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

Good morning and thank you for joining us for the Funding Circle Half Year 2023 Results. The first half has been a good solid half for Funding Circle. We have delivered performance in line with our expectations and demonstrated the resilience of the business and our attitude at responding to the changing economic environment. Our U.K. Loans business is profitable, our loan returns remain robust and attractive for our investors and we're making good progress on our strategic plan with growth in U.S. Loans and strong momentum in FlexiPay. We're continuing to do what we said we would in spite of the environment. I'm going to kick off with a quick business overview, I'll then pass to Oliver for the financial results and we'll finish by running through our medium-term plan with a particular focus on FlexiPay. We are the U.K.'s leading SME finance platform with a material and growing presence in the U.S. To date, we've extended over GBP 16 billion in credit from over 140 institutional investors to over 140,000 businesses. For our businesses, we offer a quick and slick way to get finance. Our instant decisions enable them to get back to doing what they do best, running their business whether that's making Brazilian cheese bread, manufacturing furniture or selling flowers. Businesses come to us for finance for 3 things: to borrow for the long term with our term loans in the U.K. and the U.S.; to pay, spreading their bills and invoices over a longer term through FlexiPay; or to spend, financing their day-to-day transactions with our FlexiPay Card. For our investors, we offer access to an alternative asset class at scale with stable, attractive yields. SME lending isn't easy. The market is underserved as data is sparse. SMEs have limited assets and the ticket sizes are often small. We've solved this problem by using our proprietary technology and data. Our data lake has over 2 billion data points and we use this data to create models and in combination with our technology, this leads to valuable customer outcomes. Our models are 3x better at discriminating risk in the BRA scores. This leads to higher conversion for the same risk. Our customer experience is unrivaled. 75% of U.K. loan applicants now receive an instant decision. This is up from 70% in March. As a result, our customer satisfaction levels remain high with an NPS of 76 and a Trustpilot score of 4.6. As I said at the start, this has been a good solid half for Funding Circle and I wanted to share some of the highlights. Despite the tough environment, our originations have grown 14% to GBP 771 million. Our credit performance has remained stable showing the strength of our risk models. We've priced up in line with the market to continue to deliver attractive returns to investors and as a result, we've agreed 3 new forward flow agreements. I'm pleased with performance across each of our 3 business segments. The U.K. Loans business delivered GBP 1.4 million in PBT. This is our most established business and demonstrates the scalability of the platform even at a low point in the cycle. We continue to make controlled investment in the U.S. Loans business and FlexiPay in order to capture growth over the medium term. In the U.S., growth continued with more than 20% growth half-on-half. FlexiPay transactions doubled half-on-half. I'm encouraged by the customer engagement as we see strong recurring revenue trends. Overall, whilst we remain mindful of the economic backdrop, the business has shown its resilience and adaptability. We're not standing still. We have a great team and in the first half, we have in particular strengthened our U.S. team with Steve Allocca, our U.S. Managing Director, who started in January and our U.S. Chief Product Officer, who joined a couple of months ago. We have a clear strategy. We're optimizing and finding new opportunities in our core business, launching new products and continuing to evolve the business. Now over to Oliver for the financial performance.

Thank you, Lisa. Good morning, everyone. It is my pleasure to be able to share Funding Circle's financial performance for the 6 months to 30th of June 2023. We have shared this slide with you before, but I think it will be helpful to recap on how Funding Circle makes money. We are predominantly a fee-based income model in what we call operating income consisting of loan transaction fees and servicing fees and increasingly also FlexiPay fees. Transaction fees are charged to borrowers and are driven by origination volume. Following testing and price elasticity, we revised origination fees in both the U.K. and the U.S. Loans businesses. The typical yield is now circa 6% compared to circa 5% during full year of 2022. Servicing fees are more of an annuity stream we charge to institutional investors at around 1% per annum and are driven by the loans under management. FlexiPay's economic model in terms of a fee charged to this transaction made against the line of credit, payable in line with the FlexiPay loan over 3 months. At launch, it was 3%. With a rising base rate environment, this is now 4.9%. FlexiPay income will account for an increasing proportion of our fee income as the product scales. Investment income is driven by our capital invested in support of the loans businesses and, as expected, this has reduced. Let's now look at the group results. The financial performance in half 1 2023 was in line with our expectations notwithstanding the volatile macroeconomic environment. Before we go to detail, it is worth noting that we've made a number of changes to the presentation of our financial results in order to better reflect the changing nature of our business. We are now showing all interest earned within income. Previously, interest earned on cash balances was shown below operating profit. This new presentation is clearer, is consistent with peers and avoids the situation where, for example, a decision to deploy cash in 1 way leads to interest being recognized as top line income and deployed, another does not. This change also flows through into adjusted EBITDA. With FlexiPay becoming more material, we are now separately identifying the cost of funds and the expected credit loss line items. With no meaningful other items between operating profit and profit before tax, we no longer present an operating profit line item. Comparative financial information has been re-presented. A reconciliation can be found on the first page of the appendix. Now on to the results. Originations grew in each business unit half 1 '23 compared to half 2 '22. Total originations are GBP 771 million in the half, up 14%. This growth was despite our continued disciplined approach to originations and is testament to the strength of our business even in tougher macroeconomic environments. We continue to prioritize long-term investor return performance over short-term originations. This is aligned with the expectations of our institutional investors and as a responsible approach to our borrowers. Headline loans under management continued to reduce to GBP 3.5 billion as the government loan schemes continued to amortize down. Commercial lending loans under management continued to grow up to GBP 1.5 billion, an increase of 9%. Total income was GBP 76.6 million with growth from each of our business units compared to half 2 of 2022. Income has grown despite the drag from the continued and anticipated reductions in investment income. As a reminder, half 1 2022 still included the impact of a significant level of government loan schemes in the U.K. and some deferred revenue of the PPP scheme in the U.S. Adjusted EBITDA was GBP 3 million negative and PBT was a loss of GBP 16.6 million. As we have previously guided, we anticipate losses near term as we choose to invest in growth, scaling our U.S. Loans and establishing our FlexiPay businesses. Our established U.K. Loans business is now profitable at the PBT level as we continue to deliver on effectively managing this business through the changing economic conditions. Cash and net assets remain strong. Funding Circle has cash of GBP 204 million and a net asset value of GBP 264 million. This puts us in a fully funded position to deliver our medium-term plans. I will now walk through each business unit in more detail. The U.K. Loans business is well positioned for continued growth. It is a market-leading platform for SME lending, has scale and is PBT profitable. Originations grew sequentially half-on-half despite the impact of the continued business approach to underwriting where changes have been made in September 2022. Half 1 of 2022 still contain a significant level of government guaranteed lending. Loans under management reduced as the government supported lending book continues to amortize down. Commercial lending continued to increase. Total income was GBP 57.1 million, up from GBP 56.5 million in half 2 of 2022. This reflects the origination trends, the increase in origination fee yield and higher interest income offset by the expected reductions in servicing income and in investment income. Adjusted EBITDA was positive GBP 8.8 million, up from GBP 5.7 million in half 2 of '22. This was driven by income growth and cost management in the U.K. Loans business driving improved margins and despite the reduction in investment adjusted EBITDA. U.K. Loans adjusted EBITDA has been positive since half 2 of 2020 demonstrating the robustness and scale of the U.K. Loans business. The business is profitable at GBP 1.4 million profit before tax. Turning to the U.S. Loans business. U.S. Loans continues to show good top line growth. U.S. total originations increased 21% on half 2 to $259 million. The U.S. has continued to grow originations each half year since commercial lending resumed after the government supporting lending seized in May of '21. As in the U.K. Loans business, we're continuing with a disciplined approach to originations. Loans under management were $502 million increasing from $454 million at December '22. PPP loans are virtually all forgiven, only $9 million remains in the LUM. Total income was $20.7 million, up from $17.4 million. This improvement was driven by the increase in originations in loans under management and the increase in origination yield, partially offset by the reduction in investment income. Underlying operating income continues to grow strongly. As a reminder, total income in half 1 2022 included $3.3 million of PPP deferred income, which accounting standards required to spread over the expected life of the loans. The U.S. Loans business recorded a negative adjusted EBITDA of $4.8 million in the half and a loss before tax of $11.5 million. We are continuing to make controlled investment in the U.S. driving scale to profitability. Now to FlexiPay. FlexiPay's key drivers are transactions and end of month balances, which are broadly comparable to the originations and loans under management metric of our loans businesses. FlexiPay transactions have more than doubled to GBP 90 million in the half. Period-end balances have also grown to GBP 34 million. This momentum has resulted in strong top line growth with total income of GBP 2.3 million in half 1 '23, more than double the prior half. EBITDA was GBP 7.8 million negative as we continue to invest in FlexiPay. We have invested in technology and the FlexiPay team. Additionally, as anticipated, marketing spend and the expected credit loss provision build front-run income. Profitability for FlexiPay comes from repeated usage of the product, which will become evident as the customer base becomes more established. Operating expenses continue to be actively and tightly managed according to the strategic needs of each business segment. Funding Circle's cost base consists mostly of staff costs, marketing costs and technology costs. Overall costs were GBP 96.2 million in half 1 versus GBP 91 million in half 2 of 2022. In summary, this is due to investment in the U.S. Loans business and FlexiPay partially offset by tight cost management in the U.K. Loans business. The U.K. Loans business is the most established segment with an increasingly efficient cost base that will allow us to benefit from operational leverage as we grow and as the economic backdrop recovers. U.K. Loans in half 1 of '23 demonstrated improved cost efficiency with costs decreasing to GBP 56.1 million whilst total income increased by 1%. The U.S. Loans business is scaling up. Controlled spend in marketing and other costs have supported volume growth and platform scaling. Both half 2 '22 and half 1 '23 costs included roughly GBP 2 million of impairment charges for the write-down of the sublet of the San Francisco office. FlexiPay is demonstrating a strong growth trajectory and, as discussed, we are investing behind the product. Let's now turn to our term loan performance and the returns provided to our platform investors. The overall book has remained very stable despite the macroeconomic environment. We have seen pockets of stress versus initial expectations in the 2022 cohort where we are forecasting small reductions in the expected returns in the U.K. of 40 bps and in the U.S. of 30 bps. In half 2 of 2022, we saw some leading indicators of stress in the macro environment and took preemptive action. The reduction in return expectations results from originations in the earlier part of that year. Returns post tightening are in line with expectations. All other annual cohort returns have either been revised upwards or have remained constant. 2023 illustrates how we've responded to the changing base rate environment and being able to reprice interest steepening yield curve to maintain returns. These borrower price increases have been broadly in line with the wider market price moves. Clearly we are dealing with a heightened period of macro uncertainty. We are confident with our credit strategy, we continue to monitor all indicators closely, are very agile and respond quickly when needed. Our credit risk management is proven, our borrowers are resilient and the loan quality is good. The loan returns demonstrate the robustness through the cycle of the asset class that Funding Circle has developed and also the capabilities that Funding Circle has built to originate, underwrite and manage these loans. Funding Circle has a diverse, agile and sustainable funding model. The pie chart shows the diversification of sources of funding for our total loans under management with asset managers and banks continuing to be our largest investors. In each of these segments, we maintain a further diversified investor base. The closed retail book continues to diminish as a proportion of our loans under management now down to just 1%. And of the GBP 3.5 billion of loans under management, only 2% is funded by Funding Circle capital invested. We have continued to deliver sustainable funding and a flow of new loan investors. In the U.K. as of the end of June, we have GBP 1.6 billion of agreed funding, including signing an additional material forward flow agreement in January. In the U.S., we have GBP 0.4 billion of agreed funding, including signing both a material asset manager forward flow agreement and also a second credit union partner. In June, we successfully brought in Citibank as a senior debt provider to leverage Funding Circle equity invested in FlexiPay. This was through an initial GBP 150 million facility. Executing this in demanding market conditions is again testament to the quality of Funding Circle's credit risk management and capital market capabilities. In the U.K. in August, we launched our participation in the third iteration of the Recovery Loan Scheme and brought on Allica Bank as a new bank investor. This is another example of Funding Circle continuing to adapt to the changing macroeconomic environment. Participation in the scheme enables us to meet our objectives of saying yes to more businesses and further diversifies our investor base. It's worth noting that the third iteration of the Recovery Loan Scheme is quite different from some of the earlier programs. Whereas during COVID, government guaranteed lending displaced a large share of commercial lending. The most recent iteration of RLS is intended to work alongside commercial lending addressing structural lending gaps and the majority of our originations will continue to be commercial lending. Our balance sheet remains robust. Net assets of GBP 264 million including cash of GBP 204 million and invested capital was GBP 69 million. The decrease in net assets of GBP 20 million is driven principally by investment choices into U.S. Loans and FlexiPay. Cash has increased by a net GBP 26 million. This is driven by working capital movements including timing of payments to the British Business Bank; investment cash flow, including cash repayments from invested capital; plus proceeds from the sale of the $20 million of U.S. loans we temporarily funded at the end of 2022, this was partially offset by the buyout of the remaining U.S. securitization vehicle as we continue to simplify our balance sheet; growing the FlexiPay lines of credit and then leveraging with a new Citibank senior facility. And these have been offset by trading results and our investments to support the growth in the U.S. Loans business and FlexiPay. Invested capital has decreased by GBP 28 million converting to cash as described above. This slide illustrates how we think about using our cash and deploying our capital. I see our balance sheet as a source of competitive advantage. We support our operations. We were in various stress tests and ensure we hold enough cash to protect against a combination of stress scenarios. We will also fund the operating cash flows necessary for the U.S. and for FlexiPay to scale to become cash generative. We invest where it makes the platform stronger. Use cases include limited co-investment for risk alignment with our institutional investors for example as we do in the RLS and to support our research and development efforts before the associated products or features become adopted within our product set. Funding Circle is the equity investor in FlexiPay. As already mentioned, towards the end of half 1 we successfully leveraged to that equity investment. We have sufficient cash to deliver our medium-term plan. In addition, we have cash available for new growth opportunities should these become apparent. We will continue to manage share dilution by supporting the employee benefit trust in purchasing our shares in the market to fulfill our employee share awards. All in all, I am pleased with Funding Circle's financial performance in half 1 of 2023. We've achieved good results in volatile macroeconomic conditions with U.K. and U.S. base rates looking like they will be higher for longer and the economic recovery pushed out. The business has proved to be resilient and adaptable. We have sustained our credit quality and loan returns. Institutional investors remain committed to funding an attractive asset class. Funding Circle has continued to deliver on its growth strategy. Our solid performance and our robust balance sheet sets up the business well to drive future growth. We are well positioned for long-term success despite our expectation of continued economic uncertainty near term. Our 2023 and medium-term guidance is unchanged. I would now like to hand back to Lisa to take us through how we continue to execute on our strategy.

Thanks, Oliver. I shared our medium-term growth plan 18 months ago. As a reminder, we're in a strong position. We've built good scale in the U.K. Loans business. The SME loans market across the U.S. and U.K. is large and underserved with more than GBP 300 billion in loans outstanding. Our data and technology provides us with a sustainable competitive advantage and our customer satisfaction remains high. These give us good foundations from which to grow. We continue to make good progress against the 3 pillars of our growth plan. We are attracting more businesses through expanded and strengthened distribution channels alongside an expanded product set. We are saying yes to more businesses and this doesn't mean irresponsible lending, but rather expanding into segments and delivering the right product to the right business, whether our own or through our third-party lenders and we're building products where we can achieve market-leading positions with FlexiPay. I'll share some of the highlights on each pillar now. We are attracting more businesses through an expanded product set, focused brand investment and continued strengthening of existing channels. Each of our product expansions increases our relevance to our customers and enables us to go deeper in marketing channels. FlexiPay in particular meets a more frequent customer use case, attracting more customers. We've completed our first season of sports sponsorship to improve brand metrics with the Rugby Premiership in the U.K. And we continue to strengthen our existing channels with new partnerships such as Sage in the U.K. I've spoken before about Lending as a Service in the U.S., a more embedded partnership where we partner with financial institutions to enable their SME lending. We knew that these partnerships would take some time come to fruition and the Silicon Valley Bank failure and knock-on effects have delayed this further. As a result, whilst we remain excited about this opportunity, I do not expect to see any material contribution from Lending as a Service this year. We want to say yes to as many businesses as possible by expanding our end-to-end conversion. Last month in the U.K., we began our participation in the government's third iteration of the Recovery Loan Scheme. We offer these loans alongside our commercial loans and it enables us to serve an incremental number of businesses. Last year we leveraged our data to find further opportunity and expanded into super prime in the U.S. and near prime in the U.K. In the U.S. in the first half, super prime was nearly 1/3 of originations by value helping fuel our growth. In the U.K., near prime was 12% of volumes of origination. The value is smaller about 7%. However, the number of loans is important as these lines typically are to newer or smaller businesses and we expect to see migration from near prime into our prime products over time. We strengthened our marketplace, referring businesses that we cannot support to other lenders and enabling us to leverage and monetize our advantage in distribution and marketing. We work with 30 lenders. And in the U.K., we can now make third-party offers via our API in as little as 15 minutes. Our marketplace now accounts for 13% of our group originations. Our third pillar relates to new products. As a reminder, FlexiPay solves SME's biggest pain point, cash flow management. It enables us to solve more of our customers' needs, building a deeper and more engaging relationship and access a sizable new market. We are seeing good growth with the doubling of transactions in the first half. Our total transactions are now more than GBP 150 million. And after a successful beta phase, we're moving into launch phase for our FlexiPay Card enabling customers to finance their day-to-day spend. In line with the product having reached sufficient maturity and scale, we're excited to have senior debt funding from Citibank in place, which helps accelerate FlexiPay growth and diversify our funding sources. To bring FlexiPay to life, I'm going to play a short video to show you how it works and how our customers are using it. [Presentation]

That video gives just a little window into the positive feedback and engagement that we're seeing from our customers using FlexiPay and FlexiPay Card. FlexiPay transactions more than doubled in H1 '23 to GBP 90 million and we have over 3,800 active lines of credit. We have high customer engagement with businesses using FlexiPay 1.3x on average each month. Businesses have now FlexiPay-ed more than 40,000 times since we launched. What is particularly exciting for me is the chart on the right hand side. This shows transactions each half by cohorts of joining FlexiPay shown in the different shades of purple. You can see the overall growth, the doubling in the most recent half and the new customers that we're bringing on over time, but also the level of engagement we see with existing customers. Once a customer begins to use FlexiPay, they continue to do so and it becomes part of their day-to-day way of managing the business. As you look at this cohort analysis, you can see that trend with strong and increasingly predictable repeat usage delivering recurring revenue. The product economics and risk profile are attractive. We take the marketing costs upfront as we acquire customers, but the credit cycles quickly and the nature of the customer relationship is long. Customers come back and the product has frequent usage and recurring fee income. This is why we continue to be really excited about the opportunity that FlexiPay will generate and why, as Oliver explained, we're investing in FlexiPay. In summary, despite the tough economic environment, we've delivered a good solid set of results in line with expectations. We've once again demonstrated the resilience of the business and our attitude at responding to the changing economic environment. Our U.K. Loans business is profitable. We have seen good growth in the U.S. Loans business and FlexiPay. We are continuing to execute on our medium-term plan to address the large and underserved markets in both the U.S. and the U.K. Our technology and data gives us a clear competitive advantage and is the moat around our business. It delivers a superior customer experience through our Instant Decision lending technology, a platform on which to build new products and 3x better risk discrimination than the BRA scores. We have delivered robust and attractive loan returns thanks to our risk approach, which combines our data and analytics with a credit expertise overlay and means we continue to see strong investor demand. Looking ahead, we have a strong team, a clear strategy and we're focused on executing against our plan. We are unwavering in our mission to help more small businesses win and we continue to do so in spite of the volatile macro environment. Thank you for joining us today. Oliver and I would now be very happy to take any questions.

[Operator Instructions] And your first question comes from the line of Kim Bergoe from Numis.

Kim Bergoe from Numis. I have 3 questions, if I may. My first question is if I think of your results as more of a sort of proof of concept than performance in the first half, I'm thinking about sort of the profitability of your business and how I should be thinking about that. Could you sort of expand a little bit on that? Is U.K. as your more sort of mature business and obviously the largest part of the group, the profitability there that you've shown in the first half, is that a good sort of indicator of where the business might go and if you can expand a little bit on that by division? My second question is how we should be thinking about the funding side, I mean the current trend. How is the funding side, for instance how they reacted to in a higher interest rate environment? Are you still sort of competitive and seen as same sort of providers as you were in a lower interest rate environment? And my third question is around credit quality in terms of what's the outlook and current trends and if you obviously split that by U.K., U.S., term loans and then FlexiPay? And then how you are responding to changes in that environment?

Again some good questions to get us started. So first of all, on profitability. I think you're right in that we need to think about profitability based on the separate dynamics of the 3 business segments. So yes, U.K. Loans is the established part of the group, is PBT profitable in the first half of the year and we would expect that to continue. It's been EBITDA profitable since half 2 of 2020. As I think we've also demonstrated, we see good operational leverage. So as we continue to grow as the economic backdrop improves, we would expect to see good operational leverage come through and continued profit growth in that segment. In both the U.S. and in FlexiPay, we're continuing to invest. So investing in the U.S. to bring to scale and we will continue to see similar investment in half 2, maybe slightly more in the U.S. as it scales up. And in FlexiPay, again a pattern we're investing in the technology and the team. but also some costs, marketing and the expected credit loss provision build front-running income. FlexiPay has very much got a model of lifetime value and repeat usage so some costs are incurred upfront and the revenue comes over an extended period. In terms of half 2, we've guided on income for FlexiPay and EBITDA. Costs again be equal to or maybe slightly greater in half 2 than in half 1. Your second question I think was on funding. We continue to see strong demand from funding partners to work with Funding Circle and work on our platform. We have high levels of agreed funding in both the U.K. Loans and the U.S. Loans businesses and during the half added 1 new funding partner in the U.K., 2 new funding partners in the U.S. Also, as mentioned, we leveraged the Funding Circle balance sheet investment in FlexiPay bringing on Citibank as a senior debt provider and that was a major achievement given the newness of the product, the challenging economic environment which again is testament to both our risk management skills, the attractiveness of FlexiPay as a product and our capital market skills. We've also further diversified our product mix and with that our funding mix. We're participating in the third iteration of the U.K. government's Recovery Loan Scheme and bringing in Allica Bank as a bank partner to fund that. Your third question was around credit risk and credit risk trends. We continue to see a very stable book and that manifests itself into the attractive returns we continue to offer our institutional investors. End of 2022 and '23, which you can see on Slide 13 of the presentation, we've successfully priced into the rising yield curve. We've met borrower expectations of higher nominal returns that's reflected in higher borrower price points, but we price very much in line with market. And linking back to the second question, we are still seeing strong demand from institutional investors and that's because the returns and the credit risk performance remains very, very strong on Funding Circle loans. Hopefully, that's covered your various and quite broad questions.

It has indeed. Just 1 follow-up, if I can. Can you just remind me to the sort of duration on your funding side? I know it doesn't quite work like that. But how should I be thinking about that? I mean the general sort of how will you make and when you have a new funding provider in there. I take it I mean basically if there is a duration on your funding side, it's actually longer than the duration on your loans. Is that the correct way of thinking about it?

There's probably 2 things there. So our institutional investors buy loans. So in other words, a loan is sold to those and they fund that loan for the duration of that loan. In terms of our funding agreements, these are typically multiyear and they vary by agreement to agreement. But for example, the amounts quoted on the funding slide here carry over into 2024.

Your next question comes from the line of Rahim Karim from Investec.

3 questions, if I may. You talked about the yield increases that you managed to achieve especially on the transaction side. Just trying to get a sense of how all those have been received by clients. I guess it's slightly easier given the movement in interest rates to pass through a slightly larger transaction fee because it's obviously a smaller proportion of the total amount that someone is paying. But just any color you could provide on that and how sticky you think that fee increase is and whether in fact there are any further opportunities like that within the business? The second question was just around RLS. Clearly it looks like an interesting complementary opportunity. If you could perhaps give us a sense of how significant you think this could be within the mix of the business and the portfolio. And then finally, on the U.K. business, just be useful to get some color if you can in terms of the strong cost performance there. I assume that's headcount driven and it'd be useful just to confirm that and also get a sense of how you see that cost-to-income ratio potentially evolving going forward and the operational leverage that should come through, I guess a little bit to Kim's point earlier, around how the profitability of especially the U.K. business should evolve over the next year or 2?

Rahim, thanks for the questions. So on the first one -- I'll take the first 2 and then I'll pass to Oliver for the third one on the U.K. costs. In terms of the yield increases on the transaction side, you're right. We actually find whenever we do any of these changes, we do test them first and we check price sensitivity to our borrowers. So actually we've been able to pass these through quite easily in the context of I think everything is becoming more expensive and so costs are being passed through. In terms of further opportunities, we're not planning any further raises at this stage so I think those will be stable going forward. RLS, you asked about RLS. We see this actually as a really nice natural extension to the commercial loans that we're doing. It enables us to serve an incremental set of businesses that we wouldn't have been able to serve otherwise. But it's worth noting this is a very different program to those programs that existed through COVID like [ CBOs ] and bounceback loans and this is intended to be incremental. So we still see the vast majority of our loans being commercial loans and the scheme is due to end in June. And I'll pass to Oliver for the last question on U.K. costs.

Yes. So on U.K. costs, as you've noted, we expanded the margin in the U.K.; income increasing and costs reducing. The U.K. is a scalable established platform and we will continue to manage costs tightly. I would expect costs in half 2 to be broadly flat as opposed to continually reduce, but clearly we expect income to continue to grow in half 2.

Next question comes from the line of Perlie Mong from KBW.

I guess just 2 questions. One is going back to the credit quality especially in relation to FlexiPay. I guess the reason I'm asking is because obviously now you're taking an impairment charge for the FlexiPay product because obviously that book is growing very fast and typically for the bank as they grow very fast, you'll have to take more sort of Stage 1 model impairment charges. And obviously as the book seasons, you will also see some of that move to Stage 2. So almost mechanically just by growing the book and having it around for longer, you should see that line grow. Is that the same for you? So I guess that's the first part of it. And the second part of it is your sort of credit experience so far, how does that compare to your sort of main loan book? So just your experience of FlexiPay, is there any difference in trend for example? So I guess that's the first question. And the second question is relating to your medium-term target especially the income part of the target. So I guess if I look at half-on-half growth in the first half of this year, about 12% increase in operating income. So I guess just on that run rate, it would be pretty close to the medium-term target in 18 months' time. But I mean I would expect loans from management to either be flat or maybe down a little bit as more of the government loan schemes roll off and so I guess that would affect the service fee part and origination has been good so far. But obviously the macro trend for the sector is quite challenging and SME loans have been falling a lot and I guess especially some of your larger peers have obviously talked about SME loans being quite anemic in general. So if originations were to, I don't know, flat line or come down a little bit or have a more difficult trend, then obviously I know you're growing FlexiPay, but it is as it is quite a small part of your income. So just any other levers or factors that would help you meet the medium-term target would be helpful.

Perlie, quite a lot in there. I'll try to unpack it, but let me know if I miss anything. So I'll begin with FlexiPay and the expected credit loss provision. So you're absolutely right, we do an IFRS 9 provision similar to banks and other nonbank lenders. It front-runs the income, which is part of the investment J curve we go from FlexiPay. It will grow as we ramp up FlexiPay, you're absolutely right there. It's included as part of our overall FlexiPay guidance. Someone spoke about earlier about costs increasing slightly in half 2. That includes the element of costs of the ECL provision and I think you can look at RLS and say that was about GBP 2 million in the half. Clearly, FlexiPay is new. We haven't got a lot of observable data. Very happy to say a lot of the observable data we're lacking is defaults and delinquencies because the books performed very well. But we think if anything, we've been relatively conservative in our approach to ECL on a new product. But fundamentally, you're right that will grow as FlexiPay continues to scale up quite rapidly, but that is contained within the guidance we've given on FlexiPay. Our overall risk performance on FlexiPay is very much in line with expectations, again with a caveat it's a new product. We haven't seen any material deviation in trends between FlexiPay and between the term loan book in the U.K. It's not 1 is performing well or 1 is not performing well. We've seen a very similar pattern of performance. Moving on to guidance. We reaffirmed our medium-term guidance. Clearly we are sensitive to the broader macroeconomic environment. I think we all expect by 2025 to have more certainty and some degree of a more attractive economic environment. But I think what you've seen is Funding Circle continues to adapt, continues to be resilient, continues to manage the P&L well. I think our participation in the third iteration of the Recovery Loan Scheme is testament to seeing an opportunity to serve our customers whilst managing our P&L. To your point specifically on servicing income so in the U.S. we're growing loans under management. In the U.K., you're right, loans under management reduced half-on-half and that was due to the high level of particularly [ CIBILs ] origination amortizing down and washing through, commercial loans under management grew. I would expect U.K. loans under management to continue to fall in half 2 of this year and turnaround as it were during 2024 so growing again comfortably by 2025. Equally you're right, we have a number of income streams, transaction fees and as you saw again, we've worked on the yield part plus originations are growing. Interest income, servicing fee income and a little bit of residual investment income so some diversification of income streams. All in all, that gives us the confidence to reaffirm the medium-term guidance.

I will now hand over to Morten Singleton, Director of Investor Relations, to relay some webcast questions.

Yes, we've got a few questions online so I'll relay perhaps the first 3 of those before handing back to the operator for the caller questions. The first one comes from Vish Bhatia of J O Hambro. It's a question for Oliver. On the FlexiPay funding from Citibank, please can you provide color around the process? How long did it take? How competitive was it? And what level of annual transactions can this GBP 150 million line support in addition to your own equity? Would the team still be interested in addition more debt providers to further support FlexiPay growth?

Okay. It was a competitive process. We had interest from a number of banks and Citibank won out. We have a strong existing relationship with Citi, which again is a testament to the capital market capabilities Funding Circle developed over the years. The process was completed in line with our target timing. It was completed at terms that I'm happy with. For commercial reasons, I'm not going to be able to reveal the pricing or the advance rate, but certainly I'm quite comfortable with where we got to. The amount supports the longer-term growth for FlexiPay and we entered into an arrangement of an initial facility with an opportunity maybe to upsize it in order to support our existing plans. We do not need to upsize during 2023. It carries us quite comfortably into 2024. Because of that and because we have a good relationship with our counterparty, at the moment we're not looking to bring on a second partner.

The next question is for Lisa also from Vish. You mentioned the group has in excess of 2 billion data points. How are you using the capabilities of AI and machine learning to improve your own decision-making process, scalability of your proposition and maybe even coming up with new product innovations?

Vish, thanks for the question. So let me talk a little bit about how we're using AI machine learning today and how we have been and then also Gen AI going forward given that's what's on everyone's mind. So today in our modeling, we're using machine learning AI helps us to get the best models and we continue to drive benefit from that and that's why we have the better risk discrimination that we see with our models versus the bureau score 3x better at discriminating risk. This also enables us, you speak about new product innovations. It also enables us to find opportunities given that large data set. So I mentioned in the presentation last year when we launched super prime in the U.S. and we launched near prime in the U.K., that was because we could identify a pocket of businesses for whom we could either serve much better prices or that we could serve fewer, newer, less established smaller businesses. So that's been a kind of very tangible example of where we've been able to use our superior modeling capability. Going forward when we think about Gen AI, there's obviously lots of hype around this and we see it as an exciting new technology. We see the use cases being mainly in 3 areas. So the first is productivity and we're doing some trials around that, in particular in our software engineering looking at how we can use tools to make them more productive, writing code, being able to manage knowledge management through the team. We're also looking at it from secondly, customer experience. So can we use AI to drive better and more targeted communications? Can we use that in some of the ways that we interact with our customers? And we're doing some trials there. And then there's a third bucket, which is more transformative. So we've got a few test ideas that we're working through in a cross-functional team across the business.

And the last question for now from the webcast comes from Matt Evans of Equity Development. This question is for Oliver. How do you look at competing priorities in terms of your capital allocation while also keeping a disciplined approach? If you had an extra GBP 1 to spend today, would you most like to deploy it via more lending? And if so, would that be in U.K. Loans, U.S. Loans or FlexiPay or in other areas like developing new products or increasing the marketing budget?

So we are fully funded for our existing medium-term plan. So Lisa spoke about both today plus at the last full year our medium-term plan and the various objectives around that. So the first use of that cash is to deploy and to deliver what we said we'd do and which we're making great progress on delivering. And we will continue to be very efficient in our cash usage there and the leveraging of our balance sheet investment in FlexiPay is an example of that as is some of the monetization of the legacy loans investments recycling into cash. So we continue to look to maintain a very efficient use of our cash and of our capital. We also, as I mentioned, retain some cash as a prudential buffer, which in today's volatile macroeconomic environment is a very sensible thing to do. And we also use some cash, a very small amount, to avoid or to manage share dilution by supporting the employee benefit trust in buying any share awards. Over and above that, we have some additional cash that we would deploy into future growth opportunities as and when they become apparent. Morten, back to you.

Back to the operator for taking calls from the line.

So the next question comes from the line of Alexander Bowers from Berenberg.

Just 3 questions for me. First is on funding, the funding agreements you signed in H1. Can just confirm were those at all with new investors or whether some are sort of repeat investors? Would you also be able to give a view as to what the pipeline looks like for funding going forward? Secondly, on Lending as a Service, I was wondering if you could give some feedback on how your existing partnerships and pilots with Pitney Bowes and DreamSpring are progressing and what you've learned from those to date? And then sort of lastly on cost. You grew headcount in FlexiPay. Just wondering if you'd give a view as to how many more people are required to kind of bring that business to scale.

Okay. Maybe I'll do the first and the third and Lisa can speak to LaaS. So in terms of funding, all the 3 agreements we spoke about, 1 in the U.K. and 2 in the U.S., were with new investors though it's worth noting that the U.S. is an existing investor in the U.K. So it's building a global relationship, which again I think is a powerful testament to the attractiveness of the asset class, the credibility of which Funding Circle is seen and the ability to develop strong and deep capital market relationships. In terms of pipeline, we always look to have an active pipeline. We always look to have diversification. But equally we're conscious that our institutional investors look for a degree of scale. So it's a slight balancing act of keeping diversification, keeping the potential for new pipeline yet meeting the existing expectations of our existing investors. So we have an active pipeline. I'm not necessarily expecting a lot new use in the very short term because we're quite happy with our funding position. Lisa, you want to talk to LaaS and I'll pick up the third question?

Sure. So on Lending as a Service, just as a reminder, this is where we have more integrated partnership with financial services institutions that enable us to serve their customers with small business loans and the partner themselves provides the funding. And the reason that partners look to us is because of that expertise that we have in underwriting the technology, the process, the straight through proposition that we can provide. We remain very excited about this opportunity. You can see that we're pretty uniquely placed in the U.S. to be able to offer this to partners and Steve and the team -- Steve is building the team to be able to enter into that market more so. As I said in the presentation, it has been slightly delayed given Silicon Valley Bank and the community banks, the implication thereof and those were a number of our partner targets. In terms of the existing relationships that we have, we've learned around them who are the right partners for us to partner with and where this proposition will work most effectively. And that's in terms of things like the size of the SMB base, the type of relationship that they have with those customers and the type of proposition that works as well as which types of integrations work most effectively. And those are learnings that we're feeding into our go-forward approach with Lending as a Service.

Okay. And the third question I think was around FlexiPay costs and particularly FlexiPay headcount. So we have, as you said, ramped up FlexiPay headcount both in terms of the technology teams, the product teams, the commercial team and some of the sales teams. In particular, we've learned sales and outbound sales is quite an effective route to spend our marketing money on with FlexiPay. I would expect to see further modest growth in FlexiPay as we continue to ramp up the product and build out the capabilities.

Your next question comes from the line of Orson Rout from Barclays.

Just 2 quick ones from me. The first is on 2023 guidance, which of course is unchanged on a headline basis. But if we account for the new presentation of interest income and look on a like-for-like basis, it's of course a slight downgrade especially on EBITDA where the interest on cash will of course flow through. So I was just wondering given this accounting change, do you now feel more confident that you'll be able to deliver the top end of the guidance or has the macro toughened more than you have expected, which would not give you the confidence at this moment to guide more towards the top end of the guidance? So that's the first one. Then the second question was just on FlexiPay where obviously to achieve the GBP 10 million target for '23, you need quite a sequential uptick in H2. So I was just wondering if you could give a little bit of color on what gives you the confidence to achieve such a ramp up. And maybe you could talk a bit on the cohort analysis because looking there, I can see that for example the 1H '22 cohort doesn't seem to have grown too much from 2H '22 level. But the more recent cohorts are performing quite well. So I was wondering if you've been making any tweaks to the product that has seen more sort of net customer retention within FlexiPay as well?

Okay. I think first of all, around guidance. So yes, we are confident in our '23 guidance and reconfirmed that. It's fair to say we are seeing a more challenging macro environment that then when we published the guidance back at full year. But I think as half 1 proved, Funding Circle is showing agility and adaptability in running the business through these challenging times. I think your point about interest income is probably the wrong way to look at this. So when we set the guidance, interest income was not significant. We've effectively done the re-presentation in order to provide clarity in order to be comparable with peers and most importantly in my view, to avoid the situation of how we chose to use our cash resources resulted in interest income appearing in different places on the P&L. In terms of your FlexiPay question, you're right, we have a significant ramp up in half 2. That's driven by 3 main things. The first is, as mentioned, the FlexiPay fee charged has moved from 3% at launch to about 4.9% now. That change happened at the end of half 1, beginning of half 2 so we have the full benefits of the yield improvement flowing into half 2. The second driver is new customers. So as Slide 24 of the presentation shows, we continue to add new customers coming into FlexiPay and we expect that trajectory to grow. But the third dynamic, which is illustrated brilliantly by the chart on Slide 24, is as we bring on customers, they then use the product more. So customers who joined FlexiPay in half 1, particularly towards the end of half 1, their usage would itself ramp up. And those 3 factors together give us confidence that we would deliver the income ramp-up we are projecting in half 2. I think you had another question also, which I have to admit, slipped my mind. Could you remind me?

No, I think that answers the main 2. I guess the follow-on was just about on the cohort analysis for FlexiPay and whether you've changed sort of the product over the last couple of half years to increase stickiness and net retention. But I think the first 2 answers already sort of give a lot of color on FlexiPay. So that's helpful.

Yes. Orson, I can pick up on that latter one. I think what you see in the cohort analysis and what we kind of expect going forward, the level of interaction is somewhat limited by the level of credit line that we give to these customers. So we wouldn't expect each cohort to grow exponentially as they come onboard, but rather for those to be flat with a small amount of growth from level of engagement and then over time as those businesses become more established, maybe we're able to increase the credit line. What we are doing though in terms of product features, which I spoke about, is we've completed our beta test on the card and we've moved into launch phase on that. And what that means is in addition to the FlexiPay line of credit where we have customers spreading their invoices over 3 months, we capture a larger share of customers' spend payments because we capture that through their spend throughout the course of the month. So typically at the moment on FlexiPay, the average transaction size is about GBP 3,000, GBP 3,500 whereas what we are finding come through the beta is that customers are using the card much more frequently and therefore building up across various smaller spends throughout the month.

I'll just pipe in. We've got one last question from the webcast from Vish Bhatia of J O Hambro. It's for Oliver. On the significant cash pile the group has in excess of GBP 170 million unrestricted, what kind of rates is the business able to deploy these funds at?

We are very actively managing these rates. We've moved a lot of the money into money market accounts. It varies by account and it varies by geography, but we're receiving 3% to 4%-plus.

Thanks, Oliver. With that, I think we are able to close. Thanks, everyone, for your attention today.

Thanks very much.