GREENSKY, INC. You should read the following discussion and analysis of our financial condition and results of operations together with our Consolidated Financial Statements and related notes included in Part II, Item 8 of this Form 10-K. This discussion and analysis contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various important factors, including those set forth under Part I, Item 1A"Risk Factors" in this Form 10-K.
Unless the context requires otherwise, "we," "us," "our," "GreenSky" and "the
Company" refer to
Organization
GreenSky, Inc. was formed as aDelaware corporation onJuly 12, 2017 . The Company was formed for the purpose of completing an IPO of its Class A common stock and certain Reorganization Transactions in order to carry on the business of GSLLC, aGeorgia limited liability company, which is an operating entity.GS Holdings , a holding company with no operating assets or operations, was organized as a wholly-owned subsidiary ofGreenSky, Inc. inAugust 2017 . OnAugust 24, 2017 ,GS Holdings acquired a 100% interest in GSLLC. Common membership interests ofGS Holdings are referred to as "Holdco Units." See Note 1 to the Consolidated Financial Statements in Part II, Item 8 for a detailed discussion of the Reorganization Transactions (as defined in that note) and the IPO. Executive Summary
For a Company overview, see Part I, Item 1 "Business."
Merger Agreement
InSeptember 2021 , the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with The Goldman Sachs Group, Inc. ("Goldman Sachs"), andGoldman Sachs Bank USA ("Goldman Sachs Bank "), a wholly owned subsidiary of Goldman Sachs. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, (a)Goldman Sachs Bank will establish a new whollyowned subsidiary ("Merger Sub 1") into whichGreenSky, Inc. will be merged (the "Company Merger"), with Merger Sub 1 surviving the Company Merger as a whollyowned subsidiary ofGoldman Sachs Bank ; and (b)Goldman Sachs Bank will establish a new whollyowned subsidiary ("Merger Sub 2") that will be merged intoGS Holdings (the "Holdings Merger" and, together with the Company Merger, the "Mergers"). Consummation of the transaction is subject to the receipt of required regulatory approvals and satisfaction of other customary closing conditions. See Note 1 to the Consolidated Financial Statements included in Part II, Item 8 for additional information.
Covid-19 Pandemic
On
The following are key impacts of COVID-19 on our business:
Transaction Volume. Our transaction volume began to be impacted significantly by COVID-19 inmid-March 2020 , and certain of our transaction volumes continue to be impacted. For the year endedDecember 31, 2021 , our transaction volume increased 6% compared to the prior year. Our transaction volume growth was impacted by escalating supply chain constraints in theU.S. that we expect to shift transactions to future periods. Portfolio Credit Losses. We entered the COVID-19 pandemic with historically strong credit performance and we believe our home improvement sector program borrowers, particularly in concert with our focus on promotional credit, are financially resilient. To maintain our strong credit position in this uncertain economic environment, we continue to emphasize our super-prime promotional loan programs with our merchants. 55 -------------------------------------------------------------------------------- Table of
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As the impact of COVID-19 continues to persist and evolve, GreenSky remains committed to serving GreenSky program borrowers and ourBank Partners and merchants, while caring for the safety of our associates and their families. The potential impact that COVID-19 could have on our financial condition and results of operations remains highly uncertain. For more information, refer to Part I, Item 1A "Risk Factors" and, in particular, "- The global outbreak of the novel coronavirus, or COVID-19, initially caused severe disruptions in theU.S. economy and our business, and may further impact our performance and results of operations." 2021 Results
The following are key business metrics and financial measures for the year ended
Business Metrics •Transaction volume (as defined below) was$5.9 billion during the year endedDecember 31, 2021 compared to$5.5 billion during the year endedDecember 31, 2020 (increase of 6%) and$6.0 billion during the year endedDecember 31, 2019 (decrease of 7%); •Total revenue of$518.1 million during the year endedDecember 31, 2021 decreased by 1% from$525.6 million during the year endedDecember 31, 2020 , which in turn decreased by 1% from$532.6 million during the year endedDecember 31, 2019 ;
•The outstanding balance of loans serviced by our platform totaled
•We maintained a strong consumer profile. For all loans originated on our platform during 2021, the credit-line weighted average consumer credit score was 780. Furthermore, consumers with credit scores over 780 comprised 42% of the loan servicing portfolio as ofDecember 31, 2021 , and over 90.9% of the loan servicing portfolio as ofDecember 31, 2021 consisted of consumers with credit scores over 700. •The 30-day delinquencies as ofDecember 31, 2021 were 0.84%, an improvement of 15 basis points overDecember 31, 2020 . The delinquency rate includes accounts that received COVID-19 assistance that are no longer in payment deferral. Less than 0.1% of the total loans serviced by our platform as ofDecember 31, 2021 were in deferral status, compared to approximately 0.8% as ofDecember 31, 2020 and approximately 4% at the peak in the second quarter of 2020.
Financial Measures
Net income of$117.8 million during the year endedDecember 31, 2021 increased from$28.7 million during the year endedDecember 31, 2020 . The increase in net income for the year endedDecember 31, 2021 relates primarily to a reduction in cost of revenue largely driven by a decrease in change in fair value of our FCR liability, which was primarily a function of higher performance fees attributable to lower charge-offs and due to a lower balance of deferred interest loans subject to FCR as a result of our funding diversification that began in mid-2020. The increase in net income was also impacted by a financial guarantee benefit of$15.2 million compared to financial guarantee expense of$5.0 million during the year endedDecember 31, 2020 . Adjusted EBITDA (as defined below) of$208.8 million during the year endedDecember 31, 2021 increased 97% compared to$105.9 million during the year endedDecember 31, 2020 . Net income of$28.7 million for the year endedDecember 31, 2020 decreased from$96.0 million during the year endedDecember 31, 2019 . The decrease in net income for the year endedDecember 31, 2020 relates primarily to cost of revenue acceleration associated with the transition to a diversified funding model in 2020. During the last four months of 2020, the Company facilitated sales of over$1.0 billion in whole loans or loan participations. Adjusted EBITDA (as defined below) of$105.9 million during the year endedDecember 31, 2020 was largely consistent with the$105.0 million during the year endedDecember 31, 2019 .
Information regarding our use of Adjusted EBITDA, a non-GAAP measure, and a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP (as defined below) measure, is included in "Non-GAAP Financial Measures."
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Non-GAAP Financial Measures
In addition to financial measures presented in accordance with United States
generally accepted accounting principles ("GAAP"), we monitor Adjusted EBITDA to
manage our business, make planning decisions, evaluate our performance and
allocate resources. We define "Adjusted EBITDA" as net income before interest
expense, taxes, depreciation and amortization, adjusted to eliminate
equity-based compensation and payments and certain non-cash and non-recurring
expenses.
We believe that Adjusted EBITDA is one of the key financial indicators of our
business performance over the long term and provides useful information
regarding whether cash provided by operating activities is sufficient to
maintain and grow our business. We believe that this methodology for determining
Adjusted EBITDA can provide useful supplemental information to help investors
better understand the economics of our business.
Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, the analysis of other GAAP financial measures, such as net income. Some of the limitations of Adjusted EBITDA include:
•It does not reflect our current contractual commitments that will have an impact on future cash flows;
•It does not reflect the impact of working capital requirements or capital expenditures; and
•It is not a universally consistent calculation, which limits its usefulness as a comparative measure.
Management compensates for the inherent limitations associated with using the
measure of Adjusted EBITDA through disclosure of such limitations, presentation
of our financial statements in accordance with GAAP and reconciliation of
Adjusted EBITDA to the most directly comparable GAAP measure, net income, as
presented below.
Year Ended December 31,
2021 2020 2019
Net income $ 117,814 $ 28,662 $ 95,973
Interest expense(1) 26,269 25,024 23,860
Tax expense (benefit) 13,880 1,597 (7,125)
Depreciation and amortization 14,045 11,330 7,304
Share-based compensation expense(2) 15,660 14,923 13,769
Change in financial guarantee liability - Non-renewal of Bank Partner(3)
- - 16,215
Financial guarantee liability - Escrow(4) - - (241)
Servicing asset and liability changes(5) (13,773) (2,157) (29,679)
Mark-to-market on sales facilitation obligations(6) 2,604 10,655 -
Discontinued charged-off receivables program(7) - - (29,190)
Merger-related costs(8) 11,735 - -
Transaction and non-recurring expenses(9) 13,788 15,818 14,149
Adjusted EBITDA $ 202,022 $ 105,852 $ 105,035
(1)Interest expense on the Warehouse Facility and interest income on the loan
receivables held for sale are not included in the adjustment above as amounts
are components of cost of revenue and revenue, respectively.
(2)See Note 12 to the Consolidated Financial Statements included in Part II, Item 8 for additional discussion of share-based compensation.
(3)Includes losses recorded in the fourth quarter of 2019 associated with the financial guarantee arrangement for a Bank Partner that did not renew its loan origination agreement when it expired inNovember 2019 . See Note 14 to the Consolidated Financial Statements included in Part II, Item 8 for additional discussion of financial guarantee arrangements. (4)Includes non-cash charges related to our financial guarantee arrangements with our ongoingBank Partners , which are primarily a function of new loans facilitated on our platform during the period increasing the contractual escrow balance and the associated financial guarantee liability. In the fourth quarter of 2020, due to expectations that some of these financial guarantees may require cash settlement, the Company discontinued adjusting EBITDA for financial guarantees. 57 -------------------------------------------------------------------------------- Table of
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(5)Includes the non-cash changes in the fair value of servicing assets and liabilities related to our servicing arrangements withBank Partners and other contractual arrangements. See Note 3 to the Consolidated Financial Statements included in Part II, Item 8 for additional discussion of servicing assets and liabilities. (6)Mark-to-market on sales facilitation obligations reflects changes in the fair value in the embedded derivative for sales facilitation obligations. The changes in fair value are recognized as a mark-to-market expense in cost of revenue for the period. See Note 3 to the Consolidated Financial Statements included in Part II, Item 8 for additional discussion.
(7)Includes the amounts related to the now discontinued program of transferring our rights to charged-off receivables to third parties.
(8)Includes professional services fees related to the pending merger with Goldman Sachs.
(9)For the year endedDecember 31, 2021 , primarily includes legal fees associated with IPO litigation and regulatory matter. For the year endedDecember 31, 2020 , primarily includes legal fees associated with IPO litigation and regulatory matter, increased costs resulting from the COVID-19 pandemic, professional fees associated with our strategic alternatives review process, and loss on remeasurement of our tax receivable agreement liability. For the year endedDecember 31, 2019 , primarily includes legal fees associated with IPO litigation.
Business Metrics
We review a number of operating and financial metrics to evaluate our business,
measure our performance, identify trends, formulate plans and make strategic
decisions, including the following.
Year Ended December 31,
2021 2020 2019
Transaction Volume
Dollars (in millions) 5,866 5,515 5,954
Percentage increase (decrease) 6 % (7) %
Loan Servicing Portfolio
Dollars (in millions, at end of period) 9,631 9,549 8,984
Percentage increase 1 % 6 %
Cumulative Consumer Accounts
Number (in millions, at end of period) 4.4 3.7 3.0
Percentage increase 18 % 23 %
Transaction Volume. We define transaction volume as the dollar value of loans facilitated on our platform during a given period. Transaction volume is an indicator of revenue and overall platform profitability.
Loan Servicing Portfolio. We define our loan servicing portfolio as the aggregate outstanding consumer loan balance (principal plus accrued interest and fees) serviced by our platform at the date of measurement. Our loan servicing portfolio is an indicator of our servicing activities. The average loan servicing portfolio for the years endedDecember 31, 2021 , 2020 and 2019 was$9.5 billion ,$9.4 billion and$8.2 billion , respectively. Cumulative Consumer Accounts. We define cumulative consumer accounts as the aggregate number of consumer accounts approved on our platform since our inception, including accounts with both outstanding and zero balances. Although not directly correlated to revenue, cumulative consumer accounts is a measure of our brand awareness among consumers, as well as the value of the data we have been collecting from such consumers since our inception. We may use this data to support future growth by cross-marketing products and delivering potential additional customers to merchants that may not have been able to source those customers themselves.
Factors Affecting our Performance
Robust Network of Merchants and Transaction Volume. We derive transaction volumes from our robust network of merchants. Our revenues and financial results are heavily dependent on our transaction volume, which represents the dollar amount of loans funded on our platform and, therefore, influences the fees that we earn and the per-unit cost of the services that we provide. Our transaction volume depends on our ability to retain our existing platform participants, add new participants and expand to new industry verticals. Bank Partner Relationships; Other Funding. "Bank Partners " are the federally insured banks that originate loans under the consumer financing and payments program that we administer for use by merchants on behalf of such 58 -------------------------------------------------------------------------------- Table of
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banks in connection with which we provide point-of-sale financing and payments technology and related marketing, servicing, collection and other services (the "GreenSky program" or "program"). Our ability to generate and increase transaction volume and expand our loan servicing portfolio is, in part, dependent on (a) retaining our existingBank Partners and having them renew and expand their commitments, (b) adding newBank Partners and/or (c) adding complementary funding arrangements to increase funding capacity. Our failure to do so could materially and adversely affect our business and our ability to grow. A Bank Partner's funding commitment typically has an initial multi-year term, after which the commitment is either renewed (typically on an annual basis) or expires. No assurance is given that any of the current funding commitments of ourBank Partners will be renewed. As ofDecember 31, 2021 , we had aggregate funding commitments from our ongoingBank Partners of approximately$7.9 billion , a substantial majority of which are "revolving" commitments that replenish as outstanding loans are paid down. Of the funding commitments available atDecember 31, 2021 for use in the next 12 months, approximately$2.3 billion was unused and we anticipate approximately$1.8 billion of additional funding capacity will become available as loans pay down under revolving commitments during this period. As we add newBank Partners , their full commitments are typically subject to a mutually agreed upon onboarding schedule. From time to time, certain of ourBank Partners have requested adjustments to the volume or type of loans that they originate, including, on occasion, temporary increases, decreases or suspensions of originations. We have generally honored these requests in the ordinary course of our relationships with ourBank Partners and, to date, they have not had a significant impact on the GreenSky program. In addition to customary expansion of commitments from existingBank Partners and the periodic addition of newBank Partners to our funding group, we have diversified the funding for loans originated by ourBank Partners to include alternative structures with institutional investors, financial institutions and other funding sources. In the first half of 2021, the Company executed an arrangement with a leading insurance company that included an initial sale of loan participations totaling approximately$135 million and a forward flow commitment for the sale of up to$1.5 billion in additional loan participations over a one-year period. OnSeptember 14, 2021 , concurrently with the execution of the Merger Agreement and as a condition to the Company's entry into the Merger Agreement, certain of the Company's subsidiaries entered into a commitment letter for a backstop participation purchase facility withGoldman Sachs Bank . OnNovember 17, 2021 , such subsidiaries andGoldman Sachs Bank entered into the definitive agreements for such purchase facility, pursuant to whichGoldman Sachs Bank provided such subsidiaries with (a) a commitment of up to$0.8 billion to purchase participations in loans originated by the Company'sBank Partners under the GreenSky program during the period from the execution of definitive agreements for such purchase facility through the earlier of (i) the consummation of the Mergers pursuant to the Merger Agreement and (ii) the termination of the Merger Agreement in accordance with its terms, and (b) in the event that the Merger Agreement is terminated in accordance with its terms prior to the consummation of the Mergers, a commitment of up to$1.0 billion to purchase participations in loans originated by the Company'sBank Partners under the GreenSky program during the period from the Merger Agreement termination date throughAugust 31, 2022 . During the year endedDecember 31, 2021 , GreenSky executed approximately$2.0 billion of sales of loan participations and whole loans (inclusive of the arrangements referenced above). A portion of these transactions included the sale of participations previously purchased by the Warehouse SPV, and the related proceeds from such sales were used to pay down amounts previously borrowed under the Warehouse Facility. If the Mergers are not consummated, we anticipate whole loan or loan participation sales to continue to be important to our funding capacity. If we do not timely consummate our anticipated whole loan or loan participation sales, or if these sales combined with funding commitments from ourBank Partners are not sufficient to support expected loan originations, it could limit our ability to facilitate GreenSky program loans and our ability to generate revenue at or above current levels.
Performance of the Loans in our
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•Our contracts with ourBank Partners entitle us to incentive payments when the finance charges billed to borrowers exceed the sum of (i) an agreed-upon portfolio yield, (ii) a fixed servicing fee and (iii) realized credit losses. This incentive payment varies from month to month, primarily due to the amount of realized credit losses. •With respect to deferred interest loans, the GreenSky program borrowers are billed for interest throughout the deferred interest promotional period, but they are not obligated to pay any interest if the loans are repaid in full before the end of the promotional period. We are obligated to remit this accumulated billed interest to ourBank Partners to the extent the loan principal balances are paid off within the promotional period (each event, a finance charge reversal or "FCR") even though the interest billed to the GreenSky program borrowers is reversed. Our maximum FCR liability is limited to the gross amount of finance charges billed during the promotional period, offset by (i) the collection of incentive payments from ourBank Partners during such period, (ii) proceeds received from transfers of charged-off receivables, and (iii) recoveries on unsold charged-off receivables. Our profitability is impacted by the difference between the cash collected from these items and the cash to be remitted on a future date to settle our FCR liability. Our FCR liability quantifies our expected future obligation to remit previously billed interest with respect to deferred interest loans. •Under our Bank Partner agreements, if credit losses exceed an agreed-upon threshold, we make limited payments to ourBank Partners from the escrow accounts we establish for them. Our related maximum financial exposure is contractually limited to those escrow amounts, which represented a weighted average target rate of 2.8% of the total outstanding loan balance as ofDecember 31, 2021 . Cash set aside to meet this requirement is classified as restricted cash in our Consolidated Balance Sheets. As ofDecember 31, 2021 , the financial guarantee liability associated with our escrow arrangements was approximately$102 million , which represents approximately 60% of the contractual escrow that we have established with each Bank Partner.
Performance of Loan Participations. We bear substantially all of the credit risk of loan receivables held for sale; however, our intent is that our holding period for such loan receivables is relatively brief.
For further discussion of our sensitivity to the credit risk exposure of ourBank Partners , see Part II, Item 7A "Quantitative and Qualitative Disclosure About Market Risk-Credit risk." General Economic Conditions and Industry Trends. Our results of operations are impacted by the relative strength of the overall economy and its effect on unemployment, consumer spending behavior and consumer demand for our merchants' products and services. In addition, trends within the industry verticals in which we operate affect consumer spending on the products and services our merchants offer in those industry verticals. For example, the strength of the national and regional real estate markets and trends in new and existing home sales impact demand for home improvement goods and services and, as a result, the volume of loans originated to finance these purchases. In addition, trends in healthcare costs, advances in medical technology and increasing life expectancy are likely to impact demand for elective medical procedures and services. Refer to "Executive Summary" above for a discussion of the recent impact on our business from the COVID-19 pandemic.
Seasonality. See Part I, Item 1 "Business", for a seasonality discussion.
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Results of Operations Summary
Years Ended
In the following results of operations discussion, unless otherwise indicated, references to 2021 and 2020 mean the years endedDecember 31, 2021 andDecember 31, 2020 , respectively. Total Revenue
We generate a substantial majority of our total revenue from transaction fees paid by merchants each time a consumer utilizes our platform to finance a purchase and, to a lesser extent, from fixed servicing fees on our loan servicing portfolio and interest income from loan receivables held for sale.
Transaction fees
We earn a specified transaction fee in connection with each purchase made by a consumer based on a loan's terms and promotional features. Transaction fees are billed to, and collected directly from, the merchant and are considered to be earned at the time of the merchant's transaction with the consumer. We also may earn a specified interchange fee in connection with purchases in which payments are processed through a credit card payment network. Transaction fees revenue decreased 3% during 2021 compared to 2020 due to a decrease in transaction fee rate (transaction fees earned as a percentage of transaction volume), partially offset by an increase in transaction volume of 6% year over year. The transaction fee rate was 6.47% during 2021 compared to 7.13% during 2020. The year over year transaction fee rate decrease is primarily related to the mix of promotional terms of loans originated on our platform. Loans with lower interest rates, longer stated maturities and longer promotional periods generally carry relatively higher transaction fee rates. Conversely, loans with higher interest rates, shorter stated terms and shorter promotional periods generally carry relatively lower transaction fee rates. In addition, the mix of loans offered by merchants generally varies by merchant category, and is dependent on merchant and consumer preference. Therefore, shifts in merchant mix have a direct impact on our transaction fee rates. With the onset of the COVID-19 pandemic in 2020, our merchants offered a larger proportion of promotional loans, which resulted in the upward shift in the transaction fee rate in 2020 compared to 2019. In 2021, we have experienced a reversion to pre-pandemic levels as it relates to the mix of loans. In addition, the mix of loans offered by merchants generally varies by merchant category, and is dependent on merchant and consumer preference.
Servicing
We earn a specified servicing fee for providing professional services to manage loan portfolios on behalf of ourBank Partners , including servicing of participated loans for a Bank Partner that retains the loan and servicing rights. Servicing fees are paid monthly and are typically based upon an annual fixed percentage of the average outstanding loan portfolio balance. Servicing revenue is also impacted by the fair value change in our servicing assets and liabilities associated with the servicing arrangements with ourBank Partners . See Note 3 to the Consolidated Financial Statements included in Part II, Item 8 for additional information on our servicing assets and liabilities.
The following table presents servicing revenue earned from servicing fees and the fair value change in servicing assets included in our servicing revenue.
Year Ended
2021 2020
Servicing fee $ 111,781 $ 115,110
Fair value change in servicing assets and liabilities 12,452 345
Total servicing revenue $ 124,233 $ 115,455 During 2021, servicing revenue increased
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arrangements in 2021 of$12.5 million in 2021, as compared to$0.3 million in 2020. The fair value increase reflects changes in balances of Bank partner portfolios and the respective applicable fees during the year as well as significant improvements in credit forecasts since 2020. The servicing fee decrease reflects a 2021 average servicing fee rate of 1.18% compared to 1.26% in 2020, primarily attributable to the diversification of our funding strategy toward capital markets transactions with servicing fees, on average, marginally lower than under our Bank Partner servicing arrangements.
Interest and other
We earn interest income from loan receivables held for sale, including loan participations purchased by the Warehouse SPV. The amount of interest for each period depends on the average level of loan participations and the mix of loans owned for each period. During 2021, interest and other revenue decreased$3.0 million compared to 2020, primarily due to the significant reduction in loan receivables held for sale on our Consolidated Balance Sheets as ofDecember 31, 2021 .
Cost of Revenue (exclusive of depreciation and amortization expense)
Year Ended
2021 2020
Origination related $ 21,354 $ 26,044
Servicing related 49,939 53,208
Fair value change in FCR liability 72,443 147,018
Loan and loan participation sales costs 52,565 72,357
Mark-to-market on sales facilitation obligations 2,603 10,655
Total cost of revenue (exclusive of depreciation and amortization
expense) $ 198,904 $ 309,282
Origination related
Origination related expenses typically include costs associated with our
customer service staff that supports Bank Partner loan originations, credit and
identity verification, loan document delivery, transaction processing by our
third-party transaction processor and customer protection expenses when we
indemnify a Bank Partner if a merchant does not fulfill its obligation to the
end consumer.
During 2021, origination related expenses decreased 18% compared to 2020,
largely driven by a decrease in customer protection expenses, which were $3.6
million lower compared to 2020. In addition, we experienced operational
efficiencies in loan processing, with origination related expenses as a percent
of transaction volume decreasing to 0.36% in 2021 from 0.47% in 2020.
Servicing related
Servicing related expenses are primarily reflective of the cost of our personnel (including dedicated call center personnel) and printing and postage related to consumer statement production. During 2021, servicing related expenses decreased 6% compared to 2020 due to lower delinquency rates, which reduce collection costs. Servicing related expenses as a percent of our average loan servicing portfolio were 0.53% and 0.57% for the years endedDecember 31, 2021 and 2020, respectively.
Fair value change in FCR liability
Under our contracts withBank Partners , we receive incentive payments fromBank Partners based on the surplus of finance charges billed to borrowers over an agreed-upon portfolio yield, a fixed servicing fee and realized net credit losses. We reduce these incentive payments based on estimated future reversals of previously billed interest on deferred interest loan products that we will be obligated to remit toBank Partners in future periods. These estimated future reversals are recorded as a liability on our Consolidated Balance Sheets. See Note 3 to the Consolidated Financial Statements included in Part II, Item 8 for additional information on our finance charge reversal liability, including a qualitative discussion of the impact to the fair value of our liability 62 -------------------------------------------------------------------------------- Table of
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resulting from changes in the finance charge reversal rate and discount rate. See Part II, Item 7A "Quantitative and Qualitative Disclosures About Market Risk-Credit risk"
The following table reconciles the beginning and ending measurements of our FCR
liability and highlights the activity that drove the fair value change in FCR
liability included in our cost of revenue. With the implementation of our whole
loan and loan participation sales program in mid-2020, we experienced a decline
in deferred interest loans in Bank Partner portfolios, primarily attributable to
the diversification of our funding strategy and purchases of participations in
deferred interest loans by the Warehouse SPV.
Year Ended December 31,
2021 2020
Beginning balance $ 185,134 $ 206,035
Receipts(1) 223,650 215,049
Settlements(2) (337,698) (382,968)
Fair value change in FCR liability(3) 72,443 147,018
Ending balance $ 143,529 $ 185,134
(1)Includes: (i) incentive payments from Bank Partners , which is the surplus of
finance charges billed to borrowers over an agreed-upon portfolio yield, a fixed
servicing fee and realized net credit losses and (ii) cash received from
recoveries on previously charged-off Bank Partner loans. We consider all monthly
incentive payments from Bank Partners during the period to be related to billed
finance charges on deferred interest products until monthly incentive payments
exceed total billed finance charges on deferred products, which did not occur
during the periods presented.
(2)Represents the reversal of previously billed finance charges associated with
deferred payment loan principal balances that were repaid within the promotional
period and includes billed finance charges not yet collected on loan
participations purchased by the Warehouse SPV of $20.1 million and $28.8
million , respectively, during the years ended December 31, 2021 and 2020, which
were not yet collected and subject to a potential future finance charge reversal
at the time of purchase. These amounts were paid to the Bank Partner in full as
of the participation purchase dates.
(3)A fair value adjustment is made based on the expected reversal percentage of
billed finance charges (expected settlements), which is estimated at each
reporting date. The fair value adjustment is recognized in cost of revenue in
the Consolidated Statements of Operations.
Further detail regarding our receipts is provided below for the years indicated:
Year Ended December 31,
2021 2020
Incentive payments $ 191,858 $ 198,570
Recoveries on unsold charged-off receivables(1) 31,792 16,479
Total receipts $ 223,650 $ 215,049
(1)Represents recoveries on previously charged-off Bank Partner loans. We
collected recoveries on previously charged-off and transferred Bank Partner
loans on behalf of our charged-off receivables investors of $20.1 million and
$22.7 million during the years ended December 31, 2021 and 2020, respectively.
These collected recoveries are excluded from receipts, as they do not impact our
fair value change in FCR liability.
The decrease of
Loan and loan participation sales costs
Loan and loan participation sales costs primarily include interest expense on the Warehouse Facility, realized gains and losses on sold participations, changes in lower of cost or fair value adjustments on currently owned Warehouse Loan Participations, certain fees and the amortization of deferred debt issuance costs incurred in connection with obtaining the Warehouse Facility. During the years endedDecember 31, 2021 and 2020, loan and loan participation sales costs were$52.6 million and$72.4 million , respectively, inclusive of realized losses of$40.0 million and$57.0 million , respectively, on Warehouse Loan Participations sold. The lower cost in 2021 reflects an increase in the price for loan products, the mix of loans, and the level of Warehouse Loan Participations held for sale by the Company. 63 -------------------------------------------------------------------------------- Table of
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Mark-to-market on sales facilitation obligations
The mark-to-market on sales facilitation obligations reflects the changes in the fair value in the embedded derivative for loan participation commitments and are recognized as a mark-to-market in cost of revenue for the period. While our Bank Partner funding costs are recognized over the life of the loan, the fair value adjustments on Warehouse Loan Participations and sales facilitation obligations are recognized in the period of the purchase of the loan participations by the Warehouse SPV or entering into the loan participation commitment. Thus, the fair value adjustments will create a benefit in the form of reducing Bank Partner funding costs over the life of the loan. During the years endedDecember 31, 2021 and 2020, the mark-to-market on sales facilitation obligations were$2.6 million and$10.7 million , respectively. See Note 3 to the Consolidated Financial Statements in Part II, Item 8 for further information. Compensation and benefits Compensation and benefits expenses primarily consist of salaries, benefits and share-based compensation for all cost centers not already included in cost of revenue, such as information technology, sales and marketing, product management and all overhead related activities. During 2021, compensation and benefits expense increased$3.4 million , or 4%, compared to 2020 as a result of higher salary expense of$2.3 million , a$0.7 million decrease in capitalized IT costs during the period, and an increase in share-based compensation expense of$0.6 million .
Property, office and technology
Property, office and technology expenses primarily relate to technology, telecommunications and third party rent expense. These costs also include maintenance and security expenses associated with our facilities.
During 2021, property, office and technology expense increased
Depreciation and amortization
Depreciation and amortization expense is related to capitalizable computer hardware, furniture and leasehold improvements, as well as software, which is primarily internally developed. Computer hardware is depreciated over three years, software is amortized over three years, furniture is depreciated over five years and leasehold improvements are depreciated over the shorter of the expected life of the asset or the remaining lease term. During 2021, depreciation and amortization expense increased$2.7 million , or 24%, compared to 2020 primarily driven by increases over time in capitalized internally-developed software.
Sales, general and administrative
Sales, general and administrative expenses primarily consist of legal, accounting, consulting and other professional services, recruiting, non-sales and marketing travel costs and promotional activities. The majority of our sales and marketing spend is "business-to-business" related, as we primarily attract new merchants to our program through trade shows, on-site visits with prospective merchants and other means. During 2021, sales, general and administrative expense decreased$5.0 million , or 12%, compared to 2020 predominantly due to a decrease of$8.0 million in provision for losses related to loan receivables held for sale. The lower provision was directly related to the$566.1 million decrease in loan receivables held for sale. The decrease was partially offset by an increase in legal and regulatory costs of$3.0 million .
Financial guarantee expense (benefit)
Financial guarantee expense (benefit) primarily consists of changes in our non-cash charges and actual cash escrow used byBank Partners . Upon our adoption of the provisions of ASU 2016-13 onJanuary 1, 2020 , our financial guarantee liability associated with our escrow arrangements with ourBank Partners was recognized in accordance 64 -------------------------------------------------------------------------------- Table of
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with ASC 326, Financial Instruments - Credit Losses ("CECL"). Changes in the
financial guarantee liability each period as measured under CECL are recorded as
non-cash charges in the Consolidated Statements of Operations.
During 2021, the Company recognized a financial guarantee benefit of $15.2
million , compared to financial guarantee expense of $5.0 million in 2020. The
financial guarantee benefit recognized in 2021 is primarily due to an improved
forecast for future charge-offs and to accelerated prepayments on loans within
our Bank Partner portfolios, as well as our funding diversification which
resulted in a larger portion of our transaction volumes in 2021 being sold as
loan participations into alternative structures that are not subject to the
financial guarantees of our Bank Partner portfolios. In 2020, financial
guarantee expense was impacted by the onset of the COVID-19 pandemic and the
related increased expectations of Bank Partner loan portfolios. See Note 1 and
Note 14 to the Consolidated Financial Statements included in Part II, Item 8 for
additional information regarding the measurement of our financial guarantees
under the new standard.
Merger-related costs
Merger-related costs include legal and other professional services expenses
related to the pending merger with Goldman Sachs, and totaled
Related party
Related party expenses, on a recurring basis, primarily consist of rent expense,
as we lease office space from a related party. During 2021, related party
expenses increased
Other income (expense), net
The
Interest and dividend income decreased$0.6 million during 2021, while interest expense increased$1.2 million , or 5%, during 2021, primarily due to a higher average balance of our term loan in 2021, as it was amended and upsized inJune 2020 (the 2020 Amended Credit Agreement). See Note 7 to the Consolidated Financial Statements included in Part II, Item 8 for additional information regarding our borrowings. Other losses were$3.8 million during 2021, primarily related to a net loss related to our interest rate swap of$6.8 million , partially offset by the change in fair value of our servicing liabilities of$1.3 million and other gains of$1.5 million . During 2020, other gains were$1.6 million and primarily related to the fair value change in servicing liabilities of$1.8 million and other gains of$1.5 million , partially offset by the remeasurement of our tax receivable agreement liability of$1.4 million .
Income tax expense (benefit)
Income tax expense recorded during 2021 reflected actual and expected income tax expense of$13.9 million on the net earnings for the entire year related toGreenSky, Inc.'s economic interest inGS Holdings . Expected income tax expense during 2020 was$3.1 million and was offset by a net tax benefit of$1.5 million . The increase in the expected income tax expense was primarily related to the increase in net earnings attributable toGreenSky, Inc.'s economic interest inGS Holdings , for which earnings are subject toU.S. federal and state corporate taxation.
Net income attributable to noncontrolling interests
Net income attributable to noncontrolling interests during 2021 reflects income
attributable to the Continuing LLC Members for the period based on their
weighted average ownership interest in
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Financial Condition Summary
Changes in the composition and balance of our assets and liabilities as of
•a$84.8 million increase in cash and cash equivalents and restricted cash. See "Liquidity and Capital Resources" in this Item 7 for further discussion of our cash flow activity;
•a
•a
•a$41.6 million decrease in the FCR liability primarily due to a decline in deferred interest loans in Bank Partner portfolios attributable to the diversification of our funding strategy and sales of loan participations. This activity is analyzed in further detail throughout this Item 7; •a$27.8 million decrease in our financial guarantee liability primarily driven by (i) the credit performance of the Bank Partner portfolios in 2021 and (ii) the improvement in the forecasted credit performance of those portfolios relative to 2020. The decrease in the liability also reflects approximately$6.5 million in escrow payments funded during the period related to a Bank Partner that is no longer originating loans under the GreenSky program. There was no utilization of escrow by any Bank Partner that was originating loans under the GreenSky program during 2021;
•a
•a
•an increase in total equity of$147.3 million primarily due to: (i) net income of$117.8 million , (ii) share-based compensation of$15.7 million , (iii) other comprehensive income, net of tax of$12.8 million associated with our interest rate swap, partially offset by distributions of$15.6 million , which were primarily tax distributions.
Liquidity and Capital Resources
We are a holding company with no operations and depend on our subsidiaries for cash to fund all of our consolidated operations, including future dividend payments, if any. We depend on the payment of distributions by our current subsidiaries, includingGS Holdings and GSLLC, which distributions may be restricted as a result of regulatory restrictions, state law regarding distributions by a limited liability company to its members, or contractual agreements, including agreements governing their indebtedness. For a discussion of those restrictions, refer to Part I, Item 1A "Risk Factors-Risks Related to Our Organizational Structure." In particular, the Credit Facility (as defined below) contains certain negative covenants prohibitingGS Holdings and GSLLC from making cash dividends or distributions unless certain financial tests are met. In addition, while there are exceptions to these prohibitions, such as an exception that permitsGS Holdings to pay our operating expenses, these exceptions apply only when there is no default under the Credit Facility. We currently anticipate that such restrictions will not impact our ability to meet our cash obligations. Our principal source of liquidity is cash generated from operations. Our transaction fees are the most substantial source of our cash flows and follow a relatively predictable, short cash collection cycle. Our short-term liquidity needs primarily include setting aside restricted cash for Bank Partner escrow balances and interest payments onGS Holdings' Credit Facility, which consists of the term loan and revolving loan facility, funding the portion of the Warehouse Loan Participations that is not financed by the Warehouse Facility, interest payments and unused fees on the Warehouse Facility, as defined and discussed in "Term loan and revolving loan facility" and "Warehouse Facility" within this Item 7, and sales facilitation obligations as discussed within this Item 7 and Note 3 to the 66 -------------------------------------------------------------------------------- Table of
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Consolidated Financial Statements in Part II, Item 8. Further, in the near term, we expect our capital expenditures to be small relative to our unrestricted cash and cash equivalents balance. We currently generate sufficient cash from our operations to meet these short-term needs. In addition, we expect to use cash for: (i) FCR liability settlements, which are not fully funded by the incentive payments we receive from ourBank Partners , but for which$53.3 million is held for certainBank Partners in restricted cash as ofDecember 31, 2021 , and for payments under our financial guarantees (see Note 14 to the Consolidated Financial Statements in Part II, Item 8 for further discussion), and (ii) sales facilitation obligations (see Note 3 to the Consolidated Financial Statements in Part II, Item 8 for further discussion of our sales facilitation obligations). Our$100 million revolving loan facility is also available to supplement our cash flows from operating activities to satisfy our short-term liquidity needs. The Warehouse Facility finances purchases by the Warehouse SPV of participations in loans originated through the GreenSky program. The Warehouse Facility provides committed financing of$555.0 million and provides financing for a significant portion of the principal balance of such participations and the Company funds the remainder. Although the portion financed by the Warehouse Facility varies based on the composition of the pool of participations being purchased, we expect such portion to be approximately 84% on average. From time to time, the Company purchases participations in loans that have future funding obligations. Such future funding obligations will be funded by the Bank Partner that owns the loan; however, the Company is required to purchase a participation in the future funding amount, which the Company would intend to finance through the Warehouse Facility at similar rates. As ofDecember 31, 2021 , the Warehouse SPV held$4.9 million of loan participations and the Warehouse Facility did not have an outstanding loan balance. In addition, the Warehouse SPV may conduct periodic sales of the loan participations or issue asset-backed securities to third parties, which sales or issuances would allow additional purchases to be financed at similar rates. Our most significant long-term liquidity need involves the repayment of our term loan upon maturity inMarch 2025 , which assuming no prepayments, will have an expected remaining unpaid principal balance of$444.6 million at that time, as well as the repayment of our revolving Warehouse Facility upon maturity inDecember 2023 . Assuming no extended impact of the COVID-19 pandemic, we anticipate that our significant cash generated from operations will allow us to service these debt obligations. Should operating cash flows be insufficient for this purpose, we will pursue other financing options. We have not made any material commitments for capital expenditures other than those disclosed in the "Contractual Obligations" table later in this Item 7.
Significant Changes in Capital Structure
There were no significant changes in the Company's capital structure during the
year ended
Cash flows
We prepare our Consolidated Statements of Cash Flows using the indirect method,
under which we reconcile net income to cash flows provided by operating
activities by adjusting net income for those items that impact net income, but
may not result in actual cash receipts or payments during the period. The
following table provides a summary of our operating, investing and financing
cash flows for the periods indicated.
Year
Ended
2021 2020 2019
Net cash provided by/(used in) operating
activities $ 630,901 $ (468,101) $ 153,327
Net cash used in investing activities $ (15,602) $ (14,567) $ (15,381)
Net cash provided by/(used in) financing
activities $ (530,513) $
504,481
Cash and cash equivalents and restricted cash totaled
Our restricted cash balances as of
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as limited protection to theBank Partners in the event of certain Bank Partner portfolio credit losses or in the event that the finance charges billed to borrowers do not exceed the sum of an agreed-upon portfolio yield, a fixed servicing fee and realized credit losses; (ii)$53.3 million and$84.6 million , respectively, which represented an additional restricted cash balance that we maintained for certainBank Partners related to our FCR liability; (iii)$33.3 million and$27.7 million , respectively, which represented certain custodial in-transit loan funding and consumer borrower payments that we were restricted from using for our operations; and (iv)$5.2 million and$34.4 million , respectively, which represented temporarily restricted cash related to collections in connection with Warehouse Loan Participations (which is released from restrictions in accordance with the terms of the Warehouse Facility). The restricted cash balances related to our FCR liability and our custodial balances are not included in our evaluation of restricted cash usage, as these balances are not held as part of a financial guarantee arrangement. See Note 14 to the Consolidated Financial Statements in Part II, Item 8 for additional information on our restricted cash held as escrow withBank Partners .
Cash provided by/(used in) operating activities
Year EndedDecember 31, 2021 . Cash flows used in operating activities were$630.9 million during 2021. Primary sources of operating cash during 2021 were: (i) earnings and other working capital benefits; and (ii) a decrease in loan receivables held for sale as a result of completed sales during the period. These sources of cash were partially offset by uses of cash from: (i) previously billed finance charges that reversed in the period; and (ii) financial guarantee liabilities.
Cash used in investing activities
Detail of the cash used in investing activities is included below for each year.
Year Ended December 31,
2021 2020 2019
Software $ 14,286 $ 13,607 $ 12,684
Computer hardware 665 726 1,184
Leasehold improvements 651 91 911
Furniture - 143 602
Purchases of property, equipment and software
Cash provided by/(used in) financing activities
Our financing activities in the periods presented consisted of equity and debt related transactions and distributions.GS Holdings makes tax distributions based on the estimated tax payments that its members are expected to have to make during any given period (based upon various tax rate assumptions), which are typically paid in January, April, June and September of each year. We had net cash used in financing activities of$530.5 million during 2021. In 2021, our primary use of cash was net repayments on the Warehouse Facility of$507.5 million as a result of sales of loan participations.
Borrowings
See Note 7 to the Consolidated Financial Statements in Part II, Item 8 for further information about our borrowings, including the use of term loan proceeds, as well as our interest rate swap.
Term loan and revolving facility
OnMarch 29, 2018 ,GS Holdings amended itsAugust 25, 2017 Credit Agreement ("2018 Amended Credit Agreement") to provide for a$400.0 million term loan, the proceeds of which were used, in large part, to settle the outstanding principal balance on the$350.0 million term loan previously executed under the Credit Agreement inAugust 2017 , and includes a$100.0 million revolving loan facility. The revolving loan facility also includes a$10.0 million letter of credit. The Credit Facility is guaranteed byGS Holdings' significant subsidiaries, including GSLLC, and is secured by liens on substantially all of the assets ofGS Holdings and the guarantors. Interest on the loans can be based either on a "Eurodollar rate" or a "base rate" and fluctuates depending upon a "first lien net 68 -------------------------------------------------------------------------------- Table of
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leverage ratio." The 2018 Amended Credit Agreement contains a variety of covenants, certain of which are designed in certain circumstances to limit the ability ofGS Holdings to make distributions on, or redeem, its equity interests. In addition, during any period when 25% or more of our revolving facility is utilized,GS Holdings is required to maintain a "first lien net leverage ratio" no greater than 3.50 to 1.00. There are various exceptions to these restrictions, including, for example, exceptions that enable us to pay our operating expenses and to make certainGS Holdings tax distributions. The$400.0 million term loan matures onMarch 29, 2025 , and the revolving loan facility matures onMarch 29, 2023 . OnJune 10, 2020 , we entered into a Second Amendment to our Credit Agreement ("2020 Amended Credit Agreement"), which provided for an additional$75.0 million term loan ("incremental term loan"). The term loan and revolving loan facility under the 2018 Amended Credit Agreement and incremental term loan under the 2020 Amended Credit Agreement are collectively referred to as the "Credit Facility." The modified term loan and the incremental term loan are collectively referred to as the "term loan." The incremental term loan, incurs interest, due monthly in arrears, at an adjusted LIBOR, which represents the one-month LIBOR multiplied by the statutory reserve rate, as defined in the 2020 Amended Credit Agreement, with a 1% LIBOR floor, plus 450 basis points. The incremental term loan has the same security, maturity, principal amortization, prepayment, and covenant terms as the 2018 Amended Credit Agreement, maturing onMarch 29, 2025 . There was no amount outstanding under our revolving loan facility as ofDecember 31, 2021 , which is available to fund future needs ofGS Holdings' business. We also did not draw on our available letter of credit as ofDecember 31, 2021 .
Warehouse Facility
OnMay 11, 2020 , the Warehouse SPV entered into the Warehouse Facility to finance purchases by the Warehouse SPV of 100% participation interests in loans originated through the GreenSky program. The Warehouse Facility initially provided a revolving committed financing of$300 million , and an uncommitted$200 million accordion that was subsequently accessed inJuly 2020 . OnDecember 18, 2020 , the Warehouse Facility was amended ("Amended Warehouse Facility") to increase the amount of the Warehouse Facility's revolving commitment from$300 million to$555 million , including$500 million under the Class A commitment and$55 million under the Class B commitment. With the addition of the Class B commitment, the advance rate under the Warehouse Facility has generally been approximately 84% (on average) of the principal balance of the purchased participations. As ofDecember 31, 2021 , there was no outstanding loan balance on the Warehouse Facility. The Warehouse Facility is secured by the loan participations held by the Warehouse SPV, and Warehouse Facility Lenders do not have direct recourse to the Company for any loans made under the Warehouse Facility.
Expected Replacement of LIBOR
The use of the London Interbank Offered Rate ("LIBOR") will be phased out by
mid-2023. LIBOR is currently used as a reference rate for certain of our
financial instruments, including our $475.0 million term loan under the 2020
Amended Credit Agreement, which is set to mature after the expected phase out of
LIBOR. Our Warehouse Facility and the related interest rate cap also include
certain rates that are impacted by LIBOR; however, the agreement includes LIBOR
transition provisions. We will work with our lenders and counterparties to
accommodate any suitable replacement rate where it is not already provided under
the terms of the financial instruments and, going forward, we will use suitable
alternative reference rates for our financial instruments, such as the Secured
Overnight Financing Rate ("SOFR"). We will continue to assess and plan for how
the phase out of LIBOR will affect the Company; however, while the LIBOR
transition could adversely affect the Company, we do not currently perceive any
material risks and do not expect the impact to be material to the Company.
Tax Receivable Agreement
Our purchase of Holdco Units from the Exchanging Members using a portion of the net proceeds from the IPO, our acquisition of the equity of certain of theFormer Corporate Investors , and any future exchanges of Holdco Units for our Class A common stock pursuant to the Exchange Agreement (as such terms are defined in Note 1 to the 69 -------------------------------------------------------------------------------- Table of
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Consolidated Financial Statements in Part II, Item 8) are expected to result in increases in our allocable tax basis in the assets ofGS Holdings . These increases in tax basis are expected to increase (for tax purposes) depreciation and amortization deductions allocable to us and, therefore, reduce the amount of tax that we otherwise would be required to pay in the future. This increase in tax basis may also decrease gain (or increase loss) on future dispositions of certain assets to the extent tax basis is allocated to those assets.We and GS Holdings entered into a Tax Receivable Agreement ("TRA") with the "TRA Parties" (the equity holders of theFormer Corporate Investors , the Exchanging Members, the Continuing LLC Members and any other parties receiving benefits under the TRA, as those parties are defined in Note 1 to the Consolidated Financial Statements included in Part II, Item 8), whereby we agreed to pay to those parties 85% of the amount of cash tax savings, if any, inUnited States federal, state and local taxes that we realize or are deemed to realize as a result of these increases in tax basis, increases in basis from such payments, and deemed interest deductions arising from such payments. As a condition to the Merger Agreement, the Company and certain beneficiaries party to the TRA were required to enter into an amendment to the TRA (the "TRA Amendment"), which TRA Amendment provided that no payments under the TRA will be made following or as a result of the consummation of the Mergers.
Contractual Obligations
Our principal commitments consisted of obligations under our outstanding term loan and operating leases for office facilities. The following table summarizes our commitments to settle contractual obligations in cash as ofDecember 31, 2021 . Less than 1-3 3-5 More than Total 1 year years years 5 years Term loan(1)$ 458,875 $ 4,750 $ 9,500 $ 444,625 $ - Interest payments on term loan(2) 74,437 23,223 45,722 5,492 - Revolving loan facility fees(3) 620 500 120 - - Interest payments and fees on Warehouse Facility(4) 12,600 6,300 6,300 - - Operating leases(5) 18,554 3,813 4,670 4,188 5,883 Total contractual obligations$ 565,086 $ 38,586 $ 66,312 $ 454,305 $ 5,883
(1)The principal balance of the term loan is repaid on a quarterly basis at an amortization rate of 0.25% per quarter, with the balance due at maturity.
(2)Variable interest payments on our term loan are calculated based on the
interest rate as of
(3)Amounts presented reflect a quarterly commitment fee rate of 0.50% per annum, and assume that the entire$100 million revolving loan facility is unused (the conditions that existed as of period end) for the duration of the agreement, which matures onMarch 29, 2023 . (4)Variable interest payments on our Warehouse Facility are calculated based on the applicable Class A and Class B interest rates as ofDecember 31, 2021 , and assume that the outstanding balance on the Warehouse Facility as ofDecember 31, 2021 remains outstanding for the duration of the agreement. Warehouse Facility fees are calculated based on a daily unused commitment rate of 0.50% per annum, and assume that the unused commitment balance as ofDecember 31, 2021 remains unused for the duration of the agreement. The Warehouse Facility matures onDecember 17, 2023 . (5)Our operating leases are for office space. Certain of these leases contain provisions for rent escalations and/or lease concessions. Rental payments, as well as any step rent provisions specified in the lease agreements, are aggregated and charged evenly to expense over the lease term. However, amounts included herein do not reflect this accounting treatment, as they represent the future contractual lease cash obligations. The payments that we may be required to make under the TRA to the TRA Parties may be significant and are not reflected in the contractual obligations table set forth above. Refer to Part I, Item 1A "Risk Factors-Risks Related to Our Organizational Structure" and to Note 13 to the Consolidated Financial Statements in Part II, Item 8 for additional detail. 70 --------------------------------------------------------------------------------
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Contingencies
From time to time, we may become a party to civil claims and lawsuits in the
ordinary course of business. We record a provision for a liability when we
believe that it is both probable that a liability has been incurred and the
amount can be reasonably estimated, which requires management judgment. Should
any of our estimates or assumptions change or prove to be incorrect, it could
have a material adverse impact on our consolidated financial condition, results
of operations or cash flows. See Note 14 to the Consolidated Financial
Statements in Part II, Item 8 for discussion of certain legal proceedings and
other contingent matters.
Recently Adopted or Issued Accounting Standards
See "Recently Adopted Accounting Standards" and "Accounting Standards Issued, But Not Yet Adopted" in Note 1 to the Consolidated Financial Statements in Part II, Item 8 for additional information.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements were prepared in conformity with GAAP. The preparation of financial statements in conformity with GAAP requires that management make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. Such estimates and assumptions include, but are not limited to, those that relate to fair value measurements around our FCR liability and servicing assets and liabilities, the measurement of our financial guarantees, and income taxes. In developing estimates and assumptions, management uses all available information; however, actual results could materially differ because of uncertainties associated with estimating the amounts, timing and likelihood of possible outcomes. On an ongoing basis, we evaluate our judgments and estimates that are based upon historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements in Part II, Item 8. The following is a summary of our most critical accounting estimates, which represent those that involve a higher degree of uncertainty, judgment or complexity. Accordingly, these are the policies we believe to be most critical in fully understanding and evaluating our financial condition, results of operations and cash flows.
Finance charge reversals
OurBank Partners offer certain loan products that have a feature whereby the account holder is provided a promotional period to repay the loan principal balance in full without incurring a finance charge. For these loan products, we bill interest each month throughout the promotional period and, under the terms of the contracts with ourBank Partners , are obligated to remit this billed interest to theBank Partners if an account holder pays off the loan balance in full within the promotional period. This obligation is partially offset by the receipt of monthly incentive payments, which vary from month to month, fromBank Partners during the promotional period. Therefore, the monthly process of billing interest on deferred loan products triggers a potential future FCR liability for us. The FCR component of our Bank Partner contracts qualifies as an embedded derivative accounted for under Accounting Standards Codification ("ASC") 815, Derivatives and Hedging. The FCR liability is carried at fair value on a recurring basis in our Consolidated Balance Sheets and is estimated based on historical experience and management's expectation of future FCR. The FCR liability is classified within Level 3 of the fair value hierarchy, as the primary component of the price is obtained from unobservable inputs based on our data, reasonably adjusted for assumptions that would be used by market participants. The FCR liability is not designated as a hedge for accounting purposes and, as such, changes in its fair value are recorded within cost of revenue in the Consolidated Statements of Operations. See Part II, Item 7A for a discussion of our exposure to interest rate risk and credit risk as it relates to our FCR. Our discussion in Item 7A provides a useful sensitivity analysis to help facilitate a further understanding of the impact of our FCR liability on our net income. 71 -------------------------------------------------------------------------------- Table of
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Servicing assets and liabilities
The Company assumes a right, obligation, or neither a right nor obligation to service consumer loans each time a loan is originated by a Bank Partner. Additionally, the Company services charged-off receivables to which we transferred our rights to third parties andBank Partners , but for which we do not charge a servicing fee. The Company identified Bank Partner loans as one class of servicing rights and charged-off receivables as a separate class of servicing rights. In accordance with ASC 860, Transfers and Servicing, when we determine that the compensation we receive to service loans is more or less than adequate, we assess the fair value of a servicing asset or liability, respectively, using a discounted cash flow model. We previously elected the fair value method to measure each class of servicing rights subsequent to initial recognition, as we believe that fair value is a more meaningful measure of our expected right or obligation with respect to these classes of servicing assets or liabilities, respectively. This election is irrevocable for these classes of servicing assets or liabilities. The fair value of our servicing assets associated with Bank Partner loans was$54.9 million and$30.8 million as ofDecember 31, 2021 and 2020, respectively, which is recorded within other assets in the Consolidated Balance Sheets. The fair value of our servicing liabilities associated with Bank Partner loans and charged-off receivables was$12.3 million and$2.0 million as ofDecember 31, 2021 and 2020, respectively, which is recorded within other liabilities in the Consolidated Balance Sheets. Changes in the fair value of our servicing assets and liabilities related to our bank partner arrangements are recorded within servicing revenue and changes in the fair value of our servicing liabilities related to charged-off receivables are recorded within other gains (losses), net in the Consolidated Statements of Operations. The determination of the fair values of our servicing assets and liabilities requires management judgment due to the number of assumptions that underlie the valuation, including: market cost of servicing, discount rate, weighted average remaining life and recovery period. See Note 3 to the Consolidated Financial Statements in Part II, Item 8 for a qualitative discussion of how changes in each of these assumptions are generally expected to affect our fair value measures. Our servicing assets and liabilities are classified within Level 3 of the fair value hierarchy, as the primary components of the fair values are obtained from unobservable inputs based on peer market data, reasonably adjusted for assumptions that would be used by market participants to service our Bank Partner loans and transferred charged-off receivables portfolios, for which market data is not available. During the year endedDecember 31, 2019 , we renegotiated certain Bank Partner agreements pursuant to which we agreed to post additional escrow and increase the agreed-upon Bank Partner portfolio yield. In exchange for these considerations, we received an increase in our loan servicing fees from theBank Partners . We determined that the increase in servicing fees resulted in an increase to the fair value of our servicing assets for theseBank Partners . We also anticipate that, all other factors remaining constant, these increased servicing fees will contribute to lower incentive payments received in future periods from theBank Partners . Further, the fair value of our servicing assets is determined based on the serviced loan portfolios at the date of measurement and does not take into account potential future loan sales betweenBank Partners within our network or between GreenSky and ourBank Partners , institutional investors, or financial institutions. When such transactions occur, they could materially impact the fair value measure of our servicing assets if the contractually specified fixed servicing fees vary between the seller and purchaser.
Financial Guarantees
Under the terms of the contracts with ourBank Partners , we provide limited protection to theBank Partners in the event of certain Bank Partner portfolio credit losses or in the event that certain finance charges billed to borrowers do not exceed the sum of an agreed-upon portfolio yield, a fixed servicing fee and realized credit losses, by holding cash in restricted, interest-bearing escrow accounts in an amount equal to a contractual percentage of theBank Partners' monthly originations and month-end outstanding portfolio balance, which represented a weighted average target rate of 2.8% of the total outstanding balance of the relevant Bank Partner portfolio loans as ofDecember 31, 2021 . The Company's maximum exposure under these financial guarantees is contractually limited to the escrow that we establish with each Bank Partner. Cash set aside to meet this requirement is classified as restricted cash in our Consolidated Balance Sheets and totaled$164.2 million as ofDecember 31, 2021 . 72 -------------------------------------------------------------------------------- Table of
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Our contracts with ourBank Partners entitle us to incentive payments when the finance charges billed to borrowers exceed the sum of an agreed-upon portfolio yield, a fixed servicing fee and realized credit losses. This incentive payment varies from month to month, primarily due to the amount of realized credit losses. If credit losses exceed an agreed-upon threshold, we are obligated to make limited payments to ourBank Partners . This obligation represents a financial guarantee in accordance with ASC 460, Guarantees. Under ASC 460, the guarantor undertakes a noncontingent obligation to stand ready to perform over the term of the guarantee and a contingent obligation to make future payments if the triggering events or conditions under the guarantee arrangements occur. EffectiveJanuary 1, 2020 , we adopted the provisions of ASU 2016-13, which apply only to the contingent aspect of the guarantee arrangement. Under the new standard, we are required to estimate the expected credit losses over the contractual period in which we are exposed to credit risk via a present contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the issuer. As applied to our financial guarantee arrangements, we are required to estimate expected credit losses, and the impact of those estimates on our potential escrow payments, for loans within our Bank Partner portfolios that are either funded or approved for funding at the measurement date, but are precluded from including future loan originations by ourBank Partners . Consistent with the modeling of loan losses for any consumer loan portfolio assumed to go into "run-off," our recognized financial guarantee liability under this model represents a significant portion of the contractual escrow established with each Bank Partner. Typically, additional financial guarantee liabilities are recorded as new Bank Partner loans are facilitated, along with a corresponding non-cash charge recorded as financial guarantee expense in the Consolidated Statements of Operations. Historically, our actual cash payments required under the financial guarantee arrangements have been immaterial for our ongoingBank Partners . As the terms of our guarantee arrangements are determined contractually with each Bank Partner, we measure our contingent obligation separately for each Bank Partner using a discounted cash flow method based on estimates of the outstanding loan attributes of the Bank Partner's loan servicing portfolio and our expectations of forecasted information, including macroeconomic conditions, over the period that our financial guarantee is expected to be used in a "run-off" scenario. We use our historical experience as a basis for estimating escrow usage and adjust for current conditions or forecasts of future conditions if they are determined to vary from our historical experience. Refer to Note 14 for additional information on our financial guarantees. For periods prior toJanuary 1, 2020 , the contingent aspect of the financial guarantee continues to be presented and disclosed in accordance with legacy guidance in ASC 450, Contingencies. Under this guidance, the contingent aspect of the financial guarantee represented the amount of payments toBank Partners from the escrow accounts that we expected to be probable of occurring based on Bank Partner portfolio composition and our near-term expectation of credit losses. In estimating the obligation, we considered a variety of factors, including historical experience, management's expectations of current customer delinquencies converting into Bank Partner portfolio credit losses and recent events and circumstances. The estimated contingent value of the financial guarantee was$131.9 million as ofDecember 31, 2020 . As ofDecember 31, 2021 , the estimated value of the escrow financial guarantee was$104.1 million relative to our$164.2 million contractual escrow that was included in our restricted cash balance as ofDecember 31, 2021 . Refer to Note 1 to the Consolidated Financial Statements in Part II, Item 8 for additional discussion of our accounting for financial guarantees.
Income taxes
Our income tax expense, deferred tax assets and tax receivable agreement
liability reflect management's best assessment of estimated current and future
taxes. Significant judgments and estimates are required in determining the
consolidated income tax expense, deferred tax assets and tax receivable
agreement liability. Deferred income taxes arise from temporary differences
between the tax basis of assets and liabilities and their reported amounts in
the financial statements, which will result in taxable or deductible amounts in
the future. In evaluating our ability to recover our deferred tax assets, we
consider all available positive and negative evidence, including projected
future taxable income and results of recent operations. In projecting future
taxable income, we begin with historical results and incorporate assumptions
about the amount of future state and federal pre-tax operating income adjusted
for items that do not have tax consequences. The assumptions about future
taxable income require significant judgment
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and are consistent with the plans and estimates we are using to manage our business. Refer to Note 13 to the Consolidated Financial Statements in Part II, Item 8 for additional discussion of our accounting for income taxes.
Loan Receivables Held for Sale
Loan receivables held for sale represent a 100% participation interest in certain loans originated by ourBank Partners under the GreenSky program that the Company subsequently purchases with the intent to sell to a third party at carrying value. Loan receivables held for sale are recorded at fair value in the Consolidated Balance Sheets at the time a loan receivable is purchased and are subsequently measured at the lower of cost or fair value on an aggregate homogeneous portfolio basis. We apply the market approach, which uses observable prices and other relevant information that is generated by market transactions involving identical or comparable assets or liabilities, to value our loan receivables held for sale. Changes in the fair value of our loan receivables held for sale are recorded within cost of revenue in the Consolidated Statements of Operations. Our loan receivables held for sale are primarily loan participations owned by the Warehouse SPV, which are expected to be sold around or below par to institutional investors, financial institutions and other capital markets investors. Fair value of our loan receivables held for sale is determined based on the anticipated sale price of such participations to third parties. Loan receivables held for sale are classified within Level 2 of the fair value hierarchy, as the primary component of the price is obtained from observable values of loan receivables with similar terms and characteristics. InMay 2020 , as part of implementing GreenSky's program to accomplish alternative funding structures, the Company entered into a series of agreements (collectively, the "Facility Bank Partner Agreements") with an existing Bank Partner, to provide a framework for the programmatic sale of loan participations and whole loans by that Bank Partner to third parties. Under theFacility Bank Partner Agreements, it is contemplated that potential purchasers issue purchase commitments to the Bank Partner. The Company has certain sales facilitation obligations related thereto that qualify as embedded derivatives and are not designated as hedges for accounting purposes. As such, these sales facilitation obligations are recorded at fair value and changes in their respective fair value are recorded within cost of revenue in the Consolidated Statements of Operations. The fair value of sales facilitation obligations is based on the difference between par and the anticipated sale prices of such participations to third parties. As such, the fair value is classified within Level 2 of the fair value hierarchy, as the primary component of the price is obtained from observable values of loan receivables with similar terms and characteristics. See Part II, Item 7A for a discussion of our exposure to interest rate risk and credit risk as it relates to our loan receivables held for sale. Our discussion in Item 7A provides a useful sensitivity analysis to help facilitate a further understanding of the impact of our loan receivables held for sale on our net income.
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