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

Good morning. It has been an extraordinary period for Funding Cycle, and I feel really proud of the huge difference we've been able to make for tens of thousands of small businesses during this period. We have proven the power of our model, taking our machine learning and technology platform to a new unmatched level, and have a number of attractive growth opportunities going forward. 2020 was a year of 2 halves. In the first half, we spent time responding to COVID, moving our team to remote working and supporting small businesses through what was a difficult period for them. In the second half, we saw strong demand from investors and small businesses to access funds. In particular, in our U.K. business, we saw originations of GBP 1.5 billion, up 91% year-on-year. Our technology platform is truly transforming the small business borrowing experience, and we've reached our target of having instant decisions for 50% of loan applications. I'm pleased to say we now expect all cohorts of loans to deliver a positive return despite the severity of the recession caused by COVID. I'm proud that we have not only survived during this period but thrived, and proven the resilience of our unique model. The group was profitable in the second half of the year, delivering GBP 20 million of adjusted EBITDA and around GBP 7 million of operating profit. And in the U.K., in particular, we delivered GBP 28.6 million of EBITDA -- adjusted EBITDA, and GBP 21.3 million of operating profit. We finished the year with robust net assets of GBP 218 million. Looking ahead, we are seeing a number of exciting structural trends that really benefit Funding Circle, and I'll talk about those in a minute. As we move into 2021, we will operate our core loan product alongside the recovery loan scheme in the U.K. and bank SBA loans in the U.S. We will continue to roll out our instant decision lending platform, with a long-term target of 80% of loan decisions automated. We will also leverage our technology to launch a number of new solutions to help small businesses, which I'm excited to talk to you about later. The group has an attractive financial profile going forward. Powered by the U.K., we expect to be adjusted EBITDA profitable, and will invest in additional growth opportunities. We see a number of structural trends that have accelerated during COVID that will benefit our business going forward. Government support, not just in the U.K. and U.S., but across every country in the world for small businesses, has shown how strategically important they are to economic growth. We are seeing a significant acceleration in the adoption of online borrowing has been a 5x increase in searches for online business loans in the U.K. in 2020. Strong demand from investors, despite the severe recession, has demonstrated the quality and performance of our loans and the resilience of our platform. I'm really pleased to say that during 2020, we were able to aggregate more than GBP 2.5 billion of invested capital to lend to small businesses in the U.K. and U.S. Small businesses expect to have ongoing financing needs. 40% of small businesses that we've surveyed have said that they expect to require finance in the next 12 months, primarily for growth or investment as economies reopen. And we've seen the similar data in surveys by the Bank of England and the Fed. Our mission is to build the place where small businesses get the funding they need to win. We do this by delivering an amazing experience for small businesses powered by machine learning and technology. Small business lending is underserved by traditional lenders. On average, it represents less than 2% of bank balance sheets, but small businesses are 50% of GDP and 70% of employment. There's a big disconnect between how much the financial system cares about this type of lending and how much we all as society care about it. But for a disruptive technology business like us, this is a very large addressable market and opportunity. Over the past 10 years, we have aggregated huge amounts of data and loan performance history, allowing us to develop incredibly sophisticated machine learning models. Our models include the GBP 11.5 billion of loans we've lent to small businesses since 2010, 700,000 loan applications, data on GBP 750 million repayment events, and we have 26 million small businesses in our data lake. Our eighth generation machine learning models are 3x as predictive as traditional commercial bureau scores. And this is creating a huge competitive moat for our business. This is all powered by what I believe is the best technology and team dedicated to small business lending. We use the latest technologies with continuous deployment that enables us to scale quickly, efficiently and securely without being burdened by large legacy systems. We have built proprietary data lake with 2 billion data points on it, containing data on 26 million small businesses, and this is used for machine learning risk models and also highly targeted marketing. We have a team of 300 engineers, product managers and data scientists, and we are investing to grow this team and our machine learning and technology platform capabilities in 2021. Our technology platform is revolutionizing small business lending. Borrowers can apply in 6 minutes, 50% of loan applications get a decision within 9 seconds and are funded within 24 hours. Through this process, we deliver high credit quality loans and low interest rates for borrowers comparable or cheaper than banks. It is the combination of the amazing experience we deliver on our machine learning and technology platform with low-cost loans funded by investors that is the incredible innovation that Funding Circle has created. This technology delivers huge benefits to our customers, but also to Funding Circle. We have reached 50% of loan decisions automated, and we've set a long-term target of having 80% of loan decisions automated. Instant Decision lending delivers a number of benefits to Funding Circle. We are seeing credit performance as accurate as non instances on lending loans. We are using the same risk models developed over the past 10 years, and credit performance has been strong. We're seeing higher conversion from borrowers, getting an instant decision can improve borrower conversion by up to 25%. Lower processing costs and scalability are driving operating leverage in our business. In the second half of 2020, U.K. loan originations were up 91% year-on-year without us adding any additional head count. And this technology also allows us to launch new products, which we will begin to do in the next 12 months, and I'll talk about this a bit later. The great experience we deliver to small businesses leads to stable repeat rates and attractive unit economics. The graph on the left-hand side shows the average number of loans taken out by a small business versus the months from taking the first loan. This shows very stable, predictable repeat rates across every quarterly cohort. The graph on the right-hand side shows the lifetime value divided by the marketing customer acquisition costs. This shows that we're profitable on a first-line basis after marketing costs. And because of the stable repeat rates as borrowers take out more loans, our unit economics improve. There's very little marketing costs associated with the repeat loans. Over 51% of operating income in the U.K. came from existing customers in 2020, which improves the quality of income and increases the strong moats around our business. Since 2010, we have originated GBP 11.5 billion of loans to over 100,000 small businesses. I'm also pleased today to announce that we launched our economic impact report with research from Oxford Economics. This showed that the lending through the Funding Circle platform in 2020 created and sustained 135,000 jobs and added GBP 10 billion to GDP, demonstrating the huge economic impact our platform is delivering. Typical Funding Circle borrowers are not start-ups. They've been trading for an average of 12 years, have 8 employees, GBP 1 million of revenue. On average, our loans are GBP 80,000, and the average term of the loan is around 50 months. I'm really proud of the impact we've been able to have in supporting businesses like Wild Card Brewery. On the day the lockdown started, they opened in e-commerce store. And actually, over the past year, have been able to grow by 12%, and Funding Circle have played an important role in supporting them. And we hear these stories from a number of different small businesses right the way across the U.K. and U.S. And in many ways, this is really why I started the business in the first place to actually help get money to small businesses during times of economic stress. We are reaching a level of scale, brand awareness and customer satisfaction in the U.K. that is unmatched by other fintechs. We are the third largest CBILS loan provider in the U.K. and have approved GBP 2.6 billion of loans since we joined the program. We have brand awareness of around 50%, which is significantly higher than other fintechs, and is approaching the level of the top 4 banks. In terms of customer satisfaction, we have Net Promoter Scores of 83. That compares very favorably to the large banks, and over 80% of customers tell us they would always come back to Funding Circle first in the future once they experience this way of borrowing, they never want to go back. We have GBP 4.2 billion of loans under management funded via our platform model. We are strategically focused on having a diverse mix of investors on the platform, and this served us well during COVID. The largest group of investors on the platform are asset managers, who represent 36% of loans under management. Banks represent 35% of loans under management. Our bond program represents around 12% of loans under management. And retail represents 11% of loans under management, down from 23% in 2019. and the remainder is made up of national entities, including development banks and councils and funds that we manage. Funding Circle's equity represents only 3% of loans under management. Funding Circle only invests its own equity where it makes the platform model stronger, and we expect absolute amounts of equity invested to be around or below year-end 2020 levels of GBP 118 million. 2020 has given us lots of momentum in the business, and the Funding Circle flywheel is driving significant competitive advantage. As we get more repeat customers on the platform, this generates more data. This feeds into our machine learning models, which improve. This allows us to deliver a better borrowing experience with more automation, less documents required, faster decisioning, which in turn drives higher conversion and lower costs and more operating leverage in the business. This technology allows us to launch new products, which expands the size of our ecosystem, which in turn leads to more repeat customers and more data. I'm just going to hand over to Oliver now to talk about the financials.

Thank you, Samir. I'm proud to be presenting my first set of full year results of Funding Circle, especially as we've achieved a number of important profitability and growth milestones. Let's begin by looking at the group results and overview. Here we show in the first 2 columns the performance of half 1 and half 2 2020, along with full year 2020 compared to 2019, on the right-hand side of the page. Not only was 2020 year 2 halves, as Samir mentioned, but it is worth remembering the dynamics we saw in half 1. Pre pandemic, both the U.S. and the U.K. had very strong starts to the year. This was followed by a pause in originations as the business responded to COVID, and became accredited to government guarantee programs in both the U.K. and the U.S. and then ramped up those programs by the end of the half. In the U.K., CBILS continued throughout 2020. In the U.S., the PPP scheme initially ended early August. Working down the table. Loans under management ended the year at a record GBP 4.2 billion, up from GBP 3.7 billion in 2019. Loans under management was driven by increasing originations. In 2020, originations were GBP 2.7 billion, up from GBP 2.35 billion in 2019. This was enabled by an extremely robust performance in half 2, with a very encouraging performance in the U.K. with CBILS, and notwithstanding there being no further PPP in the U.S. for the majority of half 2. Half 1 origination of GBP 1.1 billion was marginally down in half 1 2019, and reflected the mix of a strong start and then an adjustment period to the pandemic and the government schemes. Operating income, which is all the income we earn assigned from the income from our investment vehicles, was broadly flat year-on-year. This was despite the origination on loans under management growth, and due to the lower initial yields on the PPP scheme in the U.S., where we initially followed a referral model. The origination economics of the CBILS scheme and the PPP scheme once Funding Circle is able to participate in the Fed's PPP liquidity facility are similar to the economics of the core product. This can be seen with the operating income performance in half 2. Investment income, which is the investment income less investment expense attributable to the various investment vehicles, increased sharply year-on-year. This is because the various ABS programs only commenced during 2019. In 2020, we retained a number of these investments longer than we had intended as our strategy is to sell these vehicles. Accordingly, 2020 reflected both a full year of investment income and also to higher level than originally intended. The reduction in half tier over half 1 is due to the natural roll-off of the loans within these vehicles. In total, total income was GBP 222 million for the year, up from GBP 177 million in 2019. In half 2, we saw a more normal level of fair value adjustments [ at ] negative GBP 22.2 million, and our investment adjusted EBITDA was a positive GBP 7.7 million. It is important that we consider the net of the investment income and the fair value adjustment. In the half 1, we recorded a heightened fair value adjustment due to the impact of the economic stress caused by the pandemic on our investments. Our [ forward-looking ] economic stress, which phases into the calculation of fair value, is substantially unchanged from our view as of half year. Costs, both expenses above EBITDA and expenses below EBITDA, reduced substantially both 2020 over 2019 and in half 2 compared to half 1. Exceptionals reflect the cost of actions taken in developing markets and in the U.S. The group recorded a full year adjusted EBITDA loss of GBP 63.8 million, up from GBP 27.5 million in 2019, and an operating loss of GBP 106.3 million, up from GBP 84.7 million in 2019. This was primarily driven by the fair value adjustment seen in half 1 of negative GBP 96 million or negative GBP 59.7 million after taking into account the investment income earned. The majority of this adjustment we ascribed to the economic impact of pandemic which, of course, we did not see a repetition of in half 2. The operating loss was also impacted by the GBP 18.7 million of exceptionals. Very encouragingly, in the second half of the year, the group recorded its first adjusted EBITDA profitable half with an EBITDA of GBP 20.3 million, and also its first operating profit with an operating profit of GBP 7.2 million. Overall, I'm very pleased with the financial performance during a challenging year. The actions we have taken show our commitment to delivering profitability for the company whilst we continue to see many exciting future opportunities. I will now break down these group figures in more detail. I will begin with the U.K. business. As you will see, the U.K. is the engine of the Funding Circle group. We have an advantaged position in the market, have scale and have been adjusted EBITDA profitable since 2018. The slide shows the top line of loans under management of originations on our total income, working from left to right. Full year loans under management and originations both grew strongly 2020 compared to 2019, up 27% at GBP 3,271 million, and up 36% GBP 2,111 million, respectively. Half 1 originations were impacted by the pause in business as the pandemic hit, and the adjustment to support the CBILS program. This pleasing growth is reflected in total income up 37% year-on-year at GBP 152.9 million. Within the total income, operating income grew GBP 20 million with an increase in the proportion coming from servicing fees, and investment income also grew GBP 20 million. This slide shows adjusted EBITDA and operating profit for the 2 halves of 2020 and full year 2020 and 2019. The U.K. is adjusted EBITDA profitable for 2020, even after absorbing the half 1 fair value adjustment. This is the third year our U.K. business has been adjusted EBITDA profitable. We are profitable in half 2, with an adjusted EBITDA of GBP 28.6 million, a margin of 31%. And the U.K. recorded its first half of operating profit with an operating profit of GBP 21.3 million. Turning to the U.S. The Payment Protection Program in the U.S. launched in April 2020, with Funding Circle participating by the end of April. Initially, we originated loans and refer to selected partners for funding. In June, we became eligible to participate in the PPP LF. The PPP liquidity facility enables banks and nonbanks to access federal reserve funding to support PPP loans. Participating in the PPP LF meant that the origination economics of PPP are broadly similar to that of our core product. Prior to participation, our partnership model led to lower yields. PPP ended on August 8. Following the ending of the scheme, the market was dislocated reborrow expectation of a new government scheme suppressing demand. Despite steady growth from half 2 in our referral business and relaunching our core product at the end of the half, originations in half 2 were subdued. These dynamics can be seen in the overall year-on-year decrease in originations of 7% and LuM of 11%. And also in the half 1 originations up 28% year-on-year due to the strong pre-pandemic start to the year. And the PPP scheme, followed by subdued half 2 originations with a wider market uncertainty. Total income is up 20% year-on-year at GBP 63 million driven by the year-on-year increase in investment income of GBP 25 million. The U.S. recorded a full year adjusted EBITDA loss of GBP 62.4 million, up from negative GBP 22 million in 2019, and an operating loss of GBP 83.6 million up from negative GBP 29.9 million in 2019. This is primarily driven by the fair value adjustment seen in half 1 of negative GBP 61 million or a negative GBP 41 million after reflecting the investment income earned. Our losses in half 2 are much reduced compared to half 1, notwithstanding the subdued trading performance. This is due to both the nonrecurrence of the pandemic-related fair value adjustment and to the positive impact of the cost actions announced early July to rightsize the U.S. business. Developing markets. So Germany and the Netherlands, and now a breakeven following the actions we announced in March, and successfully executed during the year to move to more of a referral model. Putting this together for Funding Circle as a whole. 2020 saw record loans under management of GBP 4.2 billion, up 13% year-on-year. And record originations of GBP 2.7 billion, up 17% year-on-year, with total income of GBP 222 million, up 25% year-on-year. 2020 was an exceptional year with the unprecedented impact of COVID-19. Full year adjusted EBITDA of negative GBP 63.8 million, an operating profit of negative GBP 106.3 million [ worsen ] year-on-year, primarily driven by the half 1 fair value adjustment of negative GBP 96 million. Within the overall performance, the operating adjusted EBITDA loss reduced from GBP 37.9 million in 2019 to GBP 11.8 million in 2020. This is the yellow box on the left-hand side of the chart. Very encouragingly, we were adjusted EBITDA and operating profitable in half 2. Adjusted EBITDA was GBP 20.3 million, a 17% margin. Both operating and investment adjusted EBITDAs were profitable. Operating profit was GBP 7.2 million in the half. I'm very happy with this performance, and it demonstrates the increasing scalability and operating leverage within the Funding Circle platform. Talking now to costs. Operating expenses have been actively, tightly managed. Operating costs are shown on the left-hand side of the slide. As you have seen, the restructuring actions announced in March and executed during the year have brought developer markets to breakeven profitability. In July, we announced the right-sizing of the U.S. business, with technology centralized in the U.K. and moved more activities to our Denver center from San Francisco. Overall, year-on-year operating expenses have reduced 12% to GBP 191 million. And half 2 over half 1 also reduced 12%. Marketing, shown on the right of the slide, has reduced from 42% as a percent of operating income in 2019, down to 30% in 2020. This is due to reduced brand spend, improved efficiency and tight control. Looking now at the performance of our loans portfolio as a whole. The chart on the right shows a flow of borrowers missing payments for the first time. After an initial spike in April, the flows remained low and stable despite the second and subsequent waves of COVID-19, and result in further lockdowns and restrictions. The chart on the left looks at our stock of borrowers. As of December, over 93% of borrowers are making payments. This has slightly improved since the half year. Overall, our borrower population proved resilient throughout the impact of the pandemic, and we are seeing no significant impact of the second subsequent waves on the pandemic. This resilience flows into the returns to our investors. All investor cohorts in both the U.K. and the U.S. Show a positive return in the latest projection, the green bar to the right of the [ tree ]. This is a slight improvement to our projections at half year where 1 U.S. cohort was forecast to make a small loss. It's important to note we have not substantially revised our future macro projections. We continue to see an economic impact of the pandemic out until end 2022. The improvement has been driven by the actual performance seen in half 2. This positive return to our investors in both geographies in all cohorts, at the time of an exceptional period of economic stress, is testament to the strength of our model and the performance of our borrowers. Moving on from our external investors to Funding Circle's own balance sheet. We end the year with a robust net asset position of GBP 218 million, including GBP 103 million of cash. Net assets were impacted half year with a fair value adjustment, but have increased slightly by year-end. We have included in the appendix a more detailed analysis of our balance sheet and the various investment vehicles, consistent with our disclosure at the half year. Let me take a minute to explain the role of equity investments in our business model and the level of that going forward. Going forward, I see the absolute level of Funding Circle equity invested to be around or below the year-end 2020 level of GBP 118 million. As a reminder, Funding Circle deploys of equity where it makes a platform stronger. This may include limited co-investments or investment in new products. We see the ability to do this as a source of competitive advantage. We do not deploy capital with the sole purpose of deepening profit through investment returns. Though we do anticipate these investments will ordinarily be profitable. As we saw in half 2 2020, the investment adjusted EBITDA, some investment income net of expenses unless a fair value adjustment contributed a positive GBP 7.7 million. We intend to recycle the investments over 2021 as opportunities through realization allow. As previously discussed, the majority of these investments we hold for sale. We will continue to leverage some of our current investments as appropriate. I'd now like to hand back to Samir.

Thanks, Oliver. I'm going to spend a few minutes talking about our priorities for 2021, and then looking ahead at future growth opportunities. Over the past 12 months, we have seen an acceleration in a number of structural trends, which benefit Funding Circle, and we have proven the power and resilience of our model. I have never felt better about where the business is. We're more excited about the opportunity going forward. In the U.K., we will operate core loans for borrowers that do not require a guarantee. We will operate the recovery loan scheme for other borrowers once the CBILS program ends. We also intend to launch new products using our technology platform to help solve more small business problems. In the U.S., we will expand our core loans once PPP finishes. We will originate government-guaranteed loans through the SBA on behalf of banks alongside this. We will continue to operate our referral model for borrowers' borrow needs outside these offerings, partnering with other providers given the scale and diversity of the U.S. lending ecosystem. 10 years of research and development have created an inflection point for Funding Circle, and I am incredibly excited about the potential going forward. Over the years, we have aggregated huge amounts of data, built incredibly sophisticated machine learning models and used technology to create a user experience for small businesses that is unmatched by other providers. This year, we'll get to the point where we can deliver a fully automated loan with money in a customer's account within 15 minutes, a massive step change from where we were when we started the business 10 years ago. In 2021, we will launch an application programming interface, or API, that will enable us to natively embed our Instant Decision lending technology into partners' websites and platforms. We will focus on partnering with finance brokers, accounting software providers and payments companies. Integrating with partners will increase the distribution of Funding Circle products while servicing small business needs wherever they are. Our mission is to build the place where small businesses get the funding they need to win, and we deliver this powered by machine learning and technology. We have spoken to a number of customers to understand their funding problems, and it is clear that we can and they want us to do more with them. In the next 12 months, we will launch new solutions to help solve more small business funding problems. We will launch a payment finance product that will help small businesses spread the cost of bills over a 3-month period. And we will also launch a card products to help small businesses finance their day-to-day spending. New products will drive more frequent usage of our platform by small businesses, which will make an increasingly integral part of their lives, and also reinforce and drive more usage of our long-term loan products. I am incredibly excited about the opportunities to grow our core loan product and to augment it with these new products going forward. I'm now going to hand over to Oliver, who will take us through the full outlook.

Thank you, Samir. Turning to 2021. And I'd like to start by saying that we've taken our forward guidance very seriously, and I've been very thoughtful in choosing what we say about our 2021 guidance. Looking forward, we have some very exciting tailwinds, as we've discussed, but there are also some real near-term uncertainties. COVID-19 has changed the SME lending landscape. Over the past 12 months, we've seen acceleration on the adoption of online borrowing. From our use of machine learning and our technology platform, we are well placed to capture this enlarged opportunity going forward. I'm very pleased to say we've gone a strong start to trading so far this year. Loans under management and originations over the full year will depend on how fast the U.K. and the U.S. economies open up alongside related macro factors such as competition and borrow demand. We expect there will be an initial reduction in lending from Q2 onwards as we transition to operating our core product alongside the government guarantee programs in the U.K. and the U.S. We are very confident we will deliver positive adjusted EBITDA for the full year, with profitability skewed towards half 1. We are very well placed to take advantage of the opportunities this coming year offers. We are hugely excited about the opportunity of Funding Circle on the medium term. As some have discussed, 2020 has seen accelerated structural changes, a balloting Funding Circle, and progress and positive proof points on our business model and technology platform. Taking a step back, this is how we see Funding Circle. The established U.K. business is the engine of Funding Circle. The U.K. represented 70% of group total income in 2020. Our business offers operational leverage is adjusted EBITDA on operating profit profitable, and has been adjusted EBITDA profitable since 2018. It's also cash generative. Growth opportunities in this -- our core market continue over the medium term. The U.K. engine enables Funding Circle to pursue additional growth opportunities. The U.S. is 5x the size of the U.K. market, but our business there is at an earlier stage of development. The PPP scheme will provide a boost of volumes and revenues in early 2021. Post PPP, as we invest to grow market share, the U.S. will likely be EBITDA loss-making for the next few years. We are very excited about the scale of the opportunity the U.S. offers. We will carefully manage the level of investment in the U.S. There is a big but early stage opportunity to support more customers by leveraging our technology platform into new adjacent products. There will be better launches in 2021, but a small income contribution initially, stepping up in the future following successful rollout. Following the restructure to a referral model in half 1 2020, the developing markets business is now breakeven. Overall, the group powered by the U.K. will be adjusted EBITDA profitable going forward, and we will continue to invest in additional growth opportunities. This is now the end of the presentation. Thank you.