ELEVATE CREDIT, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A;") is intended to help the reader understand our
business, our results of operations and our financial condition. The MD&A; is
provided as a supplement to, and should be read in conjunction with our
consolidated financial statements and the related notes and other financial
information included elsewhere in this Annual Report on Form 10-K.
Some of the information contained in this discussion and analysis, including
information with respect to our plans and strategy for our business, includes
forward-looking statements that involve risks and uncertainties. You should
review the "Risk Factors" and "Note About Forward-Looking Statements" sections
of this Annual Report on Form 10-K for a discussion of important factors that
could cause actual results to differ materially from the results described in or
implied by the forward-looking statements contained in the following discussion
and analysis. We generally refer to loans, customers and other information and
data associated with each of our brands (Rise, Elastic and Today Card) as
Elevate's loans, customers, information and data, irrespective of whether
Elevate directly originates the credit to the customer or whether such credit is
originated by a third party.
OVERVIEW
We provide online credit solutions to consumers in the US who are not
well-served by traditional bank products and who are looking for better options
than payday loans, title loans, pawn and storefront installment loans. Non-prime
consumers now represent a larger market than prime consumers but are risky to
underwrite and serve with traditional approaches. We're succeeding at it - and
doing it responsibly - with best-in-class advanced technology and proprietary
risk analytics honed by serving more than 2.7 million customers with $9.8
billion in credit. Our current online credit products, Rise, Elastic and Today
Card, reflect our mission to provide customers with access to competitively
priced credit and services while helping them build a brighter financial future
with credit building and financial wellness features. We call this mission "Good
Today, Better Tomorrow."
Prior to June 29, 2020 , we provided services in the United Kingdom ("UK")
through our wholly-owned subsidiary, Elevate Credit International Limited
("ECIL") under the brand name 'Sunny.' During the year ended December 31, 2018 ,
ECIL began to receive an increased number of customer complaints initiated by
claims management companies ("CMCs") related to the affordability assessment of
certain loans. The CMCs' campaign against the high cost lending industry
increased significantly during the third and fourth quarters of 2018 and
continued through 2019 and into the first half of 2020, resulting in a
significant increase in affordability claims against all companies in the
industry over this period. The Financial Conduct Authority ("FCA"), a regulator
in the UK financial services industry, began regulating the CMCs in April 2019
in order to ensure that the methods used by the CMCs are in the best interests
of the consumer and the industry. Separately, the FCA asked all industry
participants to review their lending practices to ensure that such companies are
using an appropriate affordability and creditworthiness analysis. However, there
continued to be a lack of clarity within the regulatory environment in the UK .
This lack of clarity, coupled with the ongoing impact of the Coronavirus Disease
2019 ("COVID-19") on the UK market for Sunny, led the ECIL board of directors to
place ECIL into administration under the UK Insolvency Act 1986 and appoint
insolvency practitioners from KPMG LLP to take control and management of the UK
business. As a result, we have deconsolidated ECIL and are presenting its
results as discontinued operations.
We earn revenues on the Rise installment loans, on the Rise and Elastic lines of
credit and on the Today Card credit card product. Our revenue primarily consists
of finance charges and line of credit fees. Finance charges are driven by our
average loan balances outstanding and by the average annual percentage rate
("APR") associated with those outstanding loan balances. We calculate our
average loan balances by taking a simple daily average of the ending loan
balances outstanding for each period. Line of credit fees are recognized when
they are assessed and recorded to revenue over the life of the loan. We present
certain key metrics and other information on a "combined" basis to reflect
information related to loans originated by us and by our bank partners that
license our brands, Republic Bank, FinWise Bank and Capital Community Bank
("CCB"), as well as loans originated by third-party lenders pursuant to CSO
programs, which loans originated through CSO programs are not recorded on our
balance sheets in accordance with US GAAP. See "-Key Financial and Operating
Metrics" and "-Non-GAAP Financial Measures."
We use our working capital and our credit facility with Victory Park Management,
LLC ("VPC" and the "VPC Facility") to fund the loans we directly make to our
Rise customers. The VPC Facility has a maximum total borrowing amount available
of $200 million at December 31, 2021 . See "-Liquidity and Capital Resources-Debt
facilities."
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We also license our Rise installment loan brand to two banks. FinWise Bank
originates Rise installment loans in 17 states. This bank initially provides all
of the funding, retains 4% of the balances of all of the loans originated and
sells the remaining 96% loan participation in those Rise installment loans to a
third-party SPV, EF SPV, Ltd. ("EF SPV"). These loan participation purchases are
funded through a separate financing facility (the "EF SPV Facility"), and
through cash flows from operations generated by EF SPV. The EF SPV Facility has
a maximum total borrowing amount available of $250 million . We do not own EF
SPV, but we have a credit default protection agreement with EF SPV whereby we
provide credit protection to the investors in EF SPV against Rise loan losses in
return for a credit premium. Elevate is required to consolidate EF SPV as a
variable interest entity ("VIE") under US GAAP and the consolidated financial
statements include revenue, losses and loans receivable related to the 96% of
the Rise installment loans originated by FinWise Bank and sold to EF SPV.
Beginning in the third quarter of 2020, we also license our Rise installment
loan brand to an additional bank, CCB, which originates Rise installment loans
in three different states than FinWise Bank . Similar to the relationship with
FinWise Bank , CCB initially provides all of the funding, retains 5% of the
balances of all of the loans originated and sells the remaining 95% loan
participation in those Rise installment loans to a third-party SPV, EC SPV, Ltd.
("EC SPV"). These loan participation purchases are funded through a separate
financing facility (the "EC SPV Facility"), and through cash flows from
operations generated by EC SPV. The EC SPV Facility has a maximum total
borrowing amount available of $100 million . We do not own EC SPV, but we have a
credit default protection agreement with EC SPV whereby we provide credit
protection to the investors in EC SPV against Rise loan losses in return for a
credit premium. Elevate is required to consolidate EC SPV as a VIE under US GAAP
and the consolidated financial statements include revenue, losses and loans
receivable related to the 95% of the Rise installment loans originated by CCB
and sold to EC SPV.
The Elastic line of credit product is originated by a third-party lender,
Republic Bank, which initially provides all of the funding for that product.
Republic Bank retains 10% of the balances of all loans originated and sells a
90% loan participation in the Elastic lines of credit. An SPV structure was
implemented such that the loan participations are sold by Republic Bank to
Elastic SPV, Ltd. ("Elastic SPV") and Elastic SPV receives its funding from VPC
in a separate financing facility (the "ESPV Facility"), which was finalized on
July 13, 2015 . We do not own Elastic SPV but we have a credit default protection
agreement with Elastic SPV whereby we provide credit protection to the investors
in Elastic SPV against Elastic loan losses in return for a credit premium. Per
the terms of this agreement, under US GAAP, we are the primary beneficiary of
Elastic SPV and are required to consolidate the financial results of Elastic SPV
as a VIE in our consolidated financial results. The ESPV Facility has a maximum
total borrowing amount of $350 million as of December 31, 2021 .
Today Card is a credit card product designed to meet the spending needs of
non-prime consumers by offering a prime customer experience. Today Card is
originated by CCB under the licensed MasterCard brand, and a 95% participation
interest in the credit card receivable is sold to us. These credit card
receivable purchases are funded through a separate financing facility (the "TSPV
Facility"), and through cash flows from operations generated by the Today Card
portfolio. The TSPV Facility has a maximum commitment amount of $50 million ,
which may be increased up to $100 million . As the lowest APR product in our
portfolio, Today Card allows us to serve a broader spectrum of non-prime
Americans. The Today Card experienced significant growth in its portfolio size
despite the pandemic due to the success of our direct mail campaigns, the
primary marketing channel for acquiring new Today Card customers. We are
following a specific growth plan to grow the product while monitoring customer
responses and credit quality. Customer response to the Today Card is very
strong, as we continue to see extremely high response rates, high customer
engagement, and positive customer satisfaction scores.
Our management evaluates our financial performance and our future strategic objectives using key indicators based primarily on the following three themes:
•Revenue growth. Key metrics related to revenue growth that we monitor by
product include the ending and average combined loan balances outstanding, the
effective APR of our product loan portfolios, the total dollar value of loans
originated, the number of new customer loans made, the ending number of customer
loans outstanding and the related customer acquisition costs ("CAC") associated
with each new customer loan made. We include CAC as a key metric when analyzing
revenue growth (rather than as a key metric within margin expansion).
•Stable credit quality. Since the time they were managing our legacy US
products, our management team has maintained stable credit quality across the
loan portfolio they were managing. Additionally, in the periods covered in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations, we have maintained our strong credit quality. The credit quality
metrics we monitor include net charge-offs as a percentage of revenues, the
combined loan loss reserve as a percentage of outstanding combined loans, total
provision for loan losses as a percentage of revenues and the percentage of past
due combined loans receivable - principal.
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•Margin expansion. We aim to manage our business to achieve a long-term
operating margin of 20%. In periods of significant loan portfolio growth, our
margins may become compressed due to the upfront costs associated with marketing
and credit provisioning expense associated with this growth. As we continue to
rebuild and scale our portfolio from the impacts of COVID-19, we anticipate that
our direct marketing costs primarily associated with new customer acquisitions
will be approximately 10% of revenues and our operating expenses will decline to
20% of revenues. While our operating margins may exceed 20% in certain years,
such as in 2020 when we incurred lower levels of direct marketing expense and
materially lower credit losses due to a lack of customer demand for loans
resulting from the effects of COVID-19, we do not expect our operating margin to
increase beyond that level over the long-term, as we intend to pass on any
improvements over our targeted margins to our customers in the form of lower
APRs. We believe this is a critical component of our responsible lending
platform and over time will also help us continue to attract new customers and
retain existing customers.
Impact of COVID-19
The COVID-19 pandemic and related restrictive measures taken by governments,
businesses and individuals caused unprecedented uncertainty, volatility and
disruption in financial markets and in governmental, commercial and consumer
activity in the United States , including the markets that we serve. As the
restrictive measures have been eased in certain geographic locations, the U.S.
economy has begun to recover, and with the availability and distribution of
COVID-19 vaccines, we anticipate continued improvements in commercial and
consumer activity and the U.S. economy. While positive signs exist, we recognize
that certain of our customers are experiencing varying degrees of financial
distress, which may continue, especially if new COVID-19 variant infections
increase and new economic restrictions are mandated.
In 2020, we experienced a significant decline in the loan portfolio due to a
lack of customer demand for loans resulting from the effects of COVID-19 and
related government stimulus programs. These impacts resulted in a lower level of
direct marketing expense and materially lower credit losses during 2020 and
continuing into early 2021. Beginning in the second quarter of 2021, we
experienced a return of demand for the loan products that we, and the bank
originators we support, offer, resulting in significant growth in the loan
portfolio from that point. This significant loan portfolio growth is resulting
in compressed margins in 2021 due to the upfront costs associated with marketing
and credit provisioning expense related to growing and "rebuilding" the loan
portfolio from the impacts of COVID-19. We continue to target loan portfolio
originations within our target CACs of $250-$300 and credit quality metrics of
45-55% of revenue which, when combined with our expectation of continuing
customer loan demand for our portfolio products, we believe will allow us to
return to our historical performance levels prior to COVID-19 after initially
resulting in earnings compression.
Both we and the bank originators are closely monitoring the key credit quality
indicators such as payment defaults, continued payment deferrals, and line of
credit utilization. While we initially anticipated that the COVID-19 pandemic
would have a negative impact on our credit quality, instead the monetary
stimulus programs provided by the US government to our customer base have
generally allowed customers to continue making payments on their loans. At the
beginning of the pandemic, we expected an increase in net charge-offs as
compared to prior periods but experienced historically low net charge-offs as a
percentage of revenue in the second half of 2020 and early 2021. With the
increased volume of new customer loans expected to be originated as we grow our
loan portfolio back to our pre-pandemic size and the ending of government
assistance, we expect an initial increase in net charge-offs in excess of our
targeted range with a return of net charge-offs to our targeted range of 45-55%
of revenue as the portfolio becomes more seasoned with a balance of new and
returning customers. Further, we believe that the allowance for loan losses is
adequate to absorb the losses inherent in the portfolio as of December 31, 2021 .
We have implemented a hybrid remote environment where employees may choose to
work primarily from the office or from home and gather collectively in the
office on a limited basis. We have sought to ensure our employees feel secure in
their jobs, have flexibility in their work location and have the resources they
need to stay safe and healthy. As a 100% online lending solutions provider, our
technology and underwriting platform has continued to serve our customers and
the bank originators that we support without any material interruption in
services.
COVID-19 has had a significant adverse impact on our business, and while
uncertainty still exists, we believe we are well-positioned to operate
effectively through the present economic environment and expect continued loan
portfolio growth and strong credit quality into the next year. We will continue
assessing our minimum cash and liquidity requirement, monitoring our debt
covenant compliance and implementing measures to ensure that our cash and
liquidity position is maintained through the current economic cycle.
KEY FINANCIAL AND OPERATIONAL INDICATORS
As discussed above, we regularly monitor a number of metrics in order to measure
our current performance and project our future performance. These metrics aid us
in developing and refining our growth strategies and in making strategic
decisions.
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Certain of our metrics are non-GAAP financial measures. We believe that such
metrics are useful in period-to-period comparisons of our core business.
However, non-GAAP financial measures are not an alternative to any measure of
financial performance calculated and presented in accordance with US GAAP. See
"-Non-GAAP Financial Measures" for a reconciliation of our non-GAAP measures to
US GAAP.
Revenues
As of and for the years ended
2021 2020 2019 Revenues$ 416,637 $ 465,346 $ 638,873 Period-over-period revenue decrease (10) % (27) % (4) % Ending combined loans receivable - principal(1) 558,759 399,822 607,149 Average combined loans receivable - principal(1)(2) 432,836 453,983 561,334 Total combined loans originated - principal 940,510 628,660 1,102,766 Average customer loan balance (indollars)(3 ) 1,992 1,861 2,011 Number of new customer loans 168,339 68,245 159,725 Ending number of combined loans outstanding 280,506 214,848 301,959 Customer acquisition costs (in dollars) $ 247$ 297 $ 241 Effective APR of combined loan portfolio 95 % 102 % 113 % _________ (1)Combined loans receivable is defined as loans owned by us and consolidated VIEs plus loans originated and owned by third-party lenders pursuant to our CSO programs. See "-Non-GAAP Financial Measures" for more information and for a reconciliation of Combined loans receivable to Loans receivable, net, the most directly comparable financial measure calculated in accordance with US GAAP. (2)Average combined loans receivable - principal is calculated using an average of daily Combined loans receivable - principal balances. (3)Average customer loan balance is an average of all three products and is calculated for each product by dividing the ending Combined loans receivable - principal by the number of loans outstanding at period end.
Revenues. Our revenue is made up of Rise finance fees, Rise CSO fees (which are fees we receive from customers who obtain a loan through the CSO program for credit services, including loan guarantee, which we provide), revenue earned from the Elastic line of credit, and finance charges and fee revenue from the Today Card credit card product. See