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GreenSky opens door to nonbanks funding its loans

This story is the second in a two-part series on the digital lender GreenSky and its bank partnership model. Part 1 can be read here.

Ahead of losing a big chunk of its bank funding, one major digital lender is considering an alternative to its traditional bank partnership model.

GreenSky Inc. announced in its most recent earnings call that it might seek additional funding from insurance companies, asset managers and portfolio managers. Executives said the possible new funding sources would supplement, rather than replace, the company's current bank partner model. But the announcement came as Regions Bank, one of GreenSky's largest partners, pulled out of its funding relationship, pushing GreenSky into a new period of uncertainty roughly one year after becoming a public company.

Regions launched its partnership with the digital lender in 2014 and had committed $2 billion to originate loans through GreenSky's platform. The partnership represented a sizable funding source for the lender, which saw about 17% of its total $11.9 billion in loan commitments come from Regions.

GreenSky facilitates point-of-sale loans for highly discretionary consumer spending, mostly in home improvement — purchases that dry up in a downturn. While analysts say Regions likely will be the only bank to drop out over the near term, GreenSky could have difficulty finding new bank partners willing to commit to consumer loans as the economic cycle grows later and later. A new form of partnerships with nonbanks could help the lender diversify its funding sources.

Insurance companies and asset managers are likely candidates for funding agreements, according to Sandler O'Neill analyst Christopher Donat. The analyst pointed to ECN Capital Corp., which has a business segment that does similar home improvement lending and has been able to partner with insurance companies.

Those partnerships could take a while to come to fruition for GreenSky, Donat said in an interview. But the company has a track record of loan performance and regulatory compliance to show new partners.

"The good news for GreenSky is that they've been working with these kinds of partnerships since 2011," Donat said. "They have loans with performance records. They've been able to satisfy their existing bank partners and the regulators of the bank partners."

However, the analyst expects partnering with insurance companies will be less profitable for GreenSky than working with banks.

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The digital lender makes about 85% of its revenue from the transaction fees charged to merchants.

It also makes some money from its bank partners, both through a fixed servicing fee and a variable performance fee, which it calls an incentive fee. That incentive fee can vary month to month, largely based on realized credit losses during the period. Realized credit losses represent money that GreenSky could have earned in its incentive payment, so the higher the losses, the lower GreenSky's payout will be. The company's payment can never be less than zero.

GreenSky's bank partners make money through an agreed-upon margin yield. If the bank does not hit that margin in a given month, then GreenSky makes escrow available to the bank partner to cover that shortfall. That escrow is typically equal to 1% of the bank's originations made through GreenSky's platform.

The digital lender's top five banking partners — BMO Harris Bank NA, Fifth Third Bank, Regions, SunTrust Bank and Synovus Bank — account for almost 90% of the company's funding commitments, according to a quarterly filing. GreenSky does not disclose how much funding each bank in particular contributes. Its other partners are Flagstar Bank FSB, Ion Bank, Midland States Bank and Renasant Bank.

In possible partnerships with insurance companies, GreenSky would still make money through a servicing fee. However, it likely would not get a performance fee like it does with its bank partners. Instead, GreenSky would probably see a premium on transferring loans to the insurance company, executives said during their second-quarter earnings call.

Through that model, the insurance partner would then carry all the risk, whereas GreenSky's revenue on each loan would be finalized upon origination.

Regions' departure also likely shifts the balance of power to the banks in future negotiations, Donat said. That might allow the banks to bargain for higher margins, leaving GreenSky with less of the profits.

But GreenSky Chairman and CEO David Zalik has previously said the bank partners often seek to increase their commitments. On the company's earnings call in March, Zalik said GreenSky was "oversubscribed" in demand from its bank network.

The company added BMO Harris and Flagstar most recently, in the third quarter of 2018. GreenSky has yet to announce any bank partners this year, but that might not be a problem yet. The lender's current unused funding commitments, which totaled $4.0 billion as of June 30, would fund originations into 2021, even without the capital commitment from Regions. But if loan demand picks up, GreenSky will likely need additional funding sources.

Gerry Benjamin, GreenSky's chief administrative officer, said the potential for new funding sources does not change the importance of the lender's bank partners.

"The bank partner model is fundamental to what we do. It's incredibly important," Benjamin said in an interview. "We are not looking to replace our banks."

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