Funding Circle Holdings plc (FCH) Earnings Call Transcript & Summary

Welcome to the Funding Circle First Half 2020 Results Presentation. It's been an extraordinary period for Funding Circle, but I feel really proud of the huge difference that we've been able to make to so many small businesses during this period. We started Funding Circle 10 years ago to really help small businesses access funding from alternative sources to banks. And our online-only platform model is really delivering for them during this time of need. Our model is also benefiting from some really powerful trends. Across many industries, there has been an increase in the adoption of digital services, and we are seeing that same trend in online small business lending. We also see that interest rates are lower, and we expect them to be low and possibly even negative for a long time. This is attracting record levels of institutional funding on to our platform who are looking for yield and looking to fund small business borrowers. We feel that we have successfully navigated the very difficult conditions from COVID and the business is well positioned to take advantage of these trends in the future. In the first half, we saw very strong demand from borrowers and investors. In the U.K., we have become the fifth-largest CBILS lender with close to 20% market share of approval since we joined the program. We've approved GBP 1.2 billion of loans and originated GBP 850 million, and our originations in June to August have been up more than 30% year-on-year. In the U.S., we are approved to the PPP program, and we've originated over $1 billion of loan -- approved over $1 billion of loans and originated around $500 million. We feel we're effectively managing our loan book during this period of extreme stress. Following an initial spike, the number of borrowers missing payments is now below pre-COVID levels -- missing payments for the first time, and more than 90% of borrowers are making payments. Investor returns are resilient. And after applying our central COVID stress scenario, we expect all U.K. cohorts to deliver positive net return and all U.S. cohorts, except 2019. Our new Instant Decision lending technology is really transforming the small business borrower experience, representing 40% of the applications in the U.K., and these have -- and these allow borrowers to apply in just 6 minutes and get a decision within 9 seconds. From a P&L perspective, we saw strong income growth. Total income reached GBP 101.2 million, which is up 24% year-on-year. And our free cash flow improved to a negative GBP 29.6 million (sic) [ GBP 9.6 million ] from a high level this time last year. The business continues to be very well capitalized with a strong balance sheet of around GBP 217 million of net assets. Our adjusted EBITDA was a negative GBP 84.1 million, which was primarily due to the impact of COVID-19 on the valuation of loans we were holding for sale, which Oliver will talk through and explain later. The Funding Circle model has proven itself to be incredibly resilient during this time of stress. We connect up thousands of small business borrowers with thousands of investors to allow both to get a better deal. We have originated over GBP 10 billion of loans since our platform, which is cumulatively 2x as large as when we took the business public 2 years ago. And we do generally believe that our ability to very quickly aggregate huge amounts of capital and distribute that to small businesses has been a real source of strength and a real validation of our business model. There were 3 phases of activity in the half. We started the year very strongly in January and February with a clear focus on improving conversion and keeping net returns attractive for investors. Originations were at the high side of expectations, driven by the demand for SME loans in the U.K. following Brexit and the general election. But also in the U.S., we were at the highest levels of origination for 12 months. And we completed the build of our Instant Decision lending technology and has started to test that in the market. Our January to February originations were around GBP 425 million. As COVID hit, we adapted very, very quickly and significantly tightened our credit criteria, which brought down originations but protected returns for investors as we sought to understand what was happening in the economies we operate in. We successfully transitioned all of our workforce to remote working and dramatically increased our collections resource and capabilities to help borrowers who requested payment plans. We also became the only lender to become accredited to both the U.S. and U.K. government programs. We were one of the first lenders accredited in the U.S. and the first fintech accredited in the U.K. And in May to April, our originations were lower at about GBP 147 million as we transitioned. And in the last phase, which has really lasted in May and June, but also in Q3, I'm really proud of how the amazing efforts from our team and how quickly we've been able to really ramp up originations to help thousands of small businesses. We launched PPP loans in the U.S. and CBILS in the U.K. We were able to very quickly close record levels of funding to meet SME demand, which is really down to the long track record that we've been able to develop, which gave a lot of institutions the comfort to increase their commitments and also put more money for new investors to join our platform to get money to small businesses. We've achieved record levels of origination. And actually, in the U.K., from June to August, we've continued to show an uplift of more than 30% year-on-year. And so over that period, our May to June originations have been around GBP 539 million. So I'm just going to hand over to Jerome who's going to talk about the SME credit environment.

Hello. I am Jerome Le Luel. I'm the Chief Risk Officer at Funding Circle. I've been with the company for 5 years, in charge of risk management globally. And prior to that, I spent 20 years in financial services in similar roles. My previous position was with Barclays. I was the Chief Risk Officer of Barclaycard. And there, I managed a portfolio of GBP 40 billion of assets through the 2008 crisis. And I would say that this experience, which has been extremely rich, is now very helpful to help me and the team navigating this new crisis. So what have we seen so far with the COVID crisis? Well, when the lockdown happened in late March, we experienced a surge of borrowers reaching out to ask for payment plans. They were typically quality borrowers who never had missed payments before. They were just concerned with preserving cash for the business at a time of high uncertainty. So we did enroll quite a few of those borrowers on payment plans. And what you can see on this graph here is the index flow of those customers who are moving from making payments to not making payments over time. And you can see that we reached a peak around late April. And since then, this has come down. And from July onwards, we're actually now running at a level of new entries into those plans that is below the pre-COVID level. On the left-hand side, you see the experience we've had in the U.K.; on the right-hand side, what we've seen in the U.S. The 2 follow a very similar pattern. So what has happened to those customers who did enroll on plans? We deployed a lot of resources to help them increase staffing in collections and recovery teams, offering different versions of forbearance plans, making sure we were advising them in the right way to make -- take advantage of government support, being furlough of government schemes, government-backed loans. And our borrowers have made good use of those tools to help the business at the time of crisis. The good news is that as those customers exited their plans, which was typically a 3-month plan, the vast majority of them are restarting, making their normal contractual repayments. You can see on the graph a snapshot of the U.K. and U.S. portfolio as of the end of August. And it shows that in the U.K., more than 90% of borrowers are now making their full contractual payments every month. A few percent are still on a plan that has not reached its term, and we only have around 7% of borrowers who are not making their payments. And we're helping them finding solutions to get back on their feet. In the U.S., it's a similar pattern. The percentage of customers making payments is above 80%. We have a larger proportion of borrowers in the U.S. who are still on a payment holiday. This is because of the way the plans were structured under timing, but these customers are due to exit their plan in the coming few months, and we hope that the majority of them will restart paying like we've seen in the U.K. And it's less than 10% of the borrowers in the U.S. who are not paying at this stage. So overall, I would say the recovery to payment has been better than what we could have expected from a population in financial difficulty, which, again, give us the evidence that those customers were quality borrowers to start. They just had temporary issues, and they've managed to get back on their feet and supported by the government actions. It looks like the vast majority of them are going to recover. Now what does this mean for the longer term? It's obviously quite difficult at this stage to tell how this recession is going to play out. We're only at the beginning of it. So if you take a look back at what recessions typically mean in terms of credit stress, you can represent that in a graph like you have on this page, where the recession would translate into an index of multiplication of the baseline monthly credit losses. The green line here shows an environment that is benign, that's what we assume pre-COVID. The black line shows what the stress would be if you use the Bank of England 2019 stress test scenario, and this is a very similar representation to what the 2008 recession actually did in the U.K. So credit losses ramp up over the normal baseline over 15 months to a peak of around 2x and then gradually de-stress over the following 3 years. Well, in this recession, we think the pattern will be a bit different. We expect the initial spike to be sharper and higher. That's something we've already seen. And then there will be a distressing and a longer tail, which will be obviously dependent on how the economy is faring. So looking at the -- at our portfolio and its composition as of today, we've been able to create a forecast, which we think is quite reasonable at this stage. And it is represented by the orange curve on this slide. So we do see the spike going maybe up to 3.5x over the baseline and then a very fast de-stressing. And we're very much now at the point where we're seeing the de-stressing as those customers, the new entries into not paying have come down, and we see people getting out of plans and restarting paying. But there is some unknown around how fast it's going to actually de-stress and with the dependency on the ongoing government support and how lockdown measures might evolve. In the longer term, it's hard to tell. We've assumed in our scenario, which is our central scenario here, that the U.K. economy would probably experience a recession similar to 2008. That's our base assumption. The way this could translate into losses is a bit different from 2008 because some of the defaults have been brought forward. So this cleansing effect means that there should be fewer defaults down the road for the same difficult economy, hence, why the orange curve is below the black curve in the outer years. Overall, this orange curve has a stress multiplier of 1.4x over the period, similar to the Bank of England stress test. But because the losses are brought forward and because our loans are amortizing, it does translate into higher overall losses than the 2008 recession would have done, probably around 2x. And so overall, it's a scenario that is more pessimistic than the 2008 recession. We've then taken this stress scenario, the orange curve. And using this, we've been able to recompute the expected returns by cohort of loans originated in the past. So looking at the actual so far and then making a projection going forward, we can run the expected annualized return for our investors who are exposed to these various cohorts of loans. We've always -- Funding Circle strived to protect the capital of our investors and make sure that in the -- in a stress situation, investors would recoup their original investment at the very least. We've built buffers in the pricing of loans, in the credit parameters to ensure there was enough resilience in the portfolio. And I'm quite pleased to see that through this estimation we've done using the latest data we have, it looks very likely now that our investors in the U.K. are going to earn positive returns on their investment despite the stress. If you look at it by cohort, you can see that the -- all the cohorts are going to experience less stress than the recent cohort. The black bar shows the estimation of return we had made in -- back in January before knowing about COVID. The blue bar shows the latest estimate we have in factoring the COVID stress, and you can see that there is little difference between the blue and the black bar on the older cohorts. But on the more recent one, the gap in yield is bigger. You should expect the yield to go down when losses are higher, but you can see that the blue bar remains positive, which is a good thing. The reason the recent cohorts have a bigger difference in yield is because they have more to go and they are less amortized, so they are more impacted by the current crisis. In the U.S., it's a very similar story. The older cohorts are going to deviate less than the recent ones. There is one cohort, 2019, where we think it's going to go slightly negative, and this is due to the fact that the loss coverage was not as rich in the U.S. as it was in the U.K. The more recent bookings of 2020, whether they are pre the government programs or the government programs themselves, CBILS in the U.K., PPP in the U.S., are expected to deliver positive returns because we've been able to tighten pre-government programs and then government programs provide guarantees that obviously make them very resilient to our investors. So overall, I think this is a proof that the way those loans were calibrated was very reasonable. And I'm pleased to see that some of the investors who did invest in the unsecured loans pre-COVID are now also willing to invest in the government program loans we offer today. And for me, that's a strong sign that the trust that we are taking care of the assets very well and that we're going to carry on doing that going forward. And now I'm going to hand over to Oliver White, our CFO.

Thank you, Jerome. I'm very happy to be joining you all at my first set of Funding Circle results, and I'm very excited about the future here at Funding Circle. We have just discussed the actual and forecast impact of the pandemic on our SME borrowers and the impact of returns to our investors. Turning now to the impact on Funding Circle's balance sheet. As you know, Funding Circle funds its GBP 3.7 billion loan book from a variety of sources: retail will be individuals directly purchasing fractional loans; national entities, such as the British Business Bank, which is a U.K. government's investment bank; private and public funds; institutional investors directly purchasing whole loans. Additionally, in 2019, we launched new investor products to aggregate loans in warehouses for substant sale of bonds of our securitization. We did this to widen the universe of investors that could access our loans and, indeed, successfully added 30 new investors. But it's also an efficient mechanism to provide working capital to build an inventory of loans. GBP 759 million of these bonds and warehouses are consolidated on the balance sheet for accounting purposes. This represents about 20% of total loans under management. These loans are holding bankruptcy remote vehicles. Funding Circle's exposure, therefore, was limited to its investment in these SME loans. As of June 2020, Funding Circle's investment was GBP 110 million. These vehicles are subject to regular assessments of their value. It should also be noted that Funding Circle has negligible balance sheet exposure to the other sources of investor funding. Diving deeper into the GBP 110 million investment, there were 4 main types of vehicles in which Funding Circle invests its capital and SME loans, some of which are intended to be temporary. These vehicles have very different risk dynamics, and therefore, impacted by economic stress and the pandemic in different ways. And clearly, the speed of the impact of COVID-19 in the wider economy was unprecedented. Firstly, Funding Circle was acquired by regulation to retain a 5% vertical slice of any securitization issuance. This has an equal participation in all classes of bond, resulting in relatively low impact from COVID-19. Secondly, there were a small amount of other investments, comprising seed investments in private funds and participation investment in the U.K. CBILS program. These also of equal participation on loans, the impact is again low. Thirdly, the warehouse structures combine Funding Circle equity bank debt. The intent of the warehouses is to aggregate loans prior to securitization. This is effectively our working capital and our inventory of loans. When COVID hit, the U.K. warehouses were at 100% of capacity with a planned securitization in April, and the U.S. warehouses were at 30% of capacity following a successful securitization of loans in January. Due to the impact of COVID, we were unable to securitize these warehouses when originally planned. Funding Circle's exposure in these vehicles is to the loan book as a whole, but the debt is senior, which means our equity is more exposed to changing the valuation of the loans. Finally, once we have securitized loans, we have temporarily retained the horizontal tranche with the intention to sell these loans once they seasoned. We did this as we're a new issuer, and we wish to establish some early proof points on performance. Due to the structure of securitizations, these tranches have the potential to earn greatest returns but also absorb the losses first. This is why they have a higher COVID-19 impact than the vertical tranches. The timing of the pandemic meant it was not feasible to dispose of these horizontal tranches in half 1. Turning now to the changes in these vehicles in half 1. Firstly, talking to the chart on the left-hand side of the slide and considering what principal Funding Circle is built in these vehicles. As at the end of December 2019, we'd invested principal of GBP 134 million of equity. As shown in the chart, GBP 34 million more was added, primarily being the increased utilization of the warehouses. We extracted GBP 9 million of cash out of these vehicles, which leaves us a principal of GBP 159 million as at 30th of June 2020. Secondly, the chart on the right-hand side shows the balance sheet valuation of these vehicles. This is consistent with the central stress scenario outlined earlier by Jerome. The balance sheet view shows GBP 145 million as at December 2019. This includes the interest earned in 2019, which has been reinvested into these vehicles. The additions are GBP 34 million or the same as the previous chart. The income earned and the fair value adjustment combined to an investment adjusted EBITDA of negative GBP 60 million, which is what's seen on the face of the P&L. In half 1, we generated investment income of GBP 36 million from these vehicles. The evaluation of fair value resulted in adjustment of negative GBP 96 million, primarily due to the economic stress of COVID-19. After the GBP 9 million of cash extracted, we are left with a valuation of these assets of GBP 110 million. It should be noted there's an element of unwind in the fair value as income becomes crystallized in the investment income line and fair value reduces. The fair value adjustment seen in Q1, in other words, before the pandemic struck, was negative circa GBP 11 million. Should these vehicles be hold to maturity, we would expect total future cash flows of circa GBP 149 million. The impact of the COVID-19 economic stress is concentrated on the assets in the warehouses and the horizontal securitization retention, both of which we intended to sell. The timing of COVID-19 impacted our ability to sell on these assets in the time scaled originally intended. And the speed of the impact of COVID-19 in the economy was unprecedented, with the speed from peak to trough much faster than seen in the 2007 to 2008 economic crisis. The balance sheet valuation for the vertical securitization tranche is GBP 18 million with negligible fair value adjustment. The other investments have a valuation of GBP 16 million, a gain of negligible fair value adjustment. The warehouses generated GBP 15 million investment income in the half, with a GBP 35 million fair value adjustment and a balance sheet valuation of GBP 66 million. The principal in the warehouses was GBP 80 million. The horizontal securitization tranches with the first loss risk characteristics generated GBP 21 million of income with a fair value adjustment of GBP 61 million and with a balance sheet valuation as of June of GBP 10 million. GBP 45 million of principal had been invested. It is still our intention to sell these assets once markets have normalized. Funding Circle continues to maintain a strong balance sheet. Net assets of GBP 217 million, as discussed, we retained GBP 110 million of investments in warehouses securitizations and the other vehicles. And as noted, it's still our intention to sell these assets once markets have normalized. GBP 107 million of net assets are deployed against the trading business, including GBP 74 million of cash and cash equivalents. Turning now to the group's financial performance. Loans under management increased by 5% to over GBP 3.7 billion. This increase was seen in all geographies with, at constant currency, the U.K. growing 5%; and the U.S., 3%. Originations totaled GBP 1.1 billion, down 7% year-on-year, primarily due to the lower levels of activity in March and April as the business adjusted to the pandemic and adapted to the SME government guarantee programs. As Samir noted, January and February provided a strong start to the year in both the U.K. and the U.S. and may endure a record month for origination. Origination growth was up year-on-year in February and again in May and June. Total income growth was 24%, supported by the contribution of the investment income, in other words, the income from the investment vehicles discussed a few slides back. Consistent with our presentation of adjusted EBITDA, we're here on the right-hand side of the slide show income from the operating activities, so the transaction fee income from originations, the servicing fees and other fees; and the income from investments, so investment income, less investment expense. We launched the new investor products in the second half of 2019. So as you can see on the right-hand chart, there was limited investment income generated. Since then, investment income has grown strongly. In half 2 2019, investment income was GBP 19.1 million and continued to grow to GBP 36.4 million in half 1 2020. Operating income was reduced to the lower levels of origination activity in March and April. The CBILS loans have similar economics to our core lending product but slightly lower transaction fee and slightly higher servicing fees. PPP loans have a transaction yield of about 2.5%, as we discussed on the July 8 announcement. Within operating income, transaction income was reduced to the lower levels of origination activity in March and April. Transaction yield was slightly down, predominantly due to the nature of the government support to loan schemes in the U.K. and the U.S. Servicing yield was slightly impacted due to the increase in borrowers and collections, including payment plans. Retail investors do not pay servicing fees when borrowers are not fully up to date. As can be seen in the chart on the left-hand side of the page, the increase in total income is seen across both the U.K. and the U.S. Developing markets income reduced 39%, in line with changes in the business model previously announced and the impact of COVID-19 on these markets. We restructured the businesses and changed the model to originate loans for other lenders in the market rather than for our investors. The restructure is being successfully completed and in line with guidance set out at the full year results. Due to the impact of COVID-19 and local government responses, we hold back initial investment in the new model, and this has affected growth, especially in the Netherlands. Total income here excludes the fair value adjustments. Total income less fair value adjustment subtotals to net income, as shown on Slide 21. The adjusted EBITDA loss is driven by the COVID-19 impact on fair value we've previously discussed. There was a strong improvement in free cash flow. The chart on the left-hand side shows the adjusted EBITDA split between the contribution of the operating activity and the investments. The operating activities adjusted EBITDA deteriorated slightly from negative GBP 20.7 million in the half 1 2019 and negative GBP 17.3 million in half 2 2019 to negative GBP 24.4 million in the half. This is primarily driven by the reduced origination activity in March and April and its impact on transaction fees. The investment income adjusted EBITDA reduced from GBP 9.5 million positive to negative GBP 59.7 million due to the fair value adjustments, partially offset by the increased investment income. Free cash flow continues to improve from negative GBP 28.1 million in half 1 '19 to negative GBP 21.3 million in half 2 '19 to negative GBP 9.6 million in half 1 of 2020. This is due to continuing improvements in the cash-generating components of adjusted EBITDA, partially offset by working capital movements. Operating costs are down 10% year-on-year, falling from GBP 112.7 million to GBP 101.7 million and are expected to fall a further 15% in half 2 over half 1. In half 1, this was primarily driven by the reduction in marketing, with marketing falling to 22% of total income, down from 43% in the prior period. The fall was driven by reduced activity levels in March and April, the revised nature of marketing to support government loan schemes, the broader downward pressure on marketing costs due to broader economic conditions and importantly, the ability of Funding Circle to use marketing as a countercyclical lever. Operating costs will further decline in half 2 as it benefits from the previously announced restructure from developing markets and the U.S. business were realized. Funding Circle's operating loss is impacted by the significant fair value adjustment driven by COVID-19 and by onetime exceptional costs. The exceptional items are the GBP 5 million restructuring charge for the developing markets revised business model and the GBP 12 million for the noncash write-off of the goodwill associated with the acquisition of the U.S. business in 2013 related to the restructure of the U.S. business. To summarize the previous slides as they feed into operating loss. Fee income or the operating income has been impacted by the slowdown in activity in March and April, with slightly reduced transaction and servicing yields. Loans under management is up, and originations are very strong in the first and last parts of the half. Total income was up 24%, supported by the increase in investment income. Net income is significantly impacted by the COVID-19-driven fair value adjustment. Operating expenses, excluding exceptional items, fall year-on-year. In total, Funding Circle's operating loss for the half pre-exceptional is GBP 96.6 million and post exceptional is GBP 113.5 million. I would now like to pass over to Samir.

Thank you, Oliver. I just wanted to talk through our views on the overall market environment and then finish on the outlook. So COVID has been an extreme stress, and we wouldn't have wished for a recession, certainly one as bad as COVID-19, but we do really feel that there are some powerful trends that are emerging from this that will really benefit Funding Circle. First of all, government support for small businesses across all of the economies we operate in and pretty much every country in the world really demonstrates the strategic importance of small businesses to economic growth. Governments have stepped in to help support small businesses and lending to them in a way that they haven't done for, say, consumer lending or mortgage lending or other products. And that's reflected in the $520 billion of loans borrowed by small businesses during the lockdown in the U.S. and the GBP 50 billion borrowed by SMEs in the U.K. So whilst we're really proud of the impact that Funding Circle has been able to have, you can see that there's still a huge addressable market for us to be going after. There's been a significant acceleration in the adoption of digital activities, online purchasing, not just in our industry but across all industries. And we really do see that trend emerging in small business lending. We've seen a 2x increase in the amount of searches for business loans online, and we really do believe that as the largest online small business loan provider across our markets, we're really in a unique position to take advantage of these different trends. Interest rates are low. They've been cut low, and we expect them to stay low for a long time, and that's certainly reflected in yield curves. In fact, we may even see a period of negative interest rates in the U.K. and U.S. What this means is that we're seeing incredible amounts of demand from institutional investors to purchase loans that we're originating because they really provide access to yield that isn't available on most traditional fixed income products. And that's reflected in the GBP 1.25 billion of investor capital that we've managed to raise so far since the beginning of COVID to lend to small businesses in the U.K. and U.S. on our platform. There's been huge demand from these institutions to access this asset class, and we expect that to continue and to benefit from that. Finally, more small businesses have actually borrowed money. So actually, in most economies, the majority of small businesses typically don't access borrowing partly because they don't need to, partly because they don't understand the process as well, whereas the vast majority of now have experienced borrowing. And we expect them to actually continue to -- now that they've tried it, to actually continue to do so in the future as a way to manage their business. And that's reflected in the fact that 55% of small businesses expect to require access to finance in the next 6 months. So this is really an area where there will be an ongoing need, and we're in a prime position to really help those small businesses and take advantage. Our unique model we feel is really well placed to deliver these government programs. So in the U.K., CBILS loans have an 80% guarantee and of loans above GBP 50,000. We've approved GBP 1.2 billion of loans since we became accredited at the beginning of May and originated GBP 815 million of loans. And since joining the scheme, we're the fifth-largest CBILS lender after the big 4 High Street banks. Our market share of the number of approvals is 20%, which is -- demonstrates the huge impact we've been able to have in a very short period of time and, really, the big impact we've been able to have. We've seen very strong investor demand purchase loans, as I've talked about. We're fully funded to meet our CBILS capacity. And our funding has been agreed with multiple different institutional investors, and that includes banks, asset managers, insurance companies, a number of companies really placing their faith in our data-driven advanced credit assessment and our ability to distribute and process loans at a very large scale. The graphs on the right just demonstrate the real breadth of the lending that we've been able to facilitate. I'm not picking on anything in particular, but across all of the regions of the U.K., across a variety of different sectors, we've really been able to help a lot of small businesses and have a huge impact. In the U.S., we are well positioned for the second half. We started the year very strongly. Our January and February originations were the highest they've been for 12 months. And in response, the U.S. government -- in response to COVID, the U.S. government introduced the Paycheck Protection Program. And the way that scheme works is similar to the U.K. furlough scheme, whereby, the SBA will forgive loans if the funds are used to pay eligible expenses such as payroll costs of employees. These loans are 100% guaranteed, and we are accredited for the programs at the end of April and had a very strong May, June, July and August as the schemes carried on. And they're currently -- the current scheme is currently paused at the moment. We've originated $1 billion of loans -- sorry, we've approved $1 billion of loans, and we've originated around $500 million of loans as at the 20th of September. You may remember in July that we introduced changes in the U.S. business to accelerate the path to profitability. This included centralizing our U.S. technology team in the U.K. and moving our sales and marketing teams to our Denver office with workforce reductions in aggregate, resulting in a net reduction of 85 roles. The restructure has gone well, and the team are very focused on delivering a strong second half. We have 2 areas of priority for the second half. At the moment, the PPP program is paused, and we're awaiting feedback on whether there will be an extension of that, which has the support of both the Democrats and Republicans, although the impact of an extension on PPP has not been included in the outlook that we'll talk about later. And we're focused on restarting our core lending product and helping more borrowers, including adding other lenders to our marketplace, including 7 SBA (7)a guaranteed loan providers. What I'm really excited about and what we've been able to really roll out this year is our Instant Decision lending technology, which is really having revolutionary results for small businesses. And this is something we've been working on for a very long time. It really takes advantage of the 10 years of experience that we've been able to accumulate the 1 million -- over 1 million applications, huge teams that we have in engineering and data analytics that have really been focused on processing this. And we've got the technology to a point where we've been able to process 40% of our loans in the U.K. through this platform. It takes on average just 6 minutes to apply, and borrowers get decisions in only 9 seconds. And we've also been really pleased with the initial results, monitoring the credit performance of these loans, which we can see from both pre-COVID and during the COVID environment. So really, this is a really exciting development for us. It really game-changes the platform. At the moment, operating for loans below 100,000, but one that we can roll out progressively over time and really allows us to build a lot of new products and integrations on top of this technology that will really allow us to take Funding Circle to another level. So really excited to be able to talk about those innovations in the coming months and years. And this Instant Decision lending technology is really making a big difference to small business borrowers. Borrowers like Debbie Leon, who set up Fashionizer in 1993. She's an existing Funding Circle borrower. And as soon as she had found out that she could get a loan through us, she very quickly applied, really delighted with the speed. The turnaround time really allowed us to get back to running her business, in particular, producing more facemasks, actually, given the current environment. Or borrowers like Konk Furniture, produces handmade, sustainable furniture, again, looking for support during the COVID period found the whole process insanely easy, amazed how quick the decision was. And getting a decision was very important for him because it allowed him to have the reassurance but also allowed him to get on with the changes he needed to make in his business to help him thrive over this period. So by seamlessly connecting capital with small business borrowers that need access to it in a super fast and efficient way, we really can stimulate economic growth and job creation. So in terms of our outlook. As I said before, we would not have wished for a recession and certainly not one as bad as COVID-19. However, we really do feel that we're proving the value of our platform and just how resilient it is regardless of the economic environment. The economic environment does remain very uncertain. And our H2 expectations are predicated on there being no further prolonged national lockdowns across our geographies and includes the expectation of ongoing support for small businesses in the U.K. until the end of the year but does not explicitly include additional government support in the U.S. We're reinstating our previous guidance of close to adjusted EBITDA breakeven in the second half, which we hope speaks to the confidence that we have in the business and its trajectory, and we really remain committed to delivering profitable growth and generating long-term value for shareholders. Thank you. We'll now move to Q&A.

[Operator Instructions] We do have a question now from Victor Cheng from Bank of America.

Two, if I may. First one on the EBITDA breakeven in H2. Just wondering what the drivers are. Is that primarily driven by less fair value adjustment that you obviously had in H1? So that's driving the EBITDA breakeven? And then secondly, on the securitization, how should we think about the investment EBITDA going forward? I would imagine fair value adjustment, like I said, will be less drastic in H2. So should we expect big improvement in H2? And how also we should think about the investment income going forward as, obviously, now it's a bigger portion of your income? Should we expect further securitization and warehousing to resume anytime soon?

Okay. Quite a few questions in there. So I begin to unpick those. So in terms of the EBITDA breakeven guidance, we would probably see income broadly similar but perhaps a little bit more on the operating income or the fee income and a little bit less on the investment income. You're absolutely right, we would not expect the large fair value adjustment to be repeated given it was driven by COVID-19. But there's always a small element of, if you like, BAU or non-exceptional fair value that we'd receive -- would continue. But most importantly, as we spoke about in the presentation, we see a further reduction in our cost base as we see the benefits realized from the announced restructurings in developing markets and in the U.S. I guess linked to that, to your investment EBITDA point, we would still expect to see relatively significant investment income but perhaps a little bit less as some of the vehicles pay down going into the second half. And clearly, we would not expect the repeat of the one-off fair value adjustments primarily driven by the COVID-19 economic stress impact. In terms of the future of securitizations, at the moment with the government programs, we're not actively doing a go-forward securitization in that our institutional investor funding and support for the government-backed SME programs are done through other mechanisms. But we do see securitizations or rather warehousing followed by securitizations as being an efficient and effective way to manage our working capital. And we do see in the future, we would expect the securitization markets to normalize. We would be looking potentially to do more there as and when our core products begin to get reintroduced. I'm not sure if, Samir, you want to add anything to that.

Yes. I mean the only thing I would add is the impact of COVID-19 has been unprecedented, and the speed at which it impacted various markets is very different to previous recessions that we've seen. The peak to trough in the fixed income markets was within a period of a few weeks and markets were pretty much shut down for a period, whereas in, say, 2007, 2008, it took a 9- to 12-month period for that to really evolve and manifest itself. And as a result, we were unable to sell positions that we would have ordinarily expected in pretty much any other market environment to be able to do so. We continue to look to sell those positions, as Oliver stated before. But the primary reason we introduced the products was to diversify the funding sources that we have on the platform and attract new investors onto the platform, and we successfully added 30 new investors. So it is something we would like to continue in the future. And we expect to continue in the future. I think this has just been a very unprecedented situation. And just circling back on the fair value point, Oliver mentioned in the presentation the fair value adjustment that we would have -- we had in Q1 pre COVID was around GBP 11 million. So that gives you a kind of context of the kind of ongoing type of levels that could potentially be expected without a very severe stress being applied.

That's very clear. Just one follow-up, if I may. Just on these vehicles, where you said the expected future cash flow is GBP 149 million. Over what time period are we talking about? What's the average duration of these vehicles?

I mean it goes out potentially 5 to 6 years. It's really the average duration of the loan that drives that. And obviously, the difference between the fair value and the future cash flows is driven by the discount rate.

Just to be clear on these. Our intention is still to sell these investments, and we were unable to do so in the time frames we would have preferred to do during COVID. But we put in the cash flows to illustrate that were we to decide to hold these to maturity, which I think is unlikely, we would, on a principal basis, not be having much impact on them, just to show the kind of long-term cash flows of the vehicles. But clearly, our intention is, like it's always been, to be selling these positions.

Our next question today comes from James Hamilton from Numis.

Just one for me. And what I'd like to know is, what assumptions have you made on the other side when we get to recovery in terms of potential collections from entrepreneurs who -- to recover? And sort of any collateral values that there might be with regards to -- in the context of both your fair value adjustment and, of course, the estimates of returns from the cohorts that you have?

This is Jerome. So in the -- in our central stress scenario, we did assume a stress of the growth default as per the orange curve that you can see on the graph. So we've assumed those multipliers by calendar month going forward across all the cohorts and all the loans. And then on the top of that, we also assume a reduction in recoveries, just to be prudent in the context of stress. So over the same period of time, we've assumed that for the loans who default, the percentage of recovery would be 20% lower in relative terms than it would have been otherwise. So in normal circumstances, we would expect around -- on the recent -- the more recent cohort, we expect around 35% of recoveries, and we've reduced that by 20% to -- down to around 29%, just to reflect the fact that there might be some stress on the value of the assets. We've not assumed that this would bounce back in the short term. We've taken the conservative view that it would remain low over the period. There is a possibility that if the property market doesn't crash really, which is kind of where we are today, or if there is a bounce back of businesses, we might actually see more recoveries, but it's not something we've assumed in our central scenario.

We'll go to our next question now from Mohammed Moawalla from Goldman Sachs.

I had a couple of questions. I guess, firstly, just given your originations showed reacceleration in sort of August and September, how much visibility do you have on the current government support for SMEs when the currently run schemes expire, particularly in the U.K. and U.S.? And how many more schemes do you sort of expect the government to launch for the remainder of this year and into sort of 2021? And then just related to that, given the bulk of the originations now are dependent on some of these government schemes, should we anticipate any kind of pressure on the kind of the take rate on some of these loans?

So thanks, Mo. I'll answer those. So with respect to the government schemes, the CBILS scheme that we participate in, in the U.K. is an 80% guarantee scheme and is actually a rebranding of an existing scheme called the EFG scheme that existed prior to CBILS. And what we've always said is that small business lending is a much more resilient asset class than it appears on the -- when you first look at it because small businesses are strategically important to governments. They're 50% of jobs, 60% of private sector GDP. And so during recessions, there is always a mix of more government support, more guaranteed lending, and this isn't just something we've seen in the U.K. and U.S. It's been in Germany, France, Spain, pretty much every developed country in the world. Now COVID has been a very extreme stress scenario where pretty much all the lending that we've done in the U.K. and U.S. has been through these schemes. However, the government has put in place some structural features of those schemes, which makes it very difficult to do non-guaranteed lending. So for instance, in the U.K., the first year's interest and fees are paid by the U.K. government, which means that there's very little to negligible demand for non-guaranteed loans. However, we expect that structural feature to be withdrawn at some point. There's an announcement by Rishi Sunak today in the Commons about where the schemes will go and whether this particular feature will be -- will really be retained. But once that feature goes, we do feel that we can reintroduce our core lending product, and there is demand for that on the institutional investor side to purchase given the performance that we've been able to show over this period but also on loans originated during this period. But there will always be a mix of some of these guaranteed loans during recessionary periods, because that's part of the nature of the model we feel. It's either governments lend through platforms like us or they provide guarantee schemes which work. So really, we think that the reason why the vast majority of the lending has been done in this way is really because of some very particular structural features as opposed to necessarily us not being able to generate demand for non-guaranteed loans or be able to -- from the institutional investor side but -- or be able to process that. In terms of the margins, as I said, we take a slightly lower take rate on the U.K. government scheme. The U.S. government scheme is slightly different, and that's a 100% guarantee scheme. So the margins of the loans we originated up until August 8 were lower than our pre -- roughly half of our pre-COVID levels. However, there is uncertainty at the moment around whether there will be an extension to the U.S. government schemes. We haven't explicitly included it in our guidance just because of the U.S. election. I think if there wasn't a U.S. election, it would be -- it's quite likely there's going to be some level of stimulus. It's just the period in which it acts and whether it actually would happen for us in the second half. So overall, there would be -- if there is an extension to the government schemes in the second half in the U.K., which seems likely there will be some pressure on the take rate, like you mentioned, but equally, volumes have been elevated. And then post this period, we do expect to continue to be doing some level of schemes and the schemes to revert to what they were before but to reintroduce the core product and have the mix shift over time to much more non-guaranteed lending. But again, we do feel that this really demonstrates the resilience of small business lending. The fact it's a very different asset class to -- you haven't seen guarantee schemes in consumer lending, credit cards, mortgages, things like that and really speaks to the fact that we do believe our model is much more resilient than we've potentially been given credit for.