Earnings Call Transcript - OPRT Q4 2020

Operator, Operator

Greetings, and welcome to the Oportun Financial Corporation Fourth Quarter 2020 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Nils Erdmann, Vice President, Investor Relations. Please go ahead, sir.

Nils Erdmann, Vice President, Investor Relations

Thanks, and good afternoon, everyone. Joining me today to discuss Oportun’s fourth quarter and full year 2020 results are Raul Vazquez, Chief Executive Officer; and Jonathan Coblentz, Chief Financial Officer and Chief Administrative Officer. I’ll remind everyone on the call or webcast that some of the remarks made today will include forward-looking statements related to our business, future results of operations and financial position, planned products and services, business strategy and plans and objectives of management for our future operations. Actual results may differ materially from those contemplated or implied by these forward-looking statements, particularly given the uncertainties caused by the COVID-19 pandemic, and we caution you not to place undue reliance on these forward-looking statements.

Raul Vazquez, CEO

Good afternoon, everyone, and thank you for joining us. We concluded 2020 well situated to grow our business and expand our mission, and I’d like to start by highlighting five things that became clear about our company as a result of successfully navigating the challenges of the pandemic. First, our business is resilient and showing additional signs of recovery. In the fourth quarter, we grew aggregate originations 48% sequentially, generated $141 million of total revenue and $17.5 million of adjusted net income or $0.60 of adjusted EPS. We also grew our managed principal balance to $1.9 billion, up sequentially from $1.8 billion. In summary, our fourth quarter results were strong and give us confidence that we exited the year on a trajectory for continued growth.

Jonathan Coblentz, CFO and Chief Administrative Officer

Thanks, Raul, and hello, everyone. In the fourth quarter, our business exhibited growth in originations and revenue, normalization of our credit performance and improved profitability. Aggregate originations were $448.6 million, up 48% sequentially. Total revenue was $140.8 million, up 3% sequentially due to higher interest income and higher noninterest income but down 15% year-over-year. Interest income was $129.9 million, up 1% sequentially but down 12% year-over-year. Noninterest income, which includes cash gain on sale from our whole loan sale program, was $10.9 million, 36% lower than the prior year period but up 36% sequentially due to higher originations, reflecting the volume of loans sold, offset by a higher gain on sale premium of 12.8% versus 10.2% in the prior year period.

Raul Vazquez, CEO

In closing, I want to thank all of Oportun employees for their ongoing commitment. Their efforts made it possible for Oportun to navigate through the pandemic successfully. What’s more, we’ve accomplished this while ensuring that we stayed committed to our mission of helping hard-working people in the U.S. build a better life for themselves and their families. Entering 2021, we are well positioned for growth, and I’m very excited about all the things we’ve set out to accomplish this year. Thank you all for your time, and now we welcome your questions and comments. Operator?

Operator, Operator

The first question is from Sanjay Sakhrani, KBW.

Sanjay Sakhrani, Analyst

So first question, it’s a three-part question about the branch closures. I want to clarify that the branches you closed were in close proximity to one another, which is why you achieved efficiencies. The second part is whether there are more branches like that which you might consider closing in the future. The next question is if there are any noticeable behaviors of consumers that you acquire online compared to offline, or are you confident that there’s no adverse selection happening there? Lastly, regarding the $19 million in savings, will that be reflected in 2022? We're investing this year, but will we see that benefit in 2022?

Raul Vazquez, CEO

Sure. Sanjay, this is Raul. So on the branch closures, you’re absolutely right. The branches were close to each other. On average, the next closest branch to one that we’re closing is about 3 miles away. And in our dense markets like L.A., the average distance is 1.2 miles. So as we executed our strategy and saw customers shift to the digital capabilities, we did have an opportunity to optimize the network given the fact that we have branches nearby. So you’re absolutely right. The second part to your first question was whether there are more branches like this. We’re always monitoring our footprint, and we’re always taking a look at whether or not there are opportunities to optimize our omnichannel approach. So that will be something that we continue to do and continue to monitor. So that’s the first part. Let me pause there and see if you have any follow-up questions on that.

Sanjay Sakhrani, Analyst

No, that’s good.

Raul Vazquez, CEO

Okay. Your second one was whether or not we see any differences by channel and do we believe there’s any sort of adverse selection. We do not. We’re really pleased with the progress that we made with this strategy, and what we’ve seen is just the performance continue to improve across really just about every metric in mobile. So we are making this decision with a lot of confidence given the numbers that we’ve seen, given the performance in our mobile channel. And then your third question is the $19 million. So yes, we believe that there is kind of the recurring savings, if you will, relative to what our run rate was. How much we drop to the bottom line versus how much we invest, we’ll make that decision as we go into the next year. As you heard me describe in the beginning of this call, there are a lot of growth opportunities that we’re very excited about going into 2021. So this year, we decided to reinvest that capital, but that will be the sort of thing that we’ll take a look at as we go into 2022.

Sanjay Sakhrani, Analyst

Okay, great. Just one last one on the deferrals. I see on Slide 11, you guys talked about how that picked up a little bit on the shutdowns, but since the start of 2021, they’ve decreased. As far as that pickup is concerned, is that because your customers are sort of indexed to professions that are leveraged to the shutdowns or what? I’m just trying to make sure I understand that part.

Jonathan Coblentz, CFO and Chief Administrative Officer

Yes, this is Jonathan. That’s a good question. We don't have specific data on that. Obviously, it was a very small increase. It closely correlates with the timing of shutdowns and the subsequent reopenings in California. As you noted, we saw a peak in December, and since then, it has been declining. However, that peak was only slightly higher, going from 0.9 at its low during the quarter to just 0.4, and it is trending down again.

Operator, Operator

We have a question from Mark DeVries, Barclays.

Mark DeVries, Analyst

Yes. So it looks like you had some pretty encouraging developments around the digital engagement that gave you confidence to make the decision to shut some of the branches. Just curious to hear how you’re thinking about the risk that you’re doing that, when maybe customers are engaging more out of necessity and at a time as we emerge from this pandemic where they may actually look to want to move back to more of that kind of in-store interaction.

Raul Vazquez, CEO

That’s a great question, Mark. I would say there are three parts to how we think about this. First, it is the fastest-growing and primary channel for our customers now, whether or not there were restrictions in place or if we were in a less severe situation. What we have observed, similar to many industries, is that the pandemic accelerated efforts already underway. Regarding potential risks, we believe they are not significant since many people are already conducting transactions outside of stores. The second factor that makes this risk manageable is the proximity to other locations. We've conducted extensive analysis, considering the customers who interact in the stores set to close. We have a well-established playbook to migrate customers to other stores, whether due to weather events or prior store optimization. We consistently monitor our footprint and optimize our channels. The third aspect we've adjusted in our channel ecosystem is considering partner locations as part of that ecosystem. When we think about our physical presence and the ability to interact in person, we see it as a combination of our locations and those of our partners. As mentioned during the call, our goal for 2021 is to expand our partnership with DolEx to 150 locations. So, even with a decline of 136 of our own locations, adding 150 locations with DolEx means we are still net up 14 locations over the year, which helps mitigate the risk.

Mark DeVries, Analyst

Okay. Got it. That’s helpful. And then I appreciate given the uncertainty you don’t want to provide any kind of guidance. But just given kind of where you were this quarter with both new originations and loan growth, where are you in terms of the impact from both tightening and demand? And what do you think the implications are for growth as we look forward into 2021?

Raul Vazquez, CEO

Yes. As we look ahead to 2021, we are very optimistic. Regarding the tightening, we have strong confidence in our models, which have benefited from over 12 years of investment in machine learning and AI. These models were tested last year and performed exceptionally well. Since June, we have been increasing approval rates, starting with repeat customers who have already shown success with our product. We are also raising approval rates for new customers as we progress through the latter part of 2020. Additionally, first payment defaults remain favorable, and our credit performance is solid. If we examine charge-offs in dollar terms, we are below last year's levels. This gives us a strong belief in our models and instills confidence that we can maintain growth into 2021. On the demand side, the government's current actions are beneficial for communities as they are providing financial support to families and individuals in need. Recent retail results indicate that customers are utilizing this financial support. This could lead to a slight dip in demand in the short term, similar to what we observed when the $600 checks were disbursed at the end of last year, which customers spent at the beginning of this year. The reason we are not providing guidance at this moment, despite our optimism, is the ongoing discussions about another significant stimulus initiative. We want to understand the specifics of this initiative, such as who will receive support and the projected timelines, as this will inform us about the short-term effects on demand. Once we navigate that, we remain very optimistic for the remainder of the year.

Operator, Operator

We have a question from David Scharf, JMP Securities.

David Scharf, Analyst

Listen, Raul, I'll focus on the store rationalization and the channel strategy. Can you remind me, after the 136, what will be the remaining number of branch locations?

Raul Vazquez, CEO

We currently have 361 locations, and as I mentioned during the call, we will be closing 136 of them, leaving us with 225 locations.

David Scharf, Analyst

Got it. Okay. And I guess following up on the kind of the drivers of the shift in focus. I’m wondering, in terms of the proximity issue, I mean, obviously that’s existed for a while. And I’m wondering, is the overwhelming rationalization less maybe the proximity and redundancy of some branch locations as opposed to just how the pandemic has been playing out with respect to close to about two-thirds of your applications moving online? I mean just trying to get a better sense for, ultimately, what’s an operational decision versus what’s a strategic decision and which is really the one we should be focusing on more.

Raul Vazquez, CEO

I would say, and to give you insight into how we thought about this, this is a strategic decision. So what the pandemic did was it accelerated the outcomes of our strategy. Ever since 2014, we started our mobile journey, and every year, we’ve invested a bit more. And every year, the customer shows us that they like the capability, they like the convenience, which then creates this cycle, right, where the more positive feedback we get, the more that we invest there. And what happened this year during the pandemic, David, because I really like your question, is all of those trends just got accelerated. I mentioned that last year, about 46% of new customers were applying online. So it was certainly high, but it really crossed over the 50% and got to be that two-thirds level that you talked about. We saw the same dynamic in terms of activity outside of our stores when it came to payments. And it was very consistent in different states. It was very consistent in different periods of the year. So we think that in many ways, what has happened is for consumers, the genie is out of the bottle and now they’ve interacted via mobile with their favorite retailers, with their restaurants, with financial services, right, with each other. I’m even struck by the number of QR codes that we see because China has had them for some time and they never really took off here in the U.S., and now we see them in a lot of restaurants. So we think the pandemic simply accelerated the strategic outcomes that we were driving. The benefits to us as a company are that there was an element of our expense base that you could think of as being fixed. And now by moving more to a mobile element, we think it’s a lot more variable. It’s a lot more capital efficient, and it’s consistent with a direction in which we want to go, which is to be digital first. And we’ve had that view before, but it got accelerated during the pandemic.

David Scharf, Analyst

As we consider the potential increase of that 65% figure, the percentage of applications that are online or mobile, I'm trying to understand if there are specific thresholds you have in mind that might lead to further consolidation of branches, even if there aren't many stores within a few miles of each other.

Raul Vazquez, CEO

Well, David, we absolutely believe that a physical location can be a differentiator for us. We have a portion of customers that like those physical interactions, and we’re always going to be led by serving the customer in the way that the customer wants to be served. We’ve said for years now that we think the physical locations allow us to add to our addressable market because there may be some people that don’t want to deal with us digitally. I agree with your point, David. I do think that this number, this 65%, is only going to continue to go up. So as that continues to happen, we’ll do exactly what I mentioned earlier. We’ll monitor our footprint, and we’ll continue to optimize our omnichannel approach, in particular, with an eye to putting our capital against the efforts that are going to drive the most growth and the most value. And then per the question that was asked earlier, also trying to figure out how much of that capital then, after we feed our growth investments, we can go ahead and drop to the bottom-line so that we can get back to the ROE trajectory that we’ve committed to investors.

David Scharf, Analyst

Got it. And just one last follow-up along the same lines on the channel strategy. Can you remind us sort of what percentage of the marketing has traditionally been direct mail? And does this more balance shift to digital origination also mean you’re going to redirect more of your marketing spend to online lead generation partners?

Raul Vazquez, CEO

That’s a great question. So although we have not disclosed historically where we spend our marketing dollars, your intuition is correct. What has happened over the last few years, and again, it was accelerated last year during the pandemic, is we’ve invested a lot in a data infrastructure and set of capabilities for marketing that are very similar to what we have done for 12-plus years in our risk. We’ve increased our hiring. We’ve got a great team there. They did a fantastic job last year. So the mix of our marketing that went to digital did absolutely go up last year, David, and we expect that to continue to go up. Because one of the nice things between digital marketing and the digital capabilities that we’ve developed is there’s a very nice handoff there, right? You can put someone straight into the application, and you can present information in a more compelling way. So we’ve got a lot of faith in our team. They’ve done a great job, and we expect that mix to go up. On the direct mail side, one of the other things that has happened over the years as the customers were responding positively to our digital capabilities is the direct mail started to emphasize our mobile capabilities a lot more. So if you were to look at our direct mail from a few years ago, right, there would have been more prominence for location. And then what has happened over time is digital and the store started to get equal rate, and now there are some creatives that we test in which the call to action really feels like much more of a mobile one. So that shift has already taken place as we have monitored how customers are using our omnichannel network.

Operator, Operator

We have a question from Rick Shane, JP Morgan.

Rick Shane, Analyst

I’m listening to my colleagues ask questions, and I know they have been following your company for a long time. When we consider what you will become in two years, it's a significant shift from where you were two years ago, likely becoming more focused online rather than on branches and possibly obtaining a national bank charter and becoming a depository rather than remaining a nonbank. This represents a major transition. Among all these changes, I am particularly interested in the move towards having your own bank charter. At this stage, with your partnerships, you seem to enjoy many advantages in asset gathering, but I wonder if the regulatory requirements of being a depository offer sufficient benefits.

Raul Vazquez, CEO

We believe that becoming a bank will bring significant advantages. We're enthusiastic about the opportunities this new chapter will present. From a cost perspective, our funding costs would improve notably, which would allow us to enhance our pricing, invest more in our business, and better our return on equity. This is a major benefit. Additionally, having a consistent set of products across all 50 states would be advantageous for our company. We've already discussed our channel ecosystem, and now we're also developing a product ecosystem. Our personal loan product is our strongest offering, and we've made considerable progress recently, especially in the fourth quarter, with our secured personal loans and credit card products. As a bank, we could provide these offerings uniformly across all states, leading to operational efficiencies and better pricing for our customers. Strategically, we excel in two main areas: underwriting individuals with no credit history or thin credit files and delivering exceptional service as they build their credit scores. When we reflected on our strategic opportunities, we recognized the potential for growth through platforms like DolEx, which allows us to leverage our core competencies in a more capital-efficient manner. The DolEx model uses our product structure while maintaining our pricing and protections, resulting in a positive impact on our profits. We're encouraged by the progress with DolEx and the interest from other potential clients. This has prompted us to explore new avenues for digital distribution, which ties into our banking goals. We see lending as a service as a promising opportunity in the long term, especially as we establish our bank and gain experience. We're hopeful that as we progress and regulators become comfortable with us, we can also explore banking as a service, collaborating with partners in a capital-efficient, digitally distributed manner. Overall, we are confident that becoming a bank will benefit our customers and shareholders.

Rick Shane, Analyst

Got it. I think that’s a great answer, and I agree with your assessment of your core strengths. I'm intrigued by your comment about product as a service. However, I believe that some of the constraints faced by regulated banks and others on this call over the past year have highlighted the flexibility that nonbanks have enjoyed, which presents an opportunity to gain market share as a result.

Raul Vazquez, CEO

We still have so much share opportunity in front of us that I think even as we work through potentially some of those challenges, Rick, the positives greatly, greatly outweigh any potential negatives. I absolutely hear what you’re saying. We think we’re barely scratching the surface in our addressable market. One of the things I mentioned that we’re really excited about is MetaBank, right? We’re going to almost double our addressable market this year. That shows how much potential there still is in our business and how excited we are about unlocking it, whether it’s through partners like MetaBank or DolEx or our own bank charter.

Operator, Operator

We have a question from John Hecht, Jefferies.

John Hecht, Analyst

Most have actually been asked, but I’ve got a couple more. Thinking about the Meta and the DolEx, Raul, you mentioned some service components of those relationships. Can you tell us, are you going to be housing all the credit? Or with those partnerships, will DolEx and Meta be housing some of the credit? And is there anything as those partnerships develop that we think in terms of mix of fee income versus net interest income and so forth on your income statement?

Raul Vazquez, CEO

Yes. It’s a great question. And as you know, historically, we have sold 10% to 15% of our loans. So we’ve had a portion of our P&L that is already fee income. The specific partnerships that you asked about Meta, it is largely with us. There is an element that is theirs, and with DolEx, it is as well. So for now, it is ours.

John Hecht, Analyst

Okay. I have a broad question regarding credit this year. You are entering this year with strong momentum in delinquencies and loss rates, and you have effectively improved your underwriting process. However, we have more stimulus influencing credit demand, and some credit card issuers are setting aside larger allowances, indicating they anticipate some charge-off cycle throughout the year. Given the momentum you have and these factors, along with broader macro conditions, how do you see the year shaping up?

Raul Vazquez, CEO

It's a great question. You and the others on this call have known us for quite some time, John. We’ve always aimed to be a company that pursues growth responsibly. In lending, it's important to take that approach; otherwise, you can be caught off guard. Given all the uncertainty in 2020, we acted cautiously. We pulled back at the start of the pandemic to see how things would unfold globally. We were trying to understand the situation with the shutdowns and the recession, which created a lot of uncertainty. Looking into 2021, there’s still more to address. We’ve seen that about one in ten people nationwide has received the vaccine. The number of doses given is now twice the amount of confirmed COVID-19 cases in the U.S. The Biden administration is definitely committed to a significant role in distributing vaccines to as many willing individuals as possible. We believe this trend will be very positive and will help the economy recover, leading to more employment and increasing demand. Regarding your point about stimulus, while it may reduce demand temporarily, our customers often live paycheck to paycheck. Thus, when stimulus checks arrive, whether it's $600 or $1,200, they provide short-term relief but may not be sufficient when unexpected expenses arise. Therefore, we are looking beyond the short-term impact of the next stimulus. We will certainly account for it when we provide guidance. However, we believe the impact will be short-lived while we experience growth in our personal loan, auto loan, secured personal loan, and credit card businesses.

Jonathan Coblentz, CFO and Chief Administrative Officer

If I could just add one thing, John, because you asked about provision, which we have remaining cumulative charge-off as part of our fair value calculation, and I’m looking at Page 15 of the deck that we shared online. At the end of this past year, December 31, 2020, that remaining cumulative charge-off number came down by about 60 basis points. It’s 10% now, 10.0%. In comparison, at the end of 2019, that forward-looking estimate was 9.5%. So consistent with all of the other credit trends that are normalizing, that forward-looking outlook is normalizing as well. So I just wanted to share that number.

John Hecht, Analyst

Okay. While we're discussing this, I'm thinking about the flexibility you have by opening so many channels this year. Even if there is a slowdown in credit demand overall, you can still grow because you're expanding so many DolEx branches in the markets with Meta. Given this, do you expect any changes in the average credit performance in those channels? Or are they fairly consistent with your historical delinquencies and losses?

Jonathan Coblentz, CFO and Chief Administrative Officer

So we expect that they'll be, I'm sorry. Go ahead, Raul.

Raul Vazquez, CEO

I’ll just start, Jonathan. You’re absolutely right. Let me first confirm your intuition. One of the things that makes this year exciting for us is that we believe we’re really opening up the top of the funnel. We’re adding 30 additional states and focusing on marketing these new products. We’ve also added 150 more DolEx locations, and we’re seeing a great response to our digital efforts, which we can continue to scale up. Your intuition is definitely accurate. What makes this such an exciting year for us is that the top of the funnel is really going to expand. This means that even if there’s a slight dip in demand due to stimulus or if it takes longer to achieve herd immunity, we still anticipate significant growth this year. Regarding the mix shift, we know how to manage this effectively. We’ve opened new states and channels and have been very intentional about growing our mobile presence. When we reintroduce guidance, we’ll provide an outlook on what we expect our losses to look like. As a reminder, one of the things we discussed when we went public is that we believe we are at a stage where losses will seek to optimize our responsible lending approach while also focusing on profitability growth. This growth means we are investing in low- and moderate-income communities. We believe it’s very manageable, and we’ll set expectations when we provide guidance.

Operator, Operator

Ladies and gentlemen, this is the end of the question-and-answer session. And now I’d like to turn the call back over to Raul Vazquez for closing remarks.

Raul Vazquez, CEO

Well, I want to thank everyone once again for joining us on today’s call, and we look forward to speaking with you again soon. Thank you.

Operator, Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you.