compared to $3.5 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 7.49% during the three months ended June 30, 2020 compared to 6.87% during
the same period in 2019, and 7.02% during the six months ended June 30, 2020
compared to 6.82% 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
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longer promotional periods generally carry relatively higher transaction fee rates. Conversely, 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 endedJune 30, 2020 , servicing revenue decreased$1.8 million , or 6%, compared to the same period in 2019, which was primarily attributable to the$1.0 million decrease in the fair value change in our servicing asset in 2020, as compared to the$9.0 million increase in the fair value change in our servicing asset during the same period in 2019, which offset the impact of the 18% increase in the average servicing portfolio and higher contractual servicing fee rate of 1.27%, compared to 1.08% during the same period of 2019. During the six months endedJune 30, 2020 , servicing revenue increased$9.8 million , or 20%, compared to the same period in 2019, which was primarily attributable to the increases in our average loan servicing portfolio of 20%, 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 1.28% of the average loan servicing portfolio for the six months endedJune 30, 2020 from 1.07% in the same period in 2019. Interest and other During the three and six months endedJune 30, 2020 , interest income increased$2.6 million for both periods compared to the same periods in 2019, which was primarily attributable to 2020 interest income from loan receivables held for sale due to the purchase of participations in loans by the SPV. Cost of Revenue (exclusive of depreciation and amortization expense) Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Origination related$ 5,958 $ 7,119 $ 12,415 $ 15,654 Servicing related 12,073 10,327 24,887 21,064 Fair value change in FCR liability 36,050 38,782 88,554 77,547 Mark-to-market and other on loan participations 10,849 - 10,849 - Total cost of revenue (exclusive of depreciation and amortization expense)$ 64,930 $ 56,228 $ 136,705 $ 114,265 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 six months endedJune 30, 2020 , origination related expenses decreased 16% and 21%, respectively, compared to the same periods in 2019, commensurate with our 14% and 3% period over period, respectively, decrease in transaction volume. The lower expenses were largely driven by lower customer protection expenses of$1.1 million and$2.9 million during the three and six months endedJune 30, 2020 , respectively, compared to the same periods in 2019, which are incurred when the Company determines that a merchant did not fulfill its obligation to the end consumer and compensates a Bank Partner for the applicable portion of the loan principal balance. 58 -------------------------------------------------------------------------------- Table of
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Servicing related Servicing related expenses are primarily reflective of the cost of our personnel (including dedicated call center personnel), printing and postage. During the three and six months endedJune 30, 2020 , servicing related expenses increased 17% and 18%, respectively, compared to the same periods in 2019, which resulted from our 18% and 20% period over period, respectively, average loan servicing portfolio growth. The increases in servicing related expenses associated with the increases in loans serviced were primarily for personnel costs within our customer service, collections and quality assurance functions. Fair value change in FCR liability The following table reconciles the beginning and ending measurements of our FCR liability and highlights the activity that drove the fair value change in FCR liability included in our cost of revenue. Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Beginning balance$ 213,158 $
149,598$ 206,035 $ 138,589 Receipts(1) 59,600 38,931 104,308 71,054 Settlements(2) (110,053) (62,332) (200,142) (122,211) Fair value changes recognized in cost of revenue(3) 36,050 38,782 88,554 77,547 Ending balance$ 198,755 $ 164,979 $ 198,755 $ 164,979 (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. Amount also includes the settlement of$20.0 million of billed finance charges not yet collected on participations in loans held by the SPV, which were paid to the Bank Partner in full as of the participation purchase dates. (3)A fair value adjustment is made based on the expected reversal percentage of billed finance charges (expected settlements), which is estimated at each reporting date. The fair value adjustment is recognized in cost of revenue in the Unaudited Condensed Consolidated Statements of Operations. Further detail regarding our receipts is provided below for the periods indicated. Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Incentive payments$ 55,759 $ 30,465 $ 98,212 $ 54,402 Proceeds from Charged-Off Receivables transfers(1) - 7,427 - 14,782 Recoveries on unsold charged-off receivables(2) 3,841 1,039 6,096 1,870 Total receipts$ 59,600 $ 38,931 $ 104,308 $ 71,054 (1)We collected recoveries on previously charged-off and transferred Bank Partner loans on behalf of our Charged-Off Receivables investors of$5.3 million and$5.5 million during the three months endedJune 30, 2020 and 2019, respectively, and$11.1 million and$10.7 million during the six months endedJune 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$2.7 million , or 7%, in the fair value change in FCR liability recognized in cost of revenue during the three months endedJune 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 59 -------------------------------------------------------------------------------- Table of
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impact of the growth of the FCR Liability, net of settlements and the absence of proceeds from Charged-Off Receivables transfers in the three months endedJune 30, 2020 compared to proceeds of$7.4 million in the same period in 2019. The increase of$11.0 million , or 14% in the fair value change in FCR liability recognized in cost of revenue during the six months endedJune 30, 2020 compared to the same period in 2019, was primarily a function of the absence of proceeds from Charged-Off Receivables transfers in the six months endedJune 30, 2020 compared to proceeds of$14.8 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 22% and 4% for the three and six months endedJune 30, 2020 , respectively, relative to our 15% and 15% growth in the loan servicing portfolio, respectively, as we benefited from a 83% and 81% increase in incentive payments resulting from the combination of lower interest rates and lower Bank Partner portfolio credit losses. Mark-to-market and other on loan participations These amounts primarily include interest expense on the SPV Facility, lower of cost or fair value adjustments on our SPV Participations, fair value changes in the purchase price discount/premium, certain fees and the amortization of deferred debt issuance costs incurred in connection with obtaining the SPV Facility. During both the three and six months endedJune 30, 2020 , the mark-to-market and other costs on loan participations were$10.8 million . As theFacility 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 six months endedJune 30, 2019 . Compensation and benefits During the three and six months endedJune 30, 2020 , compensation and benefits expense increased$1.6 million , or 8%, and$4.4 million , or 11%, compared to the same period in 2019 as a result of increased expenses of$1.5 million and$2.7 million , respectively, related to newly formed departments in 2020, increases of$0.6 million and$0.8 million , respectively, attributable to increased executive compensation primarily consisting of stock-based compensation, and increases of$0.4 million and$0.6 million , respectively, in accounting related expenses, offset by decreases in severance pay. Property, office and technology During the three and six months endedJune 30, 2020 , property, office, and technology expense decreased$0.3 million , or 6%, and$0.7 million , or 7%, compared to the same period in 2019 primarily due to decreases of$0.2 million and$0.9 million , respectively, in consulting expenses associated with additional technology process innovation costs in the 2019 period. During the six months endedJune 30, 2020 , the decrease in consulting expense was partially offset by increases in software, hardware and hosting costs of$0.2 million . Depreciation and amortization During the three and six months endedJune 30, 2020 , depreciation and amortization expense increased$1.1 million , or 63%, and$2.0 million , or 65%, 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 six months endedJune 30, 2020 , sales, general and administrative expense increased$1.3 million , or 18%, and$4.1 million , or 28%, respectively, compared to the same periods in 2019 primarily related to (i) provision for losses for loan receivables held for sale of$1.7 million and$3.9 million , respectively; (ii) professional fees related to litigation and compliance matters of$1.2 million and$1.9 million , respectively; and (iii) advisory and insurance costs of$0.6 million and$0.9 million , respectively. These increases were offset by decreases in trade show attendance, advertising fees and marketing related travel expenses largely related to impacts of the COVID-19 pandemic. 60 -------------------------------------------------------------------------------- Table of
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Financial guarantee During the three and six months endedJune 30, 2020 , non-cash financial guarantee expenses recognized subsequent to our adoption of ASU 2016-13 onJanuary 1, 2020 totaled$10.2 million and$28.7 million , respectively, representing the estimated increases in the financial guarantee liability. As measured in accordance with the new standard, the increases in the financial guarantee liability were primarily associated with new Bank Partner loans facilitated during the three and six month periods, 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 six months endedJune 30, 2019 , financial guarantee expenses recognized in accordance with legacy guidance in ASC 450, Contingencies, were$1.7 million and$2.9 million , respectively, representing expected escrow usage in future periods associated with Bank Partner loan credit performance that was determined to be probable of occurring. Related party During the three and six months endedJune 30, 2020 , related party expenses decreased$0.1 million , or 19%, and$0.2 million , or 15%, 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 and six months endedJune 30, 2020 , other expense decreased$6.7 million , or 58%, and$7.7 million , or 47%, compared to the same periods in 2019, which 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) decreases in interest expense during the three and six months endedJune 30, 2020 of$0.5 million and$1.1 million , respectively, due primarily to a lower effective interest rate on our term loan. Income tax expense (benefit) Income tax expense recorded during the three and six months endedJune 30, 2020 of$1.5 million and$0.6 million reflected the expected income tax expense of$1.4 million and$0.3 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 six months endedJune 30, 2020 was combined with$0.1 million and$0.3 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 benefit recorded during the three and six months endedJune 30, 2019 reflected the expected income tax expense of$3.4 million and$3.9 million , respectively, on the net earnings for the periods related toGreenSky, Inc.'s economic interest inGS Holdings . Income tax expense during the three and six months endedJune 30, 2019 was more than offset by$7.9 million and$9.0 million , respectively, of tax benefits arising from discrete items, which primarily included remeasurement of our net deferred tax assets of$7.5 million and$7.5 million , respectively, and warrant and stock-based compensation deductions of$0.3 million and$1.4 million , respectively. 61 -------------------------------------------------------------------------------- Table of
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The increase in the income tax expense during the three and six months endedJune 30, 2020 as compared to the same periods in 2019 was primarily related to more discrete items in 2019 as compared to 2020 and an increase in the statutory tax rate offset by a decrease in overall net earnings attributable toGreenSky, Inc.'s economic interest inGS Holdings compared to the 2019 periods. Net income attributable to noncontrolling interests Net income attributable to noncontrolling interests for the three and six months endedJune 30, 2020 and 2019 reflects income attributable to theContinuing LLC Members for the entire periods based on their weighted average ownership interest inGS Holdings , which was 63.1% and 65.3% for the three months endedJune 30, 2020 and 2019, respectively, and 63.5% and 66.6% for the six months endedJune 30, 2020 and 2019, respectively. Financial Condition Summary Changes in the composition and balance of our assets and liabilities as ofJune 30, 2020 compared toDecember 31, 2019 were principally attributable to the following: •a$8.4 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$359.0 million increase in loan receivables held for sale, net, primarily due to the purchase of SPV Participations totaling$431.0 million in the second quarter of 2020; •a$7.3 million decrease in the FCR liability, which was primarily due to the settlement of$20.0 million 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. 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$28.7 million based on our subsequent measurement during the six months endedJune 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$1.4 million increase in accounts payable primarily due to monthly settlements withBank Partners related to their portfolio activity; •a$13.7 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$3.2 million decrease in transaction processing liabilities, which is reflective of the reduction in custodial in-transit loan funding requirements; •a$299.0 million increase in notes payable attributable to the new SPV Facility upon draw to fund loan purchases by the SPV; •a$69.4 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$141.9 million primarily due to: (i) the measurement of our financial guarantee liability under ASU 2016-13, as discussed above, (ii) distributions of$31.5 million , which were primarily tax distributions, and (iii) other comprehensive loss of$12.4 million associated with our interest rate swap, as discussed above. These decreases were partially offset by share-based compensation of$7.0 million . 62 -------------------------------------------------------------------------------- Table of
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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. 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$94.7 million is held for certainBank Partners in restricted cash as ofJune 30, 2020 , and (ii) payments under our financial guarantee related to our portfolio with a Bank Partner that did not renew its loan origination agreement in late 2019 and our portfolio with a Bank Partner that adjusted its funding commitment effectiveApril 30, 2020 and into which loans will not be originated until the balance of the portfolio is below the adjusted funding commitment. 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 . During the second quarter of 2020, the Company completed purchases of SPV Participations of$431.0 million , of which$298.4 million was financed through the SPV Facility, with the Company funding the remaining balance. InJuly 2020 , the SPV purchased additional loan participations totaling$284.0 million , financed in part by$200.0 million of borrowings under the uncommitted accordion provided by the SPV Facility. The Company currently expects that the SPV Facility will provide financing for approximately 70% of the principal balance for such participations (on average), and the Company will fund the remainder. 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. In addition, we expect the SPV 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. No such sales occurred as ofJune 30, 2020 . 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 repayments and the balloon payment at maturity. Should operating cash flows be insufficient for this purpose, we will pursue other financing options. We have not 63 -------------------------------------------------------------------------------- Table of
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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 six months endedJune 30, 2020 . Significant Changes in Capital Structure During the six months endedJune 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 six months endedJune 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. 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. Six Months EndedJune 30, 2020 2019
Net cash provided by (used in) operating activities
$ 89,789 Net cash used in investing activities$ (8,524) $ (7,123) Net cash provided by (used in) financing activities$ 333,929
Cash and cash equivalents and restricted cash totaled$437.4 million as ofJune 30, 2020 , a decrease of$8.4 million fromDecember 31, 2019 . Restricted cash, which had a balance of$289.8 million as ofJune 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 six months endedJune 30, 2020 consisted of$333.8 million of cash used for operating activities,$8.5 million of cash used for investing activities, and$333.9 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. Our restricted cash balances as ofJune 30, 2020 andDecember 31, 2019 were comprised of four components: (i)$169.5 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 excess Bank Partner portfolio credit losses; (ii)$94.7 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)$20.6 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)$5.0 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 . 64 -------------------------------------------------------------------------------- Table of
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Cash provided by operating activities Six Months EndedJune 30, 2020 . Cash flows used in operating activities were$333.8 million during the six months endedJune 30, 2020 . Net income of$2.4 million was adjusted favorably for certain non-cash items of$50.6 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 six months endedJune 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. Six Months EndedJune 30, 2019 . Cash flows provided by operating activities were$89.8 million during the six months endedJune 30, 2019 . Net income of$46.6 million was adjusted favorably for certain non-cash items of$2.8 million , which were predominantly related to depreciation and amortization, equity-based expense, financial guarantee losses and fair value changes in servicing liabilities, partially offset by deferred tax benefit. Primary sources of operating cash during the six months endedJune 30, 2019 were: (i) earnings, (ii) an increase in billed finance charges on deferred interest loans that are expected to reverse in future periods, (iii) an increase in accounts payable largely driven by Bank Partner settlements related to their portfolio activity and payables for price concessions to a significant merchant group, (iv) an increase in transaction processing liabilities, which is reflective of the growth in custodial in-transit loan funding requirements and consumer borrower payments primarily drive by a Bank Partner addition at the end of 2018 and origination volume growth. These increases were offset by a use of cash associated with accounts receivable, which was largely commensurate with the increase in transaction volume. Cash used in investing activities Detail of the cash used in investing activities is included below for each period (dollars in millions). Six Months Ended June 30, 2020 2019 Software$ 7.9 $ 5.2 Computer hardware 0.4 0.8 Leasehold improvements 0.1 0.6 Furniture 0.1 0.5 Purchases of property, equipment and software$ 8.5 $ 7.1 The$1.4 million higher spend on investing activities during the six months endedJune 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$333.9 million during the six months endedJune 30, 2020 compared to net cash used of$131.7 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$299.0 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 65 -------------------------------------------------------------------------------- Table of
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distributions to members of$31.5 million and$1.9 million , respectively, and repayments of the principal balance of our term loan (net of original issuance discount) of$2.1 million . 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$17.8 million , (iii) payments under out TRA of$4.7 million , and (iv) equity activity of$3.1 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 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 ofJune 30, 2020 , which is available to fund future needs ofGS Holdings' business. 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 . The SPV Facility is secured by the loan participations held by the SPV and Lenders will 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 . There was$299.0 million outstanding under the SPV Facility as ofJune 30, 2020 . OnJuly 24, 2020 , the Company accessed the$200.00 million uncommitted accordion. 66 -------------------------------------------------------------------------------- Table of
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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.
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 the
Former 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 of GS 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 the Former 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, in
United 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 purchase of Holdco Units from the Exchanging Members,
our acquisition of the equity of certain of the Former Corporate Investors 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 $317.8 million as of June 30, 2020 .
Because we are the managing member of GS 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 to GS 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 of
June 30, 2020 and December 31, 2019 , we did not record any provision for
liability. Should any of our estimates or assumptions change or prove
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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 six months endedJune 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. 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 six months endedJune 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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