Good afternoon, and welcome to the Oportun Financial Corporation Second Quarter 2020 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Nils Erdmann, Vice President, Investor Relations. Mr. Erdmann, you may begin.

Thanks, and good afternoon, everyone. Joining me today to discuss Oportun's second quarter 2020 results are Raul Vazquez, Chief Executive Officer; and Jonathan Coblentz, Chief Financial Officer and Chief Administrative Officer. Before we get started, let me remind you that some of the remarks made today will include forward-looking statements. Actual results may differ materially from those contemplated or implied by these forward-looking statements, particularly given the uncertainties caused by the COVID-19 pandemic. Let me caution you not to place undue reliance on these forward-looking statements. A more detailed discussion of the risk factors that could cause these results to differ materially are set forth in our earnings press release and in our filings with the Securities and Exchange Commission under the caption Risk factors, including our most recent quarterly report on Form 10-Q and our annual report on Form 10-K. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. Also on today's call, we will present both GAAP and non-GAAP financial measures, which we believe will provide useful information to investors regarding our financial condition and results of operation. A reconciliation of non-GAAP to GAAP measures is included in our earnings press release, our second quarter 2020 financial supplement and the appendix section of the second quarter 2020 earnings presentation, all of which are available on the Investor Relations website at investor.oportun.com. In addition, this call is being webcast, and an archived version will be available after the call on the Investor Relations portion of our website. With that, I will now turn the call over to Raul.

Thank you, Nils. And thanks to everyone on the webcast and phone line for joining us this afternoon. I hope you, your loved ones, your friends and colleagues continue to be well. On our previous earnings call, I highlighted the proactive measures we were taking in response to the pandemic to navigate this challenging environment. I'm pleased to say that because of these proactive measures, we have been successfully managing through this critical period, and our second quarter's performance demonstrates the benefit of our significant investment in technology, risk analytics and data science as well as the strength of our omnichannel network. Despite the impact of the pandemic, we generated $143 million of total revenue and $4.8 million of adjusted EBITDA for the second quarter. And while improvement in the prices of our bonds are beneficial for our ability to access funding at an attractive cost of funds, the short-term impact on our fair value marks grow down our net change in fair value, which weighed on our net revenue and EPS. Jonathan will share the details of our second quarter financials, but before that, I would like to talk about how we plan to return to growth while maintaining a thoughtful approach to underwriting. As I outlined in May, our 3 near-term focus areas are: first, managing for good credit outcomes; second, continuing to serve our customers; and finally, maintaining our capital and liquidity. I will now go through each of these in a bit more detail. Starting with credit. By creating new payment and collections tools as well as focusing on helping our customers manage hardships they may be facing, many of our customers have emerged from deferral and delinquency status and returned to repayment. Among others, the tools we've developed include: one-click SMS deferrals; reduced payment plan…

Thanks, Raul, and hello, everyone. In addition to GAAP, we also evaluate our performance based on fair value pro forma results, which we believe present a more consistent view of the underlying trends of the business. Unless I state otherwise, all of the metrics that I will now share with you will be on a fair value pro forma basis for the purposes of comparison to prior year periods. A full list of definitions and reconciliations can be found in our earnings materials. As Raul mentioned a moment ago, we experienced steady improvement throughout the second quarter, and that has continued into the current quarter. So I'll start by providing a summary of our second quarter results. And I'll also discuss some recent trends and insights from the month of July. We experienced a reduction in loan applications in the second quarter, and as part of our disciplined response to the pandemic, we tightened our underwriting criteria, both of which led to lower originations. Our aggregate originations of $157.6 million for the second quarter, down 67% from the prior year period, showed steady improvement month-over-month. As we experienced a gradual improvement in the overall economic environment, we increased our credit decisioning accordingly so that by the end of June, loan originations had increased 46% as compared to May. For July, our aggregate originations were $85.3 million, an increase of 24% over the month of June, narrowing the year-over-year decline to 54%. On both a GAAP and a fair value pro forma basis, total revenue for the second quarter was $142.7 million, up slightly relative to prior year quarter. The increase was primarily due to higher interest income during the period. Our interest income for the second quarter increased to $136.1 million, up 5% year-over-year, while our managed principal balance at…

Thank you, Jonathan. The external environment continues to be challenging, but we are confident that our high-quality team and technology platform will enable us to advance our strategies and identify new growth opportunities, like the DolEx partnership we announced today. We are grateful for the support of our shareholders, and we remain committed to the creation of sustainable long-term value and competitive advantage. Thank you all for your time, and now we welcome your questions and comments. Operator?

[Operator Instructions] Our first question today is coming from Mark DeVries from Barclays.

Could you just talk a little bit more about timing of the DolEx partnership and the rollout of products and also just philosophy around whether this is the right time to be kind of launching adjacent products?

Sure. So I'll start with the timing, Mark. So from a timing perspective, there's still some regulatory approvals that we need to figure out. But we expect to be able to get those things nailed down in the next few weeks, and then the rollout would start in Q4. In terms of additional products, just to be clear, it is our unsecured consumer installment loan that we're going to be offering through their locations. So we did the exact same product that we use today with the exact same 100% centralized, 100% automated risk engine. What makes it so exciting for us is we look at the footprint that DolEx has kind of coast to coast and we think about the opportunity to get these additional distribution mechanisms and points of presence in a lot of communities and leveraging all of the investments that we made in the risk engine. So we don't see this as an additional product, we see it as an additional channel for our business.

Got it. And then next question, I mean, I appreciate this is kind of nonoperating noise. But as we think about kind of the fair value marks during the quarter, Jonathan, where do the prices now of your ABS compare to where they were kind of pre-pandemic? And how much more negative mark could you get if those kind of revert to where they were several months back?

That's a great question, Mark. Thank you. And on Page 11 of our deck, we actually laid out the fair value marks. And if you take a look at 2Q '19, which was in a good economy, the overall price of our fair value bonds was 101.6%. So we announced that at June 30, our fair value mark on our bonds was 98.7%. So if we get back to a fully normalized market, obviously, we could see all of the bonds collectively being above par. Our senior bonds are already trading above par right now.

The next question today is coming from John Hecht from Jefferies.

I guess sticking along the liability discussion. Just so as you move toward maturity, assuming you'll pay off the notes at par, do you claw back that fair value right up over time?

No, that's a great question, John. So yes, one would assume that as we approach the end of the revolving period and potential call dates, that regardless of market conditions, that the bonds should converge to par. That's certainly what we've seen in past markets.

And then, I mean, just thinking about benchmark rates in this set, I mean, is it a fair statement just to say the residual risk of a write-up in the liabilities is very low at this point in time going forward?

I think there is some risk still, but obviously, certainly not the amount that we saw this quarter, right? We saw our mark improve from 90.5% to 98.7% as the markets had normalized after significant dislocation. So I can't speculate on where the markets will trade or be trading as of September 30 through December 31. But clearly, the magnitude is very different. Remember also, as rates and yields improve, which drive prices and the bond market, we look to that as a reference for how we mark our asset-backed loan -- or excuse me, our fair value loans as well, right? And as you saw, the discount rate improved, and so that will be a factor as well overall.

Okay. And then you guys, specifically, you noted that, in a sense, you pulled forward some higher-risk, late-stage delinquencies into charge-off buckets this quarter and that you'll be doing that for the near term. But is the way that you interpret kind of the forward book of credit is generally healthier than you would have expected, say, 3 months ago because of payment rates and lower delinquencies, but that near-term charge-offs might have a little bit of elevation relative to where they would have been just because you're cleaning out those riskier accounts given like the typical post-emergency state of affairs

I think that's a very good way to think about it, John. I think that's accurate. And actually, let me point you to one of the metrics that I shared in my remarks. So for July, we had an annualized net charge-off rate of 11.9%. But 290 basis points of that was due to the pull forward of $4 million in charge-offs, the ones you were referring to. So if you back that out, we would have had a 9% charge-off rate, right, which was within the 7% to 9% annualized target that we had before.

And John, this is Raul. Just to add to that, the part that I also agree with is your view and the way you characterized it on the post-pandemic originations that we've made. You may have seen on Page 10 of the earnings deck, we presented an updated view of the first payment defaults. And you see, really, that the first payment defaults of the originations we've made since the pandemic began, they're below last year's levels and below the levels before the pandemic. And that's part of what gave us confidence to start increasing our approval rates in mid-June, is, frankly, they're coming in even lower than we would have expected, so that gives us confidence, especially as the economy has started to stabilize a bit, that we could go ahead and start growing again and increasing approval rates.

Yes. And then, I guess, a side comment would be also, Jonathan, there had to be some sort of denominator impact on your charge-offs as well, given where you would have been on loan portfolio size relative to where we ended up. And then the final question is related to, I guess, DolEx. You mentioned 500 locations. I didn't hear -- did you mention the geographies that, that will bring you to? And I guess, what type of addressable market does it bring you into that you're not already at? And what should we think about the cadence of that ramp, considering the environment and the opportunity?

Sure. So we did not discuss the specifics yet because there was a part of the regulatory approvals that I mentioned that we still need to work through. What's exciting for us, from an opportunity perspective, is there is certainly some overlap. So if you were to look at the map that we present on Page number 4 and you look at the states that are marked green for our personal loans, there is overlap there in states like California, Florida and Texas. But they're also in some states that we're not in, and we would look forward to being able to offer our personal loans in those states once we figure out the regulatory elements. But it's a little early to start to give a sense of what that cadence is going to be aside from the fact that our team and their team are excited about this partnership. We're very committed to it. And that's why we expect to be able to start originating in Q4.

Our next question today is coming from Sanjay Sakhrani from KBW.

This is actually Steven Kwok filling in for Sanjay. I guess the first one I had was just trying to dive a little bit deeper at the fair value marks. And if we were to use the end of July as a proxy, like where would the marks be?

So we haven't publicly disclosed that number. As you know, Steven, and hopefully, other folks know as well, all asset-backed trades have to be recorded on TRACE. And you can find the information on Bloomberg. What I can say is that, obviously, market sentiment and performance has continued to improve through the month of July. We've seen that from the volume of new issuance in asset backs and where new issues have priced, and our bonds, along with other issuers, certainly have benefited.

Got it. And then the second question I had was just around the charge-off rate trajectory, given that you've seen the delinquency rate come down, but yet the charge-off is going higher. Should we expect like July to have been the peak? If you can help us think through kind of the sequencing of that, that would be great.

Sure. Sure. So first of all, we're not providing guidance on charge-offs right now. And so I can't, unfortunately, point you to a specific number. I think we have 2 things going on in the portfolio. As you know, when we calculate annualized net charge-offs, we're dividing by our portfolio balance, our average daily principal balance. And so depending upon our origination trends, we certainly saw during the month of -- during the quarter, that the portfolio came down. And so if your denominator gets smaller, your number gets higher. We're definitely also going to -- we would assume, we would continue to see some of the earlier charge-offs that we've been taking for the quarter, and that has an impact. Just to remind you of the statistics that we shared earlier, in July, we saw 11.9% annualized net charge-offs, but 290 basis points of that was the early charge-offs. And so if you back that out, we would have had a 9% annualized net charge-off rate.

Before we take the next one, I just want to circle back to the question that Mark and John had on DolEx. Just to frame this in a better way than it seems we may have in the script, part of what's exciting to us about DolEx and even the 36% opportunity is that in the current economic environment, starting all the way back when shelter-in-place took effect, we've seen just less applications than we saw last year. We think that both reflects the fact that people are seeking to not leave home as often as they used to and just the uncertainty that exists in the economy. I think we've demonstrated now, when you look at the first payment defaults and as we've shown, the improvement in losses, that the risk engine is doing a great job, making adjustments in light of the challenging environment. And one of the best things we can do right now for the business is just open up the top of the funnel, right? So how do we just get more applications coming into our funnel that then, Pat, our Chief Credit Officer, and the team can make sure that we're decisioning appropriately. So what's exciting to us about the 36% opportunity, for example, is it's going to give us a chance to market our loans in places like NerdWallet and other places, where because of the small percentage of loans that we had over 36%, we didn't get adequate visibility. The same thing is true in DolEx. In DolEx now, we're going to have an opportunity to interact with consumers that we may not have otherwise seen, even in the states where we do have a presence. And both of those efforts, in essence, open up that very top of the funnel so that we can just go ahead and see more applications. So I just want to provide that clarity there. We don't think of this as a new and say, risky product to take on in the current environment. We don't think that even adding this channel in this environment is a risky thing to do because we're still going to use the exact same decisioning that Pat and the team have used to provide these really compelling first payment defaults. We're just opening up the funnel to more applicants. So I just want to provide that to you, given the questions from Mark and John.

[Operator Instructions] Our next question is coming from Rick Shane from JPMorgan.

First, in terms of expenses, I'm curious and if you could look at this both in terms of marketing and more general G&A. What is the mix right now between fixed and variable expenses? Obviously, we saw the customer acquisition costs go up pretty substantially. And that makes sense. It's really a function of the slowdown in the portfolio growth. But I'm curious if some of that was marketing that you guys had committed to and we'll see that shrink as we move through the year. Or was that a strategic decision to keep going on the marketing plan?

Yes. Rick, this is Raul. So we don't disclose the breakdown between fixed and variable, but your intuition is correct. If we were to look on Page 7 of the earnings deck that we provided and you were to look at, say, the increase for March, which was a CAC of $215 million, to April being at $574 million, that did reflect some investments, say, direct mail that were implied. Or you pick the list weeks in advance, you commit to that list, you pay for that list, and then you have to send mail to them. So even though the pandemic was already starting to take shape here, there was nothing we could do in terms of that particular list. You then start to see it come down to $461 million in May and $298 million in June because that was really when we had an opportunity in direct mail, and that was part of the optimization that I referred to, to make the adjustments even with the long lead times that exist in direct mail. So that is absolutely one of the adjustments that we've made to the variable elements. It's just ratcheting that down based on the response rates that we're seeing in the pandemic. To your point, there are other elements, say, the retail rent and the labor that we have there that also are relatively fixed elements, but what we've really tried to do is to figure out what are all the variable pieces that we can pull down, how can we shift to marketing vehicles that have shorter lead times, so digital, in particular, and then try to look at every other part of the organization to figure out how to reduce operating expenses. And I know you were focused on marketing, so I won't list those, but that has been a big effort that Jonathan has led as well, is looking at how do we reduce, not just the marketing expenses, but other parts of the business as well.

Got it. And by the way, we really appreciate the monthly data. It's very helpful in understanding the trends. I want to pivot to DolEx as well or DolEx as well. I assume that one of the regulatory issues, because they are, from what I understand, the money transfer business, is getting lending licenses. Is that an approval that you need? Or is that an approval that they need? So I'm assuming these are going to be loans that are written and closed in your name and that they're just an agent on that transaction, essentially providing the front end.

That's exactly right. So you're touching on one of the other things that makes this exciting for us, Rick, is the operating expenses for issuing these loans are going to be very different. These are going to happen in DolEx locations. So there's going to be none of the build-out that we even have with our co-locations, which has historically been our partnership structure, is that we build our own location and we staff it. In this case, they are going to serve as an agent of Oportun, so there's no build-out on our part, there's no incremental labor. And then depending on the state, we have to figure out those regulatory relationships -- I'm sorry, the regulatory structure that needs to exist given that agent relationship.

Got it. And it looks to me -- I'm having a hard time figuring out where all their locations are, but it looks like their biggest footprint, it might be 30% or 40% of their branches might be in Texas. So you are fully licensed there. So I'm assuming that that's a branch network that you can turn on pretty quickly. It's just it's basically just geographic expansion in the territory you're already in.

Yes. One of the challenging but fascinating parts of this business is every state is a little different. So Texas is different than California, which is different than Florida, which is different than New Jersey. So I don't want to characterize any one state as being easier than another one at this point. That's part of the work that is happening jointly right now between our compliance team and DolEx' compliance team, to figure out where do we want to start and how do we expand the size of the partnership as quickly as possible, which they want and we want. Operator?

He must be on another call.

I think that brings us to the conclusion of our call. So thank you again for joining us on today's call. And we look forward to speaking with all of you again soon. Take care.

Bye-bye.