GreenSky, Inc. - Quarter Report: 2020 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________________________
FORM 10-Q
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the quarterly period ended September 30, 2020
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
Commission File Number: 001-38506
GreenSky, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 82-2135346 | |||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
5565 Glenridge Connector, Suite 700, Atlanta, Georgia | 30342 | |||||||
| (Address of principal executive offices) | (Zip Code) | |||||||
(678) 264-6105 | ||||||||
(Registrant’s telephone number, including area code) | ||||||||
Securities registered pursuant to Section 12(b) of the Act:
| Title of class | Trading Symbol | Name of exchange on which registered | ||||||
| Class A common stock, $0.01 par value | GSKY | Nasdaq Global Select Market | ||||||
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒ | Accelerated filer ☐ | Non-accelerated filer ☐ | Smaller reporting company ☐ | Emerging growth company ☐ | ||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
| Class of Common Stock | Outstanding as of October 31, 2020 | |||||||
Class A, $0.01 par value(1) | 76,416,565 | |||||||
Class B, $0.001 par value(2) | 106,165,105 | |||||||
(1) Includes 5,092,858 shares of unvested Class A common stock awards.
(2) Includes 728,697 shares of Class B common stock associated with unvested GreenSky Holdings, LLC units.
GreenSky, Inc.
FORM 10-Q
TABLE OF CONTENTS
| PAGE | ||||||||
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). In addition, our senior management makes forward-looking statements to analysts, investors, the media and others. These forward-looking statements reflect our current views with respect to, among other things, the following: our operations; our financial performance; the Company’s ability to retain existing, and attract new, merchants and Bank Partners or other funding sources, including the risk that one or more Bank Partners do not renew or reduce their funding commitments; sales of loan participations or asset-backed securities by the SPV (as defined in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”) or other special purpose vehicles that may be established from time to time by the Company; completion of New Institutional Financings (as defined in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”); our funding capacity; cash payments required under the financial guarantee arrangements; the launch and performance of new products; the extent and duration of the COVID-19 pandemic and its impact on the Company, its Bank Partners and merchants, GreenSky program borrowers, loan demand (including, in particular, for elective healthcare procedures), the capital markets, the economy in general and changes in the U.S. economy that could materially impact consumer spending behavior, unemployment and demand for our products; and our ability to mitigate or manage disruptions to our business posed by the pandemic. You generally can identify these statements by the use of words such as "outlook," "potential," "continue," "may," "seek," "approximately," "predict," "believe," "expect," "plan," "intend," "estimate" or "anticipate" and similar expressions or the negative versions of these words or comparable words, as well as future or conditional verbs such as "will," "should," "would," "likely" and "could." These statements may be found under Part I, Item 2 "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere, and are subject to certain risks and uncertainties that could cause actual results to differ materially from those included in the forward-looking statements. These risks and uncertainties include, but are not limited to, those risks described under Part II, Item 1A "Risk Factors" of this Form 10-Q. The forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, we disclaim any obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In light of these risks and uncertainties, there is no assurance that the events or results suggested by the forward-looking statements will in fact occur, and you should not place undue reliance on these forward-looking statements.
PART I - FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
GreenSky, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(United States Dollars in thousands, except share data)
| September 30, 2020 | December 31, 2019 | ||||||||||
| Assets | |||||||||||
| Cash and cash equivalents | $ | 113,573 | $ | 195,760 | |||||||
| Restricted cash | 324,934 | 250,081 | |||||||||
| Loan receivables held for sale, net | 543,316 | 51,926 | |||||||||
Accounts receivable, net of allowance of $217 and $238, respectively | 20,936 | 19,493 | |||||||||
| Property, equipment and software, net | 22,638 | 18,309 | |||||||||
| Deferred tax assets, net | 385,488 | 364,841 | |||||||||
| Other assets | 51,023 | 50,638 | |||||||||
| Total assets | $ | 1,461,908 | $ | 951,048 | |||||||
| Liabilities and Equity (Deficit) | |||||||||||
| Liabilities | |||||||||||
| Accounts payable | $ | 15,096 | $ | 11,912 | |||||||
| Accrued compensation and benefits | 11,420 | 10,734 | |||||||||
| Other accrued expenses | 4,564 | 3,244 | |||||||||
| Finance charge reversal liability | 187,512 | 206,035 | |||||||||
| Term loan | 453,342 | 384,497 | |||||||||
| SPV facility | 432,840 | — | |||||||||
| Tax receivable agreement liability | 307,294 | 311,670 | |||||||||
| Financial guarantee liability | 162,999 | 16,698 | |||||||||
| Other liabilities | 92,719 | 61,201 | |||||||||
| Total liabilities | 1,667,786 | 1,005,991 | |||||||||
| Commitments, Contingencies and Guarantees (Note 14) | |||||||||||
| Equity (Deficit) | |||||||||||
Class A common stock, $0.01 par value and 89,545,442 shares issued and 75,307,501 shares outstanding at September 30, 2020 and 80,089,739 shares issued and 66,424,838 shares outstanding at December 31, 2019 | 894 | 800 | |||||||||
Class B common stock, $0.001 par value and 107,217,505 shares issued and outstanding at September 30, 2020 and 113,517,198 shares issued and outstanding at December 31, 2019 | 108 | 114 | |||||||||
| Additional paid-in capital | 109,781 | 115,782 | |||||||||
| Retained earnings | 25,496 | 56,109 | |||||||||
| Treasury stock | (147,327) | (146,234) | |||||||||
| Accumulated other comprehensive income (loss) | (4,705) | (756) | |||||||||
| Noncontrolling interests | (190,125) | (80,758) | |||||||||
| Total equity (deficit) | (205,878) | (54,943) | |||||||||
| Total liabilities and equity (deficit) | $ | 1,461,908 | $ | 951,048 | |||||||
The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
4
GreenSky, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(United States Dollars in thousands, except per share data)
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Revenue | |||||||||||||||||||||||
| Transaction fees | $ | 107,538 | $ | 112,782 | $ | 299,199 | $ | 305,195 | |||||||||||||||
| Servicing | 27,446 | 40,626 | 87,210 | 90,577 | |||||||||||||||||||
| Interest and other | 7,039 | 121 | 10,433 | 907 | |||||||||||||||||||
| Total revenue | 142,023 | 153,529 | 396,842 | 396,679 | |||||||||||||||||||
| Costs and expenses | |||||||||||||||||||||||
| Cost of revenue (exclusive of depreciation and amortization shown separately below) | 92,346 | 65,278 | 229,442 | 180,099 | |||||||||||||||||||
| Compensation and benefits | 21,683 | 21,799 | 66,158 | 61,891 | |||||||||||||||||||
| Property, office and technology | 4,143 | 3,909 | 12,242 | 12,648 | |||||||||||||||||||
| Depreciation and amortization | 2,973 | 1,955 | 8,180 | 5,117 | |||||||||||||||||||
| Sales, general and administrative | 11,614 | 8,657 | 30,068 | 22,843 | |||||||||||||||||||
| Financial guarantee | (302) | 1,117 | 28,354 | 4,035 | |||||||||||||||||||
| Related party | 350 | 670 | 1,304 | 1,795 | |||||||||||||||||||
| Total costs and expenses | 132,807 | 103,385 | 375,748 | 288,428 | |||||||||||||||||||
| Operating profit | 9,216 | 50,144 | 21,094 | 108,251 | |||||||||||||||||||
| Other income (expense), net | |||||||||||||||||||||||
| Interest and dividend income | 157 | 780 | 1,025 | 2,490 | |||||||||||||||||||
| Interest expense | (6,775) | (5,634) | (18,289) | (18,200) | |||||||||||||||||||
| Other gains (losses), net | 410 | 318 | 2,216 | (5,400) | |||||||||||||||||||
| Total other income (expense), net | (6,208) | (4,536) | (15,048) | (21,110) | |||||||||||||||||||
| Income before income tax expense (benefit) | 3,008 | 45,608 | 6,046 | 87,141 | |||||||||||||||||||
| Income tax expense (benefit) | 197 | 1,533 | 799 | (3,528) | |||||||||||||||||||
| Net income | $ | 2,811 | $ | 44,075 | $ | 5,247 | $ | 90,669 | |||||||||||||||
| Less: Net income attributable to noncontrolling interests | 1,850 | 29,349 | 3,487 | 60,728 | |||||||||||||||||||
| Net income attributable to GreenSky, Inc. | $ | 961 | $ | 14,726 | $ | 1,760 | $ | 29,941 | |||||||||||||||
| 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 | |||||||||||||||
The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
5
GreenSky, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(United States Dollars in thousands)
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Net income | $ | 2,811 | $ | 44,075 | $ | 5,247 | $ | 90,669 | |||||||||||||||
| Other comprehensive income (loss), net of tax | |||||||||||||||||||||||
| Net unrealized gains (losses) on interest rate swap arising during the period | (493) | (2,085) | (14,037) | (4,034) | |||||||||||||||||||
| Reclassification of interest rate swap settlements into interest expense (income) during the period | 1,318 | (375) | 2,453 | (375) | |||||||||||||||||||
| Other comprehensive income (loss), net of tax | 825 | (2,460) | (11,584) | (4,409) | |||||||||||||||||||
| Comprehensive income (loss) | 3,636 | 41,615 | (6,337) | 86,260 | |||||||||||||||||||
| Less: Comprehensive income (loss) attributable to noncontrolling interests | 2,624 | 27,656 | (4,148) | 57,644 | |||||||||||||||||||
| Comprehensive income (loss) attributable to GreenSky, Inc. | $ | 1,012 | $ | 13,959 | $ | (2,189) | $ | 28,616 | |||||||||||||||
`
The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
6
GreenSky, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT) (Unaudited)
(United States Dollars in thousands, except share data)
| GreenSky, Inc. Stockholders Equity | ||||||||||||||||||||||||||||||||
| Class A Shares | Class B Shares | Class A Amount | Class B Amount | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Income (Loss) | Noncontrolling Interest | Total | |||||||||||||||||||||||
| Balance at June 30, 2020 | 73,350,234 | 108,994,392 | $ | 873 | $ | 110 | $ | 112,700 | $ | 24,512 | $ | (147,005) | $ | (4,756) | $ | (183,302) | $ | (196,868) | ||||||||||||||
| Net income | — | — | — | — | — | 961 | — | — | 1,850 | 2,811 | ||||||||||||||||||||||
| Issuance of unvested Class A common stock awards | 319,224 | — | 3 | — | (3) | — | — | — | — | — | ||||||||||||||||||||||
| Class B common stock exchanges | 1,776,886 | (1,776,887) | 18 | (2) | (16) | — | — | — | — | — | ||||||||||||||||||||||
| Forfeited share-based compensation awards | (65,079) | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Shares withheld related to net share settlement and other | (73,764) | — | — | — | — | — | (322) | — | — | (322) | ||||||||||||||||||||||
| Distributions | — | — | — | — | — | 23 | — | — | (17,074) | (17,051) | ||||||||||||||||||||||
| Share-based compensation | — | — | — | — | 4,334 | — | — | — | — | 4,334 | ||||||||||||||||||||||
| Equity-based payments to non-employees | — | — | — | — | 4 | — | — | — | — | 4 | ||||||||||||||||||||||
| Tax adjustments | — | — | — | — | 389 | — | — | — | — | 389 | ||||||||||||||||||||||
| Impact of noncontrolling interest on change in ownership during period | — | — | — | — | (7,627) | — | — | — | 7,627 | — | ||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | — | — | — | 51 | 774 | 825 | ||||||||||||||||||||||
| Balance at September 30, 2020 | 75,307,501 | 107,217,505 | $ | 894 | $ | 108 | $ | 109,781 | $ | 25,496 | $ | (147,327) | $ | (4,705) | $ | (190,125) | $ | (205,878) | ||||||||||||||
| GreenSky, Inc. Stockholders Equity | ||||||||||||||||||||||||||||||||
| Class A Shares | Class B Shares | Class A Amount | Class B Amount | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Income (Loss) | Noncontrolling Interest | Total | |||||||||||||||||||||||
| Balance at December 31, 2019 | 66,424,838 | 113,517,198 | $ | 800 | $ | 114 | $ | 115,782 | $ | 56,109 | $ | (146,234) | $ | (756) | $ | (80,758) | $ | (54,943) | ||||||||||||||
| Net income | — | — | — | — | — | 1,760 | — | — | 3,487 | 5,247 | ||||||||||||||||||||||
| — | — | — | — | — | (32,212) | — | — | (75,447) | (107,659) | |||||||||||||||||||||||
| Issuance of unvested Class A common stock awards | 3,140,959 | — | 31 | — | (31) | — | — | — | — | — | ||||||||||||||||||||||
| Class A common stock option exercises | 15,051 | — | — | — | (73) | — | — | — | — | (73) | ||||||||||||||||||||||
| Class B common stock exchanges | 6,299,693 | (6,299,693) | 63 | (6) | (57) | — | — | — | — | — | ||||||||||||||||||||||
| Forfeited share-based compensation awards | (360,230) | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Shares withheld related to net share settlement and other | (212,810) | — | — | — | — | — | (1,093) | — | — | (1,093) | ||||||||||||||||||||||
| Distributions | — | — | — | — | — | (161) | — | — | (48,405) | (48,566) | ||||||||||||||||||||||
| Share-based compensation | — | — | — | — | 11,306 | — | — | — | — | 11,306 | ||||||||||||||||||||||
| Equity-based payments to non-employees | — | — | — | — | 12 | — | — | — | — | 12 | ||||||||||||||||||||||
| Tax adjustments | — | — | — | — | 1,475 | — | — | — | — | 1,475 | ||||||||||||||||||||||
| Impact of noncontrolling interest on change in ownership during period | — | — | — | — | (18,633) | — | — | — | 18,633 | — | ||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | — | — | — | (3,949) | (7,635) | (11,584) | ||||||||||||||||||||||
| Balance at September 30, 2020 | 75,307,501 | 107,217,505 | $ | 894 | $ | 108 | $ | 109,781 | $ | 25,496 | $ | (147,327) | $ | (4,705) | $ | (190,125) | $ | (205,878) | ||||||||||||||
(1)Represents the cumulative effect resulting from our adoption of the Financial Accounting Standards Board Accounting Standards Update 2016-13, Measurement of Credit Losses on Financial Instruments. See Note 1 to the Notes to Unaudited Condensed Consolidated Financial Statements for additional information on our implementation.
The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
7
GreenSky, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT) (Continued) (Unaudited)
(United States Dollars in thousands, except share data)
| GreenSky, Inc. Stockholders Equity | ||||||||||||||||||||||||||||||||
| Class A Shares | Class B Shares | Class A Amount | Class B Amount | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Income (Loss) | Noncontrolling Interest | Total | |||||||||||||||||||||||
| Balance at June 30, 2019 | 61,772,014 | 115,309,728 | $ | 753 | $ | 116 | $ | 118,382 | $ | 39,163 | $ | (146,119) | $ | (558) | $ | (108,495) | $ | (96,758) | ||||||||||||||
| Net income | — | — | — | — | — | 14,726 | — | — | 29,349 | 44,075 | ||||||||||||||||||||||
| Issuance of unvested Class A common stock awards | 976,694 | — | 10 | — | (10) | — | — | — | — | — | ||||||||||||||||||||||
| Class A common stock option exercises | 1,991,777 | — | 20 | — | (10,802) | — | — | — | — | (10,782) | ||||||||||||||||||||||
| Class B common stock exchanges | 1,726,734 | (1,764,530) | 17 | (2) | (408) | — | — | — | — | (393) | ||||||||||||||||||||||
| Forfeited share-based compensation awards | (26,295) | (21,000) | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Shares withheld related to net share settlement and other | (9,623) | — | — | — | — | — | (64) | — | — | (64) | ||||||||||||||||||||||
| Distributions | — | — | — | — | — | (17) | — | — | (4,780) | (4,797) | ||||||||||||||||||||||
| Share-based compensation | — | — | — | — | 3,777 | — | — | — | — | 3,777 | ||||||||||||||||||||||
| Equity-based payments to non-employees | — | — | — | — | 4 | — | — | — | — | 4 | ||||||||||||||||||||||
| Tax adjustments | — | — | — | — | 935 | — | — | — | — | 935 | ||||||||||||||||||||||
| Impact of noncontrolling interest on change in ownership during period | — | — | — | — | 2,292 | — | — | — | (2,292) | — | ||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | — | — | — | (767) | (1,693) | (2,460) | ||||||||||||||||||||||
| Balance at September 30, 2019 | 66,431,301 | 113,524,198 | $ | 800 | $ | 114 | $ | 114,170 | $ | 53,872 | $ | (146,183) | $ | (1,325) | $ | (87,911) | $ | (66,463) | ||||||||||||||
| GreenSky, Inc. Stockholders Equity | ||||||||||||||||||||||||||||||||
| Class A Shares | Class B Shares | Class A Amount | Class B Amount | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Income (Loss) | Noncontrolling Interest | Total | |||||||||||||||||||||||
| Balance at December 31, 2018 | 54,504,902 | 128,549,555 | $ | 591 | $ | 129 | $ | 44,524 | $ | 24,218 | $ | (43,878) | $ | — | $ | (60,349) | $ | (34,765) | ||||||||||||||
| Net income | — | — | — | — | — | 29,941 | — | — | 60,728 | 90,669 | ||||||||||||||||||||||
| — | — | — | — | — | (87) | — | — | (203) | (290) | |||||||||||||||||||||||
| Issuance of unvested Class A common stock awards | 2,850,206 | — | 29 | — | (29) | — | — | — | — | — | ||||||||||||||||||||||
| Class A common stock option exercises | 2,273,069 | — | 23 | — | (12,065) | — | — | — | — | (12,042) | ||||||||||||||||||||||
| Class B common stock exchanges | 15,730,379 | (15,910,785) | 157 | (16) | (2,339) | — | — | — | — | (2,198) | ||||||||||||||||||||||
| Class B warrant exercises | — | 1,180,163 | — | 1 | (1) | — | — | — | — | — | ||||||||||||||||||||||
| Forfeited share-based compensation awards | (173,155) | (294,735) | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
| Class A common stock repurchases | (8,744,477) | — | — | — | — | — | (102,241) | — | — | (102,241) | ||||||||||||||||||||||
| Shares withheld related to net share settlement and other | (9,623) | — | — | — | — | — | (64) | — | — | (64) | ||||||||||||||||||||||
| Distributions | — | — | — | — | — | (200) | — | — | (18,721) | (18,921) | ||||||||||||||||||||||
| Share-based compensation | — | — | — | — | 9,713 | — | — | — | — | 9,713 | ||||||||||||||||||||||
| Equity-based payments to non-employees | — | — | — | — | 11 | — | — | — | — | 11 | ||||||||||||||||||||||
| Tax adjustments | — | — | — | — | 8,074 | — | — | — | — | 8,074 | ||||||||||||||||||||||
| Impact on noncontrolling interest of change in ownership during period | — | — | — | — | 66,282 | — | — | — | (66,282) | — | ||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | — | — | — | (1,325) | (3,084) | (4,409) | ||||||||||||||||||||||
| Balance at September 30, 2019 | 66,431,301 | 113,524,198 | $ | 800 | $ | 114 | $ | 114,170 | $ | 53,872 | $ | (146,183) | $ | (1,325) | $ | (87,911) | $ | (66,463) | ||||||||||||||
(1)Represents the cumulative effect resulting from our adoption of the Financial Accounting Standards Board Accounting Standards Update 2016-02, Leases.
The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
8
GreenSky, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(United States Dollars in thousands)
| Nine months ended September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| Cash flows from operating activities | |||||||||||
| Net income | $ | 5,247 | $ | 90,669 | |||||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | 8,180 | 5,117 | |||||||||
| Share-based compensation expense | 11,306 | 9,713 | |||||||||
| Equity-based payments to non-employees | 12 | 11 | |||||||||
| Fair value change in servicing assets and liabilities | (1,370) | (24,809) | |||||||||
| Operating lease liability payments | (342) | (255) | |||||||||
| Financial guarantee losses | 26,274 | (36) | |||||||||
| Amortization of debt related costs | 1,748 | 1,258 | |||||||||
| Original issuance discount on term loan payment | (18) | (31) | |||||||||
| Income tax expense (benefit) | 799 | (3,528) | |||||||||
| Loss on remeasurement of tax receivable agreement liability | — | 6,383 | |||||||||
| Impairment losses | 188 | — | |||||||||
| Mark to market on loan receivables held for sale | 17,332 | — | |||||||||
| Changes in assets and liabilities: | |||||||||||
| (Increase) decrease in loan receivables held for sale | (508,722) | (27,493) | |||||||||
| (Increase) decrease in accounts receivable | (1,442) | (5,690) | |||||||||
| (Increase) decrease in other assets | (3,354) | 1,919 | |||||||||
| Increase (decrease) in accounts payable | 3,184 | 8,627 | |||||||||
| Increase (decrease) in finance charge reversal liability | (18,523) | 44,401 | |||||||||
| Increase (decrease) in guarantee liability | (64) | — | |||||||||
| Increase (decrease) in other liabilities | 29,073 | 19,177 | |||||||||
| Net cash provided by (used in) operating activities | (430,492) | 125,433 | |||||||||
| Cash flows from investing activities | |||||||||||
| Purchases of property, equipment and software | (12,120) | (10,921) | |||||||||
| Net cash used in investing activities | (12,120) | (10,921) | |||||||||
| Cash flows from financing activities | |||||||||||
| Proceeds from term loan | 70,494 | — | |||||||||
| Repayments of term loan | (3,170) | (2,969) | |||||||||
| Proceeds from SPV facility | 570,000 | — | |||||||||
| Repayments of SPV facility | (137,160) | — | |||||||||
| Class A common stock repurchases | — | (104,272) | |||||||||
| Member distributions | (50,965) | (23,181) | |||||||||
| Payments under tax receivable agreement | (12,755) | (4,664) | |||||||||
| Proceeds from option exercises | — | 308 | |||||||||
| Payment of option exercise taxes | (1,166) | (12,350) | |||||||||
| Payment of taxes on Class B common stock exchanges | — | (2,198) | |||||||||
| Net cash provided by (used in) financing activities | 435,278 | (149,326) | |||||||||
| Net increase (decrease) in cash and cash equivalents and restricted cash | (7,334) | (34,814) | |||||||||
| Cash and cash equivalents and restricted cash at beginning of period | 445,841 | 458,499 | |||||||||
| Cash and cash equivalents and restricted cash at end of period | $ | 438,507 | $ | 423,685 | |||||||
The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
9
GreenSky, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited)
(United States Dollars in thousands)
| Nine months ended September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| Supplemental non-cash investing and financing activities | |||||||||||
| Distributions accrued but not paid | $ | 3,470 | $ | 6,351 | |||||||
| Capitalized software costs accrued but not paid | 435 | — | |||||||||
| Tax withholding on equity awards accrued but not paid | 21 | 64 | |||||||||
The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
10
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(United States Dollars in thousands, except per share data, unless otherwise stated)
Note 1. Organization, Summary of Significant Accounting Policies and New Accounting Standards
Organization
Unless the context requires otherwise, "we," "us," "our," "GreenSky" and "the Company" refer to GreenSky, Inc. and its subsidiaries. "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").
We are a leading technology company Powering Commerce at the Point of Sale®. Our platform is powered by a proprietary technology infrastructure that facilitates merchant sales, while reducing the friction and improving the economics associated with a consumer making a purchase and a lender or financial institution extending financing for that purchase. It supports the full transaction lifecycle, including credit application, underwriting, real-time allocation to our Bank Partners, document distribution, funding, settlement and servicing. Merchants using our platform, which presently range from small, owner-operated home improvement contractors and healthcare providers to large national home improvement brands and retailers and healthcare service organizations, rely on us to facilitate low or deferred interest promotional point-of-sale financing and payments solutions that enable higher sales volume than they could otherwise achieve on their own. Consumers on our platform, who to date primarily have super-prime or prime credit scores, find financing with promotional terms to be an attractive alternative to other forms of payment. Our Bank Partners' access to our proprietary technology solution and merchant network enables them to build a diversified portfolio of high quality consumer loans with attractive risk-adjusted yields with minimal upfront investment.
GreenSky, Inc. was formed as a Delaware corporation on July 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 GreenSky, Inc. Form 10-K filed with the U.S. Securities and Exchange Commission ("SEC") on March 2, 2020 (the "2019 Form 10-K"), in order to carry on the business of GreenSky Holdings, LLC (“GS Holdings”) and its consolidated subsidiaries. GS Holdings, a holding company with no operating assets or operations, was organized in August 2017. On August 24, 2017, GS Holdings acquired a 100% interest in GreenSky, LLC ("GSLLC"), a Georgia limited liability company, which is an operating entity. Common membership interests of GS Holdings are referred to as "Holdco Units." On May 24, 2018, the Company's Class A common stock commenced trading on the Nasdaq Global Select Market in connection with its IPO.
The IPO and Reorganization Transactions resulted in the Company becoming the sole managing member of GS Holdings. As the sole managing member of GS Holdings, we operate and control all of GS Holdings’ operations and, through GS Holdings and its subsidiaries, conduct GS Holdings’ business. The Company consolidates the financial results of GS Holdings and reports a noncontrolling interest in its Unaudited Condensed Consolidated Financial Statements representing the GS Holdings interests held by the Continuing LLC Members, as such term is defined in the 2019 Form 10-K. The weighted average ownership percentages for the applicable reporting periods are used to attribute net income (loss) and other comprehensive income (loss) to the Company and the noncontrolling interest.
In 2020, we formed GS Investment I, LLC (the "SPV" or "GS Investment"), a special purpose vehicle and indirect wholly-owned subsidiary of the Company, to facilitate purchases of participation interests in loans ("SPV Participations") originated through the GreenSky program. These purchases are made through a newly-created wholly-owned subsidiary, GS Depositor I, LLC ("Depositor"), and then transferred to the SPV. Each of the SPV and Depositor is a separate legal entity from the Company and from each other subsidiary of the Company, and the assets of the SPV and Depositor are owned by the SPV or Depositor, respectively, and are solely available to satisfy the creditors of the SPV or Depositor, respectively.
11
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Summary of Significant Accounting Policies
Basis of Presentation
The Unaudited Condensed Consolidated Financial Statements were prepared in accordance with the rules and regulations of the SEC for interim financial statements. We condensed or omitted certain notes and other information from the interim financial statements presented in this Quarterly Report on Form 10-Q. Therefore, these interim statements should be read in conjunction with the 2019 Form 10-K. In the opinion of management, the Unaudited Condensed Consolidated Financial Statements reflect all adjustments, which are of a normal recurring nature, necessary for a fair statement of our financial condition and results of operations for the interim periods presented. The condensed consolidated balance sheet as of December 31, 2019, was derived from the audited annual consolidated financial statements, but does not contain all of the footnote disclosures from the annual consolidated financial statements required by United States generally accepted accounting principles ("GAAP"). All intercompany balances and transactions are eliminated upon consolidation. The results for the three and nine months ended September 30, 2020 are not necessarily indicative of results expected for the full year.
Consistent with the 2019 Form 10-K, for the three and nine months ended September 30, 2020, we created distinct financial statement line items in our Unaudited Condensed Consolidated Financial Statements associated with the contingent component of our financial guarantee as follows: (i) financial guarantee expense in the Unaudited Condensed Consolidated Statements of Operations (previously presented within general and administrative expense); and (ii) financial guarantee losses as an adjustment to reconcile net income (loss) to net cash provided by operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows (previously presented within the change in other liabilities). The classification of the financial guarantee expense for the three and nine months ended September 30, 2019 of $1,117 thousand and $4,035 thousand, respectively, and the classification of the financial guarantee gains for the nine months ended September 30, 2019 of $36 thousand were changed to conform to the current presentation.
Certain reclassifications have been made to the prior year presentation to conform to the current year presentation. The Company has reclassified certain costs associated with the Company’s operational costs to “Cost of revenue,” which were previously recorded to “Property, office and technology expense” and “Sales, general and administrative.” The costs reclassified include costs incurred to provide origination and servicing activities which consist primarily of compensation and benefits related to activities such as customer service, merchant underwriting and costs for printing and postage related to consumer statement production. The Company believes this new presentation will better assist users in understanding its results of operations. The prior periods presented reflect the reclassifications of these expenses to conform to the current period presentation.
With our formation and use of the SPV, the amount of loan receivables held for sale has increased on our Unaudited Condensed Consolidated Balance Sheet. As a result, we have reclassified the presentation of certain items associated with the loan receivables held for sale that were previously presented as "non-operating" within the Unaudited Condensed Consolidated Statements of Operations; specifically, valuation allowance (inclusive of both credit and market interest rate considerations) for loan receivables held for sale, proceeds from transferring our rights to Charged-Off Receivables attributable to loan receivables held for sale, and interest income from loan receivables held for sale. The classification of such valuation allowance for the three and nine months ended September 30, 2019 of $2,401 thousand and $3,184 thousand, respectively, and the classification of the proceeds from transferring our rights to Charged-Off Receivables for the three and nine months ended September 30, 2019 of $33 thousand and $174 thousand, respectively, were changed from "other gains (losses), net" to "sales, general and administrative" expense within the Unaudited Condensed Consolidated Statement of Operations to conform to the current presentation. The classification of such interest income for the three and nine months ended September 30, 2019 of $114 thousand and $869 thousand, respectively, was reclassified from interest and dividend income to interest and other revenue within the Unaudited Condensed Consolidated Statement of Operations to conform to the current presentation.
12
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Use of Estimates
The preparation of our financial statements in conformity with GAAP requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Such estimates and assumptions include, but are not limited to, those that relate to fair value measurements, financial guarantees, share-based compensation and income taxes. In developing estimates and assumptions, management uses all available information; however, actual results could materially differ from those estimates and assumptions.
Cash and Cash Equivalents and Restricted Cash
Cash Equivalents
We consider all highly liquid investments that mature three months or less from the date of purchase to be cash equivalents. Cash equivalents include money market mutual fund accounts, which are invested in government securities that are either guaranteed by the Federal Deposit Insurance Corporation of the U.S. government ("FDIC") or are secured by U.S. government-issued collateral for which the risk of loss from nonpayment is presumed to be zero. As such, we do not establish an allowance for credit losses on our cash equivalents. Further, the carrying amounts of our cash equivalents approximate their fair values due to their short maturities and highly liquid nature. Refer to "Recently Adopted Accounting Standards" in this Note 1 for discussion of our adoption of the provisions of Accounting Standards Update ("ASU") 2016-13, Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), effective January 1, 2020 and Note 3 for additional information on our fair value measurement.
Restricted Cash
Restricted cash includes cash held in interest-bearing escrow accounts to provide limited protection to our Bank 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. Restricted cash also includes cash maintained for certain Bank Partners related to our finance charge reversal ("FCR") liability, certain custodial in-transit loan funding and consumer borrower payments that were restricted from use for our operations, and cash related to collections in connection with SPV Participations.
The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the Unaudited Condensed Consolidated Balance Sheets to the total included within the Unaudited Condensed Consolidated Statements of Cash Flows as of the dates indicated.
| September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| Cash and cash equivalents | $ | 113,573 | $ | 206,403 | |||||||
| Restricted cash | 324,934 | 217,282 | |||||||||
| Cash and cash equivalents and restricted cash in Unaudited Condensed Consolidated Statements of Cash Flows | $ | 438,507 | $ | 423,685 | |||||||
Accounts Receivable
Accounts receivable are recorded at their original invoice amounts, which are reduced by any allowance for uncollectible amounts. Effective January 1, 2020, we adopted the provisions of ASU 2016-13, which requires upfront recognition of lifetime expected credit losses using a current expected credit loss model. In accordance with the standard, we pool our accounts receivable, all of which are short-term in nature and arise from contracts with customers, based on shared risk characteristics to assess their risk of loss, even when that risk is remote. We use the aging method to establish an allowance for expected credit losses on accounts receivable balances and consider whether current conditions or reasonable and supportable forecasts about future conditions warrant an adjustment to our historical loss experience. In applying such adjustments, we primarily consider changes in counterparty credit risk and changes in the underlying macroeconomic environment. Accounts receivable are written off once
13
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
delinquency exceeds 90 days. Recoveries of previously written off accounts receivable are recognized on a collected basis as a reduction to the provision for credit losses, which is included within sales, general and administrative expense in the Unaudited Condensed Consolidated Statements of Operations. The allowance for uncollectible amounts for periods prior to January 1, 2020 continue to be presented and disclosed under legacy guidance in Accounting Standards Codification ("ASC") 310, Receivables. Refer to "Recently Adopted Accounting Standards" in this Note 1 for discussion of our adoption of the provisions of ASU 2016-13 and Note 5 for additional information on our accounts receivable.
Fair Value of Assets and Liabilities
We have financial assets and liabilities subject to fair value measurement or disclosure on either a recurring or nonrecurring basis. Such measurements or disclosures relate to our cash and cash equivalents, loan receivables held for sale, derivative instruments, servicing assets and liabilities, and term loan.
ASC 820, Fair Value Measurement, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In valuing this asset or liability, we utilize market data or reasonable assumptions that market participants would use, including assumptions about risk and the risks inherent in the inputs to the valuation technique. The guidance within ASC 820 provides a three-level valuation hierarchy for disclosure of fair value measurements based on the transparency of inputs to the valuation of an asset or a liability as of the measurement date. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels are defined as follows:
Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
Level 3: Unobservable inputs for the asset or liability.
An asset’s or a liability’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
We apply the market approach, which uses observable prices and other relevant information that is generated by market transactions involving identical or comparable assets or liabilities, to value our cash and cash equivalents, sales facilitation obligations, loan receivables held for sale and term loan. We apply the income approach, which uses valuation techniques to convert future amounts to a single, discounted present value amount, to value our FCR liability and servicing assets and liabilities. We determine the fair value of our interest rate swap by applying a discounted cash flow model based on observable market factors and specific credit factors.
Refer to Note 3 for additional fair value disclosures.
Derivative Instruments
We are exposed to interest rate risk on our variable-rate term loan, which we manage by entering into an interest rate swap that is determined to be a derivative in accordance with ASC 815, Derivatives and Hedging. Derivatives are recorded on the balance sheet at fair value and are marked-to-market on a quarterly basis. The accounting for the change in fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate the derivative as a hedge and apply hedge accounting, and whether the hedging relationship continues to satisfy the criteria required to apply hedge accounting.
Derivatives designated and qualifying as a hedge of the exposure to variability in cash flows of a recognized asset or liability that is attributable to a particular risk are considered cash flow hedges. The primary purpose of cash flow hedge accounting is to link the income statement recognition of a hedging instrument and a hedged item whose changes in cash flows are expected to offset each other. The change in the fair value of the derivative instrument designated as a cash flow hedge is initially reported as a component of other comprehensive income (loss) and
14
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
subsequently reclassified into earnings in the same period when the hedged item affects earnings. The reclassification into earnings is reported in the same income statement line item in which the hedged item is reported.
The FCR component of our Bank Partner contracts, which arrangements are detailed in Note 3, qualifies as an embedded derivative. The FCR liability is not designated as a hedge for accounting purposes and, as such, changes in its fair value are recorded within cost of revenue in the Unaudited Condensed Consolidated Statements of Operations.
Certain sales facilitation obligations that we have with a Bank Partner, which are detailed in Note 3, qualify as embedded derivatives. The sales facilitation obligations are not designated as hedges for accounting purposes and, as such, changes in its fair value are recorded within cost of revenue in the Unaudited Condensed Consolidated Statements of Operations.
Refer to Note 8 for additional derivative disclosures.
Financial Guarantees
Under the terms of the contracts with our Bank Partners, we provide limited protection to the Bank 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, by holding cash in restricted, interest-bearing escrow accounts in an amount equal to a contractual percentage of the Bank Partners’ monthly originations and month-end outstanding portfolio balance. Our maximum exposure under these financial guarantees is contractually limited to the escrow that we establish with each Bank Partner. Cash set aside to meet this requirement is classified as restricted cash in our Unaudited Condensed Consolidated Balance Sheets.
Our contracts with our Bank 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. If credit losses exceed an agreed-upon threshold, we are obligated to make limited payments to our Bank Partners, which obligation represents a financial guarantee in accordance with ASC 460, Guarantees. Under ASC 460, the guarantor undertakes a noncontingent obligation to stand ready to perform over the term of the guarantee and a contingent obligation to make future payments if the triggering events or conditions under the guarantee arrangements occur.
Effective January 1, 2020, we adopted the provisions of ASU 2016-13, which apply only to the contingent aspect of the guarantee arrangement. Under the new standard, we are required to estimate the expected credit losses over the contractual period in which we are exposed to credit risk via a present contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the issuer. As applied to our financial guarantee arrangements, we are required to estimate expected credit losses, and the impact of those estimates on our potential escrow payments, for loans within our Bank Partner portfolios that are either funded or approved for funding at the measurement date, but are precluded from including future loan originations by our Bank Partners. 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 established with each Bank Partner. Typically, additional financial guarantee liabilities are recorded as new Bank Partner loans are facilitated, along with a corresponding non-cash charge recorded as financial guarantee expense in the Unaudited Condensed Consolidated Statements of Operations. Historically, our actual cash payments required under the financial guarantee arrangements have been immaterial for our ongoing Bank Partners.
As the terms of our guarantee arrangements are determined contractually with each Bank Partner, we measure our contingent obligation separately for each Bank Partner using a discounted cash flow method based on estimates of the outstanding loan attributes of the Bank Partner's loan servicing portfolio and our expectations of forecasted information, including macroeconomic conditions, over the period which our financial guarantee is expected to be used in a "run-off" scenario. We use our historical experience as a basis for estimating escrow usage and adjust for current conditions or forecasts of future conditions if they are determined to vary from our historical
15
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
experience. Refer to "Recently Adopted Accounting Standards" in this Note 1 for discussion of our adoption of the provisions of ASU 2016-13 and Note 14 for additional information on our financial guarantees.
For periods prior to January 1, 2020, the contingent aspect of the financial guarantee continues to be presented and disclosed in accordance with legacy guidance in ASC 450, Contingencies. Under this guidance, the contingent aspect of the financial guarantee represented the amount of payments to Bank Partners from the escrow accounts that we expected to be probable of occurring based on Bank Partner portfolio composition and our near-term expectation of credit losses. In estimating the obligation, we considered a variety of factors, including historical experience, management’s expectations of current customer delinquencies converting into Bank Partner portfolio credit losses and recent events and circumstances.
Revenue Recognition
Disaggregated revenue
Revenue disaggregated by type of service was as follows for the periods presented:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Merchant fees | $ | 100,036 | $ | 100,656 | $ | 275,158 | $ | 270,877 | |||||||||||||||
| Interchange fees | 7,502 | 12,126 | 24,041 | 34,318 | |||||||||||||||||||
| Transaction fees | 107,538 | 112,782 | 299,199 | 305,195 | |||||||||||||||||||
Servicing fees(1) | 27,446 | 40,626 | 87,210 | 90,577 | |||||||||||||||||||
Interest income(2) | 7,037 | 114 | 10,426 | 869 | |||||||||||||||||||
Other(3) | 2 | 7 | 7 | 38 | |||||||||||||||||||
| Interest and other | 7,039 | 121 | 10,433 | 907 | |||||||||||||||||||
| Total revenue | $ | 142,023 | $ | 153,529 | $ | 396,842 | $ | 396,679 | |||||||||||||||
(1)For the three and nine months ended September 30, 2020, includes decreases in fair value of our servicing asset of $792 thousand and $51 thousand, respectively, primarily due to the sale of participations in loans from an existing Bank Partner to the SPV. For the three and nine months ended September 30, 2019, includes increases in fair value of our servicing assets of $16,365 thousand and $25,331 thousand, respectively. Refer to Note 3 for additional information.
(2)Includes interest income received on loan receivables held for sale.
(3)Other revenue includes miscellaneous revenue items that are individually immaterial. Other revenue is presented separately herein in order to clearly present merchant, interchange fees, servicing fees, and interest income which are more integral to our primary operations and better enable financial statement users to calculate metrics such as servicing and merchant fee yields.
We have no remaining performance obligations as of September 30, 2020. No assets were recognized from the costs to obtain or fulfill a contract with a customer as of September 30, 2020 and December 31, 2019. Volume-based price concessions to merchants and Sponsors that were netted against the gross transaction price were $3,481 thousand and $3,077 thousand for the three months ended September 30, 2020 and 2019, respectively, and $11,512 thousand and $12,183 thousand for the nine months ended September 30, 2020 and 2019, respectively. "Sponsors" refers to manufacturers, their captive and franchised showroom operations, and trade associations with which we partner to onboard merchants. We recognized credit losses arising from our contracts with customers of $133 thousand and $98 thousand during the three months ended September 30, 2020 and 2019, respectively, and $511 thousand and $693 thousand during the nine months ended September 30, 2020 and 2019, respectively, which is recorded within sales, general and administrative expense in our Unaudited Condensed Consolidated Statements of Operations.
16
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Consolidation
In the normal course of our business, we may enter into an agreement for management, servicing, or related services or hold ownership interests in special purpose entities. We evaluate our interests and/or involvement in these entities to determine whether they meet the definition of a variable interest entity ("VIE"), pursuant to ASC 810, Consolidation, and whether we are required to consolidate these entities. A VIE is consolidated by its primary beneficiary, which is the party that has both (i) the power to direct the activities that most significantly impact the economic performance of the VIE and (ii) a variable interest that could potentially be significant to the VIE. In our determination of whether or not a variable interest we hold could potentially be significant to the VIE, we consider both qualitative and quantitative factors regarding the nature, and size of the VIE and the form of our involvement with the VIE.
Recently Adopted Accounting Standards
Measurement of credit losses on financial instruments
In June 2016, the FASB issued ASU 2016-13, which requires upfront recognition of lifetime expected credit losses on certain financial instruments (or groups of financial instruments) using a current expected credit loss ("CECL") model. The standard is intended to better align the recognition of credit losses on financial instruments with management’s expectations of the net amount of principal balance expected to be collected on such financial instruments. Under CECL, management must determine expected credit losses for certain financial instruments held at the reporting date based on relevant information about past events, including historical experience, current conditions and reasonable and supportable forecasts. We adopted the standard as of January 1, 2020. Comparative periods continue to be presented and disclosed in accordance with applicable legacy guidance.
Our primary financial instruments in the scope of CECL include cash equivalents, accounts receivable and off-balance sheet credit exposures under our financial guarantee arrangements with our Bank Partners, each of which is discussed in further detail below (as it relates to our implementation of the new standard) and within the respective sub-headings under "Summary of Significant Accounting Policies" in this Note 1.
Cash Equivalents
As our cash equivalents are invested in government securities that are either guaranteed by the FDIC or are secured by U.S. government-issued collateral, the risk of loss from nonpayment is presumed to be zero. As such, we did not establish an allowance for credit losses on our cash equivalents upon our adoption of the standard.
Accounts Receivable
We pool our accounts receivable, all of which are short-term in nature and arise from contracts with customers, based on shared risk characteristics to assess their risk of loss, even when that risk is remote. Historically, the majority of our accounts receivable did not have write-offs. For accounts receivables for which we historically experienced losses, we used an aging method and the average 12-month historical loss rate as a basis for estimating credit losses on the current accounts receivable balance. In the absence of relevant historical loss experience for the other pools of accounts receivables, we also used this average 12-month loss rate to inform our estimate of credit losses on those balances. For each pool of accounts receivable, we considered the conditions at the adoption date, such as the manner in which we collect funds, our counterparty credit risk and the underlying macroeconomic environment, and determined that the current conditions were comparable to our historical conditions. Further, given that we establish an allowance for all delinquent accounts receivable (typically deemed to be 31 days or more past due), providing for a maximum 30-day term of our accounts receivable balances, we determined that the forecasts about future conditions were also comparable to our historical conditions. As such, we did not adjust our historical loss rates at the adoption date and we continue to establish allowances for a portion of current accounts receivable and all delinquent accounts receivable.
Based on this methodology, we determined that the allowance for uncollectible accounts measured under the new standard at the adoption date for our pools of accounts receivable for which no history of losses existed was
17
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
immaterial to our consolidated financial statements. Additionally, we determined that there was no impact from our adoption of the standard on the allowance for uncollectible accounts for our accounts receivable for which we historically experienced losses. Therefore, our adoption of the standard on January 1, 2020 did not have any impact on our consolidated financial statements. Refer to Note 5 for additional information on our accounts receivable.
Financial Guarantees
We are required to estimate expected credit losses, and the impact of those estimates on our potential escrow payments, for loans within our Bank Partner portfolios that are either funded or approved for funding at the measurement date, but are precluded from including future loan originations by our Bank Partners. We used a discounted cash flow method to estimate our expected risk of loss under the contingent aspect of our financial guarantees for each Bank Partner. In determining this measure, we forecasted each Bank Partner's loan portfolio composition in a "run-off" scenario, which is primarily impacted by assumptions around prepayments and loan pay downs. Our prepayment and loan pay down assumptions were derived from historical behavior curves for each loan plan and were applied to each Bank Partner's portfolio based on its composition of loans and where such loans were in their economic life cycle. The loan portfolio composition additionally informs our forecasts of the components that determine our incentive payments or, alternatively, escrow usage. Further, we use lifetime historical credit loss experience for each loan plan as a basis for estimating future credit losses. While there have subsequently been significant changes in macroeconomic conditions, as of our January 1, 2020 adoption date, we determined that the macroeconomic conditions representing the largest potential indicators of changes in credit losses, particularly the unemployment rate, were comparable to our historical conditions. Further, as our forecast period for escrow usage in a "run-off" scenario is typically relatively short-term in nature, we determined that the forecasts about future conditions were also comparable to our historical conditions. As such, we did not adjust our historical credit loss rates at the adoption date for our financial guarantee arrangements.
As a result of adopting this standard, we recorded 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. Our recognized financial guarantee liability subsequent to our adoption of the new standard of $134.7 million represented a significant portion of our $150.4 million contractual escrow that was included in our restricted cash balance as of December 31, 2019. Historically, our actual cash payments required under the financial guarantee arrangements have been immaterial for our ongoing Bank Partners. Refer to Note 14 for additional information on our financial guarantees.
Customer's accounting for implementation costs incurred in a cloud computing arrangement that is a service contract
In August 2018, the FASB issued ASU 2018-15, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include access to an internal-use software license). Accordingly, costs for implementation activities in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and post-implementation stages are expensed as the activities are performed. This standard also requires entities to amortize the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement and to apply the existing impairment guidance in ASC 350-40, Internal-Use Software, to the capitalized implementation costs as if the costs were long-lived assets. The standard clarifies that such capitalized implementation costs are also subject to the guidance on abandonment in ASC 360, Property, Plant, and Equipment.
In addition, this standard requires alignment in presentation between: (i) the expense related to the capitalized implementation costs and the fees associated with the hosting element (service) of the arrangement on the statement of operations, (ii) the capitalized implementation costs and any prepayment for the fees of the associated hosting arrangement on the balance sheet, and (iii) the payments for capitalized implementation costs and the payments made for fees associated with the hosting element in the statement of cash flows. We elected to apply
18
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
the standard prospectively to implementation costs incurred after the date of adoption. Therefore, our adoption of this standard on January 1, 2020 did not have any impact on our Unaudited Condensed Consolidated Financial Statements.
Codification Improvements to Financial Instruments
In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments, which improves various financial instruments topics, including CECL. ASU 2020-03 includes seven different issues that describe the areas of improvement and the related amendments to GAAP, intended to make the standards easier to understand and apply by eliminating inconsistencies and providing clarifications. Our adoption of ASU 2020-03 did not have a material impact on the Unaudited Condensed Consolidated Financial Statements.
Accounting Standards Issued, But Not Yet Adopted
Facilitation of the Effects of Reference Rate Reform on Financial Reporting
In March 2020, the FASB issued ASU 2020-04, which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate ("LIBOR") or another reference rate expected to be discontinued because of reference rate reform, if certain criteria are met. The standard applies to contract modifications that replace a reference rate affected by reference rate reform and contemporaneous modifications of other contract terms related to the replacement of the reference rate. Further, the standard provides exceptions to certain guidance in ASC 815, Derivatives and Hedging, related to changes to the critical terms of a hedging relationship due to reference rate reform and provides optional expedients for fair value, cash flow and net investment hedging relationships for which the component excluded from the assessment of hedge effectiveness is affected by reference rate reform. This standard is effective as of March 12, 2020, and an entity may elect to adopt it through December 31, 2022 based on applying as of the beginning of an interim period up to the date that the financial statements are available to be issued. Once elected, the provisions of the standard must be applied prospectively for all similar eligible contract modifications. We are currently identifying arrangements referenced to rates, such as US dollar LIBOR, that are expected to be discontinued and are evaluating our options for modifying such arrangements in accordance with the standard. We expect to adopt this guidance but have not yet elected an adoption date.
Simplifying the Accounting for Income Taxes
In December 2019, the FASB issued ASU 2019-12, which modifies ASC 740, Income Taxes, to simplify the accounting for income taxes by removing certain exceptions to simplify the accounting for income taxes by removing certain exceptions, including intraperiod tax allocations and the calculation of income taxes in an interim period when in a loss position. Additionally, the standard simplifies accounting in several areas, including the allocation of tax expense to a legal entity that is not subject to tax in standalone financial statements and enacted changes in tax laws. The standard is effective for us on January 1, 2021 and the transition method depends on the nature of the guidance. We do not expect the adoption to have a material effect on our financial statements, including our deferred tax assets and tax receivable agreement liability.
Note 2. Earnings per Share
Basic earnings per share of Class A common stock is computed by dividing net income attributable to GreenSky, Inc. by the weighted average number of shares of Class A common stock outstanding during the period. Diluted earnings per share of Class A common stock is computed by dividing net income attributable to GreenSky, Inc., adjusted for the assumed exchange of all potentially dilutive Holdco Units for Class A common stock, by the weighted average number of shares of Class A common stock outstanding adjusted to give effect to potentially dilutive elements.
19
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The following table sets forth reconciliations of the numerators and denominators used to compute basic and diluted earnings per share of Class A common stock for the periods indicated.
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Numerator: | |||||||||||||||||||||||
| Income before income tax expense (benefit) | $ | 3,008 | $ | 45,608 | $ | 6,046 | $ | 87,141 | |||||||||||||||
| Less: Net income attributable to noncontrolling interests | 1,850 | 29,349 | 3,487 | 60,728 | |||||||||||||||||||
| Less: Income tax expense (benefit) | 197 | 1,533 | 799 | (3,528) | |||||||||||||||||||
| Net income attributable to GreenSky, Inc. – basic | $ | 961 | $ | 14,726 | $ | 1,760 | $ | 29,941 | |||||||||||||||
| Add: Reallocation of net income attributable to noncontrolling interests from the assumed exchange of Holdco Units for Class A common stock | 1,850 | 29,349 | 3,487 | 60,728 | |||||||||||||||||||
Less: Income tax expense on reallocation of net income attributable to noncontrolling interests(1) | 624 | 3,056 | 1,201 | 7,617 | |||||||||||||||||||
| Net income attributable to GreenSky, Inc. – diluted | $ | 2,187 | $ | 41,019 | $ | 4,046 | $ | 83,052 | |||||||||||||||
| Denominator: | |||||||||||||||||||||||
| Weighted average shares of Class A common stock outstanding – basic | 69,960,268 | 61,855,370 | 66,267,288 | 60,309,032 | |||||||||||||||||||
Add: Dilutive effects, as shown separately below | |||||||||||||||||||||||
| Holdco Units exchangeable for Class A common stock | 106,832,298 | 113,390,825 | 110,327,688 | 117,400,829 | |||||||||||||||||||
| Class A common stock options | 352,798 | 1,666,253 | 387,516 | 2,340,102 | |||||||||||||||||||
| Holdco warrants exchangeable for Class A common stock | — | — | — | 109,344 | |||||||||||||||||||
Unvested Class A common stock(2) | 912,318 | 141,666 | 554,374 | 170,802 | |||||||||||||||||||
| Weighted average shares of Class A common stock outstanding – diluted | 178,057,682 | 177,054,114 | 177,536,866 | 180,330,109 | |||||||||||||||||||
| Earnings per share of Class A common stock outstanding – basic | $ | 0.01 | $ | 0.24 | $ | 0.03 | $ | 0.50 | |||||||||||||||
| Earnings per share of Class A common stock outstanding – diluted | $ | 0.01 | $ | 0.23 | $ | 0.02 | $ | 0.46 | |||||||||||||||
Excluded from diluted earnings per share, as their inclusion would have been anti-dilutive(3) | |||||||||||||||||||||||
| Holdco Units | 529,729 | 410,200 | 529,729 | 410,200 | |||||||||||||||||||
| Class A common stock options | 4,230,566 | 2,989,904 | 4,230,566 | 2,989,904 | |||||||||||||||||||
| Class A common stock awards | 1,951,439 | 1,986,409 | 1,951,439 | 1,986,409 | |||||||||||||||||||
(1)We assumed effective tax rates of 27.3% and 10.1% for the three months ended September 30, 2020 and 2019, respectively, and 33.1% and 4.7% for the nine months ended September 30, 2020 and 2019, respectively, which represents the effective tax rates on the consolidated GreenSky, Inc. entity inclusive of the income taxes on the portion of GS Holdings' earnings that are attributable to noncontrolling interests.
(2)Includes both unvested Class A common stock issued as part of the Reorganization Transactions and unvested Class A common stock awards issued subsequent to the Reorganization Transactions.
(3)These amounts represent the number of instruments outstanding at the end of the period. Application of the treasury stock method would reduce these amounts if they had a dilutive effect and were included in the computation of diluted earnings per share.
Shares of the Company’s Class B common stock do not participate in the earnings or losses of the Company and, therefore, are not participating securities. As such, separate presentation of basic and diluted earnings per share of Class B common stock under the two-class method has not been included.
20
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Note 3. Fair Value of Assets and Liabilities
The following table summarizes, by level within the fair value hierarchy, the carrying amounts and estimated fair values of our assets and liabilities measured at fair value on a recurring or nonrecurring basis or disclosed, but not carried, at fair value in the Unaudited Condensed Consolidated Balance Sheets as of the dates presented. There were no transfers into, out of, or between levels within the fair value hierarchy during any of the periods presented. Refer to Note 4, Note 7, Note 8 and Note 9 for additional information on these assets and liabilities.
| Level | September 30, 2020 | December 31, 2019 | |||||||||||||||||||||||||||
| Carrying Value | Fair Value | Carrying Value | Fair Value | ||||||||||||||||||||||||||
| Assets: | |||||||||||||||||||||||||||||
Cash and cash equivalents(1) | 1 | $ | 113,573 | $ | 113,573 | $ | 195,760 | $ | 195,760 | ||||||||||||||||||||
Loan receivables held for sale, net(2) | 2 | 543,316 | 547,391 | 51,926 | 55,958 | ||||||||||||||||||||||||
Servicing assets(3) | 3 | 30,408 | 30,408 | 30,459 | 30,459 | ||||||||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||||||||
Finance charge reversal liability(3) | 3 | $ | 187,512 | $ | 187,512 | $ | 206,035 | $ | 206,035 | ||||||||||||||||||||
Term loan(1) | 1 | 453,342 | 442,467 | 384,497 | 392,201 | ||||||||||||||||||||||||
Interest rate swap(3) | 2 | 15,609 | 15,609 | 2,763 | 2,763 | ||||||||||||||||||||||||
Servicing liabilities(3) | 3 | 2,375 | 2,375 | 3,796 | 3,796 | ||||||||||||||||||||||||
Sales facilitation obligations(3) | 2 | 18,262 | 18,262 | — | — | ||||||||||||||||||||||||
(1)Disclosed, but not carried, at fair value. The increase in fair value of the term loan at September 30, 2020 compared to December 31, 2019 is primarily a result of the incremental term loan of $75.0 million entered into in June 2020, offset by a decrease related to COVID-19 impacts on the U.S. corporate debt market. Refer to Note 7 for additional details.
(2)Measured at fair value on a recurring basis. Loan receivables held for sale are recorded net of provision for credit losses.
(3)Measured and carried at fair value on a recurring basis.
Cash and cash equivalents
Cash and cash equivalents are classified within Level 1 of the fair value hierarchy, as the primary component of the price is obtained from quoted market prices in an active market. The carrying amounts of our cash and cash equivalents approximate their fair values due to the short maturities and highly liquid nature of these accounts.
Loan receivables held for sale, net
Loan receivables held for sale are recorded in the Unaudited Condensed Consolidated Balance Sheets at the lower of cost or fair value and, therefore, are measured at fair value on a nonrecurring basis. Prior to 2020, the fair value of our loan receivables held for sale historically approximated par value, as we have consistently sold loans for the full current balance transactions with our Bank Partners. With the implementation of the SPV in 2020 to facilitate purchases of participation interests in loans, our loans receivable held for sale are primarily loan participations owned by the SPV and are expected to be sold to institutional investors, financial institutions and other capital markets investors. Fair value of our loan receivables held for sale is determined based on the anticipated sale price of such participations to third parties. Loan receivables held for sale are classified within Level 2 of the fair value hierarchy, as the primary component of the price is obtained from observable values of loan receivables with similar terms and characteristics.
Interest rate swap
In June 2019, we entered into a $350.0 million notional, four-year interest rate swap agreement to hedge changes in our cash flows attributable to interest rate risk on $350.0 million of our variable-rate term loan to a fixed-
21
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
rate basis, thus reducing the impact of interest rate changes on future interest expense. This swap involves the receipt of variable-rate amounts in exchange for fixed interest rate payments over the life of the agreement without an exchange of the underlying notional amount and was designated for accounting purposes as a cash flow hedge. The interest rate swap is carried at fair value on a recurring basis in the Unaudited Condensed Consolidated Balance Sheets and is classified within Level 2 of the fair value hierarchy, as the inputs to the derivative pricing model are generally observable and do not contain a high level of subjectivity. The fair value was determined based on the present value of the estimated future net cash flows using implied rates in the applicable yield curve as of the valuation date.
Finance charge reversal liability
Our Bank Partners offer certain loan products that have a feature whereby the account holder is provided a promotional period to repay the loan principal balance in full without incurring a finance charge. For these loan products, our Bank Partners bill interest each month throughout the promotional period and, under the terms of the contracts with our Bank Partners, we are obligated to pay this billed interest to the Bank Partners if an account holder repays the loan balance in full within the promotional period. Therefore, the monthly process of billing interest on deferred loan products triggers a potential future finance charge reversal ("FCR") liability for the Company. The FCR component of our Bank Partner contracts qualifies as an embedded derivative. The FCR liability is not designated as a hedge for accounting purposes and, as such, changes in its fair value are recorded within cost of revenue in the Unaudited Condensed Consolidated Statements of Operations.
The FCR liability is carried at fair value on a recurring basis in the Unaudited Condensed Consolidated Balance Sheets and is estimated based on historical experience and management’s expectation of future FCR. The FCR liability is classified within Level 3 of the fair value hierarchy, as the primary component of the fair value is obtained from unobservable inputs based on the Company’s data, reasonably adjusted for assumptions that would be used by market participants. The following table reconciles the beginning and ending fair value measurements of our FCR liability during the periods indicated.
| Three Months Ended September 30, | Nine Months Ended 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 from Bank 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 from Bank 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 ended September 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.
22
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Significant assumptions used in valuing our FCR liability include the following:
Reversal rate: The reversal rate represents our estimate of the percentage of previously billed interest on deferred loan products that we expect we will be obligated to remit to the Bank Partners due to the account holder paying off the loan balance in full within the promotional period. Management has developed more specific reversal rates for categories of deferred loan products based on the length of the interest-free promotional period (ranging from to 24 months), whether or not loan principal payments were required to be paid during the interest-free promotional period, and the industry vertical (home improvement or elective healthcare). The historical period over which we evaluate reversal rates may also vary among the categories of deferred loan products based on the length and relevance of our historical experience with such products at the measurement date. The slight decrease in reversal rates from December 31, 2019 is primarily attributable to lower assumed reversal rates for 24-month loan products.
Discount rate: The discount rate reflects the time value of money adjusted for a risk premium and decreased from December 31, 2019 primarily due to the decreased interest rate environment primarily resulting from the COVID-19 pandemic.
The following table presents quantitative information about the significant unobservable inputs used to value the Level 3 FCR liability as of the dates presented.
| September 30, 2020 | December 31, 2019 | ||||||||||||||||||||||
| Range | Weighted Average | Range | Weighted Average | ||||||||||||||||||||
| Reversal rate | 63.0% – 95.5% | 87.3 | % | 60.0 – 96.8% | 87.5 | % | |||||||||||||||||
| Discount rate | 3.5 | % | 3.5 | % | 5.2 | % | 5.2 | % | |||||||||||||||
The reversal rate weighted averages were calculated by first determining the percentage of the reporting date FCR liability attributable to each category of deferred loan products for which a reversal rate assumption was determined. We then multiplied these weights by the unique reversal rate for each category and summed the resulting products.
A significant increase or decrease in the estimated reversal rates could result in a significantly higher or lower, respectively, calculation of our expected future payments to our Bank Partners, resulting in a higher or lower, respectively, fair value measurement of our FCR liability.
A significant increase or decrease in the discount rate could result in a lower or higher, respectively, fair value measurement of our FCR liability.
Charged-Off Receivables
Historically, we have periodically transferred our rights to previously charged-off loan receivables ("Charged-Off Receivables") in exchange for a cash payment based on the expected recovery rate of such loan receivables, which consist primarily of previously charged-off Bank Partner loans. We have no continuing involvement with these Charged-Off Receivables other than performing reasonable servicing and collection efforts. The proceeds from transfers of Charged-Off Receivables attributable to Bank Partner loans are recognized on a collected basis as reductions to cost of revenue, which reduces the fair value adjustment to the FCR liability in the period of transfer. The proceeds from transfers of Charged-Off Receivables attributable to loan receivables held for sale are recognized on a collected basis as reductions to sales, general and administrative expense, which reduces the valuation allowance for loan receivables held for sale. There were no transfers of Charged-Off Receivables during the nine months ended September 30, 2020. As such, we retain the rights to Charged-Off Receivables and recognize recoveries on a collected basis each period.
23
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The following table presents details of Charged-Off Receivables transfers during the three and nine months ended September 30, 2019.
| Aggregate Unpaid Balance | Proceeds | ||||||||||||||||||||||||||||||||||
| Bank Partner loans | Loan receivables held for sale | Total | Bank Partner loans | Loan receivables held for sale | Total | ||||||||||||||||||||||||||||||
| Three Months Ended September 30, 2019 | $ | 56,876 | $ | 237 | $ | 57,113 | $ | 7,921 | $ | 33 | $ | 7,954 | |||||||||||||||||||||||
| Nine Months Ended September 30, 2019 | 164,113 | 1,264 | 165,377 | 22,703 | 174 | 22,877 | |||||||||||||||||||||||||||||
During the three months ended September 30, 2020 and 2019, $6,327 thousand and $5,574 thousand, respectively, of the aggregate unpaid balance on cumulative transferred Charged-Off Receivables was recovered through our servicing efforts on behalf of our Charged-Off Receivables investors. During the nine months ended September 30, 2020 and 2019, such recoveries on behalf of our Charged-Off Receivables investors were $17,539 thousand and $16,229 thousand, respectively.
Term loan
The carrying value of our term loan is net of unamortized debt discount and debt issuance costs. The fair value of our term loan is classified within Level 1 of the fair value hierarchy, as the primary component of the price is obtained from quoted market prices in an active market.
Servicing assets and liabilities
We previously elected the fair value method to account for our servicing assets and liabilities to more appropriately reflect the value of the servicing rights in our Unaudited Condensed Consolidated Financial Statements. As a result of this election, our servicing assets and liabilities are carried at fair value on a recurring basis within other assets and other liabilities, respectively, in the Unaudited Condensed Consolidated Balance Sheets and are estimated using a discounted cash flow model. Servicing assets and liabilities are classified within Level 3 of the fair value hierarchy, as the primary components of the fair values are obtained from unobservable inputs based on peer market data, reasonably adjusted for assumptions that would be used by market participants to service our Bank Partner loans and transferred Charged-Off Receivables portfolios, for which market data is not available. Changes in the fair value of our servicing assets are recorded within servicing and other revenue and changes in the fair value of our servicing liabilities are recorded within other gains (losses), net in the Unaudited Condensed Consolidated Statements of Operations.
Contractually specified servicing fees recorded within servicing revenue in the Unaudited Condensed Consolidated Statements of Operations totaled $28,238 thousand and $24,261 thousand for the three months ended September 30, 2020 and 2019, respectively, and $87,261 thousand and $65,246 thousand for the nine months ended September 30, 2020 and 2019, respectively. The cash flow impacts of our assets and liabilities that are measured at fair value on a recurring basis are included within net cash provided by operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows. In the second half of 2019, we renegotiated certain Bank Partner agreements where the Company agreed to post additional escrow and increase the agreed-upon Bank Partner portfolio yield. In exchange for these considerations, we received an increase in our loan servicing fees from the Bank Partners. We determined that the increase in servicing fees resulted in an increase to the fair value of our servicing assets for these Bank Partners. We also anticipate that, all other factors remaining constant, these increased servicing fees will contribute to lower incentive payments received in future periods from the Bank Partners.
24
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The following table reconciles the beginning and ending fair value measurements of our servicing assets associated with Bank Partner loans during the period presented.
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Beginning balance | $ | 31,200 | $ | 8,966 | $ | 30,459 | $ | — | |||||||||||||||
Additions, net(1) | 407 | 2,169 | 2,391 | 2,169 | |||||||||||||||||||
Fair value changes recognized in servicing revenue(2) | (1,199) | 14,196 | (2,442) | 23,162 | |||||||||||||||||||
| Ending balance | $ | 30,408 | $ | 25,331 | $ | 30,408 | $ | 25,331 | |||||||||||||||
(1)For the three and nine months ended September 30, 2020, includes additions through assumptions of servicing obligations each time a loan is originated on our platform by a Bank Partner, as well as through transfers of loan receivables between Bank Partners or of loan receivables between GreenSky and Bank Partners and is net of the impact of loan principal pay downs in the Bank Partner portfolios. Additions are recognized in servicing revenue in the Unaudited Condensed Consolidated Statements of Operations.
(2)For the three and nine months ended September 30, 2020, primarily reflects the reduction of our servicing assets due to the passage of time and impact of purchases of participations in loans by the SPV. For the three and nine months ended September 30, 2019, primarily reflective of an increase to the contractually specified fixed servicing fee for one of our Bank Partners.
The following table reconciles the beginning and ending fair value measurements of our servicing liabilities associated with transferring our rights to Charged-Off Receivables during the periods presented.
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Beginning balance | $ | 2,799 | $ | 3,347 | $ | 3,796 | $ | 3,016 | |||||||||||||||
Initial obligation from transfer of Charged-Off Receivables(1) | — | 685 | — | 1,983 | |||||||||||||||||||
Fair value changes recognized in other gains (losses), net(2) | (424) | (494) | (1,421) | (1,461) | |||||||||||||||||||
| Ending balance | $ | 2,375 | $ | 3,538 | $ | 2,375 | $ | 3,538 | |||||||||||||||
(1)Recognized in other gains (losses), net in the Unaudited Condensed Consolidated Statements of Operations.
(2)Represents the reduction of our servicing liabilities due to the passage of time and collection of loan payments.
Significant assumptions used in valuing our servicing assets and liabilities include the following:
Cost of servicing: The cost of servicing represents the servicing rate a willing market participant would require to service loans with similar characteristics as the Bank Partner loans or Charged-Off Receivables. The cost of servicing is weighted based on the outstanding balance of the loans.
Discount rate: The discount rate reflects the time value of money adjusted for a risk premium and is within an observable range based on peer market data.
Weighted average remaining life: For Bank Partner loans, the weighted average remaining life is determined using the aggregate curves for each loan product type based on expected cumulative annualized rates of prepayments and defaults.
Recovery period: For Charged-Off Receivables, our recovery period is determined based on a reasonable recovery period for loans of these sizes and characteristics based on historical experience. We assume that collection efforts for these loans will cease after five years, and the run-off of the portfolio will follow a straight-line methodology, adjusted for actual cash recoveries over time.
25
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The following table presents quantitative information about the significant unobservable inputs used to value the Level 3 servicing assets and liabilities as of the dates presented.
| Input | September 30, 2020 | December 31, 2019 | ||||||||||||||||||||||||
| Range | Weighted Average | Range | Weighted Average | |||||||||||||||||||||||
| Cost of servicing (basis points) | 57.5 – 108.0 | 106.5 | 57.5 – 108.0 | 106.2 | ||||||||||||||||||||||
| Discount rate | 18.0 | % | 18.0% | 18.0 | % | 18.0% | ||||||||||||||||||||
| Weighted average remaining life (years) | 2.4 – 5.9 | 2.4 | 2.3 – 5.9 | 2.4 | ||||||||||||||||||||||
| Recovery period (years) | 1.8 - 4.2 | 3.3 | 2.6 – 4.9 | 4.1 | ||||||||||||||||||||||
A significant increase or decrease in the market cost of servicing could have resulted in significantly lower or higher, respectively, servicing assets and higher or lower, respectively, servicing liabilities as of the measurement date.
A significant increase or decrease in the discount rate could have resulted in lower or higher, respectively, servicing assets and liabilities as of the measurement date. However, as the weighted average remaining life of loans is relatively short, we would not expect significant changes in the discount rate to materially impact the fair value measure.
The average remaining life is weighted by the unpaid balance of the Bank Partner loans as of the measurement date. The weighted average remaining life represents the period over which we expect to collect servicing fees on the Bank Partner loans and primarily changes based on expectations of loan prepayments and defaults. The change in expected prepayments and defaults has an inverse correlation with the weighted average remaining life. A significant increase or decrease in the expected weighted average remaining life could have resulted in significantly higher or lower servicing assets as of the measurement date.
The recovery period is weighted by the unpaid balance of previously transferred Charged-Off Receivables as of the measurement date. The recovery period reflects the length of time over which we expect to perform servicing activities and has an inverse correlation with the amount by which the servicing liability is reduced each reporting period. As such, a significant increase or decrease in the expected recovery period could have resulted in higher or lower, respectively, servicing liabilities.
Sales facilitation obligations
In May 2020, as part of implementing GreenSky's program to accomplish alternative funding structures, the Company entered into a series of agreements (collectively, the “Facility Bank Partner Agreements”) with an existing Bank Partner, to provide a framework for the programmatic sale of loan participations and whole loans by that Bank Partner to third parties. Under the Facility Bank Partner Agreements, it is contemplated that potential purchasers will issue purchase commitments to the Bank Partner. The Company has certain sales facilitation obligations related thereto that qualify as embedded derivatives and are not designated as hedges for accounting purposes. As such, these sales facilitation obligations are recorded at fair value and changes in their respective fair value are recorded within cost of revenue in the Unaudited Condensed Consolidated Statements of Operations.
26
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
First, the Company has agreed under the Facility Bank Partner Agreements to facilitate sales by the Bank Partner of loan participations and whole loans to third parties (including sales to the Company or its affiliates, including the SPV) by funding into an escrow account, established by the Company for the Bank Partner, the shortfall (if any) in purchase price commitment below par (“purchase price discount”) at the time a purchase commitment is made. The Bank Partner has agreed that it will fund into the escrow account any purchase price in excess of par (“purchase price premium”) associated with a sale. Any purchase price discount will net settle with any contemporaneous purchase price premiums upon sale of the loan participations or whole loans, with a net discount being settled by a release of escrow funds to the Bank Partner at sale and a net premium being settled by a release of excess escrow funds (above minimum escrow requirements), if any, to the Company shortly following the sale. Because the purchase commitments that have been issued to date and the loan participation sales that have occurred to date have been conducted at par between the Bank Partner and the Company, there have been no purchase price discounts or purchase price premiums under the Facility Bank Partner Agreements and, therefore, no related escrow or liability as of September 30, 2020.
Second, the Company may, from time to time, directly issue to the Bank Partner commitments to purchase loan participations at par under the Facility Bank Partner Agreements. The fair value of the resulting sales facilitation obligations are based on the difference between par and the anticipated sale prices of such participations to third parties, including institutional investors, financial institutions and other capital markets investors. As such, the fair value is classified within Level 2 of the fair value hierarchy, as the primary component of the price is obtained from observable values of loan receivables with similar terms and characteristics.
At September 30, 2020, the Company had sales facilitation obligations for which the fair value of the liability was $18.262 million. As the third quarter of 2020 was the first period for which such liability existed, the change in fair value for the three and nine months ended September 30, 2020 was $18.262 million and is reflected in cost of revenue in the Unaudited Condensed Consolidated Statements of Operations.
27
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Note 4. Loan Receivables Held for Sale
The following table summarizes the activity in the balance of loan receivables held for sale, net at lower of cost or fair value during the periods indicated.
| Nine Months Ended September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| Beginning balance | $ | 51,926 | $ | 2,876 | |||||||
Additions(1) | 906,850 | 96,704 | |||||||||
Proceeds from sales and borrower payments(2) | (370,142) | (67,355) | |||||||||
| Loss on sale | (19,685) | — | |||||||||
Decrease (increase) in valuation allowance(3) | (19,441) | (637) | |||||||||
Transfers(4) | (161) | 243 | |||||||||
Write-offs and other(5) | (6,031) | (1,462) | |||||||||
| Ending balance | $ | 543,316 | $ | 30,369 | |||||||
(1)Includes purchase of $754.8 million participations in loans by the SPV.
(2)Includes accrued interest and fees, recoveries of previously charged-off loan receivables held for sale, as well as proceeds from transferring our rights to Charged-Off Receivables attributable to loan receivables held for sale. We retain servicing arrangements on sold loan receivables with the same terms and conditions as loans that are originated by our Bank Partners. Income from loan receivables held for sale activities is recorded within interest and other revenue in the Unaudited Condensed Consolidated Statements of Operations.
(3)Valuation allowance includes an increase in lower of cost or market fair value adjustments on our SPV Participations of $17,332 thousand and $0 during the nine months ended September 30, 2020 and 2019, respectively, and an increase in provision for credit losses of $2,109 thousand during the nine months ended September 30, 2020 and an increase in provision for credit losses of $637 thousand during the nine months ended September 30, 2019.
(4)We temporarily hold certain loan receivables, which are originated by a Bank Partner, while non-originating Bank Partner eligibility is being determined. Once we determine that a loan receivable meets the investment requirements of an eligible Bank Partner, we transfer the loan receivable to the Bank Partner at cost plus any accrued interest. The reported amount also includes loan receivables that have been placed on non-accrual and non-payment status while we investigate consumer inquiries.
(5)We received recovery payments of $265 thousand and $33 thousand during the nine months ended September 30, 2020 and 2019, respectively. Recoveries of principal and finance charges and fees on previously written off loan receivables held for sale are recognized on a collected basis. Separately, during the nine months ended September 30, 2020 and 2019, write-offs and other were reduced by $0 and $174 thousand, respectively, related to cash proceeds received from transferring our rights to Charged-Off Receivables attributable to loan receivables held for sale. The cash proceeds received were recorded within sales, general and administrative expense in the Unaudited Condensed Consolidated Statements of Operations.
The following table presents activities associated with our loan receivable sales and servicing activities during the periods indicated.
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Gain (loss) on sold loan receivables held for sale | $ | (19,685) | $ | — | $ | (19,685) | $ | — | |||||||||||||||
| Cash Flows | |||||||||||||||||||||||
| Sales of loans | $ | 300,641 | $ | — | $ | 340,657 | $ | 63,673 | |||||||||||||||
| Servicing fees | (1,282) | 924 | 3,529 | 2,660 | |||||||||||||||||||
28
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The following tables present information about sold loan receivables held for sale that are not recorded in our Unaudited Condensed Consolidated Balance Sheets, but with which we have a continuing involvement through our servicing arrangements with our Bank Partners. The sold loan receivables held for sale are pooled with other loans originated by the Bank Partners for purposes of determining escrow balances and incentive payments. The escrow balances represent our only direct exposure to potential losses associated with these sold loan receivables.
| September 30, 2020 | December 31, 2019 | ||||||||||
| Total principal balance | $ | 449,159 | $ | 326,556 | |||||||
| Delinquent loans (unpaid principal balance) | 12,945 | 18,033 | |||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Net charge-offs (unpaid principal balance) | $ | 1,597 | $ | 4,457 | $ | 7,847 | $ | 12,664 | |||||||||||||||
Note 5. Accounts Receivable
As of September 30, 2020, our allowance for losses on accounts receivable was measured under ASC 326. Historically, the majority of our pools of accounts receivable did not have write-offs. For the pool of accounts receivable for which we had historical write-offs, we used an aging method and the average 12-month historical loss rate as a basis for estimating credit losses on the current accounts receivable balance. In the absence of relevant historical loss experience for the other pools of accounts receivables, we also used this average 12-month loss rate to inform our estimate of credit losses on those balances. For each pool of accounts receivable, we considered the conditions at the measurement date and reasonable and supportable forecasts about future conditions to consider if adjustments to the historical loss rate were warranted. Given our methods of collecting funds on merchant and servicing receivables, that we have not observed meaningful changes in our counterparties' abilities to pay, and that we establish an allowance for all delinquent accounts receivable (typically deemed to be 31 days or more past due), providing for a maximum 30-day term of our accounts receivable balances, we determined that our historical loss rates remain most indicative of our lifetime expected losses.
Accounts receivable consisted of the following as of the dates indicated.
| Accounts Receivable, Gross | Allowance for Uncollectible Amounts | Accounts Receivable, Net | |||||||||||||||
| September 30, 2020 | |||||||||||||||||
| Transaction related | $ | 11,094 | $ | (217) | $ | 10,877 | |||||||||||
| Servicing related | 10,059 | — | 10,059 | ||||||||||||||
| Total | $ | 21,153 | $ | (217) | $ | 20,936 | |||||||||||
| December 31, 2019 | |||||||||||||||||
| Transaction related | $ | 12,863 | $ | (238) | $ | 12,625 | |||||||||||
| Servicing related | 6,868 | — | 6,868 | ||||||||||||||
| Total | $ | 19,731 | $ | (238) | $ | 19,493 | |||||||||||
29
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The following table summarizes the activity in the balance of allowance for uncollectible amounts during the periods indicated.
| Three Months Ended September 30, 2020 | Nine Months Ended September 30, 2020 | |||||||||||||
| Beginning balance | $ | (218) | $ | (238) | ||||||||||
| Provision for expected losses | (133) | (511) | ||||||||||||
| Write-offs | 230 | 628 | ||||||||||||
| Recoveries | (96) | (96) | ||||||||||||
| Ending balance | $ | (217) | $ | (217) | ||||||||||
Note 6. Property, Equipment and Software
Property, equipment and software were as follows as of the dates indicated.
| September 30, 2020 | December 31, 2019 | ||||||||||
| Furniture | $ | 2,692 | $ | 2,907 | |||||||
| Leasehold improvements | 4,649 | 4,902 | |||||||||
| Computer hardware | 2,638 | 2,494 | |||||||||
| Software | 29,330 | 20,126 | |||||||||
| Total property, equipment and software, at cost | 39,309 | 30,429 | |||||||||
| Less: accumulated depreciation | (6,221) | (5,701) | |||||||||
| Less: accumulated amortization | (10,450) | (6,419) | |||||||||
| Total property, equipment and software, net | $ | 22,638 | $ | 18,309 | |||||||
Note 7. Borrowings
Credit Agreement
In August 2017, we entered into a $450.0 million credit agreement ("Credit Agreement"), which provided for a $350.0 million term loan ("original term loan") maturing on August 25, 2024 and a $100.0 million revolving loan facility maturing on August 25, 2022. The net proceeds from the term loan of $338.6 million, along with $7.9 million of cash, were set aside for a subsequent $346.5 million payment (which is occurring in stages) to certain equity holders and a related party. With the exception of the payments to the related party, which were related party expenses, the payments were accounted for as distributions.
The distribution to GS Holdings unit holders and GS Holdings holders of profits interests was made on a basis generally proportionate to their equity interests in GS Holdings. GS Holdings' members approved the Credit Agreement and the distribution of the proceeds of the original term loan to the GS Holdings unit holders, holders of profits interests and a related party. The purpose of the distribution was to provide a cash return on investment to the GS Holdings members and former profits interests holders. See Note 11 for distribution and payment details.
30
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
2018 Amended Credit Agreement
In March 2018, we amended certain terms of our Credit Agreement ("2018 Amended Credit Agreement"). The 2018 Amended Credit Agreement replaced the original term loan with a $400.0 million term loan (“modified term loan”) and extended the maturity date to March 29, 2025. The modified term loan incurs interest, due monthly in arrears, at an adjusted LIBOR rate, which represents the one-month LIBOR rate multiplied by the statutory reserve rate, as defined in the Credit Agreement, plus a margin of 3.25% per annum. If not otherwise indicated, references to "term loan" prior to the date of the 2018 Amended Credit Agreement indicate the original term loan and references subsequent to the date of the 2018 Amended Credit Agreement but prior to the Second Amendment to our Credit Agreement ("2020 Amended Credit Agreement") indicate the modified term loan.
We contemporaneously settled the outstanding principal balance on the original term loan of $349.1 million with the issuance of the $400.0 million modified term loan. An original issuance discount of $1.0 million was reported as a direct deduction from the face amount of the modified term loan. Therefore, the gross proceeds of the modified term loan were $399.0 million. The proceeds from the modified term loan were primarily used to repay the outstanding principal balance on the original term loan and to pay $1.2 million of third party costs, including legal and debt arrangement costs, which were immediately expensed on the modification date. The remaining $48.8 million of proceeds were used to provide for distributions to certain equity holders and a related party prior to the Company's IPO. With the exception of the payments to the related party, which were related party expenses, the payments were accounted for as distributions. See Note 11 for distribution and payment details. As of September 30, 2020 and December 31, 2019, we had no borrowings under the revolving loan facility.
2020 Amended Credit Agreement
In June 2020, we entered into the 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," and the 2018 Amended Credit Agreement and the 2020 Amended Credit Agreement are collectively referred to as the "Amended Credit Agreement." 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 rate, which represents the one-month LIBOR rate 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 on March 29, 2025.
An original issuance discount of $3.0 million was reported as a direct deduction from the face amount of the incremental term loan. Fees paid to the lender of $1.6 million were deferred over the remaining life of the term loan on the modification date. Therefore, the initial gross proceeds of the incremental term loan were $70.4 million. The proceeds from the incremental term loan were used to pay third party costs, including legal fees, which were immediately expensed on the modification date. The remaining proceeds were used for general corporate purposes and to enhance the Company's overall liquidity position.
31
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Key details of the term loan are as follows:
| September 30, 2020 | December 31, 2019 | |||||||||||||
Term loan, face value(1) | $ | 464,813 | $ | 393,000 | ||||||||||
Unamortized debt discount(2) | (5,463) | (3,115) | ||||||||||||
Unamortized debt issuance costs(2) | (6,008) | (5,388) | ||||||||||||
| Term loan | $ | 453,342 | $ | 384,497 | ||||||||||
(1)The principal balance of the term loan is scheduled to be repaid on a quarterly basis at an amortization rate of 0.25% per quarter through December 31, 2024, with the balance due at maturity.
(2)For the three months ended September 30, 2020 and 2019, debt discount of $311 thousand and $153 thousand, respectively, and debt issuance costs of $342 thousand and $265 thousand, respectively, were amortized into interest expense in the Unaudited Condensed Consolidated Statements of Operations. For the nine months ended September 30, 2020 and 2019, debt discount of $651 thousand and $461 thousand, respectively, and debt issuance costs of $887 thousand and $797 thousand, respectively, were amortized into interest expense in the Unaudited Condensed Consolidated Statements of Operations.
Revolving loan facility. Under the 2018 Amended Credit Agreement, the maturity date of the $100.0 million revolving loan facility was extended to March 29, 2023. Further, the interest margin applied to revolving loans that incur interest at a base rate was modified to 2.00% per annum and the margin applied to revolving loans that incur interest at an adjusted LIBOR rate was modified to 3.00% per annum. However, if our first lien net leverage ratio is equal to or above 1.50 to 1.00, these interest margins are raised to 2.25% and 3.25%, respectively. Lastly, the 2018 Amended Credit Agreement provided for a $10.0 million letter of credit, which, to the extent drawn upon, would reduce the amount of availability under the revolving loan facility by the same amount. We had drawn $1.0 million on our available letter of credit as of September 30, 2020.
We are subject to a quarterly commitment fee based on the daily unused amount of the revolving loan facility, inclusive of the aggregate amount available to be drawn under letters of credit. The quarterly commitment fee rate is 0.50% per annum when our first lien net leverage ratio is above 1.50 to 1.00, but is reduced to 0.375% for any quarterly period in which our first lien net leverage ratio is equal to or below 1.50 to 1.00. For the three months ended September 30, 2020 and 2019, we recognized $2 thousand and $96 thousand, respectively, of commitment fees within interest expense in the Unaudited Condensed Consolidated Statements of Operations. Commitment fees were $128 thousand and $285 thousand for the nine months ended September 30, 2020 and 2019, respectively.
Covenants. The Amended Credit Agreement contains certain financial and non-financial covenants with which we must comply. The financial covenant requires a first lien net leverage ratio equal to or below 3.50 to 1.00 for any measurement date at which the principal amounts of outstanding revolving loans and letters of credit exceed 25% of the aggregate principal amount of the revolving loan facility. The first lien net leverage ratio is calculated as the ratio of (i) the aggregate principal amount of indebtedness, minus the aggregate amount of consolidated cash (exclusive of restricted cash) as of the measurement date to (ii) consolidated EBITDA, as defined in the Amended Credit Agreement, for the four prior quarters.
The non-financial covenants include, among other things, restrictions on indebtedness, liens and fundamental changes to the business (such as acquisitions, mergers, liquidations or changes in the nature of the business, asset dispositions, restricted payments, transactions with affiliates and other customary matters).
The Amended Credit Agreement also includes various negative covenants, including one that restricts GS Holdings from making non-tax distributions unless certain financial tests are met. In general, GS Holdings is restricted from making distributions unless (a) after giving effect to the distribution it would have, as of a measurement date, a total net leverage ratio of no more than 3.00 to 1.00, and (b) the source of such distributions is retained excess cash flow, certain equity issuance proceeds and certain other sources.
We were in compliance with all covenants, both financial and non-financial, as of September 30, 2020 and December 31, 2019.
32
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The Amended Credit Agreement defines events of default, the breach of which could require early payment of all borrowings under, and termination of, the Amended Credit Agreement or similar actions. Any borrowings under the Amended Credit Agreement are unconditionally guaranteed by our subsidiaries. Further, the lenders have a security interest in substantially all of the assets of GS Holdings and the other guarantors thereunder.
Interest Rate Swap
In June 2019, we entered into an interest rate swap agreement to hedge changes in cash flows attributable to interest rate risk on $350.0 million of our variable-rate term loan. This interest rate swap was designated for accounting purposes as a cash flow hedge. See Note 8 for additional derivative disclosures.
Asset-backed Revolving Credit Facility
In May 2020, the SPV entered into a warehouse credit agreement with JPMorgan Chase Bank, N.A. ("JPMorgan") to establish an asset-backed revolving credit facility to finance purchases by the SPV of participation interests in loans originated through the GreenSky program (the "SPV Facility"). The SPV Facility provides a revolving committed financing of $300.0 million, with an additional $200.0 million uncommitted accordion that was accessed in July 2020. 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 revolving funding period is one year and the maturity date is May 10, 2022. Upon obtaining the financing commitment, the SPV was required to pay to JPMorgan an upfront, nonrefundable fee ("upfront fees") equal to 0.15% of loan commitments. The SPV paid upfront fees of $0.5 million in conjunction with the closing of the SPV Facility in May. As of September 30, 2020, the outstanding balance on the SPV Facility was $432.8 million.
Following the third month anniversary of the closing date, the Company is subject to a daily unused fee based on a percentage of the total $300.0 million of financing that remains unused. The unused fee rate is 0.50% per annum when the aggregate loan principal balance is greater than or equal to 50% of the commitments, and 1.00% if the aggregate loan principal balance is less than 50% of the commitments. The SPV paid various other legal and banking fees associated with obtaining the financing, including upfront fees, of approximately $1.0 million which were deferred over the life of the SPV Facility. During the three and nine months ended September 30, 2020, we amortized $125.6 thousand and $209.4 thousand, respectively, of these fees into cost of revenue in the Unaudited Condensed Consolidated Statements of Operations.
The Company's ability to utilize the SPV Facility is subject to the SPV's compliance with various covenants and other requirements of the warehouse credit agreement, including that the SPV enter into a hedging interest rate swap with a third-party in cases where LIBOR on the SPV Facility exceeds 3% over a defined measurement period. The failure to comply with such requirements may result in events of default, the accelerated repayment of amounts owed under the SPV Facility (often referred to as an early amortization event), a decrease in the borrowing base advance rate, an increase in the interest payable on the loans and/or the termination of the SPV Facility.
Note 8. Derivative Instruments
The Company does not hold or use derivative instruments for trading purposes.
Derivative Instruments Designated as Hedges
Interest rate fluctuations expose our variable-rate term loan to changes in interest expense and cash flows. As part of our risk management strategy, we may use interest rate derivatives, such as interest rate swaps, to manage our exposure to interest rate movements.
In June 2019, we entered into a $350.0 million notional, four-year interest rate swap agreement to hedge changes in cash flows attributable to interest rate risk on $350.0 million of our variable-rate term loan, which matures on March 29, 2025. This agreement involves the receipt of variable-rate amounts in exchange for fixed interest rate payments over the life of the agreement without an exchange of the underlying notional amount. This
33
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
interest rate swap was designated for accounting purposes as a cash flow hedge. As such, changes in the interest rate swap’s fair value are deferred in accumulated other comprehensive income (loss) in the Unaudited Condensed Consolidated Balance Sheets and are subsequently reclassified into interest expense in each period that a hedged interest payment is made on our variable-rate term loan.
As of September 30, 2020, we had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk.
| Notional Amount | Fixed Interest Rate | Termination Date | ||||||||||||||||||
Interest rate swap | $ | 350,000 | 1.80% | June 30, 2023 | ||||||||||||||||
Derivative Instruments Not Designated as Hedges
The FCR component of our Bank Partner contracts qualifies as an embedded derivative. The FCR liability is not designated as a hedge for accounting purposes and, as such, changes in its fair value are recorded within cost of revenue in the Unaudited Condensed Consolidated Statements of Operations. See Note 3 for additional information on finance charge reversals.
As part of the Facility Bank Partner Agreements, the Company has certain sales facilitation obligations that qualify as embedded derivatives and are not designated as hedges for accounting purposes. As such, changes in their fair value are recorded within cost of revenue in the Unaudited Condensed Consolidated Statements of Operations. See Note 3 for additional information on sales facilitation obligations.
Derivative Instruments on our Unaudited Condensed Consolidated Financial Statements
The following table presents the fair values and Unaudited Condensed Consolidated Balance Sheets locations of our derivative instruments as of the dates indicated.
| Balance Sheet Location | September 30, 2020 | December 31, 2019 | ||||||||||||||||||
| Designated as cash flow hedges | ||||||||||||||||||||
| Interest rate swap | Other liabilities | $ | 15,609 | $ | 2,763 | |||||||||||||||
| Not designated as hedges | ||||||||||||||||||||
| FCR liability | Finance charge reversal liability | $ | 187,512 | $ | 206,035 | |||||||||||||||
Sales facilitation obligations | Other liabilities | 18,262 | — | |||||||||||||||||
The following table presents the impacts of our derivative instruments on our Unaudited Condensed Consolidated Statements of Operations for the periods indicated.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||||||
| Designated as cash flow hedges | ||||||||||||||||||||||||||
| Interest rate swap – gain (loss) reclassified into interest expense | $ | (1,459) | $ | 410 | $ | (2,706) | $ | 410 | ||||||||||||||||||
| Interest rate swap – gain (loss) reclassified into income tax expense | 141 | (35) | 253 | (35) | ||||||||||||||||||||||
| Not designated as hedges | ||||||||||||||||||||||||||
| FCR liability – change in fair value recorded in cost of revenue | $ | 21,832 | $ | 43,616 | $ | 110,386 | $ | 121,163 | ||||||||||||||||||
Sales facilitation obligations - change in fair value recorded in cost of revenue | 18,262 | — | 18,262 | — | ||||||||||||||||||||||
Our derivative instrument activities are included within operating cash flows in our Unaudited Condensed Consolidated Statements of Cash Flows.
34
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Accumulated Other Comprehensive Income (Loss)
The following table summarizes the changes in the components of accumulated other comprehensive income (loss) associated with our cash flow hedge, which exclude amounts pertaining to noncontrolling interests, for the period presented. There was no accumulated other comprehensive income (loss) activity during the three and nine months ended September 30, 2019.
| Cash Flow Hedge | Three Months Ended September 30, 2020 | Nine Months Ended September 30, 2020 | |||||||||
| Accumulated other comprehensive income (loss), beginning balance | $ | (4,756) | $ | (756) | |||||||
| Other comprehensive income (loss) before reclassifications and tax | (511) | (6,251) | |||||||||
| Tax (expense) benefit | 125 | 1,515 | |||||||||
| Other comprehensive income (loss) before reclassifications, net of tax | (386) | (4,736) | |||||||||
Reclassifications out of accumulated other comprehensive income (loss), net of tax(1) | 437 | 787 | |||||||||
| Net (increase) decrease in other comprehensive loss | 51 | (3,949) | |||||||||
| Accumulated other comprehensive income (loss), ending balance | $ | (4,705) | $ | (4,705) | |||||||
(1)Net of tax benefit of $141 thousand and $253 thousand during the three and nine months ended September 30, 2020, respectively.
Based on the current interest rate environment, the Company estimates that approximately $5.8 million of net unrealized gains (losses) reported in accumulated other comprehensive income (loss) will be reclassified into earnings within the next twelve months.
Note 9. Other Liabilities
The following table details the components of other liabilities in the Unaudited Condensed Consolidated Balance Sheets as of the dates indicated.
| September 30, 2020 | December 31, 2019 | ||||||||||
| Transaction processing liabilities | $ | 28,305 | $ | 24,465 | |||||||
Servicing liabilities(1) | 2,375 | 3,796 | |||||||||
| Distributions payable | 3,470 | 5,978 | |||||||||
Interest rate swap(2) | 15,609 | 2,763 | |||||||||
Tax related liabilities(3) | 859 | 873 | |||||||||
| 11,151 | 13,884 | ||||||||||
| Accruals and other liabilities | 12,688 | 9,442 | |||||||||
| Sales facilitation obligations | 18,262 | — | |||||||||
| Other liabilities | $ | 92,719 | $ | 61,201 | |||||||
(1)We elected the fair value method to account for our servicing liabilities. Refer to Note 3 for additional information.
(2)Refer to Note 3 and Note 8 for additional information on our interest rate swap, which was in a liability position as of September 30, 2020 and December 31, 2019.
(3)Tax related liabilities primarily include certain taxes payable related to the Reorganization Transactions.
Note 10. Noncontrolling Interests
GreenSky, Inc. is the sole managing member of GS Holdings and consolidates the financial results of GS Holdings. Therefore, the Company reports a noncontrolling interest based on the Holdco Units held by the Continuing LLC Members. Changes in GreenSky, Inc.’s ownership interest in GS Holdings, while GreenSky, Inc. retains its controlling interest in GS Holdings, are accounted for as equity transactions. As such, future redemptions or direct exchanges of Holdco Units by the Continuing LLC Members (with automatic cancellation of an equal
35
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
number of shares of Class B common stock) for shares of our Class A common stock on a one-for-one basis will result in a change in ownership and reduce or increase the amount recorded as noncontrolling interest and increase or decrease additional paid-in capital. The Company consolidates the financial results of GS Holdings and reports a noncontrolling interest in its Unaudited Condensed Consolidated Financial Statements representing the GS Holdings interests held by Continuing LLC Members. The weighted average ownership percentages for the applicable reporting periods are used to attribute net income (loss) and other comprehensive income (loss) to the Company and the noncontrolling interests. During the three months ended September 30, 2020 and 2019, GreenSky, Inc. had a weighted average ownership interest in GS Holdings of 39.6% and 35.4%, respectively. During the nine months ended September 30, 2020 and 2019, GreenSky, Inc. had a weighted average ownership interest in GS Holdings of 37.6% and 34.1%, respectively.
As of September 30, 2020 and December 31, 2019, GreenSky, Inc. had 75,307,501 and 66,424,838 shares, respectively, of Class A common stock outstanding, which resulted in an equivalent amount of ownership of Holdco Units. During the nine months ended September 30, 2020, an aggregate of 6.3 million Holdco Units were exchanged by the Continuing LLC Members (with automatic cancellation of Class B common stock) for 6.3 million newly-issued shares of Class A common stock, and 3.1 million shares of Class A restricted stock were issued, which increased our total ownership interest in GS Holdings to 41.3% as of September 30, 2020 from 36.9% as of December 31, 2019.
Note 11. Stockholders Equity (Deficit)
Treasury Stock
As of September 30, 2020, there were 14,237,941 shares of Class A common stock held in treasury, including: (i) purchases of 13,425,688 shares at a cost of $146.1 million, (ii) 582,825 shares associated with forfeited restricted stock awards, and (iii) 229,428 shares associated with tax withholdings upon vesting of restricted stock awards. There were no reissuances of treasury shares during the nine months ended September 30, 2020.
Warrants
In January 2019, a warrant issued in January 2014 to an affiliate of one of the members of the former GSLLC board of managers was fully exercised on a cashless basis, which resulted in the issuance of 1,180,163 Holdco Units and an equal number of shares of Class B common stock.
36
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Distributions
The following table summarizes activity associated with our non-tax and tax distributions during the periods indicated.
| Three Months Ended September 30, | Nine Months Ended September 30, | Remaining Reserved Payment(1) | ||||||||||||||||||||||||||||||
| (in millions) | 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||||||||||
| Non-tax distributions previously declared and paid upon vesting | ||||||||||||||||||||||||||||||||
Credit Agreement Distributions(2) | ||||||||||||||||||||||||||||||||
| Distributions | $ | 0.4 | $ | 0.5 | $ | 1.6 | $ | 2.5 | $ | 2.3 | ||||||||||||||||||||||
| Related party payments | — | — | — | 0.6 | — | |||||||||||||||||||||||||||
Special Operating Distributions(3) | ||||||||||||||||||||||||||||||||
| Distributions | 0.2 | 0.3 | 0.9 | 1.3 | 1.2 | |||||||||||||||||||||||||||
| Related party payments | — | — | — | 0.2 | — | |||||||||||||||||||||||||||
| Tax distributions | 17.0 | 4.6 | 48.5 | 18.6 | — | |||||||||||||||||||||||||||
| Total | $ | 17.6 | $ | 5.4 | $ | 51.0 | $ | 23.2 | $ | 3.5 | ||||||||||||||||||||||
(1)As of September 30, 2020, all remaining portions of the non-tax distributions were recorded within other liabilities in the Unaudited Condensed Consolidated Balance Sheets.
(2)See Note 7 for discussion of distributions using the proceeds from our borrowings, a portion of which were declared to related parties, for which no payments were made during the three and nine months ended September 30, 2020 and for which all payments were satisfied as of September 30, 2019.
(3)In May 2018, we declared a special operating distribution of $26.2 million, a portion of which was declared to a related party, for which no payments were made during the three and nine months ended September 30, 2020 and for which all payments were satisfied as of September 30, 2019. In December 2017, we declared a $160.0 million special cash distribution to Holdco Unit holders and holders of profits interests.
Note 12. Share-Based Compensation
The Company has the following types of share-based compensation awards outstanding as of September 30, 2020: Class A common stock options, unvested Holdco Units and unvested Class A common stock awards. We recorded share-based compensation expense of $4,334 thousand and $3,777 thousand for the three months ended September 30, 2020 and 2019, respectively, and $11,306 thousand and $9,713 thousand for the nine months ended September 30, 2020 and 2019, respectively, which is included within compensation and benefits expense in the Unaudited Condensed Consolidated Statements of Operations.
37
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Class A Common Stock Options
Class A common stock option ("Options") activity was as follows during the periods indicated:
| Nine Months Ended September 30, 2020 | Nine Months Ended September 30, 2019 | ||||||||||||||||
| Number of Options | Weighted Average Exercise Price | Number of Options | |||||||||||||||
| Outstanding at beginning of period | 4,181,909 | $ | 11.36 | 8,053,292 | |||||||||||||
Granted(1) | 1,134,644 | 3.74 | 1,610,407 | ||||||||||||||
Exercised(2)(3) | (105,000) | 5.65 | (5,188,465) | ||||||||||||||
| Forfeited | (406,615) | 19.16 | (232,819) | ||||||||||||||
Expired(4) | (117,704) | 18.13 | (12,500) | ||||||||||||||
Outstanding at end of period(5) | 4,687,234 | $ | 8.80 | 4,229,915 | |||||||||||||
Exercisable at end of period(5)(6) | 1,848,493 | $ | 8.28 | 1,052,998 | |||||||||||||
(1)Weighted average grant date fair value of Options granted during the nine months ended September 30, 2020 and 2019 was $1.73 and $3.39, respectively.
(2)The total intrinsic value of Options exercised, which is defined as the amount by which the market value of the stock on the date of exercise exceeds the exercise price, during the nine months ended September 30, 2020 and 2019 was $0.2 million and $27.7 million, respectively.
(3)During the nine months ended September 30, 2020, Options exercisable for 105,000 shares of Class A common stock were exercised by means of a cashless net exercise procedure, which resulted in the issuance of 15,051 shares of Class A common stock and for which the Company paid withholding taxes of $0.1 million.
Employees paid $0.3 million to the Company during the nine months ended September 30, 2019 to exercise Options, which resulted in the issuance of 37,497 shares of Class A common stock. In addition, during this period, Options exercisable for 5,150,964 shares of Class A common stock were exercised by means of a cashless net exercise procedure, which resulted in the issuance of 2,235,572 shares of Class A common stock and for which the Company paid withholding taxes of $12.4 million.
(4)Expired Options represent vested, underwater Options that were not exercised by terminated employees within 30 days from the employment termination date, as stipulated in the Option award agreements.
(5)The aggregate intrinsic value and weighted average remaining contractual terms of Options outstanding and Options exercisable were as follows as of the date indicated:
| September 30, 2020 | |||||
| Aggregate intrinsic value (in millions) | |||||
| Options outstanding | $2.3 | ||||
| Options exercisable | $1.5 | ||||
| Weighted average remaining term (in years) | |||||
| Options outstanding | 7.5 | ||||
| Options exercisable | 5.7 | ||||
(6)The total fair value, based on grant date fair value, of Options that vested during the nine months ended September 30, 2020 and 2019 was $3.2 million and $2.1 million, respectively.
38
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Unvested Holdco Units
As part of the Reorganization Transactions and IPO, certain profits interests in GS Holdings were converted to vested and unvested Holdco Units based on the prevailing profits interests thresholds and the IPO price. The converted Holdco Units remain subject to the same service vesting requirements as the original profits interests and are not subject to post-vesting restrictions. Unvested Holdco Units activity was as follows during the periods indicated:
| Nine Months Ended September 30, 2020 | Nine Months Ended September 30, 2019 | ||||||||||||||||
| Number of Holdco Units | Weighted Average Grant Date Fair Value | Number of Holdco Units | |||||||||||||||
| Unvested at beginning of period | 1,112,607 | $ | 23.00 | 2,514,856 | |||||||||||||
| Forfeited | — | N/A | (294,734) | ||||||||||||||
Vested(1) | (336,127) | 23.00 | (750,826) | ||||||||||||||
| Unvested at end of period | 776,480 | $ | 23.00 | 1,469,296 | |||||||||||||
(1)The total fair value, based on grant date fair value, of previously unvested Holdco Units that vested during the nine months ended September 30, 2020 and 2019 was $7.7 million and $17.3 million, respectively.
Restricted Stock Awards
As part of the Reorganization Transactions and IPO, certain outstanding profits interests in GS Holdings were converted into vested and unvested Class A common stock awards based on the prevailing profits interests thresholds and the IPO price. The converted unvested Class A common stock awards remain subject to the same service vesting requirements as the original profits interests and are not subject to post-vesting restrictions.
Subsequent to the Reorganization Transactions and IPO, we granted restricted stock awards in the form of unvested Class A common stock to certain employees that vest ratably over a or four-year period based on continued employment at the Company and to certain non-employee directors that vest one year from grant date based on continued service on the Board of Directors ("Board"). For these awards, compensation expense is measured based on the closing stock price of the Company's Class A common stock on the date of grant, and the total value of the awards is expensed ratably over the requisite service period.
Unvested Class A common stock activity was as follows during the periods indicated:
| Nine Months Ended September 30, 2020 | Nine Months Ended September 30, 2019 | ||||||||||||||||
| Class A Common Stock | Weighted Average Grant Date Fair Value | Class A Common Stock | |||||||||||||||
| Unvested at beginning of period | 2,999,343 | $ | 11.53 | 454,561 | |||||||||||||
| Granted | 3,140,959 | 3.84 | 2,850,206 | ||||||||||||||
Forfeited(1) | (360,230) | 11.60 | (173,154) | ||||||||||||||
Vested(2) | (791,662) | 11.91 | (106,684) | ||||||||||||||
| Unvested at end of period | 4,988,410 | $ | 6.62 | 3,024,929 | |||||||||||||
(1)Forfeited shares of unvested Class A common stock associated with restricted stock awards are held in our treasury stock account. Refer to Note 11 for additional information on our treasury stock.
(2)The total fair value, based on grant date fair value, of previously unvested Class A common stock that vested during the nine months ended September 30, 2020 and 2019 was $9.4 million and $2.4 million, respectively.
39
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Note 13. Income Taxes
GreenSky, Inc. is taxed as a corporation and pays corporate federal, state and local taxes on income allocated to it from GS Holdings based upon GreenSky, Inc.’s economic interest held in GS Holdings. GS Holdings is treated as a pass-through partnership for income tax reporting purposes and not subject to federal income tax. Accordingly, the Company is not liable for income taxes on the portion of GS Holdings' earnings not allocated to it.
For the three months ended September 30, 2020, the Company has utilized the discrete effective tax rate method, as allowed by Accounting Standards Codification (“ASC”) 740-270-30-18, “Income Taxes—Interim Reporting,” to calculate its interim income tax provision. The discrete method is applied when the application of the estimated annual effective tax rate is impractical because it is not possible to reliably estimate the annual effective tax rate. The discrete method treats the year to date period as if it was the annual period and determines the income tax expense or benefit on that basis. In the third quarter of 2020, the Company used the discrete approach because it was unable to reasonably estimate its annual effective rate due to the variability of the rate as a result of the uncertainty in estimating annual pretax earnings based primarily on fluctuations in pre-tax income and loss between quarters thus far in 2020 and the potential impacts of mark-to-market accounting and of COVID-19 on the fourth quarter.
The Company’s effective tax rate for the three and nine months ended September 30, 2020 was 6.5% and 13.2%, respectively, and the Company recorded $197 thousand and $799 thousand of income tax expense for the three and nine months ended September 30, 2020, respectively. The Company’s effective tax rate for the three and nine months ended September 30, 2020 was less than our combined federal and state statutory tax rate of 24.3%, primarily because the Company is not liable for income taxes on the portion of GS Holdings’ earnings that are attributable to noncontrolling interests. The effective tax rate for the three and nine months ended September 30, 2020 included the effects of stock-based compensation shortfalls, which are required to be recorded discretely in the interim period in which those items occur. The effective tax rate is dependent on many factors, including the estimated amount of income subject to income tax; therefore, the effective tax rate can vary from period to period.
The Company's effective tax rate for the three and nine months ended September 30, 2019 was 3.4% and (4.0)%, respectively, and the Company recorded $1,533 thousand of income tax expense and $3,528 thousand of income tax benefit for the three and nine months ended September 30, 2019, respectively. The Company's effective tax rate for the three and nine months ended September 30, 2019 was less than our combined federal and state statutory tax rate of 24.1%, primarily because the Company is not liable for income taxes on the portion of GS Holdings’ earnings that are attributable to noncontrolling interests. Further, the effective tax rate for the three and nine months ended September 30, 2019 included the effects of remeasuring net deferred tax assets due to a change in state tax rates and warrant and stock-based compensation deductions, which are required to be recorded discretely in the interim period in which those items occur.
As of September 30, 2020 and December 31, 2019, the total liability related to uncertain tax positions was $0.1 million and $0.1 million, respectively. The Company recognizes interest and penalties, if applicable, related to uncertain tax positions as a component of income tax expense. Accrued interest and penalties were immaterial as of September 30, 2020, and therefore did not impact the effective income tax rate.
Deferred tax assets, net of $385.5 million and $364.8 million as of September 30, 2020 and December 31, 2019, respectively, relate primarily to the basis difference in our investment in GS Holdings. This basis difference arose primarily as a result of the Reorganization Transactions, the IPO and subsequent exchanges of Class B common stock for Class A common stock.
As of September 30, 2020, we concluded based on the weight of all available positive and negative evidence that all of our deferred tax assets are more likely than not to be realized. As such, no additional valuation allowance was recognized.
40
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
Tax Receivable Agreement
Pursuant to our election under Section 754 of the Internal Revenue Code (the "Code"), we expect to obtain an increase in our share of the tax basis in the net assets of GS Holdings when Holdco Units are redeemed or exchanged by the Continuing LLC Members of GS Holdings. We intend to treat any redemptions and exchanges of Holdco Units as direct purchases of Holdco Units for United States federal income tax purposes. These increases in tax basis may reduce the amounts that we would otherwise pay in the future to various tax authorities. They may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets.
On May 23, 2018, we entered into a tax receivable agreement ("TRA") that provides for the payment by us of 85% of the amount of any tax benefits that we actually realize, or in some cases are deemed to realize, as a result of (i) increases in our share of the tax basis in the net assets of GS Holdings resulting from any redemptions or exchanges of Holdco Units and from our acquisition of the equity of certain of the Former Corporate Investors, (ii) tax basis increases attributable to payments made under the TRA, and (iii) deductions attributable to imputed interest pursuant to the TRA (the "TRA Payments"). We expect to benefit from the remaining 15% of any tax benefits that we may actually realize. The TRA Payments are not conditioned upon any continued ownership interest in GS Holdings or us. The rights of each member of GS Holdings that is a party to the TRA are assignable to transferees of their respective Holdco Units. The timing and amount of aggregate payments due under the TRA may vary based on a number of factors, including the timing and amount of taxable income generated by the Company each year, as well as the tax rate then applicable.
As of September 30, 2020 and December 31, 2019, the Company had a liability of $307.3 million and $311.7 million, respectively, related to its projected obligations under the TRA, which is captioned as tax receivable agreement liability in our Unaudited Condensed Consolidated Balance Sheets. During the three and nine months ended September 30, 2020, we made a payment, inclusive of interest, of $12.8 million to members of GS Holdings pursuant to the TRA. During the three and nine months ended September 30, 2019, we made a payment, inclusive of interest, of $0 and $4.7 million, respectively, to members of GS Holdings pursuant to the TRA.
Note 14. Commitments, Contingencies and Guarantees
Commitment
Leases
In accordance with ASC 842, Leases, we determine if an arrangement is or contains a lease at inception of the contract. A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. We primarily lease our premises under multi-year, non-cancelable operating leases. Operating leases are included in Other assets and Other liabilities in our Unaudited Condensed Consolidated Balance Sheets. As of September 30, 2020 and December 31, 2019, we did not have any finance leases.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at lease commencement date based on the present value of lease payments over the lease term. As our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at lease commencement date in determining the present value of lease payments. The operating lease ROU assets are increased by any prepaid lease payments and are reduced by any unamortized lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Base rent is typically subject to rent escalations on each annual anniversary from the lease commencement dates. Lease expense for lease payments, including any step rent provisions specified in the lease agreements, is recognized on a straight-line basis over the lease term and is included within property, office and technology and related party expenses in the Unaudited Condensed Consolidated Statements of Operations. Operating lease cost associated with our ROU assets and lease liabilities was $1,088 thousand and $1,034 thousand for the three months ended
41
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
September 30, 2020 and 2019, respectively, and $3,149 thousand and $2,818 thousand for the nine months ended September 30, 2020 and 2019, respectively. See Note 15 for additional information regarding office space leased from a related party.
Our operating leases have terms expiring from 2021 through 2024, exclusive of renewal option periods. Our leases contain renewal option periods ranging from to fifteen years from the expiration dates. One lease also contains a termination option in 2023. These options were not recognized as part of our operating lease ROU assets and operating lease liabilities, as we did not conclude at the commencement date of the leases that we were reasonably certain to exercise these options. However, in our normal course of business, we expect our leases to be renewed, amended or replaced by other leases.
As of September 30, 2020, we did not have any operating leases that had not yet commenced.
Supplemental cash flow and noncash information related to our operating leases were as follows for the period indicated.
| Nine Months Ended September 30, | ||||||||||||||
| 2020 | 2019 | |||||||||||||
| Cash paid for amounts included in the measurement of operating lease liabilities | ||||||||||||||
| Operating cash flows from operating leases | $ | 3,491 | $ | 3,073 | ||||||||||
| Noncash operating lease ROU assets obtained in exchange for operating lease liabilities | ||||||||||||||
| Resulting from our adoption of ASU 2016-02 | $ | — | $ | 11,279 | ||||||||||
| Resulting from new or modified leases | 9 | 2,975 | ||||||||||||
Supplemental balance sheet information related to our operating leases was as follows as of the dates indicated.
| September 30, 2020 | December 31, 2019 | |||||||||||||
| Operating lease ROU assets | $ | 8,737 | $ | 11,268 | ||||||||||
| Operating lease liabilities | $ | 11,151 | $ | 13,884 | ||||||||||
| Weighted average remaining lease term (in years) | 2.6 | 3.3 | ||||||||||||
| Weighted average discount rate | 5.8% | 5.7% | ||||||||||||
For the periods presented, maturities of operating lease liabilities as of the date indicated and a reconciliation of the total undiscounted cash flows to the operating lease liabilities in the Unaudited Condensed Consolidated Balance Sheets, were as follows:
| September 30, 2020 | |||||
| Remainder of 2020 | $ | 1,199 | |||
| 2021 | 4,897 | ||||
| 2022 | 3,706 | ||||
| 2023 | 1,501 | ||||
| 2024 | 810 | ||||
| Thereafter | — | ||||
| Total lease payments | $ | 12,113 | |||
| Less: imputed interest | (962) | ||||
| Operating lease liabilities | $ | 11,151 | |||
Covenants
42
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The agreements with our transaction processor and some Bank Partners impose financial covenants upon our wholly owned subsidiary, GSLLC. As of September 30, 2020 and December 31, 2019, GSLLC was in compliance with the financial covenant provisions in these agreements. In addition, the agreements entered into as part of our loan participation sales with institutional asset managers impose financial covenants upon GreenSky, Inc. As of September 30, 2020, GreenSky, Inc. was in compliance with the financial covenant provisions in those agreements. See Note 7 for discussion of financial and non-financial covenants associated with our borrowings.
Other Commitments
As of September 30, 2020 and December 31, 2019, the outstanding open and unused line of credit on approved loan receivables held for sale was $103.4 million and $4.9 million, respectively. We did not record a provision for these unfunded commitments, but believe we have adequate cash on hand to fund these commitments.
For certain Bank Partners, we maintain a restricted cash balance based on a contractual percentage of the total interest billed on outstanding deferred interest loans that are within the promotional period less previous FCR on such outstanding loans. As of September 30, 2020 and December 31, 2019, restricted cash in the Unaudited Condensed Consolidated Balance Sheets included $90.4 million and $75.0 million, respectively, associated with these arrangements.
Contingencies
In limited instances, the Company may be subject to operating losses if we make certain errors in managing credit programs and we determine that a customer is not liable for a loan originated by a Bank Partner. We evaluated this contingency in accordance with ASC 450, Contingencies, and determined that it is reasonably possible that losses could result from errors in underwriting. However, in management’s opinion, it is not possible to estimate the likelihood or range of reasonably possible future losses related to errors in underwriting based on currently available information. Therefore, we have not established a liability for this loss contingency.
Further, from time to time, we place Bank Partner loans on non-accrual and non-payment status (“Pended Status”) while we investigate consumer loan balance inquiries, which may arise from disputed charges related to work performed by third-party merchants. As of September 30, 2020, Bank Partner loan balances in Pended Status were $11.8 million. While it is management’s expectation that most of these loan balance inquiries will be resolved without incident, in certain instances we may determine that it is appropriate for the Company to permanently reverse the loan balance and assume the economic responsibility for the loan balance itself. We record a liability for these instances. As of September 30, 2020, our liability for potential Pended Status future losses was $4.3 million.
Legal Proceedings
The Company, together with certain of its officers and directors and one of its former directors (the “Individual Defendants”) and certain underwriters of the Company’s IPO (the "IPO"), were named in six putative class actions filed in the Supreme Court of the State of New York, all of which actions have been consolidated (In Re GreenSky, Inc. Securities Litigation (Consolidated Action), Index No. 655626/2018 (N.Y. Sup. Ct.) (the “State Case”)), and in two putative class actions filed in the United States District Court for the Southern District of New York (the "District Court"), both of which actions also have been consolidated (In Re GreenSky, Inc. Securities Litigation (Consolidated Action), Case No. 1:2018-cv-11071-AKH (S.D.N.Y.) (the “Federal Case” and, together with the State Case, the “Consolidated Cases”)). The plaintiffs in the Consolidated Cases generally assert on behalf of certain purchasers in the IPO claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933.
The Company and Individual Defendants (together with the other defendants) filed motions to dismiss in each of the Consolidated Cases. The District Court denied the motion to dismiss the Federal Case, and discovery in the Federal Case is ongoing. On June 1, 2020, the District Court certified a class of shareholders who purchased GreenSky Class A common stock pursuant and/or traceable to the Registration Statement and Prospectus issued in connection with the IPO. For more information regarding this action, class members may view and download the Class Action Notice at www.GreenSkySecuritiesLitigation.com.
43
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
On April 22, 2020, the Supreme Court of the State of New York dismissed the State Case in its entirety and without leave to amend. On August 13, 2020, the plaintiffs filed a notice of appeal of the court's order.
On March 31, 2020, the Company (as a nominal defendant) and the Individual Defendants were also named in a putative stockholder derivative action alleging certain violations of state and federal law filed in the United States District Court for the District of Delaware, Pileggi v Zalik et al., Case No. 1:20-cv-00456 (D. Del.) (the “Derivative Case”). On August 12, 2020, the plaintiffs voluntarily dismissed the Derivative Case without prejudice.
The Company and the Individual Defendants intend to defend themselves vigorously in all respects in connection with the Consolidated Cases. Under certain circumstances, the Company may be obligated to indemnify some or all of the other defendants in the Consolidated Cases. The Company is unable to estimate the amount of reasonably possible losses it may incur with respect to the Consolidated Cases. Moreover, the Company has not determined that the likelihood of loss is probable. Therefore, the Company has not recorded any liability as of September 30, 2020 with respect to the Federal Case or the State Case.
We are also involved in a number of other proceedings concerning matters arising in connection with the conduct of our business. While the ultimate outcome of such proceedings cannot be determined, we do not believe that the resolution of these other proceedings, individually or in the aggregate, will have a material adverse effect on our financial condition, results of operations or cash flows.
With respect to all legal proceedings, it is our policy to recognize legal fees as they are incurred as a sales, general and administrative expense in our Consolidated Statements of Operations.
Financial Guarantees
As of September 30, 2020, the contingent aspect of our financial guarantee was measured under ASC 326, Financial Instruments – Credit Losses, which requires us to estimate expected credit losses, and the impact of those estimates on our required payments under the financial guarantee arrangement, for loans within our Bank Partner portfolios that are either funded or approved for funding at the measurement date, but precludes us from including future loan originations by our Bank Partners. 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. Typically, changes in the estimated financial guarantee liability as measured under ASC 326 are driven primarily by new Bank Partner loans that are facilitated on our platform during the period and thereby increase the contractual escrow balance and, to a lesser degree, by changes in underlying assumptions.
We use a discounted cash flow method to estimate our expected risk of loss under the contingent aspect of our financial guarantees for each Bank Partner. Significant assumptions for each Bank Partner portfolio used in valuing our financial guarantee liability include the following:
Loan portfolio composition: We forecasted each Bank Partner's loan portfolio composition in a "run-off" scenario, which is primarily impacted by expected loan prepayments and paydowns derived from historical behavior curves for each loan plan and were applied to each Bank Partner's portfolio based on its composition of loans and where such loans were in their economic life cycle at the measurement date. The loan portfolio composition additionally informs our forecasts of the components that determine our incentive payments or, alternatively, escrow usage. All other factors remaining constant, generally the higher the expected prepayments and pay down rates, the lower the measurement of our financial guarantee liability, as our contractual escrow balance is calculated based on the month-end outstanding portfolio balance.
Credit losses: We use lifetime historical credit loss experience for each loan plan comprising a Bank Partner's loan portfolio as a basis for estimating future credit losses. In assessing the current conditions and forecasts of future conditions as of September 30, 2020, we primarily considered the current and expected economic impacts of the COVID-19 pandemic on the macroeconomic environment, including the increase in unemployment and various mandatory state and local stay-at-home orders, as well as initiatives undertaken by the Company to mitigate credit losses, such as the emphasis on our Bank Partners' super-prime promotional loan programs with our
44
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
merchants and offering loan deferral options to GreenSky program borrowers. Based on this assessment, we adjusted for an increase to our historical credit loss experience beginning in the second half of 2020 through mid-2021. All other factors remaining constant, higher credit losses reduce our incentive payments and thereby increase our risk of loss for escrow usage. Generally, higher credit losses earlier in the forecast period expose us to greater risk of loss under our financial guarantee arrangements, as the contractual escrow balance is highest early in the forecast period in conjunction with the outstanding portfolio balance in a "run-off" scenario.
As of September 30, 2020, the estimated value of the escrow financial guarantee was $161.0 million relative to our $175.5 million contractual escrow that was included in our restricted cash balance as of September 30, 2020. Subsequent to our adoption of on January 1, 2020, the change in the liability of $28.4 million was recognized as a non-cash charge in financial guarantee expense in the Unaudited Condensed Consolidated Financial Statements. Refer to Note 1 for additional discussion of our accounting for financial guarantees.
During the third quarter of 2020, we amended a certain Bank Partner arrangement that resulted in the establishment of a credit support fund, calculated based on a percentage of the principal amount of certain loans funded or acquired by the Bank Partner, for the purposes of covering the first credit losses that occur for such loans. The credit support fund represents a financial guarantee for which we expect to pay out in its entirety and as such, the estimated value of the contingent portion as of September 30, 2020 was the same as the $2.0 million contractual amount that will be held in restricted cash.
The estimated contingent value of the financial guarantee of $16.7 million as of December 31, 2019 was measured in accordance with legacy guidance in ASC 450 and represented the amount of payments to Bank Partners from the escrow accounts that were expected to be probable of occurring based on then-current Bank Partner portfolio composition.
Note 15. Related Party Transactions
Lease
We lease office space from a related party under common management control for which lease expense is recognized within related party expenses in the Unaudited Condensed Consolidated Statements of Operations and for which operating lease ROU assets and operating lease liabilities are recognized within those respective line items in the Unaudited Condensed Consolidated Balance Sheets. Total operating lease cost related to this office space was $435 thousand and $435 thousand for the three months ended September 30, 2020 and 2019, respectively, and $1,304 thousand and $1,304 thousand for the nine months ended September 30, 2020 and 2019, respectively. Operating lease ROU assets and operating lease liabilities related to this office space were $4.1 million and $4.9 million, respectively, as of September 30, 2020, and $5.2 million and $6.2 million, respectively, as of December 31, 2019.
Contractual and Other Arrangements
In August 2018, we entered into an agreement in which an unrelated third party acted as a placement agent in connection with certain Charged-Off Receivables transfers and received a fee from us based on the proceeds received from such transfers. In performing these services, the third party agreed to use an affiliate of a member of the Board and, as such, we determined this arrangement to be related party in nature. In December 2018, the unrelated third party assigned its role in the agreement to the affiliate entity itself; therefore, the arrangement remained a related party transaction. We incurred expenses related to this arrangement of $159 thousand and $408 thousand during the three and nine months ended September 30, 2019, respectively, which are presented within related party expenses in the Unaudited Condensed Consolidated Statements of Operations. We did not incur any expenses related to this arrangement during the three and nine months ended September 30, 2020. There was no payable related to this arrangement as of September 30, 2020 and December 31, 2019.
We entered into non-interest bearing loan agreements with certain non-executive employees for which the remaining outstanding balances are forgiven ratably over designated periods based on continued employment with
45
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
the Company. As of September 30, 2020 and December 31, 2019, the remaining outstanding balances on these loan agreements were $103 thousand and $155 thousand, respectively, which are presented within related party receivables in the Unaudited Condensed Consolidated Balance Sheets.
There were no equity-based payments to non-employees that resulted in related party expenses during the nine months ended September 30, 2020 and 2019.
Note 16. Segment Reporting
We conduct our operations through a single operating segment and, therefore, one reportable segment. There are no significant concentrations by state or geographical location, nor are there any significant individual customer concentrations by balance.
Note 17. Variable Interest Entities
Upon completion of our IPO, GreenSky, Inc. became the managing member of GS Holdings with 100% of the management and voting power in GS Holdings. In its capacity as managing member, GreenSky, Inc. has the sole authority to make decisions on behalf of GS Holdings and bind GS Holdings to agreements. Further, GS Holdings maintains separate capital accounts for its investors as a mechanism for tracking earnings and subsequent distribution rights. Accordingly, management concluded that GS Holdings is a limited partnership or similar legal entity as contemplated in ASC 810, Consolidation.
Further, management concluded that GreenSky, Inc. is GS Holdings' primary beneficiary based on two conditions. First, GreenSky, Inc., in its capacity as managing member with sole voting rights, has the power to direct the activities of GS Holdings that most significantly impact its economic performance, including selecting, terminating and setting the compensation of management responsible for implementing GS Holdings' policies and procedures, as well as establishing the strategic, operating and capital decisions of GS Holdings in the ordinary course of business. Second, GreenSky, Inc. has an obligation to absorb potential losses of GS Holdings or the right to receive potential benefits from GS Holdings in proportion to its weighted average ownership interest, which was 39.6% and 35.4% for the three months ended September 30, 2020 and 2019, respectively, and 37.6% and 34.1% for the nine months ended September 30, 2020 and 2019, respectively. Management considers this exposure to be significant to GS Holdings. As the primary beneficiary, GreenSky, Inc. consolidates the results of GS Holdings for financial reporting purposes under the variable interest consolidation model guidance in ASC 810.
GreenSky, Inc.’s relationship with GS Holdings results in no recourse to the general credit of GreenSky, Inc. GS Holdings and its consolidated subsidiaries represent GreenSky, Inc.’s sole investment. GreenSky, Inc. shares in the income and losses of GS Holdings in direct proportion to GreenSky, Inc.’s ownership percentage. Further, GreenSky, Inc. has no contractual requirement to provide financial support to GS Holdings.
GSLLC is a wholly-owned subsidiary of GS Holdings and is consolidated with GS Holdings. In May 2020, GSLLC formed Depositor as a wholly-owned subsidiary, which in turn formed the SPV as a wholly-owned subsidiary, for the purposes of establishing the SPV Facility to fund purchases of loan participations. GSLLC, on behalf of the Bank Partner that owns the loans underlying the loan participations, serves as the designated servicer of the SPV’s future loan receivables held for sale. Management concluded that the SPV is a variable-interest entity. In doing so, management determined that the activity that most significantly affects the performance of the SPV is the management by the servicer (GSLLC) of the credit losses, delinquencies and defaults that may occur in the underlying loan participations held by the SPV. These activities are contractually determined through the servicing arrangement, rather than through the 100% equity holding of the Depositor. Further, because GSLLC, as agent for the Bank Partner that owns the loans underlying the loan participations, has the power to direct these activities through a servicing arrangement, GSLLC is the primary beneficiary and should consolidate the SPV under the variable interest consolidation model guidance in ASC 810.
The SPV's relationship with GSLLC results in no recourse to the general credit of the Company. Further, the Company has no contractual requirement to provide financial support to the SPV. In addition, each of the SPV and Depositor is a separate legal entity from the Company and from each other subsidiary of the Company, the
46
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
respective assets of the SPV and Depositor are owned by the SPV or Depositor, respectively, and are solely available to satisfy their respective creditors. As such, neither the SPV’s assets nor Depositor’s assets are available to satisfy obligations of GreenSky, Inc., GS Holdings, GSLLC or other subsidiaries of the Company.
Pursuant to the Facility Bank Partner Agreements, GreenSky acts as servicer on behalf of a Bank Partner for the loans with respect to which loan participations have been sold to third parties. GreenSky has concluded that the third party that purchased loan participations in the third quarter of 2020 is a variable interest entity and, as a result of this at-market servicing arrangement, GreenSky maintains a variable interest in the third party purchaser. However, GreenSky is not the primary beneficiary of the purchaser and does not consolidate the purchaser, because GreenSky lacks the power to direct the activities of the purchaser that most significantly impact its economic performance. GreenSky's exposure to loss is limited to compensation provided through the servicing arrangement. The loan participations transferred to the purchaser qualified for sales treatment under ASC 860, Transfers and Servicing, as the receivables were legally isolated from the Company, the purchaser has the right to freely pledge or exchange its interests in the receivables, and the Company does not maintain effective control over the transferred receivables.
Below are tabular disclosures that provide insight into how GS Holdings, inclusive of the SPV, affects GreenSky, Inc.’s financial position, performance and cash flows. Prior to the IPO and Reorganization Transactions, GreenSky, Inc. did not have any variable interest in GS Holdings.
47
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The following table presents the balances related to GS Holdings, inclusive of the SPV, that are included in the Unaudited Condensed Consolidated Balance Sheets as of the dates indicated, inclusive of GreenSky, Inc.'s interest in the variable interest entity.
| September 30, 2020 | December 31, 2019 | ||||||||||
| Assets | |||||||||||
| Cash and cash equivalents | $ | 90,637 | $ | 177,730 | |||||||
| Restricted cash | 324,934 | 250,081 | |||||||||
| Loan receivables held for sale, net | 543,316 | 51,926 | |||||||||
| Accounts receivable, net | 20,936 | 19,493 | |||||||||
| Property, equipment and software, net | 22,638 | 18,309 | |||||||||
| Other assets | 50,145 | 49,648 | |||||||||
Total assets(1) | $ | 1,052,606 | $ | 567,187 | |||||||
| Liabilities and Members Equity (Deficit) | |||||||||||
| Liabilities | |||||||||||
| Accounts payable | $ | 15,096 | $ | 11,912 | |||||||
| Accrued compensation and benefits | 11,420 | 10,734 | |||||||||
| Other accrued expenses | 4,564 | 3,244 | |||||||||
| Finance charge reversal liability | 187,512 | 206,035 | |||||||||
| Term loan | 453,342 | 384,497 | |||||||||
| SPV facility | 432,840 | — | |||||||||
| Financial guarantee liability | 162,999 | 16,698 | |||||||||
| Other liabilities | 91,861 | 60,328 | |||||||||
Total liabilities(2) | 1,359,634 | 693,448 | |||||||||
| Members Equity (Deficit) | |||||||||||
| Equity (deficit) attributable to Continuing LLC Members | (190,125) | (80,758) | |||||||||
| Equity (deficit) attributable to GreenSky, Inc. | (116,903) | (45,503) | |||||||||
| Total members equity (deficit) | (307,028) | (126,261) | |||||||||
| Total liabilities and members equity (deficit) | $ | 1,052,606 | $ | 567,187 | |||||||
(1)Includes $569.7 million and $0 million of assets held by the SPV as of September 30, 2020 and December 31, 2019, respectively.
(2)Includes $454.1 million and $0 million of liabilities held by the SPV as of September 30, 2020 and December 31, 2019, respectively.
The following table reflects the impact of consolidation of GS Holdings, inclusive of the SPV, into the Unaudited Condensed Consolidated Statements of Operations for the periods indicated.
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Total revenue | $ | 142,023 | $ | 153,529 | $ | 396,842 | $ | 396,679 | |||||||||||||||
| Total costs and expenses | 132,807 | 103,385 | 375,748 | 288,428 | |||||||||||||||||||
| Operating profit | 9,216 | 50,144 | 21,094 | 108,251 | |||||||||||||||||||
| Total other income (expense), net | (6,192) | (4,536) | (15,136) | (14,708) | |||||||||||||||||||
| Net income | $ | 3,024 | $ | 45,608 | $ | 5,958 | $ | 93,543 | |||||||||||||||
48
GreenSky, Inc.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(United States Dollars in thousands, except per share data, unless otherwise stated)
The following table reflects the cash flow impact of GS Holdings, inclusive of the SPV, on the Unaudited Condensed Consolidated Statements of Cash Flows for the periods indicated.
| Nine Months Ended September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| Net cash provided by (used in) operating activities | $ | (430,492) | $ | 125,433 | |||||||
| Net cash used in investing activities | (12,120) | (10,921) | |||||||||
| Net cash provided by (used in) financing activities | 430,372 | (158,308) | |||||||||
| Net increase (decrease) in cash and cash equivalents and restricted cash | (12,240) | (43,796) | |||||||||
| Cash and cash equivalents and restricted cash at beginning of period | 427,811 | 449,473 | |||||||||
| Cash and cash equivalents and restricted cash at end of period | $ | 415,571 | $ | 405,677 | |||||||
Note 18. Subsequent Events
New Bank Funding Partnership
On October 20, 2020, the Company 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. Similar to our existing Bank Partner arrangements, this partnership entitles GreenSky to receive from the Bank Partner, in addition to the transaction fees GreenSky receives from merchants, monthly servicing fee, and allows GreenSky to receive monthly incentive payments when finance charges exceed an agreed-upon portfolio yield. Further, GreenSky established a credit support fund to cover a limited amount of credit losses associated with this Bank Partner's portfolio, and an escrow account to provide limited protection to the Bank Partner 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 in excess of the credit support fund.
Loan Participation Sales
Subsequent to September 30, 2020, the Company completed loan participation sales totaling approximately $320 million. The Company will continue to service the loans in exchange for a servicing fee. In connection with the sale, the Company repaid amounts under its SPV Facility and subsequently also borrowed amounts in connection with additional SPV loan participation purchases.
49
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(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 the GreenSky, Inc. 2019 Form 10-K filed with the Securities and Exchange Commission on March 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 a Delaware corporation on July 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 of GreenSky Holdings, LLC (“GS Holdings”) and its consolidated subsidiaries. GS Holdings, a holding company with no operating assets or operations, was organized in August 2017. On August 24, 2017, GS Holdings acquired a 100% interest in GreenSky, LLC ("GSLLC"), a Georgia limited liability company, which is an operating entity. Common membership interests of GS Holdings are referred to as "Holdco Units." On May 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
On March 11, 2020, the World Health Organization designated the novel coronavirus disease (referred to as "COVID-19") as a global pandemic. In the second half of March 2020, the impact of COVID-19 and related actions to mitigate its spread within the U.S. began to impact our consolidated operating results. As of November 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 the U.S. Centers for Disease Control and Prevention and the World 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.
On March 27, 2020, the President of the 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 ended September 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
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 in mid-March 2020 and continued to be impacted through the third quarter.
For the three and nine months ended September 30, 2020, our transaction volume decreased 10% and 6%, respectively, compared to the three and nine months ended September 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 the U.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 our Bank Partners, GreenSky program borrowers impacted by COVID-19 who requested hardship assistance have received temporary relief from payments. As of September 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 our Bank Partners. We also provide limited protection to the Bank Partners through our restricted escrow accounts. Increases in credit losses have the effect of reducing our incentive payments from Bank 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 at September 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 our Bank 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 the U.S. economy, and may have an adverse impact on our performance and results of operations."
51
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 from Bank 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”) in May 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 in May 2020 with the lenders party thereto from time to time (the "Lenders"), and JPMorgan 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 and October 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 and Bank 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.
•In October 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 ended September 30, 2020:
Business Metrics
•Transaction volume (as defined below) was $1.48 billion during the three months ended September 30, 2020 compared to $1.64 billion during the three months ended September 30, 2019, a decrease of 10%. Transaction volume was $4.21 billion during the nine months ended September 30, 2020 compared to $4.46 billion during the nine months ended September 30, 2019, a decrease of 6%;
•Total revenue of $142.0 million during the three months ended September 30, 2020 decreased 7% from $153.5 million during the three months ended September 30, 2019. Total revenue of $396.8 million during the nine months ended September 30, 2020 increased 0.04% from $396.7 million during the nine months ended September 30, 2019;
•The outstanding balance of loans serviced by our platform totaled $9.55 billion as of September 30, 2020 compared to $8.76 billion as of September 30, 2019, an increase of 9%;
•Incentive payments we receive from our Bank Partners, which favorably impact our cost of revenue, increased 68% and 76% during the three and nine months ended September 30, 2020, respectively,
52
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 of September 30, 2020, and over 87% of the loan servicing portfolio as of September 30, 2020 consisted of GreenSky program borrowers with credit scores over 700; and
•The 30-day delinquencies as of September 30, 2020 were 1.04%, an improvement of 25 basis points over September 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 of September 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 ended September 30, 2020 compared to net income of $90.7 million during the nine months ended September 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 ended September 30, 2020 period in accordance with the provisions of ASU 2016-13 (referred to as "CECL"), which we adopted on January 1, 2020. Refer to "Three and Nine Months Ended September 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 ended September 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 ended September 30, 2020 increased from $33.1 million during the three months ended September 30, 2019. Adjusted EBITDA of $95.6 million during the nine months ended September 30, 2020 increased from $81.3 million during the nine months ended September 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
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 our Bank 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 with United 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
| Three Months Ended September 30, | Nine Months Ended 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.
55
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 September 30, | Nine Months Ended 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/
56
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 our Bank Partners will be renewed, since June 30, 2020 we have had three Bank Partners' funding commitments renewed for an additional year for an aggregate of $3.76 billion.
As of September 30, 2020, we had aggregate funding commitments from our ongoing Bank 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 new Bank Partners, their full commitments are typically subject to a mutually-agreed-upon onboarding schedule. As previously disclosed, in October 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 existing Bank Partners and the periodic addition of new Bank Partners to our funding group, we have diversified the funding for loans originated by our Bank Partners to also include alternative structures with institutional investors, financial institutions and other financing sources. To that end, as noted above under "Executive Summary," in May 2020, the Company entered into the Facility 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 and October 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 and Bank 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 our Bank 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 our Bank 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 our Bank 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 our Bank 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
payments from our Bank 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 our Bank 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 of September 30, 2020. Cash set aside to meet this requirement is classified as restricted cash in our Unaudited Condensed Consolidated Balance Sheets. As of September 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 of September 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 our Bank Partners, see Part I, Item 3 "Quantitative and Qualitative Disclosures About Market Risk–Credit risk." In January 2020, our Bank 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 on January 1, 2020, our financial guarantee liability associated with our escrow arrangements with our Bank 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
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 Ended September 30, 2020 and 2019
Total Revenue
During the three and nine months ended September 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 ended September 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 ended September 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 ended September 30, 2020 compared to 6.86% during the same period in 2019, and 7.12% during the nine months ended September 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
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 ended September 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 ended September 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 certain Bank 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 ended September 30, 2020 from 1.09% in the same period in 2019.
Interest and other
During the three and nine months ended September 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 September 30, | Nine Months Ended 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 ended September 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 ended September 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
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 ended September 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 September 30, | Nine Months Ended 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 from Bank 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 from Bank 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 ended September 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 September 30, | Nine Months Ended 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 ended September 30, 2020 and 2019, respectively, and $17.4 million and $16.2 million during the nine months ended September 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 ended September 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
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 ended September 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 ended September 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 ended September 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 ended September 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 ended September 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 ended September 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 ended September 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 ended September 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 ended September 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 ended September 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 ended September 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
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 ended September 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 ended September 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 ended September 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 ended September 30, 2020, non-cash financial guarantee expense (benefit) recognized subsequent to our adoption of ASU 2016-13 on January 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 ended September 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 our Bank 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 ended September 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
Related party
During the three and nine months ended September 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 ended September 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 into June 2020 (the 2020 Amended Credit Agreement) and a $0.6 million decrease in interest income.
During the nine months ended September 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 ended September 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 to GreenSky, Inc.'s economic interest in GS Holdings. The expected income tax expense for the three and nine months ended September 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 ended September 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 to GreenSky, Inc.'s economic interest in GS Holdings. Income tax expense during the three and nine months ended September 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 ended September 30, 2020 as compared to the same period in 2019 was primarily related to a decrease in overall net earnings attributable to GreenSky, Inc.'s economic interest in GS Holdings compared to the 2019 period.
The income tax expense during the nine months ended September 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 to GreenSky, Inc.'s economic interest in GS Holdings compared to the 2019 period.
Net income attributable to noncontrolling interests
Net income attributable to noncontrolling interests for the three and nine months ended September 30, 2020 and 2019 reflects income attributable to the Continuing LLC Members for the entire periods based on their weighted average ownership interest in GS Holdings, which was 60.4% and 64.6% for the three months ended September 30, 2020 and 2019, respectively, and 62.4% and 65.9% for the nine months ended September 30, 2020 and 2019, respectively.
64
Financial Condition Summary
Changes in the composition and balance of our assets and liabilities as of September 30, 2020 compared to December 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 ended September 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 our January 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 ended September 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 with Bank 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, including GS 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 prohibiting GS 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 permits GS 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
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 on GS 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 our Bank Partners, but for which $90.4 million is held for certain Bank Partners in restricted cash as of September 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," in May 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 in July 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 of September 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 in March 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 in May 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 ended September 30, 2020.
Significant Changes in Capital Structure
During the nine months ended September 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 ended September 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
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 | $ | (430,492) | $ | 125,433 | |||||||
| Net cash used in investing activities | $ | (12,120) | $ | (10,921) | |||||||
| Net cash provided by (used in) financing activities | $ | 435,278 | $ | (149,326) | |||||||
Cash and cash equivalents and restricted cash totaled $438.5 million as of September 30, 2020, a decrease of $7.3 million from December 31, 2019. Restricted cash, which had a balance of $324.9 million as of September 30, 2020 compared to a balance of $250.1 million as of December 31, 2019, is not available to us to fund operations or for general corporate purposes. Cash flow activities for the nine months ended September 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 to GS 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 of September 30, 2020 and December 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 with Bank Partners as limited protection to the Bank 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 certain Bank 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 with Bank Partners.
Cash provided by operating activities
Nine Months Ended September 30, 2020. Cash flows used in operating activities were $430.5 million during the nine months ended September 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 ended September 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 Ended September 30, 2019. Cash flows provided by operating activities were $125.4 million during the nine months ended September 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
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 ended September 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 ended September 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 ended September 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
On March 29, 2018, GS Holdings amended its August 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 in August 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 by GS Holdings’ significant subsidiaries, including GSLLC, and is secured by liens on substantially all of the assets of GS 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 of GS 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 certain GS Holdings tax distributions. The $400.0 million term loan matures on March 29, 2025, and the revolving loan facility matures on March 29, 2023.
On June 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 on March 29, 2025.
There was no amount outstanding under our revolving loan facility as of September 30, 2020, which is available to fund future needs of GS Holdings’ business. We had drawn $1.0 million on our available letter of credit as of September 30, 2020.
SPV Facility
On May 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 in July 2020. There was $432.8 million outstanding under the SPV Facility as of September 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 on May 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
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 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 of September 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 September 30, 2020 and December 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 ended September 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
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 ended September 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. On January 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 to January 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, including changes to interest rates, and credit risk. However, regarding interest rate risk, we do not expect changes in interest rates to have a material impact on our ability to finance our cost of capital, given our relatively capital light operating model.
We have established processes and procedures intended to identify, measure, monitor and control the types of risk to which we are subject. The Audit Committee of our Board of Directors is responsible for overseeing the Company’s major financial risk exposures and reviewing the steps management has taken to monitor and control such exposures.
Interest rate risk
Loans originated by Bank Partners. The agreed upon Bank Partner portfolio yield on the loans that our Bank Partners originate is calculated based upon a margin above a market benchmark at the time of origination. An increase in the market benchmark would result in an increase in the agreed upon Bank Partner portfolio yield, which impacts future incentive payments and, therefore, can negatively impact the future fair value change in our FCR liability. We are able to manage some of the interest rate risk impact on our FCR liability through the types of loan products that we design and make available through our program (e.g. higher interest rate products, all else equal, result in higher incentive payments). However, increased interest rates may adversely impact the spending levels of our merchants’ customers and their ability and willingness to borrow money. Higher interest rates often lead to higher payment obligations, which may reduce the ability of customers to remain current on their obligations to our Bank Partners and, therefore, lead to increased delinquencies, defaults, customer bankruptcies and charge-offs, and decreasing recoveries, all of which could have a material adverse effect on our business and also negatively impact the fair value change in FCR liability, which is recorded within cost of revenue in the Unaudited Condensed Consolidated Statements of Operations. Further, even though we generally intend to increase our transaction fee rates in response to rising interest rates, we might not be able to do so rapidly enough (or at all).
Loan receivables held for sale. Changes in United States interest rates affect the interest earned on our cash and cash equivalents and could impact the market value of loan receivables held for sale. A hypothetical 100 basis points increase in interest rates may have resulted in a decrease of $5.7 million and $0.5 million in the carrying value of our loan receivables held for sale as of September 30, 2020 and December 31, 2019, respectively. Alternatively, a 100 basis points decrease in interest rates would not have impacted the reported value of our loan receivables held for sale, as they are carried at the lower of cost or fair value.
71
Term loan. Interest rate fluctuations expose our variable-rate term loan, which consisted of our $400.0 million term loan under our 2018 Amended Credit Agreement, and our $75.0 million term loan under our 2020 Amended Credit Agreement, to changes in interest expense and cash flows. In June 2019, we entered into a four-year interest rate swap agreement that effectively converted interest payments on $350.0 million of our variable-rate term loan under our 2018 Amended Credit Agreement, to a fixed-rate basis, thus mitigating the impact of interest rate changes on future interest expense. The term loan has a maturity date of March 29, 2025. Based on an outstanding principal balance of $464.8 million as of September 30, 2020, and accounting for our scheduled quarterly principal balance repayments, a hypothetical 100 basis point increase in the one-month LIBOR rate would result in an increase in annualized interest expense, net of the effects of our interest rate swap, of $1.1 million.
SPV Facility. Interest rate fluctuations expose our variable-rate asset-backed revolving credit facility, which provides a revolving committed financing of $300.0 million, with an additional $200.0 million uncommitted accordion that was accessed in July 2020.. The revolving funding period is one year and the maturity date is May 10, 2022. Based on the outstanding principal balance of $432.8 million as of September 30, 2020, a hypothetical 100 basis point increase in the commercial paper conduit funding rate would result in an increase in annualized interest expense of $4.3 million.
LIBOR is used as the reference rate for our interest rate swap agreement that we use to hedge interest rate exposure of $350.0 million notional under our $475.0 million term loan. Our interest rate swap agreement is set to mature after the expected phase out of LIBOR in 2021. See Part I, Item 2 "–Liquidity and Capital Resources–Borrowings" for further discussion regarding the LIBOR transition and its perceived impact on the Company.
Credit risk
Credit risk management is a critical component of our management and growth strategy. Credit risk refers to the risk of loss arising from consumer default when GreenSky program borrowers are unable or unwilling to meet their financial obligations. We expect our credit loss rate to stay relatively constant over time; however, our portfolio may change as we look for additional opportunities to generate attractive risk-adjusted returns for our Bank Partners. Additionally, we manage our exposure to counterparty credit risk through requirement of minimum credit standards, diversification of counterparties and procedures to monitor concentrations of credit risk.
Loans originated by Bank Partners. Our Bank Partners own and bear substantially all of the credit risk on their wholly-owned loan portfolios. We regularly assess and monitor the credit risk exposure of our Bank Partners. This commences with the credit application process on our platform, during which a credit decision is rendered to a customer immediately based on preset underwriting standards provided by our Bank Partners. In rendering this decision, we generally obtain certain information provided by the applicant and a credit report from one of the major credit bureaus. Further, on behalf of our Bank Partners as part of our obligation as the loan servicer, we try to mitigate portfolio credit losses through our collection efforts on past due amounts. For loans wholly owned by our Bank Partners, our credit risk exposure impacts the amount of incentive payments and, therefore, the amount of fair value change in FCR liability, as well as any potential financial guarantee payments. Restricted cash was set aside in escrow with our Bank Partners at a weighted average target rate of 2.20% of the total outstanding loan balance as of September 30, 2020. As of September 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.
Based on our incentive payments during the three months ended September 30, 2020 and 2019, and holding all other inputs constant (namely, the size of our loan servicing portfolio and settlement activity), a hypothetical 100 basis point increase in loan servicing portfolio credit losses would result in increases of $18.7 million and $19.5 million, respectively, in the fair value of our FCR liability. For the nine months ended September 30, 2020 and 2019, a hypothetical 100 basis point increase in loan servicing portfolio credit losses would result in increases of $57.9 million and $54.2 million, respectively, in the fair value of our FCR liability. Further, such an increase in credit losses would cause us to incur additional financial guarantee expense of $2.2 million and $1.1 million during the three months ended September 30, 2020 and 2019, respectively, and $7.4 million and $3.6 million during the nine months ended September 30, 2020 and 2019, respectively.
72
Loan receivables held for sale. We bear all of the credit risk associated with the loan receivables that we hold for sale. This portfolio was highly diversified across 61,269 and 9,272 consumer loan receivables as of September 30, 2020 and December 31, 2019, respectively, without significant individual exposures. Based on our $543.3 million and $51.9 million loan receivables held for sale balance as of September 30, 2020 and December 31, 2019, respectively, a hypothetical 100 basis point increase in portfolio credit losses would result in lower annualized earnings of $5.7 million and $0.5 million, respectively.
ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of September 30, 2020, an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Act”)), was carried out by our management and with the participation of our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer). Based upon the evaluation, our principal executive officer and principal financial officer concluded that these disclosure controls and procedures were effective as of September 30, 2020.
Changes in Internal Control Over Financial Reporting
During the quarter ended September 30, 2020, no changes in our internal control over financial reporting occurred that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
73
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are party to legal proceedings incidental to our business. See Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for information regarding legal proceedings.
ITEM 1A. RISK FACTORS
Our business involves significant risks, some of which are described below. You should carefully review and consider the following risk factors and the other information included in this Quarterly Report on Form 10-Q, including the Unaudited Condensed Consolidated Financial Statements and Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1. The occurrence of one or more of the events or circumstances described in these risk factors, alone or in combination with other events or circumstances, may have a material adverse effect on our business, reputation, revenue, financial condition, results of operations and future prospects, in which event the market price of our Class A common stock could decline, and you could lose part or all of your investment. In addition, our business, reputation, revenue, financial condition, results of operations and future prospects also could be harmed by risks and uncertainties not currently known to us or that we currently do not believe are material.
Risks Related to Our Business and the Consumer Financial Services Industry
The global outbreak of the novel coronavirus, or COVID-19, has caused severe disruptions in the U.S. economy, and may have an adverse impact on our performance and results of operations.
On March 11, 2020, the World Health Organization designated the novel coronavirus disease (referred to as "COVID-19") as a global pandemic. In response, many jurisdictions in the U.S. and worldwide have instituted restrictions on travel, public gatherings, and non-essential business operations. While some jurisdictions have removed or relaxed certain restrictions, many remain and additional restrictions may be imposed or reimposed. These restrictions have significantly impacted the macroeconomic environment, including consumer confidence, unemployment and other economic indicators that contribute to consumer spending behavior and demand for credit. In particular, the majority of elective healthcare providers were closed at the start of the pandemic which reduced our elective healthcare transaction volumes from mid-March through September to de minimis levels. Furthermore, our results of operations are impacted by the relative strength of the overall economy. 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. 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.
The extent to which COVID-19 will impact our business, results of operations and financial condition is dependent on many factors, which are highly uncertain, including, but not limited to, the duration and severity of the outbreak, the actions to contain the virus or mitigate its impact, and how quickly and to what extent normal economic and operating conditions will resume. If we experience a prolonged decline in transaction volume or increases in delinquencies, our results of operations and financial condition could be materially adversely affected.
In our function as loan servicer and in partnership with our Bank Partners, we are actively engaged in discussions with GreenSky program borrowers, some of whom have indicated that they have experienced economic hardship due to the COVID-19 pandemic and have requested payment deferral or forbearance or other modifications of their loans. While we are addressing requests for loan relief, we may still experience higher instances of default, which will adversely affect our business, including, but not limited to, the credit profile of our servicing portfolio, the incentive payments we receive from our Bank Partners and the required escrow payments under our financial guarantee arrangements with our Bank Partners. Additionally, the COVID-19 pandemic could adversely affect our liquidity position and could limit our ability to grow our business or fully execute on our business strategy, including entering into alternative funding arrangements. Furthermore, the COVID-19 pandemic could negatively impact our ability to retain existing, and attract new, Bank Partners and other funding sources for the GreenSky program.
74
The COVID-19 pandemic also resulted in us modifying certain business practices, such as restricting employee travel and executing on a company-wide work-at-home program. We may take further actions as required by government authorities or as we determine to be in the best interests of our associates, Bank Partners, merchants and GreenSky program borrowers. We may experience financial losses or disruptions due to a number of operational factors, including, but not limited to:
•increased cyber and payment fraud risk related to COVID-19, as cybercriminals attempt to profit from the disruption, given increased online banking, e-commerce and other online activity;
•challenges to the security, availability and reliability of our platform due to changes to normal operations, including the possibility of one or more clusters of COVID-19 cases affecting our employees or affecting the systems or employees of our partners; and
•an increased volume of customer and regulatory requests for information and support, or new regulatory requirements, which could require additional resources and costs to address, including, for example, government initiatives to reduce or eliminate payments costs.
Even when the COVID-19 outbreak subsides, our business may continue to be unfavorably impacted by the economic turmoil caused by the pandemic. There are no recent comparable events that could serve to indicate the ultimate effect the COVID-19 pandemic may have and, as such, we do not at this time know what the extent of the impact of the COVID-19 pandemic will be on our business. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also heighten other risks described in this Part II, Item 1A.
For additional discussion of the impact of COVID-19 on our business, see additional risk factors included in this Part II, Item 1A, as well as Part I, Item 2 "Management’s Discussion and Analysis of Financial Condition and Results of Operations–Executive Summary."
Our agreements with our Bank Partners are non-exclusive, short-term in duration and subject to termination by our Bank Partners upon the occurrence of certain events, including our failure to comply with applicable regulatory requirements. If such agreements expire or are terminated, and we are unable to replace the commitments of the expiring or terminating Bank Partners, our business would be adversely affected.
We rely on our Bank Partners to originate all of the loans made through the GreenSky program. Our four largest ongoing Bank Partners – BMO Harris Bank, Fifth Third Bank, Truist Bank and Synovus Bank – provided approximately 80% of the commitments to originate loans as of September 30, 2020. We have entered into separate loan origination agreements and servicing agreements with each of our Bank Partners, each generally containing customary termination provisions and, in certain instances, entitling the Bank Partner to terminate its agreements for convenience. Bank Partners could decide to terminate or not to renew their agreements for any number of reasons, including, for example, perceived or actual erosion in the credit quality or performance of loans, the geographic or other (such as home improvement loans) concentration of loans, the type of loan products offered (such as deferred payment loans), strategic decisions to make fewer consumer loans or loans originated through channels such as ours, alternative investment opportunities that are expected to be more favorable, increases in required loan loss reserves (such as ones that might result from upcoming accounting changes) and required margins, dissatisfaction with our performance as administrator of our program or as servicer, reduced availability of funds for originating new loans, regulatory concerns regarding any of the foregoing factors or others, or general economic conditions, including those that are expected to impact consumer spending, consumer credit or default rates. If any of our largest Bank Partners were to terminate its relationship with us, it could have a material adverse effect on our business. See Part I, Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations–Factors Affecting our Performance–Bank Partner Relationships; Other Funding" for more information regarding our Bank Partner relationships.
Our agreements with our Bank Partners generally have automatically renewable one-year terms. These agreements are non-exclusive and do not prohibit our Bank Partners from working with our competitors or from offering competing products, except that certain Bank Partners have agreed not to provide customer financing outside of the GreenSky program to our merchants and Sponsors (as defined below) during the term of their agreements with us and generally for one year after termination or expiration. "Sponsors" refers to manufacturers, their captive and franchised showroom operations, and trade associations with which we partner to onboard merchants. As a result of the foregoing, any of our Bank Partners could with minimal notice decide that working
75
with us is not in its interest, could offer us less favorable or unfavorable economic or other terms or could decide to enter into exclusive or more favorable relationships with one of our competitors. We also could have future disagreements or disputes with our Bank Partners, which could negatively affect or threaten our relationships with them.
Our Bank Partners also may terminate their agreements with us if we fail to comply with regulatory requirements applicable to them. We are a service provider to our Bank Partners, and, as a result, we are subject to audit by our Bank Partners in accordance with customary practice and applicable regulatory guidance related to management by banks of third-party vendors. We also are subject to the examination and enforcement authority of the federal banking agencies, including the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, as a bank service company, and are subject to the examination and enforcement authority of the Consumer Financial Protection Bureau (“CFPB”) as a service provider to a covered person under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). It is imperative that our Bank Partners continue to have confidence in our compliance efforts. Any substantial failure, or alleged or perceived failure, by us to comply with applicable regulatory requirements could cause them to be unwilling to originate loans through our program or could cause them to terminate their agreements with us. See “–Risks Related to Our Regulatory Environment.”
If we are unsuccessful in maintaining our relationships with our Bank Partners for any of the foregoing or other reasons, or if we are unable to develop relationships with new Bank Partners or other funding sources, it could have a material adverse effect on our business and our ability to grow.
Our results of operations and continued growth depend on our ability to retain existing, and attract new, merchants, Bank Partners, and other funding sources.
A substantial majority of our total revenue is generated from the transaction fees that we receive from our merchants and, to a lesser extent, servicing and other fees that we receive from our Bank Partners and other funding sources in connection with loans made by our Bank Partners to the customers of our merchants. Approximately 75% of our total revenue for the nine months ended September 30, 2020 was generated from transaction fees paid to us by our merchants. To attract and retain merchants, we market our program to them on the basis of a number of factors, including financing terms, the flexibility of promotional offerings, approval rates, speed and simplicity of loan origination, service levels, products and services, technological capabilities and integration, customer service, brand and reputation.
There is significant competition for our existing merchants. If we fail to retain any of our larger merchants or a substantial number of our smaller merchants, and we do not acquire new merchants of similar size and profitability, it would have a material adverse effect on our business and future growth. We have experienced some turnover in our merchants, as well as varying activation rates and volatility in usage of the GreenSky program by our merchants, and this may continue or even increase in the future. Program agreements generally are terminable by merchants at any time. Also, we generally do not have exclusive arrangements with our merchants, and they are free to use our competitors’ programs at any time and without notice to us. If a significant number of our existing merchants were to use other competing programs, thereby reducing their use of our program, it would have a material adverse effect on our business and results of operations.
Competition for new merchants also is significant and our continued success and growth depend on our ability to attract new merchants and our failure to do so could limit our growth and our ability to continue generating revenue at current levels.
Our failure to retain existing, and attract and retain new, Bank Partners and other funding sources also could materially adversely affect our business and our ability to grow. We market our program to banks and other funding sources on the basis of the risk-adjusted yields available to them and geographic diversity of the loans originated through the GreenSky program, as well as the absence of significant upfront and ongoing costs and the general attractiveness of the consumers that use the GreenSky program. Bank Partners and other investors have alternative sources for attractive, if not similar, loans, including, for Bank Partners, internal loan generation, and they could elect to originate or invest in loans through those alternatives rather than through the GreenSky program.
Based upon current commitment levels, our four largest ongoing Bank Partners are BMO Harris Bank, Fifth Third Bank, Truist Bank and Synovus Bank. As of September 30, 2020, they provided approximately 80% of the
76
overall commitments to originate loans through our program. If any of our larger Bank Partners, or a substantial number of our smaller Bank Partners, were to suspend, limit or otherwise terminate their relationships with us, it could have a material adverse effect on our business. If we need to enter into arrangements with a different bank to replace one of our Bank Partners, we may not be able to negotiate a comparable alternative arrangement. See Part I, Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations–Factors Affecting our Performance–Bank Partner Relationships; Other Funding" for more information regarding our Bank Partner relationships.
A large percentage of our revenue is concentrated with our top ten merchants, and the loss of a significant merchant could have a negative impact on our operating results.
Our top ten merchants (including certain groups of affiliated merchants) accounted for an aggregate of 26% of our total revenue during the nine months ended September 30, 2020. The Home Depot is our most significant single merchant and represented approximately 4% of total revenue during the nine months ended September 30, 2020. In addition, affiliates of Renewal by Andersen, our largest Sponsor, represented together approximately 20% of total revenue during the nine months ended September 30, 2020. Our agreement with Renewal by Andersen provides that Renewal by Andersen will promote the GreenSky program through notifying its dealers of the availability of the GreenSky program and providing them ancillary materials. Both parties have the right to terminate the agreement generally upon 90 days' notice. If Renewal by Andersen terminates the agreement, Renewal by Andersen dealers would not be obligated to terminate their participation in the GreenSky program, although they could choose to do so. We expect to have significant concentration in our largest merchant relationships for the foreseeable future. In the event that (i) The Home Depot or one or more of our other significant merchants, or groups of merchants, or (ii) Renewal by Andersen or one or more of our other significant Sponsors, and their dealers, terminate their relationships with us, or elect to utilize an alternative source for financing, the number of loans originated through the GreenSky program could decline, which would materially adversely affect our business and, in turn, our revenue.
Our results depend, to a significant extent, on the active and effective promotion and support of the GreenSky program by our Sponsors and merchants.
Our success depends on the active and effective promotion of the GreenSky program by our Sponsors to their network of merchants and by our merchants to their customers. We rely on our Sponsors, including large franchisors within different home improvement industry sub-verticals, to promote the GreenSky program within their networks of merchants. A majority of our active merchants are affiliated with Sponsors. Although our Sponsors generally are under no obligation to promote the GreenSky program, many do so through direct mail, email campaigns and trade shows. The failure by our Sponsors to effectively promote and support the GreenSky program would have a material adverse effect on the rate at which we acquire new merchants and the cost thereof.
We also depend on our merchants, which generally accept most major credit cards and other forms of payment, to promote the GreenSky program, to integrate our platform and the GreenSky program into their business, and to educate their sales associates about the benefits of the GreenSky program so that their sales associates encourage customers to apply for and use our services. Our relationship with our merchants, however, generally is non-exclusive, and we do not have, or utilize, any recourse against merchants when they do not promote the GreenSky program. The failure by our merchants to effectively promote and support the GreenSky program would have a material adverse effect on our business.
If our merchants fail to fulfill their obligations to consumers or comply with applicable law, we may incur remediation costs.
Although our merchants are obligated to fulfill their contractual commitments to consumers and to comply with applicable law, from time to time they might not, or a consumer might allege that they did not. This, in turn, can result in claims against our Bank Partners and us or in loans being uncollectible. In those cases, we may decide that it is beneficial to remediate the situation, either through assisting the consumers to get a refund, working with our Bank Partners to modify the terms of the loan or reducing the amount due, making a payment to the consumer or otherwise. In addition, for SPV Participations or other loan receivables held for sale, we may have additional risk
77
for the period of time that we, or our SPV, own such participations. Historically, the cost of remediation has not been material to our business, but it could be in the future.
We have experienced rapid growth, which may be difficult to sustain and which may place significant demands on our operational, administrative and financial resources.
Our rapid growth has caused significant demands on our operational, marketing, compliance and accounting infrastructure, and has resulted in increased expenses, which we expect to continue as we grow. In addition, we are required to continuously develop and adapt our systems and infrastructure in response to the increasing sophistication of the consumer finance market and regulatory developments relating to our existing and projected business activities and those of our Bank Partners. Our future growth will depend, among other things, on our ability to maintain an operating platform and management system sufficient to address our growth and will require us to incur significant additional expenses and to commit additional senior management and operational resources.
As a result of our growth, we face significant challenges in:
•securing commitments from our existing and new Bank Partners and other funding sources to provide loans to customers of our merchants, and securing commitments from other funding sources;
•maintaining existing and developing new relationships with merchants and Sponsors;
•maintaining adequate financial, business and risk controls;
•implementing new or updated information and financial and risk controls and procedures;
•training, managing and appropriately sizing our workforce and other components of our business on a timely and cost-effective basis;
•navigating complex and evolving regulatory and competitive environments;
•securing funding (including credit facilities and/or equity capital) to maintain our operations and future growth;
•increasing the number of borrowers in, and the volume of loans facilitated through, the GreenSky program;
•expanding within existing markets;
•entering into new markets and introducing new solutions;
•continuing to revise our proprietary credit decisioning and scoring models;
•continuing to develop, maintain and scale our platform;
•effectively using limited personnel and technology resources;
•maintaining the security of our platform and the confidentiality of the information (including personally identifiable information) provided and utilized across our platform; and
•attracting, integrating and retaining an appropriate number of qualified employees.
We may not be able to manage our expanding operations effectively, and any failure to do so could adversely affect our ability to generate revenue and control our expenses.
78
If we experience negative publicity, we may lose the confidence of our Bank Partners, merchants and consumers who use the GreenSky program and our business may suffer.
Reputational risk, or the risk to us from negative publicity or public opinion, is inherent to our business. Recently, consumer financial services companies have been experiencing increased reputational harm as consumers and regulators take issue with certain of their practices and judgments, including, for example, fair lending, credit reporting accuracy, lending to members of the military, state licensing (for lenders, servicers and money transmitters) and debt collection. Maintaining a positive reputation is critical to our ability to attract and retain Bank Partners, merchants, consumers, investors and employees. Negative public opinion can arise from many sources, including actual or alleged misconduct, errors or improper business practices by employees, Bank Partners, merchants, outsourced service providers or other counterparties; litigation or regulatory actions; failure by us, our Bank Partners, or merchants to meet minimum standards of service and quality; inadequate protection of consumer information; failure of merchants to adhere to the terms of their GreenSky program agreements or other contractual arrangements or standards; compliance failures; and media coverage, whether accurate or not. Negative public opinion could diminish the value of our brand and adversely affect our ability to attract and retain Bank Partners, merchants and consumers, as a result of which our results of operations may be materially harmed and we could be exposed to litigation and regulatory action.
We may be unable to successfully develop and commercialize new or enhanced products and services.
The consumer financial services industry is subject to rapid and significant changes in technologies, products and services. Our business is dependent upon technological advancement, such as our ability to process applications instantly, accept electronic signatures and provide other conveniences expected by borrowers and counterparties. We must ensure that our technology facilitates a consumer experience that is quick and easy and equals or exceeds the consumer experience provided by our competitors. Therefore, a key part of our financial success depends on our ability to develop and commercialize new products and services and enhancements to existing products and services, including with respect to mobile and point-of-sale technologies.
Realizing the benefit of such products and services is uncertain, and we may not assign the appropriate level of resources, priority or expertise to the development and commercialization of these new products, services or enhancements. Our ability to develop, acquire and commercialize competitive technologies, products and services on acceptable terms, or at all, may be limited by intellectual property rights that third parties, including competitors and potential competitors, may assert. In addition, our success is dependent on factors such as merchant and customer acceptance, adoption and usage, competition, the effectiveness of marketing programs, the availability of appropriate technologies and business processes and regulatory approvals. Success of a new product, service or enhancement also may depend upon our ability to deliver it on a large scale, which may require a significant investment.
We also could utilize and invest in technologies, products and services that ultimately do not achieve widespread adoption and, therefore, are not as attractive or useful to our merchants and their customers as we anticipate. Our merchants also may not recognize the value of new products and services or believe they justify any potential costs or disruptions associated with implementing them. Because our solution is typically marketed through our merchants, if our merchants are unwilling or unable to effectively implement or market new technologies, products, services or enhancements, we may be unable to grow our business. Competitors also may develop or adopt technologies or introduce innovations that change the markets they operate in and make our solution less competitive and attractive to our merchants and their customers. Moreover, we may not realize the benefit of new technologies, products, services or enhancements for many years, and competitors may introduce more compelling products, services or enhancements in the meantime.
Changes in market interest rates could have an adverse effect on our business.
The fixed interest rates charged on the loans that our Bank Partners originate are calculated based upon a margin above a market benchmark at the time of origination. Increases in the market benchmark would result in increases in the interest rates on new loans. Increased interest rates may adversely impact the spending levels of consumers and their ability and willingness to borrow money. Higher interest rates often lead to higher payment obligations, which may reduce the ability of customers to remain current on their obligations to our Bank Partners and, therefore, lead to increased delinquencies, defaults, customer bankruptcies and charge-offs, and decreasing
79
recoveries, all of which could have an adverse effect on our business. See Part I, Item 3 "Quantitative and Qualitative Disclosures about Market Risk."
The expected replacement of London Interbank Offered Rate ("LIBOR") and replacement or reform of other interest rates could adversely affect our results of operations and financial condition.
LIBOR and certain other interest rate benchmarks are the subject of recent national, international and other regulatory guidance and proposals for reform. These reforms may cause such benchmarks to perform differently than in the past or have other consequences which cannot be predicted. The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, has publicly announced that it intends to stop compelling banks to submit information to the administrator of LIBOR after 2021. The continuation of LIBOR cannot be guaranteed after 2021. LIBOR is currently used as a reference rate for certain of our contractual arrangements, including our term loan under the Amended Credit Agreements and the related interest rate swap agreement, both of which are set to mature after the expected phase out of LIBOR.
The market transition away from LIBOR to alternative reference rates is complex and could have a range of adverse effects on the Company’s business, financial condition and results of operations. In particular, any such transition could:
•adversely affect the interest rates received or paid in our contractual arrangements;
•prompt inquiries or other actions from regulators in respect of the Company’s preparation and readiness for the replacement of LIBOR with an alternative reference rate;
•result in disputes, litigation or other actions with borrowers or counterparties about the interpretation and enforceability of certain fallback language in LIBOR-based contracts and securities; and
•cause us to incur additional costs in relation to any of the above factors.
While 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, in the event that an agreement cannot be reached on an appropriate benchmark rate, the availability of borrowings under these agreements could be adversely impacted. At this time, we do not perceive any material risks and do not expect a materially adverse change to the Company's financial condition or liquidity as a result of any such changes or any other reforms to LIBOR that may be enacted in the United Kingdom or elsewhere.
Increases in loan delinquencies and default rates in the GreenSky program could cause us to lose amounts we place in escrow and may require us to deploy resources to enhance our collections and default servicing capabilities, which could adversely affect our ability to maintain loan volumes, and could affect our ability to pursue or close alternative funding structures.
Loans funded by our Bank Partners generally are not secured by collateral, are not guaranteed or insured by any third party and are not backed by any governmental authority in any way, which limits the ability of our Bank Partners to collect on loans if a borrower is unwilling or unable to repay. A borrower’s ability to repay can be negatively impacted by increases in the borrower’s payment obligations to other lenders under home, credit card and other loans; loss of employment or other sources of income; adverse health conditions; or for other reasons. Changes in a borrower’s ability to repay loans made by our Bank Partners also could result from increases in base lending rates or structured increases in payment obligations. While consumers using our platform to date have had high average credit scores, we may enter into new industry verticals in which consumers have lower average credit scores, leading to potentially higher rates of defaults.
Should delinquencies and default rates increase, we will need to expand our collections and default servicing capabilities, which will require skills and resources that we currently may not have. This will result in higher costs due to the time and effort required to collect payments from delinquent borrowers.
While we are not generally responsible to our Bank Partners for defaults by customers, we have agreed with each of our Bank Partners to fund an escrow in order to provide the Bank Partners limited protection against credit
80
losses. If credit losses increase, we could lose a portion, or all, of these escrowed funds, which would have an adverse effect on our business.
Because the agreements we have with our Bank Partners are of short duration and because our Bank Partners generally may terminate their agreements or reduce their commitments to provide loans if credit losses increase, the overall volume of GreenSky program loans may decrease in the event of higher default rates. In addition, in certain limited circumstances, our Bank Partners may terminate the agreements under which we service their loan portfolios, in which case we will suffer a decrease in our revenues from loan servicing.
In addition, an increase in delinquencies and default rates would have an adverse effect on our ability to pursue, or the terms of, alternative funding structures with institutional investors, financial institutions and other sources, because of the reduced returns that would be expected as a result of such increase.
We own participations in certain loans originated through the GreenSky program, and the non-performance, or even significant underperformance, of those participations would adversely affect our business.
We hold participations in certain loans originated by our Bank Partners in order to facilitate alternative funding structures. In May 2020, our special purpose vehicle, which we refer to as the "SPV," established an asset-backed revolving credit facility with JPMorgan Chase Bank, N.A. to finance purchases by the SPV of participation interests in loans originated through the GreenSky program (the "SPV Facility"). We refer to participations owned by the SPV as “SPV Participations.” The SPV has conducted periodic sales of the SPV Participations to third parties and plans to conduct additional periodic sales of the SPV Participations or issue asset-backed securities to third parties, which sales and issuances will allow additional purchases of participations to be financed through the SPV Facility. In the future, we may form other special purpose vehicles for similar purposes. The SPV and any such other special purpose vehicles may not be able to conduct such sales or issuances in a timely manner or at expected prices, if at all. In addition, the Company issues commitments to purchase loan participations from time to time to a Bank Partner as part of the Company's facilitation of loan participation sales to third parties.
If we are not able to find third-party purchasers for loan participations that we own or that we have a commitment to purchase, we will bear the entire credit risk of such loan participations. Furthermore, in this event, our ability to finance additional purchases of participations through the SPV Facility would be limited. This could have a material adverse effect on our business, financial position, results of operations and cash flows.
We also hold participations in certain research and development loans, which we refer to as “R&D Participations.” Generally, we hold R&D Participations that we purchase from an originating Bank Partner with the intent to hold the R&D Participations only for a short period of time before we can transfer the R&D Participations to a Bank Partner following its determination to purchase the R&D Participations, which a Bank Partner might do in connection with an expansion of its credit policy. Our objective is to hold these R&D Participations only until we have enough experience with the particular products or industry verticals for our Bank Partners to purchase the R&D Participations. Our Bank Partners may not purchase the R&D Participations.
Both the SPV Participations and the R&D Participations are designated as loan receivables held for sale on our Unaudited Condensed Consolidated Balance Sheets. As of September 30, 2020, we had $543.3 million in loan receivables held for sale, net. During the period that we own the receivables, we bear the entire credit risk in the event that the borrowers default.
In addition, we are obligated to purchase from our Bank Partners the receivables underlying any loans that were approved in error or otherwise involved customer or merchant fraud.
Our ownership of receivables also requires us to commit or obtain corresponding funding. In addition, non-performance, or even significant underperformance, of the loan receivables held for sale that we own could have a materially adverse effect on our business, including with respect to the SPV Participations, an inability to repay obligations owed by the SPV under the SPV Facility.
We are subject to certain additional risks in connection with promotional financing offered through the GreenSky program.
Many of the loans originated by our Bank Partners provide promotional financing in the form of low or deferred interest. When a deferred interest loan is paid in full prior to the end of the promotional period (typically
81
six to 24 months), any interest that has been billed on the loan by our Bank Partner to the consumer is reversed, which triggers an obligation on our part to make a payment to the Bank Partner that made the loan in order to fully offset the reversal (each event, a finance charge reversal or "FCR"). We record a FCR liability on our balance sheet for interest previously billed during the promotional period that is expected to be reversed prior to the end of such period. As of September 30, 2020, this liability was $187.5 million. See Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for further information. If the rate at which deferred interest loans are paid in full prior to the end of the promotional period increases, resulting in increased payments by us to our Bank Partners, it would adversely affect our business.
Further, deferred interest loans are subject to enhanced regulatory scrutiny as a result of abusive marketing practices by some lenders, and the CFPB has initiated enforcement actions against both lenders and servicers alleging that they have engaged in unfair, deceptive or abusive acts or practices because of lack of clarity in disclosures with respect to such loans. Such scrutiny could reduce the attractiveness to consumers of deferred interest loans or result in a general unwillingness on the part of our Bank Partners to make deferred interest loans. A reduction in the dollar volume of deferred interest loans offered through the GreenSky program would adversely affect our business.
The loss of the services of our senior management could adversely affect our business.
The experience of our senior management, including, in particular, David Zalik, our Chief Executive Officer, is a valuable asset to us. Our management team has significant experience in the consumer loan business and would be difficult to replace. Competition for senior executives in our industry is intense, and we may not be able to attract and retain qualified personnel to replace or succeed members of our senior management team or other key personnel. Failure to retain talented senior leadership could have a material adverse effect on our business. We do not maintain key life insurance policies relating to our senior management.
Our vendor relationships subject us to a variety of risks, and the failure of third parties to comply with legal or regulatory requirements or to provide various services that are important to our operations could have an adverse effect on our business.
We have significant vendors that, among other things, provide us with financial, technology and other services to support our loan servicing and other activities, including, for example, credit ratings and reporting, cloud-based data storage and other IT solutions, and payment processing. The CFPB has issued guidance stating that institutions under its supervision may be held responsible for the actions of the companies with which they contract. Accordingly, we could be adversely impacted to the extent our vendors fail to comply with the legal requirements applicable to the particular products or services being offered.
In some cases, third-party vendors are the sole source, or one of a limited number of sources, of the services they provide to us. Most of our vendor agreements are terminable on little or no notice, and if our current vendors were to stop providing services to us on acceptable terms, we may be unable to procure alternatives from other vendors in a timely and efficient manner and on acceptable terms (or at all). If any third-party vendor fails to provide the services we require, fails to meet contractual requirements (including compliance with applicable laws and regulations), fails to maintain adequate data privacy and electronic security systems, or suffers a cyber-attack or other security breach, we could be subject to CFPB, FTC and other regulatory enforcement actions and suffer economic and reputational harm that could have a material adverse effect on our business. Further, we may incur significant costs to resolve any such disruptions in service, which could adversely affect our business.
Litigation, regulatory actions and compliance issues could subject us to significant fines, penalties, judgments, remediation costs and/or requirements resulting in increased expenses.
Our business is subject to increased risks of litigation and regulatory actions as a result of a number of factors and from various sources, including as a result of the highly regulated nature of the financial services industry and the focus of state and federal enforcement agencies on the financial services industry.
In the ordinary course of business, we have been named as a defendant in various legal actions, including arbitrations, class actions and other litigation. Generally, this litigation arises from the dissatisfaction of a consumer with the products or services of a merchant; some of this litigation, however, has arisen from other matters,
82
including claims of discrimination, credit reporting and collection practices. Certain of those actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. From time to time, we also are involved in, or the subject of, reviews, requests for information, investigations and proceedings (both formal and informal) by state and federal governmental agencies, including banking regulators and the CFPB, regarding our business activities and our qualifications to conduct our business in certain jurisdictions, which could subject us to significant fines, penalties, obligations to change our business practices and other requirements resulting in increased expenses and diminished earnings. Our involvement in any such matter also could cause significant harm to our reputation and divert management attention from the operation of our business, even if the matters are ultimately determined in our favor. We have in the past chosen to settle (and may in the future choose to settle) certain matters in order to avoid the time and expense of contesting them. Although none of the settlements has been material to our business, in the future, such settlements could have a material adverse effect on our business. Moreover, any settlement, or any consent order or adverse judgment in connection with any formal or informal proceeding or investigation by a government agency, may prompt litigation or additional investigations or proceedings as other litigants or other government agencies begin independent reviews of the same activities.
In addition, a number of participants in the consumer finance industry have been the subject of putative class action lawsuits; state attorney general actions and other state regulatory actions; federal regulatory enforcement actions, including actions relating to alleged unfair, deceptive or abusive acts or practices; violations of state licensing and lending laws, including state usury laws; actions alleging discrimination on the basis of race, ethnicity, gender or other prohibited bases; and allegations of noncompliance with various state and federal laws and regulations relating to originating and servicing consumer finance loans. The current regulatory environment, increased regulatory compliance efforts and enhanced regulatory enforcement have resulted in significant operational and compliance costs and may prevent us from providing certain products and services. These regulatory matters or other factors could, in the future, affect how we conduct our business and, in turn, have a material adverse effect on our business. In particular, legal proceedings brought under state consumer protection statutes or under several of the various federal consumer financial services statutes subject to the jurisdiction of the CFPB may result in a separate fine for each violation of the statute, which, particularly in the case of class action lawsuits, could result in damages substantially in excess of the amounts we earned from the underlying activities.
We contest our liability and the amount of damages, as appropriate, in each pending matter. The outcome of pending and future matters could be material to our results of operations, financial condition and cash flows, and could materially adversely affect our business.
In addition, from time to time, through our operational and compliance controls, we identify compliance issues that require us to make operational changes and, depending on the nature of the issue, result in financial remediation to impacted customers. These self-identified issues and voluntary remediation payments could be significant, depending on the issue and the number of customers impacted, and also could generate litigation or regulatory investigations that subject us to additional risk. See “–Risks Related to Our Regulatory Environment.”
Regulatory agencies and consumer advocacy groups are becoming more aggressive in asserting “disparate impact” claims.
Antidiscrimination statutes, such as the Equal Credit Opportunity Act (the “ECOA”), prohibit creditors from discriminating against loan applicants and borrowers based on certain characteristics, such as race, religion and national origin. Various federal regulatory agencies and departments, including the U.S. Department of Justice (“DOJ”) and CFPB, take the position that these laws prohibit not only intentional discrimination, but also neutral practices that have a “disparate impact” on a group and that are not justified by a business necessity.
These regulatory agencies, as well as consumer advocacy groups and plaintiffs’ attorneys, are focusing greater attention on “disparate impact” claims. To the extent that the “disparate impact” theory continues to apply, we may face significant administrative burdens in attempting to identify and eliminate neutral practices that do have “disparate impact.” The ability to identify and eliminate neutral practices that have “disparate impact” is complicated by the fact that often it is our merchants, over which we have limited control, that implement our practices. In addition, we face the risk that one or more of the variables included in the GreenSky program’s loan decisioning model may be invalidated under the disparate impact test, which would require us to revise the loan decisioning model in a manner that might generate lower approval rates or higher credit losses.
83
In addition to reputational harm, violations of the ECOA can result in actual damages, punitive damages, injunctive or equitable relief, attorneys’ fees and civil money penalties.
Fraudulent activity could negatively impact our business and could cause our Bank Partners to be less willing to originate loans as part of the GreenSky program.
Fraud is prevalent in the financial services industry and is likely to increase as perpetrators become more sophisticated. We are subject to the risk of fraudulent activity associated with our merchants, their customers and third parties handling customer information. Our resources, technologies and fraud prevention tools may be insufficient to accurately detect and prevent fraud. The level of our fraud charge-offs could increase and our results of operations could be materially adversely affected if fraudulent activity were to significantly increase. High profile fraudulent activity also could negatively impact our brand and reputation, which could negatively impact the use of our services and products. In addition, significant increases in fraudulent activity could lead to regulatory intervention, which could increase our costs and also negatively impact our business.
Misconduct and errors by our employees and third-party service providers could harm our business and reputation.
We are exposed to many types of operational risks, including the risk of misconduct and errors by our employees and other third-party service providers. Our business depends on our employees and third-party service providers to facilitate the operation of our business, and if any of our employees or third-party service providers provide unsatisfactory service or take, convert or misuse funds, documents or data or fail to follow protocol when interacting with Bank Partners, Sponsors and merchants, the number of loans originated through the GreenSky program could decline, we could be liable for damages and we could be subject to complaints, regulatory actions and penalties.
While we have internal procedures and oversight functions to protect us against this risk, we also could be perceived to have facilitated or participated in the illegal misappropriation of funds, documents or data, or the failure to follow protocol, and therefore be subject to civil or criminal liability.
Any of these occurrences could result in our diminished ability to operate our business, potential liability, inability to attract future Bank Partners, other funding sources, Sponsors, merchants and consumers, reputational damage, regulatory intervention and financial harm, which could negatively impact our business, financial condition and results of operations.
Cyber-attacks and other security breaches could have an adverse effect on our business.
In the normal course of our business, we collect, process and retain sensitive and confidential information regarding our Bank Partners, our merchants and consumers. We also have arrangements in place with certain of our third-party service providers that require us to share consumer information. Although we devote significant resources and management focus to ensuring the integrity of our systems through information security and business continuity programs, our facilities and systems, and those of our Bank Partners, merchants and third-party service providers, are vulnerable to external or internal security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors, and other similar events. We, our Bank Partners, our merchants and our third-party service providers have experienced all of these events in the past and expect to continue to experience them in the future. We also face security threats from malicious third parties that could obtain unauthorized access to our systems and networks, which threats we anticipate will continue to grow in scope and complexity over time. These events could interrupt our business or operations, result in significant legal and financial exposure, supervisory liability, damage to our reputation and a loss of confidence in the security of our systems, products and services. Although the impact to date from these events has not had a material adverse effect on us, this may not be the case in the future.
Information security risks in the financial services industry have increased recently, in part because of new technologies, the use of the internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions and the increased sophistication and activities of organized criminals, perpetrators of fraud, hackers, terrorists and others. In addition to cyber-attacks and other security breaches involving the theft of sensitive and confidential information, hackers recently have engaged in attacks that are designed to disrupt key business services, such as consumer-facing websites. We may not be able to anticipate or
84
implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently and because attacks can originate from a wide variety of sources. We employ detection and response mechanisms designed to contain and mitigate security incidents. Nonetheless, early detection efforts may be thwarted by sophisticated attacks and malware designed to avoid detection. We also may fail to detect the existence of a security breach related to the information of our Bank Partners, merchants and consumers that we retain as part of our business and may be unable to prevent unauthorized access to that information.
We also face risks related to cyber-attacks and other security breaches that typically involve the transmission of sensitive information regarding borrowers through various third parties, including our Bank Partners, our merchants and data processors. Some of these parties have in the past been the target of security breaches and cyber-attacks. Because we do not control these third parties or oversee the security of their systems, future security breaches or cyber-attacks affecting any of these third parties could impact us through no fault of our own, and in some cases we may have exposure and suffer losses for breaches or attacks relating to them. While we regularly conduct security assessments of significant third-party service providers, our third-party information security protocols may not be sufficient to withstand a cyber-attack or other security breach.
The access by unauthorized persons to, or the improper disclosure by us of, confidential information regarding GreenSky program customers or our own proprietary information, software, methodologies and business secrets could interrupt our business or operations, result in significant legal and financial exposure, supervisory liability, damage to our reputation or a loss of confidence in the security of our systems, products and services, all of which could have a material adverse impact on our business. In addition, there recently have been a number of well-publicized attacks or breaches affecting companies in the financial services industry that have heightened concern by consumers, which could also intensify regulatory focus, cause users to lose trust in the security of the industry in general and result in reduced use of our services and increased costs, all of which could also have a material adverse effect on our business.
Furthermore, in light of the COVID-19 pandemic, we have directed most of our personnel to work remotely and we have restricted on-site staff to those personnel and contractors who perform essential activities that must be completed on-site. This new working environment could increase our cyber-security risk, create data accessibility concerns, and make us more susceptible to communication disruptions, any of which could adversely impact our business operations. We continue to implement physical and cyber-security measures to ensure that our systems remain functional in order to serve our operational needs with a remote workforce and prevent disruptions to our business.
Disruptions in the operation of our computer systems and third-party data centers could have an adverse effect on our business.
Our ability to deliver products and services to our Bank Partners and merchants, service loans made by our Bank Partners and otherwise operate our business and comply with applicable laws depends on the efficient and uninterrupted operation of our computer systems and third-party data centers, as well as those of our Bank Partners, merchants and third-party service providers.
These computer systems and third-party data centers may encounter service interruptions at any time due to system or software failure, natural disasters, severe weather conditions, health pandemics, terrorist attacks, cyber-attacks or other events. Any of such catastrophes could have a negative effect on our business and technology infrastructure (including our computer network systems), on our Bank Partners and merchants and on consumers. Catastrophic events also could prevent or make it more difficult for customers to travel to our merchants’ locations to shop, thereby negatively impacting consumer spending in the affected regions (or in severe cases, nationally), and could interrupt or disable local or national communications networks, including the payment systems network, which could prevent customers from making purchases or payments (temporarily or over an extended period). These events also could impair the ability of third parties to provide critical services to us. All of these adverse effects of catastrophic events could result in a decrease in the use of our solution and payments to us, which could have a material adverse effect on our business.
In addition, the implementation of technology changes and upgrades to maintain current and integrate new systems may cause service interruptions, transaction processing errors or system conversion delays and may cause us to fail to comply with applicable laws, all of which could have a material adverse effect on our business. We
85
expect that new technologies and business processes applicable to the consumer financial services industry will continue to emerge and that these new technologies and business processes may be better than those we currently use. We may not be able to successfully adopt new technology as critical systems and applications become obsolete and better ones become available. A failure to maintain and/or improve current technology and business processes could cause disruptions in our operations or cause our solution to be less competitive, all of which could have a material adverse effect on our business.
If the credit decisioning, pricing, loss forecasting and credit scoring models we use contain errors, do not adequately assess risk or are otherwise ineffective, our reputation and relationships with our Bank Partners, other funding sources, our merchants and consumers could be harmed.
Our ability to attract consumers to the GreenSky program, and to build trust in the consumer loan products offered through the GreenSky program, is significantly dependent on our ability to effectively evaluate a consumer’s credit profile and likelihood of default in accordance with our Bank Partners’ underwriting policies. To conduct this evaluation, we use proprietary credit decisioning, pricing, loss forecasting and credit scoring models. If any of the credit decisioning, pricing, loss forecasting and credit scoring models we use contains programming or other errors, is ineffective or the data provided by consumers or third parties is incorrect or stale, or if we are unable to obtain accurate data from consumers or third parties (such as credit reporting agencies), our loan pricing and approval process could be negatively affected, resulting in mispriced or misclassified loans or incorrect approvals or denials of loans and possibly our having to repurchase the loan. This could damage our reputation and relationships with consumers, our Bank Partners, other funding sources and our merchants, which could have a material adverse effect on our business.
We depend on the accuracy and completeness of information about customers of our merchants, and any misrepresented information could adversely affect our business.
In evaluating loan applicants, we rely on information furnished to us by or on behalf of customers of our merchants, including credit, identification, employment and other relevant information. Some of the information regarding customers provided to us is used in our proprietary credit decisioning and scoring models, which we use to determine whether an application meets the applicable underwriting criteria. We rely on the accuracy and completeness of that information.
Not all customer information is independently verified. As a result, we rely on the accuracy and completeness of the information we are provided by consumers. If any of the information that is considered in the loan review process is inaccurate, whether intentional or not, and such inaccuracy is not detected prior to loan funding, the loan may have a greater risk of default than expected. Additionally, there is a risk that, following the date of the credit report that we obtain and review, a customer may have defaulted on, or become delinquent in the payment of, a pre-existing debt obligation, taken on additional debt, lost his or her job or other sources of income, or experienced other adverse financial events. Where an inaccuracy constitutes fraud or otherwise causes us to incorrectly conclude that a loan meets the applicable underwriting criteria, we generally bear the risk of loss associated with the inaccuracy. Any significant increase in inaccuracies or resulting increases in losses would adversely affect our business.
We rely extensively on models in managing many aspects of our business. Any inaccuracies or errors in our models could have an adverse effect on our business.
In assisting our Bank Partners and merchants with the design of the products that are offered on our platform, we make assumptions about various matters, including repayment timing and default rates, and then utilize our proprietary modeling to analyze and forecast the performance and profitability of the products. Our assumptions may be inaccurate and our models may not be as predictive as expected for many reasons, including that they often involve matters that are inherently difficult to predict and beyond our control (e.g., macroeconomic conditions) and that they often involve complex interactions between a number of dependent and independent variables and factors. Any significant inaccuracies or errors in our assumptions could negatively impact the profitability of the products that are offered on our platform, as well as the profitability of our business, and could result in our underestimating potential FCRs.
86
If assumptions or estimates we use in preparing our financial statements are incorrect or are required to change, our reported results of operations and financial condition may be adversely affected.
We are required to make various assumptions and estimates in preparing our financial statements under GAAP and in determining certain disclosures required under GAAP, including for purposes of determining share-based compensation; asset impairment; reserves related to litigation and other legal matters and contingencies and other regulatory exposures; the amounts recorded for certain contractual payments to be paid to, or received from, our merchants and others under contractual arrangements; fair value measurements of derivative instruments, servicing assets and liabilities and loans receivable held for sale; and measurement of financial guarantees. If the assumptions or estimates underlying our financial statements are incorrect, the actual amounts realized on transactions and balances subject to those estimates will be different, which could have a material adverse effect on our business.
The consumer finance and payments industry is highly competitive and is likely to become more competitive, and our inability to compete successfully or maintain or improve our market share and margins could adversely affect our business.
Our success depends on our ability to generate usage of the GreenSky program. The consumer financial services industry is highly competitive and increasingly dynamic as emerging technologies continue to enter the marketplace. Technological advances and heightened e-commerce activities have increased consumers’ accessibility to products and services, which has intensified the desirability of offering loans to consumers through digital-based solutions. In addition, because many of our competitors are large financial institutions that own the loans that they originate, they have certain revenue opportunities not currently available to us. We face competition in areas such as compliance capabilities, financing terms, promotional offerings, fees, approval rates, speed and simplicity of loan origination, ease-of-use, marketing expertise, service levels, products and services, technological capabilities and integration, customer service, brand and reputation. Many of our competitors are substantially larger than we are, which may give those competitors advantages we do not have, such as a more diversified product and customer base, the ability to reach more customers and potential customers, operational efficiencies, more versatile technology platforms, broad-based local distribution capabilities, and lower-cost funding. Commercial banks and savings institutions also may have significantly greater access to consumers given their deposit-taking and other services.
Our existing and potential competitors may decide to modify their pricing and business models to compete more directly with our model. Any reduction in usage of the GreenSky program, or a reduction in the lifetime profitability of loans under the GreenSky program in an effort to attract or retain business, could reduce our revenues and earnings. If we are unable to compete effectively for merchant and customer usage, our business could be materially adversely affected.
Our revenue is impacted, to a significant extent, by the general economy and the financial performance of our merchants.
Our business, the consumer financial services industry and our merchants’ businesses are sensitive to macroeconomic conditions. Economic factors such as interest rates, changes in monetary and related policies, market volatility, consumer confidence and unemployment rates are among the most significant factors that impact consumer spending behavior. Weak economic conditions or a significant deterioration in economic conditions reduce the amount of disposable income consumers have, which in turn reduces consumer spending and the willingness of qualified borrowers to take out loans. Such conditions are also likely to affect the ability and willingness of borrowers to pay amounts owed to our Bank Partners, each of which would have a material adverse effect on our business.
The generation of new loans through the GreenSky program, and the transaction fees and other fee income to us associated with such loans, is dependent upon sales of products and services by our merchants. Our merchants’ sales may decrease or fail to increase as a result of factors outside of their control, such as the macroeconomic conditions referenced above, or business conditions affecting a particular merchant, industry vertical or region. Weak economic conditions also could extend the length of our merchants’ sales cycle and cause customers to delay making (or not make) purchases of our merchants’ products and services. The decline of sales by our merchants for any reason will generally result in lower credit sales and, therefore, lower loan volume and associated fee income
87
for us. This risk is particularly acute with respect to our largest merchants that account for a significant amount of our platform revenue.
In addition, if a merchant closes some or all of its locations or becomes subject to a voluntary or involuntary bankruptcy proceeding (or if there is a perception that it may become subject to a bankruptcy proceeding), GreenSky program borrowers may have less incentive to pay their outstanding balances to our Bank Partners, which could result in higher charge-off rates than anticipated. Moreover, if the financial condition of a merchant deteriorates significantly or a merchant becomes subject to a bankruptcy proceeding, we may not be able to recover amounts due to us from the merchant.
Because our business is heavily concentrated on consumer lending and payments in the U.S. home improvement industry, our results are more susceptible to fluctuations in that market than the results of a more diversified company would be.
Our business currently is heavily concentrated on consumer lending in the home improvement industry. As a result, we are more susceptible to fluctuations and risks particular to U.S. consumer credit, real estate and home improvements than a more diversified company would be as well as to factors that may drive the demand for home improvements, such as sales levels of existing homes and the aging of housing stock. We also are more susceptible to the risks of increased regulations and legal and other regulatory actions that are targeted at consumer credit, the specific consumer credit products that our Bank Partners offer (including promotional financing), real estate and home improvements. Our business concentration could have an adverse effect on our business.
As part of our elective healthcare vertical we face some factors that differ from our home improvement vertical, and the unique considerations of this industry vertical, and our failure to comply with applicable regulations, or accurately forecast demand or growth could have an adverse effect on our business.
Our elective healthcare industry vertical involves consumer financing for elective medical procedures and products. Elective healthcare providers include doctors’ and dentists’ offices, outpatient surgery centers and clinics providing orthodontics, cosmetic and aesthetic dentistry, vision correction, bariatric surgery, cosmetic surgery, hair replacement, reproductive medicine, veterinary medicine and hearing aid devices. We may not achieve similar levels of success, if any, in this industry vertical, or that we will not face unanticipated challenges in our ability to offer our program in this industry vertical. In addition, the elective healthcare industry vertical is highly regulated and we, our merchants and our Bank Partners, as applicable, will be subject to significant additional regulatory requirements, including various healthcare and privacy laws. We have limited experience in managing these risks and the compliance requirements attendant to these additional regulatory requirements. See “–Risks Related to Our Regulatory Environment–The increased scrutiny of third-party medical financing by governmental agencies may lead to increased regulatory burdens and adversely affect our consolidated revenue or results of operations.” The costs of compliance and any failure by us, our merchants or our Bank Partners, as applicable, to comply with such regulatory requirements could have a material adverse effect on our business.
We may in the future expand into new industry verticals and our failure to mitigate specific regulatory, credit, and other risks associated with a new industry vertical could have an adverse effect on our business.
We may in the future further expand into other industry verticals. We may not be able to successfully develop consumer financing products and services for these new industries. Our investment of resources to develop consumer financing products and services for the new industries we enter may either be insufficient or result in expenses that are excessive in light of loans actually originated by our Bank Partners in those industries. Additionally, industry participants, including our merchants, their customers and our Bank Partners, may not be receptive to our solution in these new industries. The borrower profile of consumers in new verticals may not be as attractive, in terms of average FICO scores or other attributes, as in our current verticals, which may lead to higher levels of delinquencies or defaults than we have historically experienced. Industries change rapidly, and we may not be able to accurately forecast demand (or the lack thereof) for our solution or those industries may not grow. Failure to forecast demand or growth accurately in new industries could have a material adverse impact on our business.
88
Our business would suffer if we fail to attract and retain highly skilled employees.
Our future success will depend on our ability to identify, hire, develop, motivate and retain highly qualified personnel for all areas of our organization, particularly information technology and sales. Trained and experienced personnel are in high demand and may be in short supply. Many of the companies with which we compete for experienced employees have greater resources than we do and may be able to offer more attractive terms of employment. In addition, we invest significant time and expense in training our employees, which increases their value to competitors that may seek to recruit them. We may not be able to attract, develop and maintain the skilled workforce necessary to operate our business, and labor expenses may increase as a result of a shortage in the supply of qualified personnel.
The Amended Credit Agreement that governs our term loan and revolving loan facility contains various covenants that could limit our ability to engage in activities that may be in our best long-term interests.
We have a term loan and revolving loan facility that we may draw on to finance our operations and for other corporate purposes. The Amended Credit Agreement contains operating covenants, including customary limitations on the incurrence of certain indebtedness and liens, restrictions on certain intercompany transactions and limitations on dividends and stock repurchases. Our ability to comply with these covenants may be affected by events beyond our control, and breaches of these covenants could result in a default under the Amended Credit Agreement and any future financial agreements into which we may enter. If we default on our credit obligations, our lenders may require repayment of any outstanding debt and terminate the Amended Credit Agreement.
If any of these events occurs, our ability to fund our operations could be seriously harmed. If not waived, defaults could cause any outstanding indebtedness under our Amended Credit Agreement and any future financing agreements that we may enter into to become immediately due and payable.
For more information on our term loan and revolving loan facility, see Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Liquidity and Capital Resources–Borrowings” and Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1.
The SPV facility contains various covenants that could limit our ability to engage in activities that may be in our best long-term interests.
We have an SPV Facility and our ability to comply with the terms of the SPV Facility may be affected by events beyond our control. In addition, the assets of the SPV are owned by the SPV and are solely available to satisfy creditors of the SPV. As such, the SPV assets are not available to satisfy obligations of GreenSky, Inc., GS Holdings, GreenSky LLC or other subsidiaries of the Company.
For more information on the SPV Facility, see Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Liquidity and Capital Resources–Borrowings” and Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1.
We may incur losses on interest rate swap and hedging arrangements.
We may periodically enter into agreements to reduce the risks associated with increases in interest rates, such as our June 2019 interest rate swap agreement. Although these agreements may partially protect against rising interest rates, they also may reduce the benefits to us if interest rates decline. Also, nonperformance by the other party to the arrangement may subject us to increased credit risks. For additional information regarding our June 2019 interest rate swap agreement, see Note 3 and Note 8 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1.
We may be unable to sufficiently protect our proprietary rights and may encounter disputes from time to time relating to our use of the intellectual property of third parties.
We rely on a combination of trademarks, service marks, copyrights, trade secrets, domain names and agreements with employees and third parties to protect our proprietary rights. On July 28, 2020, the United States Patent and Trademark Office issued the Company’s first U.S. patent. Originally filed in 2014, the patent relates to our mobile application process and credit decisioning model. We also have trademark and service mark registrations
89
and pending applications for additional registrations in the United States. Further, we own the domain name rights for greensky.com, as well as other words and phrases important to our business. Nonetheless, third parties may challenge, invalidate or circumvent our intellectual property, and our intellectual property may not be sufficient to provide us with a competitive advantage.
Despite our efforts to protect these rights, unauthorized third parties may attempt to duplicate or copy the proprietary aspects of our technology and processes. Our competitors and other third parties independently may design around or develop similar technology or otherwise duplicate our services or products such that we could not assert our intellectual property rights against them. In addition, our contractual arrangements may not effectively prevent disclosure of our intellectual property and confidential and proprietary information or provide an adequate remedy in the event of an unauthorized disclosure. Measures in place may not prevent misappropriation or infringement of our intellectual property or proprietary information and the resulting loss of competitive advantage, and we may be required to litigate to protect our intellectual property and proprietary information from misappropriation or infringement by others, which is expensive, could cause a diversion of resources and may not be successful.
We also may encounter disputes from time to time concerning intellectual property rights of others, and we may not prevail in these disputes. Third parties may raise claims against us alleging that we, or consultants or other third parties retained or indemnified by us, infringe on their intellectual property rights. Some third-party intellectual property rights may be extremely broad, and it may not be possible for us to conduct our operations in such a way as to avoid all alleged violations of such intellectual property rights. Given the complex, rapidly changing and competitive technological and business environment in which we operate, and the potential risks and uncertainties of intellectual property-related litigation, an assertion of an infringement claim against us may cause us to spend significant amounts to defend the claim, even if we ultimately prevail, pay significant money damages, lose significant revenues, be prohibited from using the relevant systems, processes, technologies or other intellectual property (temporarily or permanently), cease offering certain products or services, or incur significant license, royalty or technology development expenses.
Moreover, it has become common in recent years for individuals and groups to purchase intellectual property assets for the sole purpose of making claims of infringement and attempting to extract settlements from companies such as ours. Even in instances where we believe that claims and allegations of intellectual property infringement against us are without merit, defending against such claims is time consuming and expensive and could result in the diversion of time and attention of our management and employees. In addition, although in some cases a third party may have agreed to indemnify us for such costs, such indemnifying party may refuse or be unable to uphold its contractual obligations. In other cases, our insurance may not cover potential claims of this type adequately or at all, and we may be required to pay monetary damages, which may be significant.
Our risk management processes and procedures may not be effective.
Our risk management processes and procedures seek to appropriately balance risk and return and mitigate our risks. We have established processes and procedures intended to identify, measure, monitor and control the types of risk to which we and our Bank Partners are subject, including credit risk, market risk, liquidity risk, strategic risk and operational risk. Credit risk is the risk of loss that arises when an obligor fails to meet the terms of an obligation. While our exposure to the direct economic cost of consumer credit risk is somewhat limited because, with the exceptions of SPV Participations, R&D Participations and other loans for which we purchase the receivables, we do not hold the loans or the receivables underlying the loans that our Bank Partners originate, we are exposed to consumer credit risk in the form of both our FCR liability and our limited escrow requirement, as well as our ability to maintain relationships with our existing Bank Partners and recruit new bank partners. Market risk is the risk of loss due to changes in external market factors such as interest rates. Liquidity risk is the risk that financial condition or overall safety and soundness are adversely affected by an inability, or perceived inability, to meet obligations and support business growth. Strategic risk is the risk from changes in the business environment, improper implementation of decisions or inadequate responsiveness to changes in the business environment. Operational risk is the risk of loss arising from inadequate or failed processes, people or systems, external events (e.g., natural disasters), compliance, reputational or legal matters and includes those risks as they relate directly to us as well as to third parties with whom we contract or otherwise do business.
90
Management of our risks depends, in part, upon the use of analytical and forecasting models. If these models are ineffective at predicting future losses or are otherwise inadequate, we may incur unexpected losses or otherwise be adversely affected. In addition, the information we use in managing our credit and other risks may be inaccurate or incomplete as a result of error or fraud, both of which may be difficult to detect and avoid. There also may be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated, including when processes are changed or new products and services are introduced. If our risk management framework does not effectively identify and control our risks, we could suffer unexpected losses or be adversely affected, which could have a material adverse effect on our business.
Some aspects of our platform include open source software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business.
Aspects of our platform include software covered by open source licenses. The terms of various open source licenses have not been interpreted by United States courts, and there is a risk that such licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our platform. If portions of our proprietary software are determined to be subject to an open source license, we could be required to publicly release the affected portions of our source code, re-engineer all or a portion of our technologies or otherwise be limited in the licensing of our technologies, each of which could reduce or eliminate the value of our technologies and loan products. In addition to risks related to license requirements, usage of open source software can lead to greater risks than use of third-party commercial software because open source licensors generally do not provide warranties or controls on the origin of the software. Many of the risks associated with the use of open source software cannot be eliminated and could adversely affect our business.
To the extent that we seek to grow through future acquisitions, or other strategic investments or alliances, we may not be able to do so effectively.
We may in the future seek to grow our business by exploring potential acquisitions or other strategic investments or alliances. We may not be successful in identifying businesses or opportunities that meet our acquisition or expansion criteria. In addition, even if a potential acquisition target or other strategic investment is identified, we may not be successful in completing such acquisition or integrating such new business or other investment. We may face significant competition for acquisition and other strategic investment opportunities from other well-capitalized companies, many of which have greater financial resources and greater access to debt and equity capital to secure and complete acquisitions or other strategic investments, than we do. As a result of such competition, we may be unable to acquire certain assets or businesses, or take advantage of other strategic investment opportunities that we deem attractive; the purchase price for a given strategic opportunity may be significantly elevated; or certain other terms or circumstances may be substantially more onerous. Any delay or failure on our part to identify, negotiate, finance on favorable terms, consummate and integrate any such acquisition or other strategic investment opportunity could impede our growth.
We may not be able to manage our expanding operations effectively or continue to grow, and any failure to do so could adversely affect our ability to generate revenue and control our expenses. Furthermore, we may be responsible for any legacy liabilities of businesses we acquire or be subject to additional liability in connection with other strategic investments. The existence or amount of these liabilities may not be known at the time of acquisition, or other strategic investment, and may have a material adverse effect on our business.
Future changes in financial accounting standards may significantly change our reported results of operations.
GAAP is subject to standard setting or interpretation by the FASB, the Public Company Accounting Oversight Board (the "PCAOB"), the SEC and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results and could affect the reporting of transactions completed before the announcement of a change.
Additionally, our assumptions, estimates and judgments related to complex accounting matters could significantly affect our financial results. GAAP and related accounting pronouncements, implementation guidelines and interpretations with regard to a wide range of matters that are relevant to our business, including revenue recognition, FCRs, loan participation sales, and share-based compensation are highly complex and involve subjective assumptions, estimates and judgments by us. Changes in these rules or their interpretation or changes in
91
underlying assumptions, estimates or judgments by us (i) could require us to make changes to our accounting systems that could increase our operating costs and (ii) could significantly change our reported or expected financial performance.
Risks Related to Our Regulatory Environment
We are subject to federal and state consumer protection laws.
In connection with our administration of the GreenSky program, we must comply with various regulatory regimes, including those applicable to consumer credit transactions, various aspects of which are untested as applied to our business model. The laws to which we are or may be subject include:
•state laws and regulations that impose requirements related to loan disclosures and terms, credit discrimination, credit reporting, money transmission, debt servicing and collection and unfair or deceptive business practices;
•the Truth-in-Lending Act and Regulation Z promulgated thereunder, and similar state laws, which require certain disclosures to borrowers regarding the terms and conditions of their loans and credit transactions;
•Section 5 of the Federal Trade Commission Act, which prohibits unfair and deceptive acts or practices in or affecting commerce, and Section 1031 of the Dodd-Frank Act, which prohibits unfair, deceptive or abusive acts or practices (“UDAAP”) in connection with any consumer financial product or service;
•the ECOA and Regulation B promulgated thereunder, which prohibit creditors from discriminating against credit applicants on the basis of race, color, sex, age, religion, national origin, marital status, the fact that all or part of the applicant’s income derives from any public assistance program or the fact that the applicant has in good faith exercised any right under the Federal Consumer Credit Protection Act or any applicable state law;
•the Fair Credit Reporting Act (the “FCRA”), as amended by the Fair and Accurate Credit Transactions Act, which promotes the accuracy, fairness and privacy of information in the files of consumer reporting agencies;
•the Fair Debt Collection Practices Act, the Telephone Consumer Protection Act, as well as state debt collection laws, all of which provide guidelines and limitations concerning the conduct of third-party debt collectors in connection with the collection of consumer debts;
•the Gramm-Leach-Bliley Act (the “GLBA”), which includes limitations on disclosure of nonpublic personal information by financial institutions about a consumer to nonaffiliated third parties, in certain circumstances requires financial institutions to limit the use and further disclosure of nonpublic personal information by nonaffiliated third parties to whom they disclose such information and requires financial institutions to disclose certain privacy policies and practices with respect to information sharing with affiliated and nonaffiliated entities as well as to safeguard personal customer information, and other privacy laws and regulations;
•the Bankruptcy Code, which limits the extent to which creditors may seek to enforce debts against parties who have filed for bankruptcy protection;
•the Servicemembers Civil Relief Act (the “SCRA”), which allows active duty military members to suspend or postpone certain civil obligations so that the military member can devote his or her full attention to military duties;
•the Electronic Fund Transfer Act and Regulation E promulgated thereunder, which provide disclosure requirements, guidelines and restrictions on the electronic transfer of funds from consumers’ bank accounts;
•the Electronic Signatures in Global and National Commerce Act and similar state laws, particularly the Uniform Electronic Transactions Act, which authorize the creation of legally binding and enforceable agreements utilizing electronic records and signatures; and
92
•the Bank Secrecy Act, which relates to compliance with anti-money laundering, customer due diligence and record-keeping policies and procedures.
While we have developed policies and procedures designed to assist in compliance with these laws and regulations, our compliance policies and procedures may not be effective. Failure to comply with these laws and with regulatory requirements applicable to our business could subject us to damages, revocation of licenses, class action lawsuits, administrative enforcement actions, and civil and criminal liability, which may harm our business.
Our industry is highly regulated and is undergoing regulatory transformation, which has created inherent uncertainty. Changing federal, state and local laws, as well as changing regulatory enforcement policies and priorities, may negatively impact our business.
In connection with our administration of the GreenSky program, we are subject to extensive regulation, supervision and examination under United States federal and state laws and regulations. We are required to comply with numerous federal, state and local laws and regulations that regulate, among other things, the manner in which we administer the GreenSky program, the terms of the loans that our Bank Partners originate and the fees that we may charge. A material or continued failure to comply with any of these laws or regulations could subject us to lawsuits or governmental actions and/or damage our reputation, which could materially adversely affect our business. Regulators, including the CFPB, have broad discretion with respect to the interpretation, implementation and enforcement of these laws and regulations, including through enforcement actions that could subject us to civil money penalties, customer remediations, increased compliance costs, and limits or prohibitions on our ability to offer certain products and services or to engage in certain activities. In addition, to the extent that we undertake actions requiring regulatory approval or non-objection, regulators may make their approval or non-objection subject to conditions or restrictions that could have a material adverse effect on our business. Moreover, some of our competitors are subject to different, and in some cases less restrictive, legislative and regulatory regimes, which may have the effect of providing them with a competitive advantage over us.
Additionally, federal, state and local governments and regulatory agencies have proposed or enacted numerous new laws, regulations and rules related to personal loans. Federal and state regulators also are enforcing existing laws, regulations and rules more aggressively and enhancing their supervisory expectations regarding the management of legal and regulatory compliance risks. Consumer finance regulation is constantly changing, and new laws or regulations, or new interpretations of existing laws or regulations, could have a materially adverse impact on our ability to operate as we currently intend.
These regulatory changes and uncertainties make our business planning more difficult and could result in changes to our business model and potentially adversely impact our results of operations. New laws or regulations also require us to incur significant expenses to ensure compliance. As compared to our competitors, we could be subject to more stringent state or local regulations or could incur marginally greater compliance costs as a result of regulatory changes. In addition, our failure to comply (or to ensure that our agents and third-party service providers comply) with these laws or regulations may result in costly litigation or enforcement actions, the penalties for which could include: revocation of licenses; fines and other monetary penalties; civil and criminal liability; substantially reduced payments by borrowers; modification of the original terms of loans, permanent forgiveness of debt, or inability to, directly or indirectly, collect all or a part of the principal of or interest on loans; and increased purchases of receivables underlying loans originated by our Bank Partners and indemnification claims.
Proposals to change the statutes affecting financial services companies are frequently introduced in Congress and state legislatures that, if enacted, may affect our operating environment in substantial and unpredictable ways. In addition, numerous federal and state regulators have the authority to promulgate or change regulations that could have a similar effect on our operating environment. We cannot determine whether any such legislative or regulatory proposals will be enacted and, if enacted, the ultimate impact that any such potential legislation or implementing regulations, or any such potential regulatory actions by federal or state regulators, would have upon our business.
With respect to state regulation, although we seek to comply with applicable state loan, loan broker, loan originator, servicing, debt collection, money transmitter and similar statutes in all U.S. jurisdictions, and with licensing and other requirements that we believe may be applicable to us, if we are found to not have complied with applicable laws, we could lose one or more of our licenses or authorizations or face other sanctions or penalties or
93
be required to obtain a license in one or more such jurisdictions, which may have an adverse effect on our ability to make the GreenSky program available to borrowers in particular states and, thus, adversely impact our business.
We also are subject to potential enforcement and other actions that may be brought by state attorneys general or other state enforcement authorities and other governmental agencies. Any such actions could subject us to civil money penalties and fines, customer remediations and increased compliance costs, as well as damage our reputation and brand and limit or prohibit our ability to offer certain products and services or engage in certain business practices.
New laws, regulations, policy or changes in enforcement of existing laws or regulations applicable to our business, or our reexamination of our current practices, could adversely impact our profitability, limit our ability to continue existing or pursue new business activities, require us to change certain of our business practices or alter our relationships with GreenSky program customers, affect retention of our key personnel, or expose us to additional costs (including increased compliance costs and/or customer remediation). These changes also may require us to invest significant resources, and devote significant management attention, to make any necessary changes and could adversely affect our business.
The highly regulated environment in which our Bank Partners operate could have an adverse effect on our business.
Our Bank Partners are subject to federal and state supervision and regulation. Federal regulation of the banking industry, along with tax and accounting laws, regulations, rules and standards, may limit their operations significantly and control the methods by which they conduct business. In addition, compliance with laws and regulations can be difficult and costly, and changes to laws and regulations can impose additional compliance requirements. For example, the Dodd-Frank Act imposes significant regulatory and compliance changes on financial institutions. Regulatory requirements affect our Bank Partners’ lending practices and investment practices, among other aspects of their businesses, and restrict transactions between us and our Bank Partners. These requirements may constrain the operations of our Bank Partners, and the adoption of new laws and changes to, or repeal of, existing laws may have a further impact on our business.
In choosing whether and how to conduct business with us, current and prospective Bank Partners can be expected to take into account the legal, regulatory and supervisory regime that applies to them, including potential changes in the application or interpretation of regulatory standards, licensing requirements or supervisory expectations. Regulators may elect to alter standards or the interpretation of the standards used to measure regulatory compliance or to determine the adequacy of liquidity, certain risk management or other operational practices for financial services companies in a manner that impacts our Bank Partners. Furthermore, the regulatory agencies have extremely broad discretion in their interpretation of the regulations and laws and their interpretation of the quality of our Bank Partners’ loan portfolios and other assets. If any regulatory agency’s assessment of the quality of our Bank Partners’ assets, operations, lending practices, investment practices or other aspects of their business changes, it may materially reduce our Bank Partners’ earnings, capital ratios and share price in such a way that affects our business.
Bank holding companies and financial institutions are extensively regulated and currently face an uncertain regulatory environment. Applicable state and federal laws, regulations, interpretations, including licensing laws and regulations, enforcement policies and accounting principles have been subject to significant changes in recent years, and may be subject to significant future changes. We do not know the substance or effect of pending or future legislation or regulation or the application of laws and regulations to our Bank Partners. Future changes may have a material adverse effect on our Bank Partners and, therefore, on us.
In January 2020, our Bank Partners became subject to a new reporting requirement, Accounting Standards Update 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments),” which may affect how they reserve for losses on loans. At this time, we do not know what effect, if any, this new reporting requirement will have on participation in our program.
We are subject to regulatory examinations and investigations and may incur fines, penalties and increased costs that could negatively impact our business.
94
Federal and state agencies have broad enforcement powers over us, including powers to investigate our business practices and broad discretion to deem particular practices unfair, deceptive, abusive or otherwise not in accordance with the law. The continued focus of regulators on the consumer financial services industry has resulted, and could continue to result, in new enforcement actions that could, directly or indirectly, affect the manner in which we conduct our business and increase the costs of defending and settling any such matters, which could negatively impact our business. In some cases, regardless of fault, it may be less time-consuming or costly to settle these matters, which may require us to implement certain changes to our business practices, provide remediation to certain individuals or make a settlement payment to a given party or regulatory body. We have in the past chosen to settle certain matters in order to avoid the time and expense of contesting them. Any future settlements could have a material adverse effect on our business.
In addition, the laws and regulations applicable to us are subject to administrative or judicial interpretation. Some of these laws and regulations have been enacted only recently and may not yet have been interpreted or may be interpreted infrequently. As a result of infrequent or sparse interpretations, ambiguities in these laws and regulations may create uncertainty with respect to what type of conduct is permitted or restricted under such laws and regulations. Any ambiguity under a law or regulation to which we are subject may lead to regulatory investigations, governmental enforcement actions and private causes of action, such as class action lawsuits, with respect to our compliance with such laws or regulations.
The CFPB is a relatively new agency, and there continues to be uncertainty as to how its actions will impact our business; the agency’s actions have had, and may continue to have, an adverse impact on our business.
The CFPB has broad authority over the businesses in which we engage. The CFPB is authorized to prevent “unfair, deceptive or abusive acts or practices” through its regulatory, supervisory and enforcement authority and to remediate violations of numerous consumer protection laws in a variety of ways, including collecting civil money penalties and fines and providing for customer restitution. The CFPB is charged, in part, with enforcing certain federal laws involving consumer financial products and services and is empowered with examination, enforcement and rulemaking authority. The CFPB has taken an active role in regulating lending markets. For example, the CFPB sends examiners to banks and other financial institutions that service and/or originate consumer loans to determine compliance with applicable federal consumer financial laws and to assess whether consumers’ interests are protected. In addition, the CFPB maintains an online complaint system that allows consumers to log complaints with respect to various consumer finance products, including those included in the GreenSky program.
There continues to be uncertainty as to how the CFPB’s strategies and priorities will impact our business and our results of operations going forward. Actions by the CFPB could result in requirements to alter or cease offering affected products and services, making them less attractive or restricting our ability to offer them. Although we have committed significant resources to enhancing our compliance programs, changes by the CFPB in regulatory expectations, interpretations or practices could increase the risk of additional enforcement actions, fines and penalties.
In March 2015, the CFPB issued a report scrutinizing pre-dispute arbitration clauses and, in May 2016, it published a proposed rule that would substantially curtail our ability to enter into voluntary pre-dispute arbitration clauses with consumers. In July 2017, the CFPB issued a final rule banning bars on class action arbitration (but not arbitration generally). Pre-dispute arbitration clauses currently are contained in all of the loan agreements processed through the GreenSky program. The new rule was subsequently challenged in Congress and, on November 1, 2017, President Trump approved a resolution repealing the rule. In the future, if a similar rule were to become effective, we expect that our exposure to class action arbitration would increase significantly, which could have a material adverse effect on our business.
On October 5, 2017, the CFPB released its final “Payday, Vehicle Title, and Certain High-Cost Lending Rule,” commonly referred to as the “Payday Loan Rule.” On February 6, 2019, the CFPB issued proposed revisions to the Payday Loan Rule. On June 7, 2019, the CFPB announced a 15-month delay in the Payday Loan Rule's August 19, 2019 compliance date to November 19, 2020 that applies only to the proposed rescinded ability-to-pay provisions. The mandatory compliance deadline for certain other provisions of the Payday Loan Rule still stands at August 19, 2019. Relatedly, the Community Financial Services Association of America sued the CFPB in April 2018 over the Payday Loan Rule. As a result, the court suspended the CFPB’s August 19, 2019 implementation of
95
the 2019 proposed revisions pending further order of the court. On August 6, 2019, the court issued an order that leaves the compliance date stay in effect. On July 7, 2020, the CFPB released a new final rule that revoked the underwriting provisions of the Payday Loan Rule but retained and ratified the payment provisions that continue to be subject to the court issued stay. While the Payday Loan Rule does not appear to be targeted at businesses like ours, some of its provisions are broad and potentially could be triggered by the promotional loans that our Bank Partners extend that require increases in payments at specified points in time. We are continuing to monitor developments associated with the Payday Loan Rule and are working toward compliance with the Payday Loan Rule requirements ahead of the ultimate compliance date.
Future actions by the CFPB (or other regulators) against us or our competitors that discourage the use of our or their services could result in reputational harm and adversely affect our business. If the CFPB changes regulations that were adopted in the past by other regulators and transferred to the CFPB by the Dodd-Frank Act, or modifies through supervision or enforcement past regulatory guidance or interprets existing regulations in a different or stricter manner than they have been interpreted in the past by us, the industry or other regulators, our compliance costs and litigation exposure could increase materially. If future regulatory or legislative restrictions or prohibitions are imposed that affect our ability to offer promotional financing for certain of our products or that require us to make significant changes to our business practices, and if we are unable to develop compliant alternatives with acceptable returns, these restrictions or prohibitions could have a material adverse effect on our business.
The Dodd-Frank Act generally permits state officials to enforce regulations issued by the CFPB and to enforce its general prohibition against unfair, deceptive or abusive practices. This could make it more difficult than in the past for federal financial regulators to declare state laws that differ from federal standards to be preempted. To the extent that states enact requirements that differ from federal standards or state officials and courts adopt interpretations of federal consumer laws that differ from those adopted by the CFPB, we may be required to alter or cease offering products or services in some jurisdictions, which would increase compliance costs and reduce our ability to offer the same products and services to consumers nationwide, and we may be subject to a higher risk of state enforcement actions.
The contours of the Dodd-Frank UDAAP standard are still uncertain and there is a risk that certain features of the GreenSky program loans could be deemed to violate the UDAAP standard.
The Dodd-Frank Act prohibits unfair, deceptive or abusive acts or practices and authorizes the CFPB to enforce that prohibition. The CFPB has filed a large number of UDAAP enforcement actions against consumer lenders for practices that do not appear to violate other consumer finance statutes. There is a risk that the CFPB could determine that certain features of the GreenSky program loans are unfair, deceptive or abusive. The CFPB has filed actions alleging that deferred interest programs can be unfair, deceptive or abusive if lenders do not adequately disclose the terms of the deferred interest loans.
Our use of third-party vendors and our other ongoing third-party business relationships are subject to increasing regulatory requirements and attention.
We regularly use third-party vendors and subcontractors as part of our business. We also depend on our substantial ongoing business relationships with our Bank Partners, merchants and other third parties. These types of third-party relationships, particularly with our Bank Partners and other funding sources, are subject to increasingly demanding regulatory requirements and oversight by federal bank regulators (such as the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation) and the CFPB. The CFPB has enforcement authority with respect to the conduct of third parties that provide services to financial institutions. The CFPB has made it clear that it expects non-bank entities to maintain an effective process for managing risks associated with third-party vendor relationships, including compliance-related risks. In connection with this vendor risk management process, we are expected to perform due diligence reviews of potential vendors, review their policies and procedures and internal training materials to confirm compliance-related focus, include enforceable consequences in contracts with vendors regarding failure to comply with consumer protection requirements, and take prompt action, including terminating the relationship, in the event that vendors fail to meet our expectations.
96
In certain cases, we may be required to renegotiate our agreements with our vendors and/or our subcontractors to meet these enhanced requirements, which could increase the costs of operating our business. It is expected that regulators will hold us responsible for deficiencies in our oversight and control of third-party relationships and in the performance of the parties with which we have these relationships. As a result, if our regulators conclude that we have not exercised adequate oversight and control over third-party vendors and subcontractors or other ongoing third-party business relationships or that such third parties have not performed appropriately, we could be subject to enforcement actions, including civil money penalties or other administrative or judicial penalties or fines, as well as requirements for customer remediation.
We are subject to numerous laws and regulations related to privacy, data protection and information security. Our actual or perceived failure to comply with such obligations could harm our business, and changes in such regulations or laws could increase our costs, affect or limit how we collect and use personal information and adversely affect our business opportunities, marketing, market research or advertising practices.
Subject to compliance with federal and state laws governing such collections, one of our subsidiary entities collects personally identifiable information and other data about consumers and prospective consumers who are also applying to participate in the GreenSky program. That subsidiary uses this information to provide services to the consumers; to support, expand and improve our business; and, subject to each consumer’s or prospective consumer’s right to decline or opt out, to market products and services to them. That subsidiary also may share consumers’ personally identifiable information with certain third parties as authorized by the consumers or as described in that subsidiary's privacy policy.
The U.S. federal and various state governments have adopted or proposed law, guidelines or rules for the collection, distribution and storage of information collected from or about consumers. The FTC and various U.S. state and local governments and agencies regularly use their authority under laws prohibiting unfair or deceptive marketing and trade practices to investigate and penalize companies for practices related to the collection, use, handling, disclosure, dissemination and security of personal data of consumers. Such laws and regulations apply broadly to the collection, use, storage, export, disclosure and security of personal information that identifies or may be used to identify an individual, such as names, contact information and, in some jurisdictions, certain unique identifiers. Furthermore, such laws and regulations are subject to frequent revisions and differing interpretations and generally have become more stringent over time.
In connection with our administration of the GreenSky program, we are subject to the GLBA and implementing regulations and guidance. Among other things, the GLBA (i) imposes certain limitations on financial institutions' ability to share their consumers’ nonpublic personal information with nonaffiliated third parties and (ii) requires certain disclosures to consumers about the institutions' information collection, sharing and security practices and the consumers' right to “opt out” of the institution’s disclosure of personal financial information to nonaffiliated third parties (with certain exceptions).
The California Consumer Privacy Act (the “CCPA”) became effective on January 1, 2020. The CCPA requires, among other things, covered companies to provide new disclosures to California consumers and afford such consumers with expanded protections and control over the collection, maintenance, use and sharing of personal information. The CCPA continues to be subject to new regulations and legislative amendments. Although we have implemented a compliance program designed to address obligations under the CCPA, it remains unclear what future modifications will be made or how the CCPA will be interpreted in the future. The CCPA provides for civil penalties for violations and a private right of action for data breaches.
In addition, the California Privacy Rights Act of 2020 (the "CRPA") ballot initiative was approved by California voters on November 3, 2020. Although this Act will not take effect until January 1, 2023, the Act will establish a privacy regulator before that date. We anticipate that CPRA will apply to our business and will work to ensure our compliance with the CPRA by its effective date.
These laws and regulations could have a significant impact on our current and planned privacy, data protection and information security-related practices; our current and planned collection, use, sharing, retention and safeguarding of consumer and/or employee information; and some of our current or planned business activities. Compliance with current or future privacy, data protection and information security laws (including those regarding security breach notification) affecting consumer and/or employee data to which we are subject could result in higher
97
compliance and technology costs and could restrict our ability to provide certain products and services (such as products or services that involve us sharing information with third parties or storing sensitive credit card information), which could materially and adversely affect our profitability. Privacy requirements, including notice and opt out requirements, under the GLBA and FCRA are enforced by the FTC and by the CFPB through UDAAP and are a standard component of CFPB examinations.
Our failure to comply with privacy, data protection and information security laws could result in potentially significant regulatory investigations and government actions; litigation; fines or sanctions; consumer, Bank Partner or merchant actions and damage to our reputation and brand; all of which could have a material adverse effect on our business. If any third parties with whom we work, such as marketing partners and vendors, violate applicable laws or our policies, such violations may put our consumers’ information at risk and could harm our business.
Future non-compliance with Payment Card Industry Data Security Standards (“PCI DSS”) may subject us to fines, penalties and civil liability and may result in the loss of our ability to accept credit and debit card payments.
We settle and fund transactions on a national credit card network and, thus, are subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, including PCI DSS, a security standard applicable to companies that collect, store or transmit certain data regarding credit and debit cards, holders and transactions.
Although we are currently in compliance with PCI DSS, we may not remain in compliance with such standards in the future. Any failure to comply fully or materially with PCI DSS at any point in the future (i) may violate payment card association operating rules, federal and state laws and regulations, and the terms of certain of our contracts with third parties, (ii) may subject us to fines, penalties, damages and civil liability, and (iii) may result in the loss of our ability to accept credit card payments. Even if we remain in compliance with PCI DSS, we still may not be able to prevent security breaches involving customer transaction data. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other events or developments could result in a compromise or breach of the processes that we use to protect customer data. If any such compromise or breach were to occur, it could have a material adverse effect on our business.
The increased scrutiny of third-party medical financing by governmental agencies may lead to increased regulatory burdens and may adversely affect our business.
We operate in the elective healthcare industry vertical, which includes consumer financing for elective medical procedures. Recently, regulators have increased scrutiny of third-party providers of financing for medical procedures that are generally not covered by health insurance. In addition, the CFPB and attorneys general in New York and Minnesota have conducted investigations of alleged abusive lending practices or exploitation regarding third-party medical financing services.
If, in the future, any of our practices in this space were found to be deficient, it could result in fines, penalties or increased regulatory burdens. Additionally, any regulatory inquiry could damage our reputation and limit our ability to conduct operations, which could adversely affect our business. Moreover, the adoption of any law, rule or regulation affecting the industry may also increase our administrative costs, require us to modify our practices to comply with applicable regulations or reduce our ability to participate competitively, which could have a material adverse effect on our business.
In recent years, federal regulators and the United States DOJ have increased their focus on enforcing the SCRA against servicers. Similarly, state legislatures have taken steps to strengthen their own state-specific versions of the SCRA.
The DOJ and federal regulators have entered into significant settlements with a number of loan servicers alleging violations of the SCRA. Some of the settlements have alleged that the servicers did not correctly apply the SCRA’s 6% interest rate cap, while other settlements have alleged, without limitation, that servicers did not comply with the SCRA’s default judgment protections when seeking to collect payment of a debt. Recent settlements indicate that the DOJ and federal regulators broadly interpret the scope of the substantive protections under the SCRA and are moving aggressively to identify instances in which loan servicers have not complied with the SCRA. Recent SCRA-related settlements continue to make this a significant area of scrutiny for both regulatory examinations and public enforcement actions.
98
In addition, most state legislatures have their own versions of the SCRA. In most instances, these laws extend some or all of the substantive benefits of the federal SCRA to members of the state National Guard who are in state service, but certain states also provide greater substantive protections to National Guard members or individuals who are in federal military service. In recent years, certain states have revised their laws to increase the potential benefits to individuals, and these changes pose additional compliance burdens on our Bank Partners and us as we seek to comply with both the federal and relevant state versions of the SCRA.
Our efforts and those of our Bank Partners to comply with the SCRA may not be effective, and our failure to comply could subject us to liability, damages and reputational harm, all of which could have an adverse effect on our business.
Anti-money laundering and anti-terrorism financing laws could have significant adverse consequences for us.
We maintain an enterprise-wide program designed to enable us to comply with all applicable anti-money laundering and anti-terrorism financing laws and regulations, including the Bank Secrecy Act and the Patriot Act. This program includes policies, procedures, processes and other internal controls designed to identify, monitor, manage and mitigate the risk of money laundering and terrorist financing. These controls include procedures and processes to detect and report suspicious transactions, perform customer due diligence, respond to requests from law enforcement, and meet all recordkeeping and reporting requirements related to particular transactions involving currency or monetary instruments. Our programs and controls may not be effective to ensure compliance with all applicable anti-money laundering and anti-terrorism financing laws and regulations, and our failure to comply with these laws and regulations could subject us to significant sanctions, fines, penalties and reputational harm, all of which could have a material adverse effect on our business.
If we were found to be operating without having obtained necessary state or local licenses, it could adversely affect our business.
Certain states have adopted laws regulating and requiring licensing by parties that engage in certain activity regarding consumer finance transactions, including facilitating and assisting such transactions in certain circumstances. Furthermore, certain states and localities have also adopted laws requiring licensing for consumer debt collection or servicing. While we believe we have obtained all necessary licenses, the application of some consumer finance licensing laws to the GreenSky program is unclear. If we were found to be in violation of applicable state licensing requirements by a court or a state, federal, or local enforcement agency, we could be subject to fines, damages, injunctive relief (including required modification or discontinuation of our business in certain areas), criminal penalties and other penalties or consequences, and the loans originated through the GreenSky program could be rendered void or unenforceable in whole or in part, any of which could have a material adverse effect on our business.
If loans originated through the GreenSky program are found to violate applicable state usury laws or other lending laws, it could adversely affect our business.
Because the loans originated through the GreenSky program are originated by and held by our Bank Partners, under principles of federal preemption the terms and conditions of the loans are not subject to most state consumer finance laws, including state licensing and usury restrictions. If a court, or a state or federal enforcement agency, were to deem GreenSky-rather than our Bank Partners-the “true lender” for loans originated through the GreenSky program, and if for this reason (or any other reason) the loans were deemed subject to and in violation of certain state consumer finance laws, we could be subject to fines, damages, injunctive relief (including required modification or discontinuation of our business in certain areas), and other penalties or consequences, and the loans could be rendered void or unenforceable in whole or in part, any of which could have a material adverse effect on our business.
We have been in the past and may in the future be subject to federal and state regulatory inquiries regarding our business.
We have, from time to time in the normal course of our business, received, and may in the future receive or be subject to, inquiries or investigations by state and federal regulatory agencies and bodies such as the CFPB, state attorneys general, state financial regulatory agencies, and other state or federal agencies or bodies regarding the
99
GreenSky program, including the origination and servicing of consumer loans, practices by merchants or other third parties, and licensing and registration requirements. For example, we have entered into regulatory agreements with state agencies regarding issues including merchant conduct and oversight and loan pricing and may enter into similar agreements in the future. We have also received inquiries from state regulatory agencies regarding requirements to obtain licenses from or register with those states, including in states where we have determined that we are not required to obtain such a license or be registered with the state, and we expect to continue to receive such inquiries. Any such inquiries or investigations could involve substantial time and expense to analyze and respond to, could divert management’s attention and other resources from running our business, and could lead to public enforcement actions or lawsuits and fines, penalties, injunctive relief, and the need to obtain additional licenses that we do not currently possess. Our involvement in any such matters, whether tangential or otherwise and even if the matters are ultimately determined in our favor, could also cause significant harm to our reputation, lead to additional investigations and enforcement actions from other agencies or litigants, and further divert management attention and resources from the operation of our business. As a result, the outcome of legal and regulatory actions arising out of any state or federal inquiries we receive could be material to our business, results of operations, financial condition and cash flows and could have a material adverse effect on our business, financial condition or results of operations.
Risks Related to Our Organizational Structure
We are a holding company with no operations of our own and, as such, depend on our subsidiaries for cash to fund all of our operations and expenses, including future dividend payments, if any.
We are a holding company and have no material assets other than our deferred tax assets and our equity interest in GS Holdings, which has the sole equity interest in GSLLC. We have no independent means of generating revenue or cash flow. We determined that GS Holdings is a variable interest entity ("VIE") and that we are the primary beneficiary of GS Holdings. Accordingly, pursuant to the VIE accounting model, we began consolidating GS Holdings in our consolidated financial statements following the IPO closing. In the event of a change in accounting guidance or amendments to the operating agreement of GS Holdings resulting in us no longer having a controlling interest in GS Holdings, we may not be able to continue consolidating its results of operations with our own, which would have a material adverse effect on our results of operations.
GS Holdings is treated as a partnership for United States federal income tax purposes, and GSLLC is treated as an entity disregarded as separate from GS Holdings for United States federal income tax purposes. As a result, neither GS Holdings nor GSLLC is subject to United States federal income tax. Instead, taxable income is allocated to the members of GS Holdings, including us. Accordingly, we incur income taxes on our proportionate share of any net taxable income of consolidated GS Holdings. We intend to cause GSLLC to make distributions to GS Holdings and to cause GS Holdings to make distributions to its unit holders in an amount sufficient to cover all applicable taxes payable by such unit holders determined according to assumed rates, payments owing under the tax receivable agreement ("TRA") and dividends, if any, declared by us. The ability of GSLLC to make distributions to GS Holdings, and of GS Holdings to make distributions to us, is limited by their obligations to satisfy their own obligations to their creditors. Further, future and current financing arrangements of GSLLC and GS Holdings contain, and future obligations could contain, negative covenants limiting such distributions. Additionally, our right to receive assets upon the liquidation or reorganization of GS Holdings, or indirectly from GSLLC, will be effectively subordinated to the claims of each entity’s creditors. To the extent that we are recognized as a creditor of GS Holdings or GSLLC, our claims may still be subordinate to any security interest in, or other lien on, its assets and to any of its debt or other obligations that are senior to our claims.
To the extent that we need funds and GSLLC or GS Holdings are restricted from making such distributions under applicable law or regulation, or are otherwise unable to provide such funds, it could materially and adversely affect our liquidity and financial condition. In addition, because tax distributions are based on an assumed tax rate, GS Holdings may be required to make tax distributions that, in the aggregate, may exceed the amount of taxes that GS Holdings would have paid if it were itself taxed on its net income (loss) at the assumed rate.
Funds used by GS Holdings to satisfy its tax distribution obligations will not be available for reinvestment in our business. Moreover, the tax distributions that GS Holdings will be required to make may be substantial and may exceed (as a percentage of GS Holdings’ income) the overall effective tax rate applicable to a similarly situated corporate taxpayer.
100
We may be required to pay additional taxes as a result of the new partnership audit rules.
The Bipartisan Budget Act of 2015 changed the rules applicable to U.S. federal income tax audits of partnerships, including entities such as GS Holdings that are taxed as a partnership. Under these rules (which generally are effective for taxable years beginning after December 31, 2017), subject to certain exceptions, audit adjustments to items of income, gain, loss, deduction, or credit of an entity (and any member’s share thereof) is determined, and taxes, interest, and penalties attributable thereto, are assessed and collected, at the entity level. Although it is uncertain how these rules will be implemented, it is possible that they could result in GS Holdings being required to pay additional taxes, interest and penalties as a result of an audit adjustment, and we, as a member of GS Holdings, could be required to indirectly bear the economic burden of those taxes, interest, and penalties even though we may not otherwise have been required to pay additional corporate-level taxes as a result of the related audit adjustment.
Under certain circumstances, GS Holdings may be eligible to make an election to cause members (including us) to take into account the amount of any understatement, including any interest and penalties, in accordance with their interests in GS Holdings in the year under audit. GS Holdings may not be able to make this election, in which case current members (including us) would economically bear the burden of the understatement even if they had a different percentage interest in GS Holdings during the year under audit, unless, and only to the extent, GS Holdings is able to recover such amounts from current or former impacted members. If the election is made, members would be required to take the adjustment into account in the taxable year in which the adjusted Schedule K-1s are issued.
The changes created by these new rules are sweeping and in many respects dependent on the promulgation of future regulations or other guidance by the U.S. Department of the Treasury.
The owners of the Class B common stock, who also are the Continuing LLC Members, control us and their interests may conflict with yours in the future.
The owners of the Class B common stock, who also are the Continuing LLC Members, control us. Each share of our Class B common stock initially entitles its holders to ten votes on all matters presented to our stockholders generally. Once the collective holdings of those owners in the aggregate are less than 15% of the combined economic interest in us, each share of Class B common stock will entitle its holder to one vote per share on all matters to be voted upon by our stockholders.
The owners of the Class B common stock owned the vast majority of the combined voting power of our Class A and Class B common stock as of September 30, 2020. Accordingly, those owners, if voting in the same manner, will be able to control the election and removal of our directors and thereby determine our corporate and management policies, including potential mergers or acquisitions, payment of dividends, asset sales, amendment of our certificate of incorporation and bylaws and other significant corporate transactions for so long as they retain significant ownership of us. This concentration of ownership may delay or deter possible changes in control of our Company, which may reduce the value of an investment in our Class A common stock. So long as they continue to own a significant amount of our combined voting power, even if such amount is less than 50%, they will continue to be able to strongly influence or effectively control our decisions.
In addition, the owners of the Class B common stock, as Continuing LLC Members, had ownership of Holdco Units of approximately 60% as of September 30, 2020. Because they hold the majority of their economic ownership interest in our business through GS Holdings, rather than GreenSky, Inc., these existing unit holders may have conflicting interests with holders of our Class A common stock. For example, the Continuing LLC Members may have different tax positions from us, which could influence their decisions regarding whether and when to dispose of assets and whether and when to incur new or refinance existing indebtedness, especially in light of the existence of the TRA. In addition, the structuring of future transactions may take into account the tax considerations of the Continuing LLC Members even where no similar benefit would accrue to us. It is through their ownership of Class B common stock that they may be able to influence, if not control, decisions such as these.
101
We will be required to pay for certain tax benefits we may claim arising in connection with the merger of the Former Corporate Investors, our purchase of Holdco Units and future exchanges of Holdco Units under the Exchange Agreement, which payments could be substantial.
On the date of our IPO, we were treated for United States federal income tax purposes as having directly purchased Holdco Units from the Exchanging Members. In the future, the Continuing LLC Members will be able to exchange their Holdco Units (with automatic cancellation of an equal number of shares of Class B common stock) for shares of Class A common stock on a one-for-one basis, subject to adjustments for certain subdivisions (stock splits), combinations, or purchases of Class A common stock or Holdco Units, or for cash (based on the market price of the shares of Class A common stock), at our option (such determination to be made by the disinterested members of our board of directors). As a result of these transactions, and our acquisition of the equity of certain of the Former Corporate Investors, we are and will become entitled to certain tax basis adjustments with respect to GS Holdings’ tax basis in its assets. As a result, the amount of income tax that we would otherwise be required to pay in the future may be reduced by the increase (for income tax purposes) in depreciation and amortization deductions attributable to our interests in GS Holdings. An 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. The IRS, however, may challenge all or part of that tax basis adjustment, and a court could sustain such a challenge.
We entered into the TRA with the TRA Parties that will provide for the payment by us of 85% of the amount of cash savings, if any, in United States federal, state and local income tax that we realize or are deemed to realize, as a result of (i) the tax basis adjustments referred to above, (ii) any incremental tax basis adjustments attributable to payments made pursuant to the TRA, and (iii) any deemed interest deductions arising from payments made by us pursuant to the TRA. While the actual amount of the adjusted tax basis, as well as the amount and timing of any payments under the TRA, will vary depending upon a number of factors, including the basis of our proportionate share of GS Holdings’ assets on the dates of exchanges, the timing of exchanges, the price of shares of our Class A common stock at the time of each exchange, the extent to which such exchanges are taxable, the deductions and other adjustments to taxable income to which GS Holdings is entitled, and the amount and timing of our income, we expect that during the anticipated term of the TRA, the payments that we may make could be substantial. Payments under the TRA may give rise to additional tax benefits and, therefore, to additional potential payments under the TRA. In addition, the TRA provides for interest accrued from the due date (without extensions) of the corresponding tax return for the taxable year with respect to which the payment obligation arises to the date of payment under the TRA.
Assuming no material changes in the relevant tax law and that we earn sufficient taxable income to realize all tax benefits that are subject to the TRA, we expect that the tax savings associated with the purchase of Holdco Units in connection with the IPO and future exchanges of Holdco Units (assuming such future exchanges occurred at September 30, 2020 and assuming automatic cancellation of an equal number of shares of Class B common stock) would aggregate to approximately $501.2 million based on the closing price on September 30, 2020 of $4.44 per share of our Class A common stock. Under such scenario, assuming future payments are made on the date each relevant tax return is due, without extensions, we would be required to pay approximately 85% of such amount, or $426.0 million.
There may be a material negative effect on our liquidity if, as a result of timing discrepancies or otherwise, (i) the payments under the TRA exceed the actual benefits we realize in respect of the tax attributes subject to the TRA and/or (ii) distributions to us by GS Holdings are not sufficient to permit us to make payments under the TRA after paying our other obligations. For example, were the IRS to challenge a tax basis adjustment or other deductions or adjustments to taxable income of GS Holdings, we will not be reimbursed for any payments that may previously have been made under the TRA, except that excess payments will be netted against payments otherwise to be made, if any, after our determination of such excess. As a result, in certain circumstances we could make payments under the TRA in excess of our ultimate cash tax savings. In addition, the payments under the TRA are not conditioned upon any recipient’s continued ownership of interests in us or GS Holdings, and the right to receive payments can be assigned.
In certain circumstances, including certain changes of control of our Company, payments by us under the TRA may be accelerated and/or significantly exceed the actual benefits we realize in respect of the tax attributes subject to the TRA.
102
The TRA provides that (i) in the event that we materially breach any of our material obligations under the TRA, whether as a result of failure to make any payment, failure to honor any other material obligation required thereunder or by operation of law as a result of the rejection of the TRA in a bankruptcy or otherwise, (ii) if, at any time, we elect an early termination of the TRA, or (iii) upon certain changes of control of our Company, our (or our successor’s) obligations under the TRA (with respect to all Holdco Units, whether or not such units have been exchanged or acquired before or after such transaction) would accelerate and become payable in a lump sum amount equal to the present value of the anticipated future tax benefits calculated based on certain assumptions, including that we would have sufficient taxable income to fully utilize the deductions arising from the increased tax deductions, tax basis and other benefits subject to the TRA.
As a result of the foregoing, if we breach a material obligation under the TRA, if we elect to terminate the TRA early or if we undergo a change of control, we would be required to make an immediate lump-sum payment equal to the present value of the anticipated future tax savings, which payment may be required to be made significantly in advance of the actual realization of such future tax savings, and the actual cash tax savings ultimately realized may be significantly less than the corresponding TRA payments. In these situations, our obligations under the TRA could have a substantial negative impact on our liquidity. We may not be able to fund or finance our obligations under the TRA. Additionally, the obligation to make a lump sum payment on a change of control may deter potential acquirers, which could negatively affect our stockholders’ potential returns. If we had elected to terminate the TRA as of September 30, 2020, based on the closing price on September 30, 2020 of $4.44 per share of our Class A common stock, and a discount rate equal to 4.27% per annum, compounded annually, we estimate that we would have been required to pay $299.8 million in the aggregate under the TRA.
If we were deemed to be an investment company under the Investment Company Act of 1940, as amended (the “1940 Act”), as a result of our ownership of GS Holdings and GSLLC, applicable restrictions could make it impractical for us to continue our business as currently contemplated and could have an adverse effect on our business.
Under Sections 3(a)(1)(A) and (C) of the 1940 Act, a company generally will be deemed to be an “investment company” for purposes of the 1940 Act if (i) it is, or holds itself out as being, engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities or (ii) it engages, or proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and it owns or proposes to acquire investment securities having a value exceeding 40% of the value of its total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. We do not believe that we are an “investment company,” as such term is defined in either of those sections of the 1940 Act.
Because GreenSky, Inc. is the managing member of GS Holdings, and GS Holdings is the managing member of GSLLC, we indirectly operate and control all of the business and affairs of GS Holdings and its subsidiaries, including GSLLC. On that basis, we believe that our interest in GS Holdings and GSLLC is not an “investment security,” as that term is used in the 1940 Act. However, if we were to cease participation in the management of GS Holdings and GSLLC, our interest in such entities could be deemed an “investment security” for purposes of the 1940 Act.
We, GS Holdings and GSLLC intend to conduct our operations so that we will not be deemed an investment company. However, if we were to be deemed an investment company, restrictions imposed by the 1940 Act, including limitations on our capital structure and our ability to transact with affiliates, could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business.
Our certificate of incorporation provides, subject to certain exceptions, that the Court of Chancery of the State of Delaware will be the sole and exclusive forum for certain stockholder litigation matters, which could limit our stockholders’ ability to bring a claim in a judicial forum that they find more favorable for disputes with us or our directors, officers, employees or stockholders.
Pursuant to our certificate of incorporation, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for (1) any derivative action or proceeding brought on our behalf, (2) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (3) any action asserting a claim against
103
us arising pursuant to any provision of the DGCL, our certificate of incorporation or our bylaws or (4) any other action asserting a claim against us that is governed by the internal affairs doctrine. The forum selection clause in our certificate of incorporation may have the effect of discouraging lawsuits against us or our directors and officers and may limit our stockholders’ ability to bring a claim in a judicial forum that they find more favorable for disputes with us or any of our directors, officers, other employees or stockholders. The exclusive forum provision does not apply to any actions under United States federal securities laws.
By purchasing shares of our Class A common stock, you will have agreed and consented to the provisions set forth in our certificate of incorporation related to choice of forum. Alternatively, if a court were to find the choice of forum provision contained in our certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.
Risks Related to our Class A Common Stock
An active trading market for our Class A common stock may not be sustained, which may make it difficult to sell shares of Class A common stock.
Our Class A common stock is listed on the Nasdaq Global Select Market under the symbol “GSKY.” An active trading market for our Class A common stock may not be sustained, which would make it difficult for you to sell your shares of Class A common stock at an attractive price (or at all).
The market price of our Class A common stock has been and will likely continue to be volatile.
Our stock price has declined significantly since our May 2018 IPO and has exhibited substantial volatility. Our stock price may continue to fluctuate in response to a number of events and factors, including the COVID-19 pandemic and the social distancing measures in response thereto, variations in our quarterly or annual results of operations, additions or departures of key management personnel, the loss of key Bank Partners, other funding sources, merchants or Sponsors, changes in our earnings estimates (if provided) or failure to meet analysts’ earnings estimates, publication of research reports about our industry, litigation and government investigations, changes or proposed changes in laws or regulations or differing interpretations or enforcement thereof affecting our business, adverse market reaction to any indebtedness we may incur or securities we may issue in the future, changes in market valuations of similar companies or speculation in the press or the investment community with respect to us or our industry, adverse announcements by us or others and developments affecting us, announcements by our competitors of significant contracts, acquisitions, dispositions, strategic partnerships, joint ventures or capital commitments, actions by institutional stockholders, and increases in market interest rates that may lead investors in our shares to demand a higher yield, and in response the market price of shares of our Class A common stock could decrease significantly. You may be unable to resell your shares of Class A common stock at or above the price you paid for them (or at all).
We are currently subject to putative securities class action litigation and a putative stockholder derivative action in connection with our IPO and may be subject to similar litigation in the future. If the outcome of this litigation is unfavorable, it could have a material adverse effect on our financial condition, results of operations and cash flows.
The Company, together with certain of its officers and directors and one of its former directors, have been named as defendants in litigation related to the Company's IPO. See Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for a description of such litigation. In the future, especially following periods of volatility in the market price of our shares of Class A common stock, other purported class action or derivative complaints may be filed against us. In addition to diverting financial and management resources, this type of litigation can result in adverse publicity that could harm our brand or reputation, regardless of its merits or whether we are ultimately held liable, and a judgment or settlement in connection with any such litigation that is not covered by, or is significantly in excess of, our insurance coverage could materially and adversely affect our financial condition, results of operations and cash flows.
As a newly public company, we are incurring, and will continue to incur, increased costs and are subject to additional regulations and requirements, and our management is required to devote substantial time to new compliance matters, which could lower profits and make it more difficult to run our business.
104
As a newly public company, we are incurring, and will continue to incur, significant legal, accounting, reporting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements and costs of recruiting and retaining non-executive directors. We also are incurring costs associated with compliance with the rules and regulations of the SEC and various other costs of a public company. The expenses generally incurred by public companies for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, although we are currently unable to estimate these costs. Our management is devoting a substantial amount of time to ensure that we comply with all of these requirements. These laws and regulations also could make it more difficult and costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations also could make it more difficult to attract and retain qualified persons to serve on our board of directors and board committees and serve as executive officers.
Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our Class A common stock, fines, sanctions and other regulatory action and potentially civil litigation.
We no longer qualify as an “emerging growth company”, and as a result, we are required to comply with increased disclosure and compliance requirements.
Prior to December 31, 2019, we were an “emerging growth company” as defined in the JOBS Act. Now, as a large accelerated filer, we are subject to certain disclosure and compliance requirements that apply to other public companies but did not previously apply to us due to our prior status as an emerging growth company. These requirements include, but are not limited to:
•the requirement that our independent registered public accounting firm attest to the effectiveness of our internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act of 2002;
•the requirement that we provide full and more detailed disclosures regarding executive compensation; and
•the requirement that we hold a non-binding advisory vote on executive compensation and obtain stockholder approval of any golden parachute payments not previously approved.
We expect that the loss of emerging growth company status and compliance with the additional requirements of being a large accelerated filer will increase our legal and financial compliance costs and cause management and other personnel to divert attention from operational and other business matters to devote substantial time to public company reporting requirements. In addition, if we are not able to comply with changing requirements in a timely manner, the market price of our stock could decline and we could be subject to sanctions or investigations by the stock exchange on which our common stock is listed, the SEC or other regulatory authorities, which would require additional financial and management resources.
Failure to comply with the requirements to design, implement and maintain effective internal controls could have an adverse effect on our business and stock price.
As a public company, we are subject to significant requirements for enhanced financial reporting and internal controls. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environment and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company.
If we are unable to establish and maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations on a timely basis, result in material misstatements in our consolidated financial statements and harm our operating results.
We concluded that our internal control was effective as of December 31, 2019. We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with the SEC rules or our independent registered public accounting firm may not issue an unqualified opinion. If, in a future
105
period, either we are unable to conclude that we have effective internal control over financial reporting or our independent registered public accounting firm is unable to provide us with an unqualified report, investors could lose confidence in our reported financial information, which could cause the price of our Class A common stock to decline and could subject us to investigation or sanctions by the SEC.
You may be diluted by the future issuance of additional Class A common stock in connection with our incentive plans, acquisitions or otherwise.
Our certificate of incorporation authorizes us to issue authorized but unissued shares of Class A common stock and rights relating to Class A common stock for the consideration and on the terms and conditions established by our board of directors in its sole discretion, whether in connection with acquisitions or otherwise. We have reserved 24,000,000 shares for issuance under our 2018 Omnibus Incentive Compensation Plan, subject to adjustment in certain events. Any Class A common stock that we issue, including under our 2018 Omnibus Incentive Compensation Plan or other equity incentive plans that we may adopt in the future, would dilute the percentage ownership held by existing investors.
Because we have no current plans to pay cash dividends on our Class A common stock, you may not receive any return on investment unless you sell your Class A common stock for a price greater than that which you paid for it.
We have no current plans to pay cash dividends on our Class A common stock. The declaration, amount and payment of any future dividends will be at the sole discretion of our board of directors. Our board of directors may take into account general and economic conditions, our financial condition and operating results, our available cash, current and anticipated cash needs, capital requirements, contractual, legal, tax and regulatory restrictions, implications on the payment of dividends by us to our stockholders or by GS Holdings to us and such other factors as our board of directors may deem relevant. In addition, the terms of our existing financing arrangements restrict or limit our ability to pay cash dividends. Accordingly, we may not pay any dividends on our Class A common stock in the foreseeable future.
Future offerings of debt or equity securities by us may adversely affect the market price of our Class A common stock.
In the future, we may attempt to obtain financing or to further increase our capital resources by issuing additional shares of our Class A common stock or offering debt or other equity securities, including commercial paper, medium-term notes, senior or subordinated notes, debt securities convertible into equity or shares of preferred stock. Future acquisitions could require substantial additional capital in excess of cash from operations. We would expect to obtain the capital required for acquisitions through a combination of additional issuances of equity, corporate indebtedness and/or cash from operations.
Issuing additional shares of our Class A common stock or other equity securities or securities convertible into equity may dilute the economic and voting rights of our existing stockholders or reduce the market price of our Class A common stock or both. Upon liquidation, holders of such debt securities and preferred shares, if issued, and lenders with respect to other borrowings would receive a distribution of our available assets prior to the holders of our Class A common stock. Debt securities convertible into equity could be subject to adjustments in the conversion ratio pursuant to which certain events may increase the number of equity securities issuable upon conversion. Preferred shares, if issued, could have a preference with respect to liquidating distributions or a preference with respect to dividend payments that could limit our ability to pay dividends to the holders of our Class A common stock. Our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, which may adversely affect the amount, timing and nature of our future offerings.
Future sales, or the expectation of future sales, of shares of our Class A common stock, including sales by Continuing LLC Members, could cause the market price of our Class A common stock to decline.
The sale of a substantial number of shares of our Class A common stock in the public market, or the perception that such sales could occur, including sales by the Continuing LLC Members, could adversely affect the prevailing market price of shares of our Class A common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price we deem
106
appropriate. In addition, subject to certain limitations and exceptions, pursuant to certain provisions of the Exchange Agreement, the Continuing LLC Members may exchange Holdco Units (with automatic cancellation of an equal number of shares of Class B common stock) for shares of our Class A common stock on a one-for-one basis, subject to customary adjustments for certain subdivisions (stock splits), combinations, or purchases of Class A common stock or Holdco Units, or for cash (based on the market price of the shares of Class A common stock), at our option (such determination to be made by the disinterested members of our board of directors). All of the Holdco Units and shares of Class B common stock are exchangeable for shares of our Class A common stock or cash, at our option (such determination to be made by the disinterested members of our board of directors), subject to the terms of the Exchange Agreement.
Our certificate of incorporation authorizes us to issue additional shares of Class A common stock and rights relating to Class A common stock for the consideration and on the terms and conditions established by our board of directors in its sole discretion. In accordance with the DGCL and the provisions of our certificate of incorporation, we also may issue preferred stock that has designations, preferences, rights, powers and duties that are different from, and may be senior to, those applicable to shares of Class A common stock. Similarly, GS Holdings Agreement permits GS Holdings to issue an unlimited number of additional limited liability company interests of GS Holdings with designations, preferences, rights, powers and duties that are different from, and may be senior to, those applicable to the Holdco Units, and which may be exchangeable for shares of our Class A common stock.
Assuming the Continuing LLC Members exchange all of their Holdco Units for shares of our Class A common stock, up to an additional 107,217,505 shares of Class A common stock will be eligible for sale in the public market, the majority of which are held by our executive officers, directors and their affiliated entities, and will be subject to volume limitations under Rule 144 and various vesting agreements. Additionally, certain of our executive officers and directors own options exercisable for shares of Class A common stock.
As unvested Class A common stock awards issued pursuant to our 2018 Omnibus Incentive Compensation Plan vest, the market price of our shares of Class A common stock could drop significantly if the holders of these shares sell them or are perceived by the market as intending to sell them.
These factors also could make it more difficult for us to raise additional funds through future offerings of our shares of Class A common stock or other securities.
Our capital structure may have a negative impact on our stock price.
In July 2017, S&P Dow Jones, a provider of widely-followed stock indices, announced that companies with multiple share classes, such as ours, will not be eligible for inclusion in certain of their indices. As a result, our Class A common stock is not eligible for these stock indices. Many investment funds are precluded from investing in companies that are not included in such indices, and these funds would be unable to purchase our Class A common stock. Other stock indices may take a similar approach to S&P Dow Jones in the future. Exclusion from indices could make our Class A common stock less attractive to investors and, as a result, the market price of our Class A common stock could be adversely affected.
Certain provisions of our certificate of incorporation and bylaws could hinder, delay or prevent a change in control of us, which could adversely affect the price of our Class A common stock.
Certain provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us without the consent of our board of directors. These provisions:
•authorize the issuance of undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock;
•prohibit stockholder action by written consent, requiring all stockholder actions be taken at a meeting of our stockholders;
•provide that the board of directors is expressly authorized to make, alter or repeal our bylaws;
107
•establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings; and
•establish a classified board of directors, as a result of which our board of directors is divided into three classes, with each class serving for staggered three-year terms, which prevents stockholders from electing an entirely new board of directors at an annual meeting.
In addition, these provisions may make it difficult and expensive for a third party to pursue a tender offer, change in control or takeover attempt that is opposed by our management or our board of directors. Stockholders who might desire to participate in these types of transactions may not have an opportunity to do so, even if the transaction is favorable to them. These anti-takeover provisions could substantially impede your ability to benefit from a change in control or change our management and board of directors and, as a result, may adversely affect the market price of our Class A common stock and your ability to realize any potential change of control premium.
If securities and industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.
The trading market for our Class A common stock depends, in part, on the research and reports that securities and industry analysts publish about us and our business. If one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our Company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Purchases of Equity Securities by the Issuer
The following table presents information with respect to our purchases of our Class A common stock during the three months ended September 30, 2020. See Note 11 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for additional discussion of our Class A common stock repurchases.
| Period | Total Number of Shares Purchased(1) | Average Price Paid per Share(1) | ||||||||||||
| July 1, 2020 through July 31, 2020 | 1,795 | $ | 4.90 | |||||||||||
| August 1, 2020 through August 31, 2020 | 8,434 | $ | 5.65 | |||||||||||
| September 1, 2020 through September 30, 2020 | 63,536 | $ | 4.17 | |||||||||||
| Total | 73,765 | |||||||||||||
(1)For the periods presented, represents shares surrendered to us to satisfy tax withholding obligations in connection with the vesting of equity awards.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
108
ITEM 6. EXHIBITS
| Exhibit Number | Exhibit Description | ||||
| 101 | The following financial information from GreenSky, Inc.'s Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2020, formatted in Inline XBRL (Inline Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 (unaudited), (ii) Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2020 and 2019 (unaudited), (iii) Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2020 and 2019 (unaudited), (iv) Condensed Consolidated Statements of Changes in Equity (Deficit) for the three and nine months ended September 30, 2020 and 2019 (unaudited), (v) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019 (unaudited), and (vi) Notes to Unaudited Condensed Consolidated Financial Statements. | ||||
| 104 | Cover Page Interactive Data File (embedded within the Inline XBRL document). | ||||
| * | Filed herewith. | ||||
| # | Certain portions of this exhibit have been excluded because they are both not material and would likely cause competitive harm to the Company if publicly disclosed. | ||||
109
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| GREENSKY, INC. | ||||||||||||||
| November 9, 2020 | By | /s/ David Zalik | ||||||||||||
David Zalik Chief Executive Officer and Chairman of the Board of Directors | ||||||||||||||
| GREENSKY, INC. | ||||||||||||||
| November 9, 2020 | By | /s/ Andrew Kang | ||||||||||||
Andrew Kang Executive Vice President and Chief Financial Officer | ||||||||||||||
110