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Edited Transcript of ONDK earnings conference call or presentation 2-May-19 12:00pm GMT

Q1 2019 On Deck Capital Inc Earnings Call

New York May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of On Deck Capital Inc earnings conference call or presentation Thursday, May 2, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kenneth A. Brause

On Deck Capital, Inc. - CFO

* Noah Breslow

On Deck Capital, Inc. - Chairman & CEO

* Stephen Klimas

On Deck Capital, Inc. - Head of IR

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Conference Call Participants

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* Eric Edmund Wasserstrom

UBS Investment Bank, Research Division - MD & Consumer Finance Analyst

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* John J. Rowan

Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance

* Melissa Marie Wedel

JP Morgan Chase & Co, Research Division - Analyst

* Robert Henry Wildhack

Autonomous Research LLP - Analyst of Payments and Financial Technology

* Scott Christian Buck

B. Riley FBR, Inc., Research Division - Research Analyst

* Steven Matthew Wald

Morgan Stanley, Research Division - Research Associate

* Vincent Albert Caintic

Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst

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Presentation

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Operator [1]

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Good morning, my name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the OnDeck First Quarter Earnings Call. (Operator Instructions). Steve Klimas, Head of Investor Relations, you may begin your conference.

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Stephen Klimas, On Deck Capital, Inc. - Head of IR [2]

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Thank you, Chris, and good morning. Welcome to OnDeck's First Quarter Earnings Call. I'm here this morning with Noah Breslow, our Chief Executive Officer; and Ken Brause, our Chief Financial Officer.

Our earnings release was issued earlier this morning and is available with our earnings presentation and financial supplement in the Investor Relations section of our website. Certain statements, including those relating to our second quarter and full year 2019 financial guidance, are forward-looking statements. They are not facts and are subject to material risks and uncertainties described in our SEC filings. These statements are based on currently available information and we undertake no duty to update them except as required by law.

Today's discussion is also subject to the forward-looking statement limitations in the earnings release and our actual results could differ materially and adversely from those anticipated. During this call, we will use terms defined in the earnings release and refer to non-GAAP financial measures. For definitions and reconciliations to GAAP, please refer to the non-GAAP tables in the earnings release and the appendix of the earnings presentation posted on our website.

With that, I'll turn the call over to Noah.

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [3]

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Thank you, Steve, and thank you all for joining us today. We had a very active first quarter, advancing our strategic initiatives while generating solid financial results. As a reminder, our strategic priorities include: building upon our success in the U.S. lending franchise; investing in our growth adjacencies, including ODX, International and equipment finance; and advancing our capabilities in risk and technology while improving our funding profile. And we made considerable progress on each of these in the first quarter.

In our U.S. lending franchise, we continued to grow the portfolio. We originated $636 million of loans, up 8% from the year-ago quarter with increases in both term loan and line of credit volume. In fact, we generated roughly $150 million of line of credit volume in the quarter, which was an all-time high for us.

These originations resulted in 3% sequential loan growth and the portfolio now exceeds $1.2 billion. That is nearly a $200 million or 19% increase from a year ago, with double-digit percentage growth in our U.S. and international operations.

Our direct channel continues to be our primary source of originations, accounting for 43% of the quarter's volume. Given the attractive customer acquisition costs in the strategic partner channel, growing existing relationships and adding new partnerships remains a focus. And we continue to have success there with record volume in that channel this quarter.

We made some adjustments to credit policy mid-quarter to pull back in certain areas. And our Funding Advisor channel volume decreased sequentially as a result. The flexibility of our multi-channel distribution network allows us to make quick adjustments to our portfolio flows and is a key competitive differentiator.

Now let's turn to our 3 growth adjacencies. First, ODX had a solid quarter. In terms of existing clients, Chase volume increased from prior periods and PNC began booking loans through the platform. While our relationship with PNC is in its early stages, I'm encouraged by the engagement and partnership with that team and we are on track to expand the rollout by launching additional marketing campaigns this spring and summer. Our new partner pipeline developed further in the quarter with several prospects advancing to later stages in the process. And we continue to invest in developing the ODX platform in a way that will enable us to more efficiently add future banks.

Turning to international, we closed our business combination with Evolocity Financial Group on April 1. As a reminder, Evolocity was founded in 2008 and has provided over CAD 250 million of funding since inception. The business is based in Montreal and has roughly 70 employees and approximately CAD 50 million in finance receivables consisting of term loans and merchant cash advances. The combination creates a leading online lender to small businesses in Canada, enabling us to better serve Canadian small businesses by offering a wider array of products and serve clients in all provinces.

This includes Quebec, which accounts for approximately 25% of the Canadian market, but we had not served that province in the past. It is truly a synergistic combination with Evolocity, having a significant local presence, infrastructure and product diversity, while OnDeck brings a stronger balance sheet, capabilities in technology and analytics and broader international lending experience.

In terms of transaction structure, the 2 companies came together under a common Canadian holding company. Evolocity contributed its full business to the holding company and OnDeck contributed its Canadian business plus some cash to account for differences in the net asset value of the contributions and OnDeck's majority ownership stake.

OnDeck holds roughly 58% of the combined OnDeck Canada, which is comparable to the stake we have in our joint venture in Australia. And we will consolidate the combined entity in our financial statements. The remaining minority stake is held by the Evolocity management team, all of which are continuing with OnDeck as part of the transaction, and the other previous Evolocity investors. The teams are now focused on integration, which is progressing smoothly thus far.

Our business in Australia continues to grow and perform well and we continue to believe that our international operations will turn profitable next year. And third, we advanced our Equipment Finance offering by in-sourcing key processes and starting to funds loans on our balance sheet. Recall, we ran a pilot Equipment Finance referral program in 2018 and that continues. The learnings from this program over the last 9 months has helped to inform our underwriting models and our go-to-market approach.

In Q1, we began transitioning more of the originations process in-house from our pilot partner and began to originate assets for our own balance sheet. We are currently focused on originating fixed-rate loans between $5,000 to $150,000 with maturities of 2 to 5 years that are secured by essential-use equipment.

As we did with our launch of the line of credit offering, we are taking a measured approach to entering the market. And so our origination targets this year are modest. However, the addition of Equipment Financing has been well received by our customers and channel partners, and we remain encouraged by the longer-term growth opportunity.

Finally, with respect to our core capabilities, we are making progress on building out our technology stack and we continue to significantly improve our funding profile. We completed 4 financings totaling nearly $600 million in the first quarter that increased our borrowing capacity, extended duration, reduced cost and otherwise improved the terms of the facilities they replaced. Ken will provide some added color, but these transactions have addressed the maturities we had coming into the year. And we accomplished all of this while generating solid financial results.

Our net income and adjusted net income were at the upper end of our guidance ranges, and our gross revenue of $110 million was at the midpoint. Loan growth met our expectations and our margin remains strong at 29.5%, as the benefit of lower funding costs mitigated a lower portfolio yield, reflecting higher delinquencies.

As we messaged last quarter, our credit metrics are normalizing. Our provision rate was 6.8%, net charge-offs were 12.2% and our 15-plus days delinquency ratio was 8.7%. These metrics reflect the impacts from the credit expansion tests conducted in the second half of 2018 as well as changes implemented to our collection practices, which resulted in us retaining more late-stage delinquent accounts. Additionally, we had some onetime effects in the first quarter due to the government shutdown and severe winter weather. Overall, the portfolio continues to perform as expected given a slightly more challenging small business lending environment in 2019. And Ken will walk you through the drivers of each metric. Given our view of the small business lending environment, we tightened underwriting and increased our loan loss reserves.

At this point in the cycle, we think a slight shift in origination strategy to favor loans at the higher end of our target demographic is prudent. This change will impact revenue growth this year, however, our full year earnings expectations are unchanged. We continue to find opportunities to improve the efficiency of our U.S. lending business while managing the timing and the magnitude of our investments to achieve income at our target levels. One of the real advantages of the OnDeck model is that we can be very nimble and react quickly to changes in our portfolio or the lending environment. At this juncture, we believe a slightly derisked stance is appropriate.

While the environment may shift quarter-to-quarter, the decade-long secular shift towards online borrowing among small businesses is accelerating as evidenced by the Federal Reserve Small Business Credit Survey that was published in April. The survey noted that of the small businesses seeking credit in 2018, 32% applied to an online lender. That is up from 24% in 2017 and 19% in 2016. Moreover, small businesses within our target demographic suggests they are more likely to apply to an online lender today than a bank, credit union or community development financial institution. That is a very powerful statement regarding the future of lending to underserved populations.

With that, I'll turn it over to Ken to walk through the financials and our updated guidance.

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [4]

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Thank you, Noah. And good morning, everyone. Our first quarter results were strong. Net income was $6 million or $0.07 per diluted share and compares to a loss of $2 million or $0.03 per diluted share a year ago and net income of $14 million or $0.18 per diluted share last quarter. Adjusted net income, which excludes stock-based compensation and other noteworthy items, of which there were none this quarter, was $8 million or $0.10 per diluted share and compares to $6 million or $0.08 per diluted share a year ago and $16 million or $0.20 per diluted share last quarter.

Getting into the details. Gross revenue was $110 million, up $1 million sequentially and $20 million or 22% from a year ago, driven by higher interest income reflecting loan growth. Loans grew 3% sequentially and 19% from a year ago to $1.2 billion. Originations were $636 million, down 3% from last quarter but up 8% from a year ago. While originations decreased from the fourth quarter, we did see an increase in application volume, which validates the continued demand for our product. Loan yield remains strong at 35.6%, unchanged from a year ago and down 100 basis points from last quarter. This sequential decline was largely a result of portfolio performance as the weighted average interest rate on the portfolio was essentially unchanged at approximately 45%.

Interest expense of just over $11 million was also unchanged sequentially despite a 4% increase in the average debt balance as our Cost of Funds Rate improved 20 basis points to 5.4%. That rate improved 140 basis points from 6.8% a year ago despite a roughly 50 basis point increase in 1 month LIBOR over the same period. As Noah mentioned, we made further progress improving our funding profile. In January, we closed an $85 million syndicated corporate credit facility with several banks, which replaced the $30 million one that expired. This facility can be used for general corporate purposes and it's priced at 1 month LIBOR plus 300 basis points, which is about 125 basis point net savings from the prior one.

In February, we upsized our Pioneers Gate facility from $100 million to $150 million and reduced its cost by approximately 25 basis points to 1 month LIBOR plus 175. And in March, we announced that we amended and extended 2 separate bank facilities that aggregated to $360 million and resulted in a blended savings of over 70 basis points. Those financing substantially addressed our funding needs coming into the year. So we're in a very strong liquidity position.

The Evolocity transaction adds about $40 million of legacy commitments, of which roughly $30 million are drawn. That debt matures within the next 12 months and we're working with the local team in Canada to refinance it at a more attractive cost of funds.

Net interest margin remains strong at 29.5% in the first quarter. While down 50 basis points from last quarter, reflecting the lower loan yield, NIM improved by 170 basis points from a year ago, reflecting the favorable trend in funding costs.

Now turning to credit. Our portfolio quality metrics are normalizing as expected. Provision expense was $43 million, up $3 million sequentially and $7 million from a year ago, and the provision rate increased to 6.8%. Our 15-day plus delinquency ratio increased 120 basis points to 8.7%. About half of the increase was in the 90-day plus bucket and reflects ongoing impacts from the insourcing of collections on late-stage delinquencies, which we have discussed for a few quarters now.

The balance of the increase in 15- to 89-day delinquent loans reflects the roll-through of the impact of the credit expansion tests we did in the second half of 2018 as well as the overall credit environment. The net charge-offs remain near the low end of our 12% to 14% target range at 12.2%. The allowance for loan losses is now $147 million, resulting in a reserve ratio of 12.5%. This reserve level reflects the growth in the loan portfolio, portfolio trends and the growing proportion of late-stage delinquencies, on which we hold higher reserves.

Total operating expenses were $48 million, up $3 million sequentially. Most of this increase was concentrated in the technology and analytics category and reflects some of the incremental investment in our strategic growth initiatives that we have discussed. Our adjusted efficiency ratio increased to 41%, reflecting the increased investment spend. And this was the first quarter we accrued for income taxes. The effective tax rate was 24%, which was a bit higher than our initial estimate of approximately 20% as we continue to refine our estimates for taxable income in the U.S. and our international subsidiaries.

Our balance sheet remains strong with growing levels of capital and liquidity. We adopted the new lease accounting standard, which effectively grossed up our balance sheet by $28 million as we recorded a lease liability and other liabilities and offsetting right-of-use assets in other assets. The net add predominantly relates to our office real estate leases and reflects the $10 million of deferred rents and other accrued lease expenses that were already in other liabilities.

Liquidity levels improved as we had approximately $340 million of available borrowing capacity under our roughly $1.2 billion of committed debt facilities as well as $60 million of cash and equivalents at quarter end. And our capital levels remain robust with equity representing 26% of assets or a debt-to-equity ratio of just 2.7x.

OnDeck shareholders' equity increased 3% since year-end to $309 million and book value per diluted share grew to $3.89. We continue to have a full valuation allowance against our net deferred tax asset of approximately $38 million or $0.50 per share. We will begin evaluating the potential for a partial release later this year.

Now turning to guidance. We are affirming the full year 2019 income guidance we provided in February, which calls for net income attributable to OnDeck between $20 million and $30 million and adjusted net income between $30 million and $40 million. We modestly reduced our gross revenue guidance range to $435 million to $455 million primarily reflecting lower asset growth than originally contemplated as we're taking a slightly more cautious view of the small business lending environment.

In terms of the other key performance indicator trends, we expect net interest margin to be stable year-over-year as the lower loan yield reflecting credit normalization and our focus on originating slightly higher quality credits is offset by funding cost improvements.

We still expect the full year provision rate to be near the midpoint of our 6% to 7% target range as our credit metric trends continue to normalize. And we still expect our adjusted efficiency ratio to increase slightly from 2018, although we will actively work to manage expenses to achieve our income targets.

For the second quarter, we're expecting gross revenue between $108 million and $112 million, net income attributable to OnDeck between $4 million and $8 million and adjusted net income between $7 million and $11 million. As Noah said, our first quarter financial results were solid and we continue to advance our strategic priorities. Our strong balance sheet and nimble operating model positions us well to capitalize on today's opportunities as well as those to come as the shift towards digital lending accelerates.

With that, let's turn the call back over to Chris and we'll take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Eric Wasserstrom of UBS.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [2]

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Noah, can you guys just maybe talk a little bit to what you saw in the lending environment that made you become incrementally more cautious? And I guess in particular what it was about the strategic adviser channel that seemed, I think, particularly different than expectations?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [3]

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Sure, Eric. No problem. This is Noah. When we look back over the last 90 days, what we saw in the environment is there's really no single driver, but we've been doing this now for over a decade, so we have a lot of data that we kind of look at, kind of to compare seasonality and what we see every year. And so what we saw internally is that even when you adjust for the credit testing we did last year and also the change in collections practices, which sort of drove the 90-plus part of our delinquency rate, the credit performance softened a bit for some of the 2018 vintages. So we saw that internally.

And then externally, small business optimism ticked down a bit from its all-time high, it's still high relative to historical levels, but it did back off a bit, and we are late in the cycle and then we did see a little bit more of an aggressive competitive environment. So we did decide to make again, as Ken said, a slight pullback on our risk tolerance, focusing a little bit more at the higher end of our target demographic.

And then the piece about the Funding Advisor channel. That channel has a slightly higher just sort of natural risk element. So our pullback wasn't necessarily specific to any one channel, but it was a little bit more across the board. It just sort of hit that channel a little bit harder because of the inherent risk differences between the 3 different channels that we have.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [4]

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And then just on the net interest margin, when you refer to the performance-based component, I'm assuming that, that means suppression or the nonrecognition of potentially forgone NII on higher late-stage delinquencies. Is that what that is?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [5]

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Well, it's just -- it is delinquencies in general, right? So if people aren't paying us, we don't recognize the income, it doesn't help your yield.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [6]

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Got it.

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [7]

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It's tied to the delinquency levels.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [8]

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And then just lastly on expenses. Of the $15 million that you had signaled would be incremental investment over the course of -- for the year, do you -- can you give us a sense of how much of that was spent or deployed in this period?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [9]

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Sure. So I'd say probably around $3 million, give or take, of that $15 million was expensed in the first quarter. So I think as we think about the full year, we said $15 million was the expected number. Obviously, there are timing issues as we implement things. So it could be a little bit light of that given the pace in the first quarter.

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Operator [10]

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Your next question comes from John Hecht of Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [11]

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First of all, the -- you're targeting originations now at the higher end of your range. You have given the aforementioned components of credit. Does that mean -- do you guys think by the end of the year you would see an alleviation of delinquency and charge-off trends or are you just sort of trying to manage into the range you're talking about right now?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [12]

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Yes. So we did implement a slight pullback in Q1. This is Noah, John. And the -- we're already seeing some evidence of improvements in the early roll rates, right. We have a little bit of a situation where some of the testing from last year and some of the weakness in those 2018 vintages is flowing through, but some of the early results are promising. So I think that's sort of point one.

Point two is, as we said in the prepared remarks, we do expect originations to be sort of flat to slightly down in Q2. But we do expect sequential growth again in the second half of the year heading into 2020. And that's been kind of our pattern for the last couple of years. So there's a little bit of a seasonal trend in Q2 that also is going on here.

So long story short is I think we're encouraged by the changes we've made in terms of their impact on the portfolio. We do see us kind of returning to sequential originations growth in the second half of the year. And again we've been doing this business for over a decade, so a lot of this is sort of how we just sort of manage the business through a variety of different environmental conditions.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [13]

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Okay. And then maybe if you - you talked about a lot of activity in the ODX pipeline and -- some of the good growth within the active partners. Maybe can you give us a little bit more color there in terms of the pipeline, sales cycle and opportunity?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [14]

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Yes. We feel great about the overall opportunity. The pipeline is strong. It's wider than it's ever been in terms of the number of opportunities where we're pursuing. And as we said in the prepared remarks, we have folks moving to later stages of the consideration process. That's all we can say at this time.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [15]

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Moving back to the ALLL, you're at 20 -- you're at 12.5% right now. Is that the new base? Should we think about any seasonal considerations there just in terms of modeling that migration over the course of the year?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [16]

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So obviously, the reserve is based on the expected loss in the portfolio. As we continue to roll out the late-stage delinquency collection process and we're holding more of the 90-plus day delinquents on balance sheet, those have the highest reserve levels attached, that we reserve about $0.85 to $0.90 on the dollar for those loans. So as that proportion continues to grow, you would expect the overall reserve to grow. So I don't think it would be surprising to see it continue to tick up in line with the other credit metrics through the course of the year

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Operator [17]

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Your next question comes from John Rowan of Janney.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [18]

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Ken, just -- sorry I joined late, and I caught kind of the tail end of a comment which made me a little confused relative to the answer you just gave to John. When I logged on, you said something about, I thought you were talking about the allowance and you were talking about a release later in the year. Can you just kind of clarify what you were talking about? Because it sounds like we're talking about building the allowance ratio later into the year.

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [19]

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Yes. So I was talking about an allowance, just not the allowance for loan losses. I was talking about the valuation allowance on our deferred tax assets.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [20]

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Okay.

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [21]

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And that's about a $38 million valuation allowance which is sitting there on the balance sheet, offsetting the deferred tax asset, is what I said, that we would begin to evaluate whether we could do a partial release as we got into the back half of the year.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [22]

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Okay, and that would offset what, cash taxes?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [23]

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Well, it would -- it would just come in as an income item on -- it would be a tax benefit that would flow into book value.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [24]

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Okay, and then so the tax rate was higher than you had anticipated. Should we take this current quarter's tax rate as a good run rate going forward?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [25]

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Yes.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [26]

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Okay, and then just last thing. Can you remind me, have you launched some of the new products? And if so, how is the credit performance of them?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [27]

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Yes. So I can take that John. I mean Equipment Finance we have been piloting with a partner actually, so the loans haven't been on our balance sheet. We have just been originating them since sort of the middle of last year. But as we mentioned in the prepared remarks, we just began to put loans on our balance sheet at the very end of Q1 here.

So will -- it will be very modest originations this year, but again we are very encouraged by what we see in the Equipment Finance opportunity. And we have a team for building up that product and our capabilities there right now. So a long story short, it's a little bit early there, but if you look at the line of credit products, where that's come over the last 5 years, now it's -- I think 18%-ish of our loan book. So the aim for Equipment Finance is to really build that up over the next 3 to 5 years to be a similar chunk of our business.

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Operator [28]

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Your next question comes from James Faucette from Morgan Stanley.

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Steven Matthew Wald, Morgan Stanley, Research Division - Research Associate [29]

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It's Steven Wald on for James. Maybe just to start off on the comment you guys made about affirming the net income guidance while the revenues are lower. Maybe just can you walk us through some of the levers you see available to pull to get to that target on the expense side?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [30]

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And I think with everything the levers on the expense side are the efficiency of the business and the pace at which we spend on the investments. So as we've talked about in the past, we continue to look for opportunities to be more efficient in our core U.S. lending business and making sure that we are spending wisely and we'll continue to manage that to hit our net income targets.

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [31]

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The only thing I would add to what Ken just said is that with a stable NIM as a result of the improvement in cost of funds and a little bit lower originations, you have a mechanical kind of offset and slightly lower provision expense. So we think the combination of those items really drives the consistency in the bottom line performance.

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Steven Matthew Wald, Morgan Stanley, Research Division - Research Associate [32]

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And then separately on the -- I think I heard a comment earlier in the call about the higher applications even though you guys are moving up the credit box and sort of lowering the originations target. Could you maybe talk through, is there some sort of shift you'd need to see in terms of who you're mainly targeting with that, bring on some incremental costs in terms of shifting, if you were unable to then, over the course of the next few quarters, reopen the credit box?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [33]

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Yes. No. We don't think actually there's incremental cost here. This is really about shaping the portfolio from the application flow that we're seeing. So I think as we mentioned in the quarter, we pulled back a little bit on the higher risk part of the equation. We have other moves we can make to better target and better convert the slightly lower risk part of that population. But I think the fact that applications were a record this quarter is a good sign, and continues some of the trends that we saw in 2018. I think it's secular growth of the space, growing awareness of the OnDeck brand and the rate of growth of our strategic partner channel, which had a record quarter.

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Operator [34]

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Your next question comes from Scott Buck of B. Riley FBR.

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Scott Christian Buck, B. Riley FBR, Inc., Research Division - Research Analyst [35]

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You guys have been fairly successful over the past few quarters, years in reducing the cost of funds. I'm curious, you mentioned Canada, but are there any other kind of low-hanging fruit out there to further reduce those in the near term? And what's the kind of longer-term outlook for cost of funds?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [36]

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Scott, I'll take that. It's Ken. So thank you for that acknowledgment. I think we're all very pleased and proud of the amount of progress we made on that front. And to be honest, other than our focus on Evolocity and the Canadian opportunity, I wouldn't say there's a lot of low-hanging fruit. I mean again when you look at 180 basis point improvement in spread over a year when interest rates have been rising, it's a pretty impressive change in the spreads that we were able to achieve on our facilities.

So I think that from this point forward, there will be continued refinement. So again, I gave the example of the Pioneers Gate facility, that we were able to bring in another 25 basis points. So I think there is -- we continue to look on the margin given market conditions, given our portfolio, to improve, but I don't think we'll see the type of benefit and improvement that we've seen over the last 12 to 24 months in the next 12 to 24. Obviously, if interest rates -- the interest rate environment changes and again, we are more liability sensitive to short-term floating rates, so that's an opportunity if, in fact, rates decline on the short end.

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Scott Christian Buck, B. Riley FBR, Inc., Research Division - Research Analyst [37]

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That's helpful and then in terms of Evolocity and Canada. You mentioned you put some additional cash into the transaction. Could you put some numbers around that or no?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [38]

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Yes. So we have not given out the details of the transaction, but it's relatively modest, and you'll see it the next quarter's financial statements. So in the range of $10 million.

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Operator [39]

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Your next question comes from Rob Wildhack of Autonomous Research.

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Robert Henry Wildhack, Autonomous Research LLP - Analyst of Payments and Financial Technology [40]

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I was hoping to get more some detail on the competitive environment. How would you rate the intensity today relative to the past couple of years? And is the increase in intensity broad-based or coming from more of a specific cohort of competitors?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [41]

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This is Noah. I can answer that. So yes we do think, and we sort of said the last couple quarters, it was stable. We do think it's a little bit more intense as we saw it in the first quarter. I would say it is broad-based, not localized to any one particular competitor. So I think you have some larger players in the market that are all getting a little bit more mature, a little bit more scale, some of them are already improving their access to capital as well. And then actually the small players still have pretty good access to capital too. So any single one of them is not that big, but if you add them all together, they're sort of equivalently sized to another OnDeck or what have you.

And so that's something that we watch as well. But again, we do think it's pretty rational competition so it's a little bit different than what we saw back in 2015 and 2016, where we saw people sort of making offers that we didn't really understand. So I think that's a good thing overall, but definitely I think the availability of capital in the market and some of the players getting a little bit bigger has resulted in a step-up this quarter.

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Robert Henry Wildhack, Autonomous Research LLP - Analyst of Payments and Financial Technology [42]

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And then I know this can be hard to quantify, but can you give us a sense for how much you're tightening the credit box here? Is it just a tweak or is it something a little more significant than that?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [43]

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I think we used the word slightly on the call, so I will say this, when you tighten the credit box sometimes there are second-order effects, right. So if you tighten and your competitors stay exactly the same, on the margin your funnel is going to deteriorate a little bit, right, because you're not making as aggressive offers as you were before. But again we've got a lot of historical data on our portfolio and our trends in the business, so we feel confident kind of in the moves we're making.

But yes, no, I think again, the core OnDeck customer, our sort of credit metrics in the first quarter, our expected loss on the first quarter population is lower than our expected losses on the fourth quarter originations. So we're making the right moves I think intrinsic to our portfolio and yes, not -- it's not a seismic shift, kind of, in who we're targeting and what we're trying to do.

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Operator [44]

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Your next question comes from the line of Vincent Caintic from Stephens.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [45]

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I just wanted to follow-up, maybe broad picture of what maybe changed your view in being a little bit more cautious? So it seems like you had the guidance change from last quarter versus this quarter in looking at 2019 with the lower loan growth, but I wondering if there's anything kind of specific that you see? Is it kind of macro trends? Or is the small business environment just getting weaker? You talked about competition, so that -- I appreciate that. But is there anything kind of else you just saw in the quarter that kind of causes you to be a bit more cautious?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [46]

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Yes, it was, Vincent, really a blend -- this is Noah -- of kind of 3 elements, right? Internally, we did see a little bit of weakening in the 2018 vintages. Obviously, we mentioned it in the prepared remarks too, we had a government shutdown. We had a -- sort of the polar vortex or winter weather issues that happened in January, so that was the real thing for a lot of small business owners.

And then externally, the small business optimism ticking back a little bit. I think a couple months ago there was a feeling of maybe the cycle was nearer to its end than we feel kind of today. And then you mentioned the competitive dynamic as well. So it was really a combination of kind of the internal, the external, a little bit of the competitive. But again with the other piece of this is that we made a pullback a little bit early in the year, so that's going to flow through our financials and our revenues this year. But we do expect to return to sequential originations growth in the second half of the year.

And again, we have a lot of arrows in the quiver to target sort of slightly higher-quality borrowers coming through our existing application funnel. So that's how we're going to kind of play the next quarter or 2 here, but overall, still very optimistic about the long-term growth prospects of the business and we're just trying to riding the wave a little bit of the economy and what we're seeing internally.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [47]

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Okay. Got it. That's helpful. And then maybe a little focus on the credit side. And if you can just maybe remind me of the seasonality of the business. So your net charge-off rate's up 130 basis points year-over-year and delinquencies is up 200 basis points. Is that -- do you expect that to kind of continue to be the trend for the next couple of quarters this year? Or is there something seasonally that makes second quarter either more or less than what it would be for the rest of the quarters?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [48]

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It's Ken. I wouldn't describe the credit metrics as necessarily seasonal. They are obviously an outgrowth of what we originate and how they perform. So I think I talked about before that the collection strategy and the fact that we were holding more of the late-stage delinquencies, which is -- accounted for roughly half of the increase in the increase in delinquency metric this quarter.

We've got another couple of quarters till that normalizes. So you're going to continue to see that 90-plus bucket grow each quarter and that obviously has an impact on the reserve rate required because those are the highest reserve loans on our books because we're essentially taking the loss in P&L and then with -- the strategy here is to do better collecting them ourselves and to sell them single cents on the dollar.

So we think again over time that, that manifests itself through improved recovery rates, which flows back through the system. So again, we've talked about normalization. We talked about this -- some of the testing we did last year running its way through the system and so you'll see that roll through the DPDs and then eventually some charge-offs, but again I think our message on normalizing to the midpoints of our range over the course of this year is the appropriate way to think about it, not necessarily on a seasonal basis.

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Operator [49]

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(Operator Instructions) Your next question comes from the line of Melissa Wedel from JPMorgan.

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Melissa Marie Wedel, JP Morgan Chase & Co, Research Division - Analyst [50]

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Just to put a fine point on it. It sounds like you are suggesting that the reserve rate could go incrementally higher through this year?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [51]

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Yes, that's right.

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Melissa Marie Wedel, JP Morgan Chase & Co, Research Division - Analyst [52]

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Okay. And then as you think about the impact of the Evolocity portfolio and anything that you're going to launch on Equipment Finance. Would those be small enough this year that they wouldn't really impact portfolio credit or yield? Or do you expect some sort sizeable change?

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [53]

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So certainly Equipment Finance is small enough that it's not going to be noticeable in the balance sheet or the reserves this year. Evolocity, as we talked about, is roughly CAD 50 million portfolio and as we have talked about on OnDeck Canada in the past there, the loss experience in Canada as in Australia is lower than in the U.S. So to the extent, it's still a relatively small number, and will have a very modest impact on the overall credit metrics.

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [54]

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That impact will be positive.

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Kenneth A. Brause, On Deck Capital, Inc. - CFO [55]

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A net positive impact, yes, but very modest. Yes.

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Melissa Marie Wedel, JP Morgan Chase & Co, Research Division - Analyst [56]

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Okay, and does that presume that you guys are going to be scaling that beyond sort of the run rate operations or are you just incorporating the existing business?

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Noah Breslow, On Deck Capital, Inc. - Chairman & CEO [57]

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Well, we're incorporating the existing business, but -- and there might be a quarter or two where kind of we're mostly focused on integration, but no, the plan is to scale that business over the next couple of years. So with a much bigger team on the ground in Canada, we have largely been supporting Canada from the U.S. with a pretty small team in country. And Evolocity actually had been a little bit constrained by their own balance sheet and so by being plugged into the OnDeck balance sheet and our access to capital, we can actually scale that business faster. So I think as we look at 2020, 2021, we mentioned on the call, we see the international businesses turning profitable next year and certainly scaling in the strong double-digit rates for years to come.

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Operator [58]

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That concludes Q&A and your conference call. Thank you for joining and have a wonderful day.