Enova International - Earnings Call - Q2 2020
July 28, 2020
Transcript
Speaker 0
Good afternoon, everyone, and welcome to the Inova International Second Quarter twenty twenty Earnings Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. And at this time, I'd like
Speaker 1
to turn the conference call
Speaker 0
over to Monica Gould, Investor Relations for Inova. Ma'am, please go ahead.
Speaker 2
Thank you, operator, and good afternoon, everyone. Inova released results for the 2020 ended 06/30/2020, this afternoon after the market closed. Inova also announced its intent to acquire OnDeck Capital. If you did not receive a copy of either our earnings press release or the transaction release, you may obtain both documents from the Investor Relations section of our website at ir.inova.com, along with a presentation discussing the transaction. With me on today's call are David Fisher, Chief Executive Officer of Inova Noah Breslow, Chairman and CEO of OnDeck and Steve Cunningham, Chief Financial Officer of Inova.
This call is being webcast and will be archived on the Investor Relations section of Inova's website. Before I turn the call over to David, I'd like to note that today's discussion will contain forward looking statements and as such is subject to risks and uncertainties. These risks and uncertainties include those risk factors discussed in the most recent reports on Form 10 Q and 10 ks filed by each company as well as those discussed in the joint press release announcing this acquisition. Any forward looking statements that are made on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. In addition to U.
S. GAAP reporting, Inova reports certain financial measures that do not conform to Generally Accepted Accounting Principles. We believe these non GAAP measures enhance the understanding of our performance. Reconciliations between these GAAP and non GAAP measures are included in the tables found in today's press release. As noted in our earnings release, we have posted supplemental financial information on the IR portion of our website.
And with that, I'd like to turn the call over to David.
Speaker 3
Thanks, Monica, and good afternoon, everyone. Thank you for joining our call today. As I'm sure you've all seen by now, we just announced that we have signed an agreement to acquire Capital. So first, I'll review the transaction. And joining me is Noah Brezel, OnDeck's CEO and Chairman of the Board, who will share his thoughts as well.
Then I will provide an overview of our second quarter results and update you on our strategy and outlook for 2020. After that, I'll turn the call over to Steve Cunningham, our CFO, who will discuss our financial results and outlook in more detail. I know many of you are very familiar with OnDeck. They are a leader in nonbank lending to small businesses, and we believe this transaction brings together two highly complementary market leading businesses with world class capabilities in both consumer and small business lending. Together, we had approximately $5,000,000,000 in originations in 2019, and cumulatively, we served approximately 7,000,000 customers.
Like Inova, OnDeck is 100% online and also like us is a pioneer in using analytics, data, and technology to make real time lending decisions. We welcome its talented team to Inova, who will increase our scale and resources, enabling us to accelerate growth in our increasingly diversified portfolio. We believe we have well aligned innovative and customer oriented cultures led by experienced management teams who are committed to creating a great place to work for team members. In terms of leadership, Noah will become Vice Chairman of Inova and will join my management team. I will continue to serve as CEO and Chairman of the Board of Inova.
Bringing our two companies together will meaningfully expand our small business offering to create a combined company with significant scale and expanded diversified products in consumer and small business markets that banks and credit unions have difficulty serving. As of 03/31/2020, the combined companies had gross receivables of $2,400,000,000 61% of which are small business assets and 39% consumer assets. For the full year 2019, on a pro form a basis, including anticipated synergies, Inova and OnDeck would have estimated combined gross revenue of over $1,600,000,000 adjusted EBITDA of over $425,000,000 and adjusted earnings of $215,000,000 We expect to have industry leading profitability metrics. And with Inova's strong liquidity, proven ability to access capital markets and a well capitalized balance sheet, we are in a great position to drive growth and help small businesses and consumers whose need for access to credit is even more critical in the wake of the COVID pandemic and current economic environment. We will also benefit from increased scale and financial strength, diversified revenues, robust cash flows and increased flexibility to drive growth, profitability and shareholder value.
Finally, my team and I have a strong history of executing and integrating successful transactions, which allow us to create significant shareholder value. We expect to achieve $50,000,000 in annual cost synergies by 2022, primarily from eliminating duplicative resources as well as $15,000,000 in run rate revenue synergies. The transaction is expected to be accretive in the first year post closing and generate non GAAP earnings per share accretion of more than 40% when the synergies are fully realized. Before I discuss our second quarter results, I would like to introduce Noah Breslow, OnDeck's Chairman and CEO, to tell you a little bit more about OnDeck. Noah?
Speaker 4
Thanks, David. I am equally excited about partnering with Inova and this opportunity to bring enhanced value, diverse products, and broadened origination channels to our combined customer base. I am proud of the business we have built and the nearly $14,000,000,000 of financing that OnDeck has provided to underserved small businesses since our founding in 02/2006. Following an extensive review of our strategic options, we believe this is the right path forward for our customers, employees, and shareholders. Joining forces with Inova, a highly respected and well capitalized leader in online lending, and leveraging our combined scale and strengths provides the best opportunity for our long term success.
Our mission at OnDeck has been to make lending easier for our small business clients, and this opportunity delivers that promise on a larger scale. OnDeck brings to Inova a diversified distribution model with three distinct origination channels. Our analytics capabilities and advanced fraud detection will build upon Inova's existing platform, and our investments to date in our next generation technology infrastructure are a complement to Innova's as well. Together, Innova and OnDeck can support the rapid growth of online lending and bring new products to market faster. Both companies have been leaders in analytics driven lending innovation, and we look forward to combining our complementary solutions and driving even greater value for our customers.
We are incredibly pleased to announce this combination, and I look forward to working closely with David, Steve, and the rest of the Inova leadership team to close this transaction and integrate our businesses. Now I will hand it back over to David.
Speaker 3
Thanks so much, Noel. Of course, we completely share your thoughts on the transaction. And now turning to the second quarter, despite the challenging environment, we are pleased with our financial results, which came in above the range that we previewed in our mid June update. Total second quarter revenue of $253,000,000 declined just 2.5% year over year, while adjusted EBITDA of $94,000,000 rose 45% and adjusted EPS of $1.68 grew 73%. As we discussed last quarter, when the seriousness of the COVID crisis increased in early March, we aggressively began to reduce originations and shift our focus to our existing customers and managing our portfolio of loans.
We rapidly and effectively acted based on the data we saw and adjusted our sophisticated analytics models to take into account the uniqueness of the economic deterioration. Because of our fast actions, both delinquency and charge off rates stabilized and have returned to pre COVID levels. Across the board, it appears that hardship accommodations have been successful in helping many of our impacted customers stay on track with their loan obligations and to avoid default. And our data from recent customer performance shows that these efforts are doing more than just delaying defaults. For example, eighty four percent of CNU customers remain in good standing after an adjustment is granted to them.
In addition, the rates of accommodations have declined significantly from the highs of late March and early April. PNU is now experiencing fewer deferrals and higher payment rates than pre COVID impact. For our near prime net credit business, as of last week, over ninety four percent of customers who had a payment modification in March have since made another payment, and we're seeing success rates for modified payments above what we've seen pre pandemic. Similarly, for small business products, the percent of nonpaying customers is below pre COVID levels with close to ninety eight percent of customers making a payment in recent weeks. As a result of the meaningful reduction in originations across all of our products to address the COVID crisis, second quarter originations declined 83% from a year ago and 81% sequentially.
We have focused origination efforts primarily on existing customers and our products with the highest unit economics while being more patient with longer duration and larger principal value loans. Our originations from new customers declined to just 7.4% of total compared to an average of 37.5% of the total over the prior four quarters. Due to our thoughtful approach to originations, our loan portfolio contracted 15% on a year over year basis in the second quarter and 29% from the first quarter. We have seen the most significant runoff in our short term book, which now represents less than 1% of the total portfolio. In the second quarter, installment products represented 72% of our portfolio and line of credit products accounted for 20%.
Our U. S. Near prime product represented 59% of our portfolio at the end of Q2, while small business represented 15%. On the cost side, our flexible business model and substantial operating leverage allowed us to quickly reduce our operating costs to align with lower business activity. And we ended the quarter with a very strong balance sheet and liquidity position, which will enable us to reaccelerate quickly when conditions dictate.
But before looking forward, I want to provide a brief regulatory update. As you may know, the CFPB finalized its long awaited small dollar rule in early July. This final rule retracted the ability to repay underwriting provision while keeping payment protections intact. We expect the final ruling to have a negligible financial impact on Inova. As we look forward, from a financial perspective, we have a strong balance sheet and ample liquidity to manage us through this economic downturn, as Steve will discuss in further detail.
Our cash position is growing, and our online only business model has significant operating leverage, so we can continue to adjust our expenses quickly to adapt to changes in our business activity as a result of market conditions. Additionally, we benefit from the higher margins and lower credit volatility as a non prime consumer lender versus a prime or super prime lender, and we have sufficient liquidity and operating capacity to expand lending once unemployment and economic conditions continue to stabilize. While COVID-nineteen has created uncertainty in the near term, we believe the fundamentals of our business are strong, and we remain committed to producing long term sustainable and profitable growth. As I mentioned, we are well positioned to navigate through the downturn and are ready to reaccelerate lending as the economy stabilizes. As we've seen in the past, most notably the financial crisis of two thousand and eight, economic downturns are typically followed by periods of rapid growth in non prime lending.
This was definitely true in 2009 and 2010, which were very strong growth years for Enova. We believe that dynamic in this downturn will be similar. As the impact of COVID diminishes, millions of people will be going back to work, increasing our addressable market substantially. In addition, many customers have been deferring purchases and paying down debt. But as the economy reaccelerates, their expenses will increase, whether it's back to school clothes for the kids, deferred medical procedures, car maintenance, missed vacations, and other unexpected expenses.
And because their debt loads are lower, they will have capacity to borrow. As a result, we fully believe that coming out of COVID demand will be very strong, and we will be prepared to fill it. To be clear, we are ready today to reaccelerate originations. We've built new tools and new models to address the uniqueness of this recession and the anticipated recovery, and we have plenty of liquidity. So we will be as aggressive as we can without being reckless.
And in the meantime, as you have heard, the business is in a very stable place. With that, I'll turn the call over to Steve, who will provide more details on our financial performance and outlook. Following Steve's remarks, we will be happy to answer any questions that you may have. Steve?
Speaker 5
Thank you, David, and good afternoon, everyone. As David mentioned in his remarks, our direct online only business model, world class analytics and technology, and deep organizational preparedness for a challenging economy have allowed us to react quickly to the uncertain economic environment facing our country. Our financial this quarter reflect the outstanding work our team has done to stabilize portfolio credit risk while supporting our customers as well as our deep organizational operating and cost discipline. Our efficient operating model and resourceful culture have allowed us to avoid disruptive cost reduction programs, enabling us to maintain an unwavering operating focus while keeping key capabilities in place that will allow us to quickly reaccelerate our businesses as the economy stabilizes and recovers. These capabilities in combination with our strong liquidity and balance sheet provide us significant strategic flexibility as we accelerate origination expansion in the coming months.
Also, as David and Nilla mentioned, we are pleased to announce the acquisition of OnDeck. This combination will create a leading online financial services company with increased scale, diversified revenues, robust cash flows, and greater flexibility to drive growth and profitability. We expect the capabilities of our combined organizations to create significant shareholder value opportunities over the next several years as we combine our operations, recognize synergies, and drive meaningful EPS accretion. Let me start my comments with a liquidity update. We ended the second quarter with $379,000,000 of cash and marketable securities, including $321,000,000 unrestricted and had an additional $124,000,000 of available capacity on our corporate revolver and $187,000,000 of available capacity on other committed facilities.
Our net cash flows from operations for the second quarter totaled $231,000,000 as a result of solid customer payment rates that have returned to pre COVID levels. In a reduced origination environment, we expect our cash position to grow even if we experience an unexpected increase in defaults, given the relatively short duration of our receivables, our revenue yields, and the frequency of contractual payments. We continue to believe our cash position, available facility capacity and portfolio repayment characteristics will provide us with a long runway of available liquidity before needing to raise new external funding even when we return to levels of originations experienced in recent years. Now turning to second quarter results, total company revenue from continuing operations decreased 2.5% to $253,000,000 The decline in revenue was driven by a 15% year over year decrease in total company combined loan and finance receivables balances, which ended the quarter at $823,000,000 on an amortized cost basis. Sequentially, the portfolio declined 29%.
As David mentioned, the decline in the portfolio during the quarter was driven primarily by our deliberate reduction in originations in the current economic environment. We expect limited marketing to new customers until lending re reacceleration tests that have started nearly 30 states across our footprint reflect signs of credit stability and acceptable unit economics. As we stated previously, we are well positioned to rapidly reaccelerate originations as the economy stabilizes. The net revenue margin for the second quarter was 52%. The improvement in net revenue margin from the first quarter was driven primarily by the impact of stabilized credit quality on the fair value of the portfolio as payment rates, delinquency rates, hardship requests and charge off rates all leveled off or improved.
As you'll recall, the change in the fair value line item is driven mostly by changes to key valuation assumptions, including credit loss expectations, prepayment assumptions, and the discount rate. Key valuation assumptions for the portfolio at June 30 were largely unchanged from the first quarter, with sequential improvements in the net revenue margin and the fair value of the portfolio driven by improvements in the credit profile of the portfolio. For the second quarter, the total company ratio of net charge offs as a percentage of average combined loan and finance receivables was 15.9% compared to 11.8 in the prior year quarter. The increase was driven by line of credit products, while the ratio for installment and RPA products was mostly unchanged from the same quarter a year ago. We saw steady improvement during the quarter in total net charge offs across the portfolio after net charge off ratios peaked during April.
In fact, the total company net charge off ratio for the month of June was just 4% higher than the same month a year ago. The percentage of total portfolio receivables past due thirty days or more declined to 4.5 at the end of the second quarter from 7.5% at the end of the first quarter and from 5.2% at the end of the second quarter a year ago. We also saw meaningful declines in early stage delinquencies during the second quarter. Even with a sharp decline in customer requests for modifications that peaked earlier in the quarter, receivables balances at the end of the second quarter tied to customers that we have granted requests for payment deferrals or modifications remains elevated across our businesses. While loans performing as agreed under modified plans are not considered delinquent, we expect customers that have received deferrals or modifications to present higher default risk than typical nondelinquent customers that continue to pay on time.
As we did last quarter, we adjusted the fair value for these loans downward to reflect the increased risk. The discount rate used in the fair value calculation was unchanged from the prior quarter. It remained at the high end of our range to reflect the uncertainty in the current economic environment and the uncertainty of additional government stimulus and benefits. To summarize fair value, we saw improvement in portfolio credit quality at the end of the second quarter. We have maintained our approach to addressing future credit uncertainties arising from the level of modified accounts and the current economic environment.
As a result, the fair value of the portfolio increased slightly to
Speaker 6
a 104%
Speaker 5
of principal at June 30 from a 103% at March 31. This is the primary reason for the meaningful improvement in our net revenue margin for the second quarter. As of late last week, we have seen a continuation of credit stability, payment rates, delinquency rates, hardship requests, and charge off rates remain at pre COVID levels even as some government stimulus programs have wound down. Turning to operating expenses. Consistent with our expectations, total operating expenses for the second quarter, including marketing, were $42,000,000 or 17% of revenue compared to $74,000,000 or 29% of revenue in the 2019.
As we discussed last quarter, the operating leverage in our business model allows for rapid reductions in operating expenses during periods of reduced originations. Consistent with the deliberate reduction in originations, we ceased most paid marketing during the quarter. As a result, marketing expenses in the second quarter were just $3,000,000 or 1% of revenue compared to $26,000,000 or 10% of revenue in the 2019. Similarly, operations and technology expenses declined 18% from the year ago quarter to $17,000,000 or 7% of revenue compared to $20,000,000 or 8% of revenue in the 2019. General and administrative expenses for the second quarter declined 21% from the year ago quarter to $22,000,000 or 9% of revenue compared to $28,000,000 or 11% of revenue in the second quarter of the prior year.
The reductions were driven by lower personnel related costs, though nearly every category of G and A expense was lower by both year over year and sequentially. We expect total operating expenses, including marketing, to normalize in the mid upper 20% of revenue by the 2020, but this will be dependent upon the timing and level of marketing spend and the resumption of meaningful originations growth. Adjusted EBITDA, a non GAAP measure, increased 45% year over year to $94,000,000 in the first quarter for the reasons I've previously discussed. Our adjusted EBITDA margin increased to 37% from 25% in the second quarter of the prior year. Our stock based compensation expense was $3,700,000 in the second quarter, which compares to $3,300,000 in the 2019.
2020 is the first year where expense associated with the 2017 increase in the vesting period for restricted stock units is fully reflected, resulting in the year over year increase. Our effective tax rate was 27% in the second quarter, which increased from 23% for the 2019. The increase in the effective tax rate was driven primarily by a reduced tax benefit from restricted stock units that invested during the second quarter at a price below the original grant price. We expect our normalized effective tax rate to remain in the mid to upper 20% range, but also expect some near term volatility depending on the trajectory of our future results. We recognized net income from continuing operations of $48,000,000 or $1.58 per diluted share in the quarter compared to $31,000,000 or $0.89 per diluted share in the 2019.
Adjusted earnings, a non GAAP measure, increased to $51,000,000 or $1.68 per diluted share from $33,000,000 or $0.97 per diluted share in the second quarter of the prior year. The trailing twelve month return on average shareholder equity using adjusted earnings decreased to 27% during the second quarter from 30% a year ago. Our debt balance at the end of the quarter includes $163,000,000 outstanding under our $350,000,000 of combined installment loan securitization facilities. We had no borrowings outstanding under our 125,000,000 corporate revolver. Our cost of funds for the second quarter declined to 7.97%, a 70 basis point decrease from the same quarter a year ago.
As we continue to recognize the cost benefits of transactions completed over the past several years as well as the benefit of lower market rates. The cost of funds improvement contributed nearly $2,000,000 of pretax income this quarter. During the second quarter, we acquired nearly a million shares at a cost of approximately $13,000,000 under our $75,000,000 share repurchase program. And as was the case last quarter, we are not providing guidance for future periods at this time given the ongoing economic uncertainty. In conclusion, we are encouraged by our credit and financial performance this quarter.
We remain focused on prudently resuming growth by leveraging our world class analytics and technology, proven approach to unit economics, and solid balance sheet. We remain well positioned to generate long term profitable growth as the economy stabilizes, loan demand recovers, and we recognize the meaningful opportunities from our I our acquisition of OnDeck. And with that, we'd be happy to take your questions. Operator?
Speaker 0
Ladies and gentlemen, at this time, we'll begin the question and answer session. If you are using a speakerphone, we do ask that you please pick up the handset before pressing the keys. To withdraw your questions, you may press star and 2. Once again, that is star and then one to ask a question. And our first question today comes from Vincent Caintic from Stephens.
Please go ahead with your question.
Speaker 6
Hey, thanks. Good afternoon, guys. So very interesting news with OnDeck acquisition, and that's my first question. So I'm just kind of wondering, putting the businesses together, just kind of thinking about any changes when you think about philosophies or adjustments to the OnDeck portfolio. Because when I think about it, there have been differences between the OnDeck and OnDeck approaches to small business lending.
So sometimes when OnDeck said, Small business lending is tough, OnDeck said it was great and back and forth. And there's been when I think of OnDeck, great revenue growth, has struggled a little bit with profitability. OnDeck has done really well with profitability, but smaller than OnDeck. So I'm kind of just wondering when you put the two companies together, what you think any changes you think might need to be made, any philosophical differences and how are you thinking about it going forward? Thank you.
Speaker 3
Sure. No problem, Vincent. I think you just kind of highlighted some of the key attributes of this deal. The businesses are complementary. I mean, sure, there's a little bit of overlap, but we did tend to tap into slightly different markets from time to time as you kind of highlighted us not always having the same view as to what the market environment look like.
And just on the product side, while there's certainly some overlap in the products, the products are not certainly the same. And so it gives us more products to go to market with as well. And then finally, you highlighted profitability. I mean, certainly with the scale of the combined business and how much operating leverage there are in both of our online businesses, it is certainly going to be beneficial from the profitability standpoint as well.
Speaker 6
Okay, great. Thank you. Switching gears here. So we have talk of a second stimulus with the government and the Republicans put out their proposal last night. I'm just kind of wondering if your thoughts of how the business gets impacted by potential second stimulus, another $1,200 check, any increases to the length of unemployment and so on.
Yes.
Speaker 3
So it certainly can't hurt, and I think it can only help both on the consumer side and the small business side. A, a lot of the small business owners will be getting stimulus checks, but also because consumers will have more money to spend at small businesses. That being said, I I don't think it's an absolute imperative for a business to be successful over the the next couple quarters. As stimulus ran out, you know, over the last several weeks and a month, we didn't see any change in consumer or small business credit behavior, if anything actually got better near the end of the stimulus. So we certainly welcome it.
It can only help, but again, certainly not necessary for our success.
Speaker 6
Okay, great. Thanks very much.
Speaker 0
Our next question comes from John Rowan from Janney. Please go ahead with your question.
Speaker 7
Good evening, guys.
Speaker 3
Hey, John.
Speaker 7
So your commentary is that on the OnDeck acquisition will be profitable in the first year post closing. And the deck for the OnDeck acquisition, no pun intended, it says it will close at the end in 2020. So does that mean that 2021, this deal is profitable, on a EPS basis? And if if so, is that on a GAAP basis or an adjusted basis?
Speaker 3
Sure. Steve, do you want to, tackle that one?
Speaker 5
Yes. Sure. Hey, John. How are doing? Good.
So I think what we were trying to let you know is that in the first year post close, we expect to be accretive to EPS. And I would say the focus should be on adjusted EPS because we will have some some onetime related charges in that first period right after close.
Speaker 7
So would we also be excluding stock based comp from that accretion figure, or is that included?
Speaker 5
I mean, we probably continue to exclude that as we have historically done for that non GAAP measure.
Speaker 7
Okay. Given that this is
Speaker 8
But John Sorry.
Speaker 0
But just just on that, there's
Speaker 3
not a ton of additional stock based comp as far as the deal where it's gonna be materially different, with or without it.
Speaker 7
Okay. Given that this is mostly stock, is there a filler killer or is there some type of collar around the Innova stock price where, you know, the there'd be some type of breakup clause?
Speaker 3
No. It's a straight fixed exchange ratio.
Speaker 7
So your stock price can do I mean, if it fell, the the OnDeck shareholders would have no recourse to get out of the the deal?
Speaker 3
That's correct.
Speaker 7
Okay. And does this change the outlook to get a bank charter for OnDeck?
Speaker 3
That's not something we're going to talk about right now, but certainly, you know, something we'll continue to explore as part, you know, when if and when the transaction closes.
Speaker 7
Okay. And then, Steve, can you just quickly repeat what you I didn't get it written down, the guidance
Speaker 5
Yeah. Sure. So, basically, what I was saying is that we would expect to our overall expenses, including marketing, to renormalize back to that mid to upper 20% of revenue range from where we are today, which is more like mid teens. But the caveat being that will all depend on, you know, the timing of marketing and how the acceleration of originations plays out.
Speaker 7
Okay. And then just lastly, it kind of looked like the blended yield on the portfolio came down quite a bit this quarter. Is that just a function of the lower CSO loans? And if so, just I want
Speaker 5
to get an idea of
Speaker 7
what the outlook for the loan portfolio yield looks like going forward.
Speaker 5
Yeah. So I would tell you so if you think about our portfolio, some of our shorter term loans, which might have had a higher revenue yield associated with them, have run off, more quickly than some of the other longer term installment loans that were the lower APR. So I think you're seeing a bit of a mix shift while we're in this unusual time. But you're likely to see, on the other side, as we start to grow where we where we focus, we'll probably emphasize some of those shorter duration smaller loans as we move out of this this downturn as well. So there may be a little bit just as a mix shift.
But just as a reminder, from a unit economics perspective, the loans that have the lower yields also have the lower credit costs associated with them. So from a margin point of view, there shouldn't be an overall impact from that.
Speaker 7
Okay. But the the just trying to backtrack. I mean, the the CSO loan balance came down quite a bit, sequentially. And, I mean, is that directly traced back to the stimulus checks?
Speaker 3
No. I can hand I let let me grab that, Steve. A lot of that has to do with the switch of our product in Ohio, which is a big CSO state, away from CSO lending, as well as the fact that those CSO loans tended to be, again, the the shortest duration loans in our portfolio.
Speaker 5
Okay. Thank you very much.
Speaker 1
And
Speaker 0
our next question is a follow-up from Vincent Caintic from Stephens.
Speaker 6
Just a couple of quick ones. When you talk about revenue synergies with the OnDeck acquisition, just kind of wondering what that could be in terms of synergies for the top line.
Speaker 3
Great. Sure. Steve, do want to grab that one?
Speaker 5
Yes. So I think that's what we've been talking about with the combination of the businesses and our ability to offer a broader set of products, go deeper with our customers, you know, across the two businesses, and working with our partners for distribution. So I think that's largely related to that. Obviously, we'll talk a lot more about it as we move through time, but that's our expectation.
Speaker 6
Okay. Great. Thank you. And so looking forward and for the consumer and small business lending space, when we think about kind of where we are in this recession and understanding that it's a unique recession, but and you were talking a little bit about the demand spikes back up. Any sort of metrics or near term things you're looking at to see or that would be a driver of demand improving and where we can see that spiking up in the origination line?
Speaker 3
Yeah. Sure. I mean, there's a whole number of factors. Our models are extremely sophisticated taking into dozens and dozens of factors, both internal and external, looking at both demand but also risk as well. I mean, you know, kind of they're they're both important.
There's excess demand, but too much risk. You you need to be careful and vice versa. But, I think, you know, the economy is opening up and people getting, back to spending money, as I said in my prepared remarks. And just getting kinda getting back to normal a normal world where there are those, unexpected expenses that, require people to access credit. And then on the small business side, obviously, as economy continues to improve and people are getting out and going about their normal days, those are the you know, small businesses tend to be the huge beneficiaries of that.
You know, as Noah mentioned, I think 99.9% of businesses in America are small businesses. And, I think they're they're the most impacted by the economy shutting down, but they'll benefit the most from the economy opening back up. And as they do, they're obviously gonna have some deficits from not having the kind of revenue that they've had in prior years. I think access to capital will be critical, and it will be there will be extremely strong demand from, from small businesses as the economy begins to improve and and and open back up.
Speaker 6
Got you. So on the small business side, have you already started to see that sort of growth there or demand from small businesses for us?
Speaker 3
Yes. We've seen it a little bit, and I think Ankara has seen it Noel, would you like to comment on that?
Speaker 4
Sure. Happy to, David. So I I think what we're seeing is, you know, the nadir of the small business sentiment and performance was kind of in April, and then we saw really rising trends going into, you know, kind of the end of the quarter. That that said, I think there is still a fair amount of uncertainty in the small business lending environment right now, and so I think it really depends on where you are and what you do. We are seeing certain industries that are, you know, starting to really increase their demand and open up and scale back their businesses, creating demand for loans.
But others, obviously, it's it's not a secret, are are hit more more hard. So we see it really phasing in over the next couple of quarters. But certainly, there is some demand out there if you know where to find it.
Speaker 6
Got you. Thanks. And last one for me. The so I remember at the beginning of, I guess, the onset of this recession, we were talking about maybe the models hadn't completely set or maybe there's additional volatility with the models. Are we at the point now where everything's stabilized and you kind of feel like a high confidence level and that the models are able to pinpoint the risk adjusted returns and with a high degree of confidence?
Speaker 3
Yes. Great question, Vincent. I think we're feeling really good about it. Our portfolio has been extremely stable over the next over the last, you know, kind of sixty to ninety days and actually improving. We think we have a really good handle on both consumer and small business behavior.
The testing we've done, especially over the last sixty days into reaccelerating originations, has come back pretty much as expected. So, you know, big lift by our team to readjust those models, take into account all the new data that, you know, the different types of behaviors from the this unique economic environment, but we're feeling really good about our ability to understand consumer and small business behavior at this point.
Speaker 6
Okay, great. Thanks, John.
Speaker 0
And our next question comes from David Scharf from JMP. Please go ahead with your question.
Speaker 1
Hi, good afternoon. Thanks for taking my questions. And I guess, David, no, congratulations to both companies. Nice. Hey.
David, wondering, maybe more of a a high level question on on the on the business combination. I I know it's hard to completely separate the two, but if if we set aside the math around accretion for a moment and just kinda put that over in a box, you know, the the this this business combination obviously transforms Innova's balance sheet from being, you know, almost a pure play consumer lender to a majority small business lender in terms of the assets. Which is more than just diversification. It's really kind of flipping the the concentration of of the business, it it would seem. Can you just talk a little bit about maybe how you view the this small business end market in terms of the opportunity relative to the consumer asset classes you currently play in?
Speaker 3
Sure. Yes. I mean, it takes us from 15% to 60%, one five to to six zero. So I mean, we had built up a fairly decent sized small business portfolio before the COVID recession. This obviously greatly increases it.
Our small business portfolio has increased something like 400% in the last two years. So we're obviously quite bullish about the small business lending environment. We think competitively, it is not as difficult as the consumer the consumer space. And certainly from a regulatory standpoint, we think there's significantly less regulatory risk and regulatory overhang than the consumer side. So we are no by no means running away from our consumer lending business.
We are think we think we are very good at it. We think there's a lot of runway in the future. And as we've mentioned coming out of this recession, we think there's gonna be a huge amount of demand. But the ability to partner with OnDeck and really double or triple down on the small business side was an opportunity we just couldn't pass by.
Speaker 1
Got it. That's helpful. And you know, in terms of thinking about, I guess, the longer term capitalization, you know, you're you're you're down to just I I think at June, you're you're at a 1.9 times debt equity. That that that obviously reflects, you know, the pullback in lending during this pandemic in in the short term nature of those assets running off. But it it'll go from 1.9 to four and a half times pro form a, I believe, based on the the deck that was provided.
Is there a long term or or sort of like a twenty four, thirty six month plan for where you want the combined company's leverage to look like?
Speaker 3
Sure, Steve. Why don't you jump in on that one?
Speaker 5
Yes, sure. So hi, David. You're right. We had been running sort of very on the very low end of leverage. And so, really, the the purpose of that, to some extent, was to give us some flexibility to continue to grow or to take on opportunities like the one we're talking about today.
As we look down the road, obviously, we'd look to sort of normalize back into a reasonable range, you know, somewhere between three and a half to four and a half, or four to five wouldn't be, you know, out of the question. But, obviously, you know, that'll help as we drive these high ROEs as you've seen on a pro form a basis that will also sort of level off the the go in leverage as well.
Speaker 1
Got it. And and just lastly, more more immediate focus on just the core consumer business. I I I didn't quite get the sense, Steve, that there's so many unknowns and uncertainties, obviously, near term. Couldn't quite gauge whether, other than doing some testing, origination activity was gonna pick up meaningfully in q three from q two levels. I'm I'm just wondering, you know, if if the runoff in the portfolio, either a dollar basis or percentage basis from Q2 to Q3 is gonna resemble what we saw from, you know, March to June?
Speaker 5
Yeah. So I think you should expect the runoff rate that we saw, the sequential 29% is probably gonna slow down a bit. As I mentioned, we saw a lot of our, you know, shorter duration, quick repayment parts of the portfolio, come off, most quickly. And then you're left with a, you know, a little bit slower amortizing, you know, the near prime, for example, that will come up more slowly. So I think you'll see if we were doing exactly what we did, in q two, I think you would I think you would see it slow down, you know, outside of a a pickup in originations.
Speaker 1
Got it. Got it. And last question. More more on the on on the accounting front. Can you maybe give us just a sixty second primer on anything we need to know about how fair value accounting may impact the on deck assets that would be brought on board?
Or is it just kind of a one time mark to market and is is sort of a one time markup or markdown? How do we think about that?
Speaker 5
Yeah. So, you know, as part of the combination, we'll have an option to bring the entirety of the portfolio over to fair value, which we would intend to do. And if you've been listening me listening to me go on and on about fair value over the past couple of quarters, you're you're pretty well versed in how that works. So there's a go in adjustment to do that, which is, you know, essentially a reversal of the allowance and some of the accruals and deferred marketing and then a mark on the portfolio itself. And then on a go forward basis, it would you know, just like it's doing with our business, would realign, credit and revenue much more closely than it does today in terms of timing.
So I think it'll be very similar to the key principles that I've talked about over the past couple of quarters with our business going forward.
Speaker 1
Got it. Okay. That's all I got. Thank you very much.
Speaker 3
Thanks, David.
Speaker 0
And our next question comes from John Hecht from Jefferies. Please go ahead with your question.
Speaker 8
Good afternoon, guys. Thanks very much for taking my questions. David,
Speaker 1
in
Speaker 8
the past, there's been a lot of discussion on new versus recurring customers in any given quarter. And obviously, with marketing down and the current environment, I'm I'm I'm sure I'm sure you're focused on more recurring customers. But can you give us that breakdown, number one and number two, to the extent you are engaging with new customers, is there any different characteristics? Maybe it's a higher quality customer, for instance, that has lost access to the traditional sources. Are you seeing any of those opportunities at this point?
Speaker 3
Yeah. I mean, you're you're 100% correct. The the, focus, I think, for a lot of reasons has been on existing customers who we have experience with. For the quarter, new customers were just, about seven and a half percent of the total, which is obviously way down from where we've been with an average of, you know, kind of, I think, about 37, 38% for the over the prior four quarters. So, obviously, meaningfully down.
I think what the focus on existing customers has done is allow us to continue to lend and manage risk during this very uncertain environment. As we're starting to see more certainty and we have more results from our testing and renewed confidence in our revised models, that proportion of new customers, will likely increase increase over, the next several quarters.
Speaker 8
Okay. Thanks. And this is more more a curiosity, and I think it'll help us gauge your your modeling the sector overall. You guys see various geographies, you know, you open and then maybe, restrict that opening because of new case ways and so forth. Is there a correlation to loan demand in those markets or is it fairly consistent, you know, no matter what, the specific geography is going through?
Speaker 3
I think they're over the, you know, longer period of time, there is a correlation. I obviously saw it when everything shut down. But if look at something like Texas, for example, where opened up, tightened back up a little bit, it's for, you know, short period of time. You know, my guess is over the next several weeks or months, they'll be opening back up. I think those kinda shorter amounts of, you know, kinda change, you don't see as much.
But, yeah, in states that have been more stable and gradually opening up opening up, you can see the demand increasing both on the consumer side.
Speaker 8
Okay. You gave some good stats about the the change in deferral programs by by product line. Missed some of those. Can you just restate the high level facts there?
Speaker 3
I'm sorry. Couldn't you you broke up for a sec. Can you just say that one more time?
Speaker 8
I I was sorry. I was asking if Steve could restate some of the, statistics around the deferral programs and the cadence, of of kind of the peaks and then what's happened since then.
Speaker 5
Yeah, John. I didn't give any actual specifics on modifications other than to highlight that they had had peaked earlier in the quarter in terms of the request for hardships and modifications, but that we had still had in our portfolio just an ongoing at the higher level in the receivables, which we're continuing our approach on the fair value to adjust the value of those those loans down even if they're performing just because of the uncertainty in the environment. Okay. Other than that, I was just speaking more on the statistics on thirty day delinquencies, which are down both sequentially and year over year.
Speaker 8
Okay. Thanks very much.
Speaker 0
And then
Speaker 3
In addition in addition, I gave a few stats about kind of payment rates post modifications, which have been very, very strong. I think, you know, if you try to compare this period to kind of pre pre COVID, you know, usually customers who had some form of payment modification or due date adjustment did not perform very well. Post COVID, those customers are actually performing very, very well, well above pre COVID levels and, you know, kind of close to kind of regular customer levels. So, you know, that that's the thing that, you know, is really we've we've learned throughout this this period.
Speaker 8
Yep. Okay. That's helpful. And then, you know, kind of higher level or a question though is, you know, across, you know, financial services and fintech and payments, we've seen, you know, not surprisingly kind of a logical acceleration of just moving to, you know, digital, you know, digital commerce. And, obviously, you guys are well positioned for that.
But I'm wondering, are you seeing are you seeing that already impact the competition? And have you guys are you able to think about how much of the world do you see as branch based versus digital? In other words, what kind of opportunities does this transformation take, you provide you over the next few years?
Speaker 3
Sure. Yeah. I I think it's a little too early to see it just because we're not really leaning into whatever demand's out there. And, obviously, demand's gonna, as we've talked about, we expect to significantly increase as the economy continues continues to open up and and improve. But, clearly, belief is almost every aspect of our economy is becoming more digital, just over time, but greatly accelerated by, by COVID.
I mean, you can see in the results of, for example, Grubhub, where where where I'm on the board. Business has just really taken off post, post post COVID world. And I think, you know, the days of people wanting to, you know, kinda schlep down to to a non to to a lender consumer lender and have to fill out a bunch of paperwork and wait in line and wait for their wait for the loan are just long long behind us. I think, increasingly, people wanna pick up their phone or log out of their computer or their iPad anytime, anywhere, and, you know, in a matter of minutes to be approved for a loan. So I think it's a great societal trend for us.
And, again, as demand picks up, you know, as we as it kind of begins to improve, we expect to see really strong results from it.
Speaker 8
Great, guys. Thanks very much.
Speaker 3
Yes. Thank you.
Speaker 8
Thank you.
Speaker 0
And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the conference call back over to Mr. David Fisher, CEO of Inova. Sir, the floor is yours.
Speaker 3
Thank you, operator. Thanks, everyone, for joining our call today. We really appreciate your time and asking all the great questions, especially about the OnDeck acquisition, which we're incredibly excited about. And we look forward to talking to you again soon. Have a great evening.
Speaker 0
Ladies and gentlemen, that does conclude today's conference call. We do thank you for joining. You may now disconnect your lines.