GreenSky Inc.'s $1.01 billion initial public offering is a milestone in the burgeoning market for point-of-sale lenders, which partner with merchants to make loans to customers through an efficient digital application process.
GreenSky has built an asset-light, scalable lending marketplace by turning thousands of home contractors into sales agents and using banks to fund loans. It grew originations 159% to $3.77 billion between 2014 and 2017, primarily by facilitating unsecured home improvement loans. While other prominent digital lenders have struggled with profitability, GreenSky's net profit margin has averaged more than 40% in recent periods.
The company has so far emphasized low customer acquisition costs, stable funding and a niche market focus. However, unique risks and growing competition could lead to lower margins in the years to come.
Through its merchant partners, the GreenSky platform connects banks with consumers looking for purchase financing. The company charges merchants a transaction fee every time a loan is made through the platform. It also charges the lenders an ongoing servicing fee, which is a fixed percentage of the outstanding loan balance.
GreenSky has secured capital commitments from banking partners to stabilize its financing. Four regional banks — SunTrust Banks Inc., Regions Financial Corp., Synovus Financial Corp. and Fifth Third Bancorp — fund most of the loans on the company’s platform. The lending platform transfers loans to the banking partners on a round-robin basis, based on the banks' underwriting criteria.
GreenSky takes many measures to ensure its bank partners receive a fixed yield from loans originated on its platform. The company collects an incentive fee to minimize credit losses and absorbs part of its partners' credit risk, which is increasingly weighing on its financials.
GreenSky's business model affords it certain operational efficiencies. Utilizing merchants as loan acquisition channels allows for low customer acquisition costs. On average, merchants become profitable for GreenSky within five months of joining the platform. And GreenSky's banking partners can leverage its low cost of acquisition to reach borrowers on a national scale.
Founded in 2006, GreenSky was an early mover in point-of-sale lending. It focused on the home improvement market for its first decade, building relations with both large retailers and networks of owner-operated home improvement contractors. Most of these contractors process annual transaction volumes of $1 million to $10 million.
The home improvement market is large and growing. Americans could spend about $387 billion on home improvement products in 2018, according to the Home Improvement Research Institute. While the median spend is less than $600, GreenSky's average loan amount was about $7,719 in 2017.
GreenSky also operates in the elective healthcare segment, offering financing for certain out-of-pocket medical costs. PrimaHealth Credit, a marketplace lender for elective healthcare treatments, estimated in 2015 that Americans used financing options for less than 20% of out-of-pocket expenses. PrimaHealth Credit expected this spend to reach $106 billion by 2019.
GreenSky recently launched a retail and e-commerce lending program. Current partners include Precor, a distributor of fitness equipment such as treadmills and stationary bikes. GreenSky will likely focus on issuing loans for such larger ticket retail items, at least initially.
The company has identified other markets including power sports and jewelry as potential expansion opportunities. While all of these markets are large, GreenSky's growth story is not without cracks in the armor. One of the most obvious comes from competition.
GreenSky's competitors include both technology startups and larger incumbents.
In the home improvement and elective medical financing segments, GreenSky faces competition from several digital lenders, including Avant, Prosper Marketplace Inc., LendingClub Corp. and LightStream Inc. While GreenSky focuses on super prime consumers, several competitors offer loans to a wider range of consumers. In retail, competition is likely even more intense. Point-of-sale lenders Affirm Inc. and Klarna Inc. have processed significant transaction volume through online retail.
PayPal Holdings Inc.'s pending sale of loan receivables to Synchrony Financial will free up capital tied to the PayPal Credit program. With Synchrony Financial becoming the exclusive financier for Paypal Credit, PayPal can continue to arrange loans without taking on credit risk. PayPal made approximately $9 billion in loans through PayPal Credit in 2017.
Synchrony, best known as an issuer of co-brand and private-label credit cards, is also a major competitor for GreenSky. Synchrony facilitated $25 billion in transaction volume in 2017 by offering credit through merchant partners for big-ticket purchase items and medical procedures. Transaction volume in these segments has been growing at a CAGR of 9% since 2013.
GreenSky’s dependence on a handful of merchants to generate most of the demand for its loans and on a few banks to fund those loans creates concentration risks.
Home Depot and referrals made by affiliates of Renewal by Andersen together contribute about one-fourth of GreenSky's revenues. Despite the addition of more than 3,500 merchants in 2017, the proportion of revenues generated by the company’s two most significant merchant and sponsor relationships remained almost flat at 25%. While that points to the growing appeal of GreenSky loans among the customers of its top merchants, the concentration in merchant relationships poses a risk.
Concentration risk on the loan origination side is even greater. SunTrust, Regions, Synovus and Fifth Third collectively provided 89% of $8.1 billion commitments to originate loans as of March 31.
However, these banks are constantly scouting for other digital lending partnerships, and all four have agreements with other fintech-enabled lenders.
For example, SunTrust, also an early investor in GreenSky, has its own online consumer lending business, Lightstream, which competes with Greensky for home improvement and medical loans. The bank recently announced a new lending partnership with Microf LLC, which provides point-of-sale financing for heating, ventilation and air conditioning systems.
To be sure, all four banks have acknowledged that their loan portfolios registered strong growth after teaming up with GreenSky and have indicated the potential for growing their loan books through the GreenSky platform. However, their arrangements with GreenSky do not bar them from other partnerships, and they can re-evaluate their association with GreenSky every year.
Only $2.6 billion of the total commitments remain unused. Without continued support from existing bank partners or expansion of its lending relationships, Greensky’s growth could come under pressure.
GreenSky may find it difficult to keep transaction fee rates at current levels as it pushes into markets where other point-of-sale lenders are established. The cost of marketing the platform to merchants will also increase as competition intensifies.
More competition will increase options for merchants and banking partners. Greensky’s non-exclusive partnerships and the proliferation of point-of-sale lenders exacerbate the concentration risks. The situation may squeeze GreenSky in its current middleman position and cause it to consider other sales channels. It recently launched a program loan initiative, offering a six-month fixed line of credit, for which consumers can sign up directly, to fund home improvement purchases. However, direct-to-consumer initiatives will also likely push up marketing expenses.
GreenSky provides several safeguards to banks that expose it to losses if default rates rise and prepayments on promotional loans accelerate.
One such measure relates to the company’s deferred interest loans that carry zero interest during promotional periods. As GreenSky pays banks the entire accrued interest on such loans, it faces losses if customers pay loans during the promotional period. An incentive fee it collects from banks for limiting credit losses provides a cushion against losses stemming from prepayment of promotional loans. In recent years, incentive payments have covered a decreasing proportion of such losses.
Another protection measure requires GreenSky to hold cash reserves in escrow to meet its promise of absorbing a portion of credit losses beyond a certain threshold. Although GreenSky's share of actual credit losses has been insignificant, the amount of cash reserved in escrow has grown to $70.9 million. Adding to restricted cash pile is another protection reserve to meet liabilities to banks arising from billed interest on promotional loans. Restricted cash tied to these protection measures stood at $115.6 million as of March 31 and will only grow in line with the portfolio, limiting the company's free cash flow. Deteriorating credit trends would exacerbate GreenSky's losses because it is entitled to incentive payments only when it generates excess profits on loans after adjusting for servicing fees and credit losses.
Leadership at GreenSky is aware of the shifting landscape. Trends in the company's loan portfolio indicate growing demand for its products. The company is originating more loans every year and increasingly lending for higher-ticket size purchases. Average loan amount grew to $7,719 in 2017 from $7,183 in 2015, while the number of loans originated grew 69%.
The company is looking to grow into new segments and exploring ways to alleviate risks. Its program loan initiative is one such attempt. But it is unlikely that the company will be able to dramatically reduce its banking and merchant concentrations in the near term. Sales and marketing costs will likely increase as the company tries to expand in a more competitive landscape.
The IPO marked the end of a period of rapid, but quiet, growth in a narrowly focused market. There are significant opportunities for expansion ahead, but competition will likely erode profit margins.