OnDeck Capital's (ONDK) CEO Noah Breslow on Q2 2016 Results - Earnings Call Transcript

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OnDeck Capital (NYSE:ONDK)

Q2 2016 Earnings Conference Call

August 08, 2016, 05:00 PM ET

Executives

Kathryn Miller - Director, IR

Noah Breslow - CEO

Howard Katzenberg - CFO

Analysts

Danyal Hussain - Morgan Stanley

Kyle Peterson - FBR

Chris Brendler - Stifel

Brian Fitzgerald - Jefferies

Rick Shane - JPMorgan

Lloyd Walmsley - Deutsche Bank

Jason - Bank of America Merrill Lynch

John Rowan - Janney

Andrew - Compass Point

Tom White - Macquarie

Operator

Good afternoon. My name is Laurel, and I will be your conference operator today.

At this time, I would like to welcome everyone to the OnDeck's Second Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

I'll now turn the call over to Kathryn Miller, head of Investor Relations. Please go ahead.

Kathryn Miller

Good afternoon, and welcome to OnDeck's second quarter 2016 earnings conference call. I am here with Noah Breslow, our Chief Executive Officer, and Howard Katzenberg, our Chief Financial Officer. As a reminder, today's conference call is being broadcast live via webcast. Our earnings release was issued earlier today, and is available on the Investor Relations section of our website.

Please remember that certain statements made during this call, including those concerning our business and financial outlook for the third quarter and full year 2016, our growth opportunities and expectations, areas of strategic focus and investments, expansion and diversification of our funding process, our market opportunities, and anticipated demand for our products, and anticipated benefits from strategic partners are not facts, and are forward-looking statements. These statements are subject to a number of risks, uncertainties, and assumptions described in our SEC filings, including the risk factors described in our annual report on Form 10-K and quarterly report on Form 10-Q to be filed on August 09, 2016.

Should any of the risks or uncertainties materialize, or should any of our assumptions prove to be inaccurate, actual results could differ materially and adversely from those anticipated. These statements are also based on currently available information, and we undertake no duty to update this information, except as required by law. Today's discussion is also subject to the limitations on forward-looking statements in today's press release.

During this call, we will be referring to both GAAP and non-GAAP financial measures. For information about these non-GAAP measures and reconciliation to GAAP, please refer to today's press release and the appendix of the Investor Relations presentation posted today on the Investor Relations section of our website.

We will also refer to credit ratings because they can impact our availability and cost to capital. Ratings are opinions of the relevant rating agency, and are not recommendations to purchase, sell, or hold any securities, and can be changed or withdrawn at any time.

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

Noah Breslow

Thanks, Katherine, and thank you all for joining us today. The second quarter marked another period of record levels of loans under management, originations and gross revenue for OnDeck and our operating results outlook has improved the remainder of the year.

First in Q2, loans under management which represents both our on balance sheet and managed portfolios reached over $1 billion. This 47% increase over last year's Q2 levels was driven primarily by 41% growth in originations, which reached $590 million in the quarter.

Also in Q2, OnDeck earned $70 million of gross revenue, which was at the top end of our guidance range and reported adjusted EBITDA of negative $12 million, which exceeded our guidance range.

Reflecting the strategy that we outlined during our Q1 call to retain more loans on balance sheet, OnDeck’s unpaid principal balance or UPB increased 57% from the prior year.

As our UPB continues to build so too should our future interest income. So while our transition to lower marketplace mix requires some near-term P&L trade-off, it should ultimately lead to even stronger economics for the business over the long term.

Before I turn the call over to Howard to provide more detail on our second quarter financial performance, I’d like to highlight some of the key trends that led to the growth of OnDeck’s originations and loans under management.

As we’ve discussed in the past, we’re focused on growing originations responsibly. We will not sacrifice credit standards. We're continuously enhancing our pricing strategies and we're going to be very prudent with respect to allocate our marketing dollars.

So even while continuing to optimize our marketing spend during Q2, OnDeck achieved record new customer acquisition. In fact origination volume from new customers increased 62% over Q2 2015.

We also experienced double-digit growth across all three of our acquisition channels. Specifically our direct and strategic channels grew 45% year-over-year and reached 74% of total dollar volume. Meanwhile, our funding adviser originations increased 31% versus the prior year and comprised 26% of total dollar volume.

OnDeck’s line of credit also contributed to the healthy pace of originations growth during the quarter. Draw volume grew 13% sequentially and reached 12% of our UPB at the end of the second quarter.

We’ve been gradually scaling our line of credit in the United States and during April, launched this offering in Canada.

With this expansion of our product portfolio, we expect to strengthen customer retention and lifetime value, thanks to the versatility of this working capital offering.

And just as we were encouraged by recent trends in Canada, we are also excited about our Australian business, which while in its early stages, has more than doubled in terms of both origination units and volume from Q1 levels.

Our strategic partnership with MYOB and the Commonwealth Bank of Australia have provided OnDeck with a significant competitive advantage and have contributed to our early momentum in Australia.

Lastly, just a quick update on our partnership with JPMorgan Chase. As many of you know, we launched and began scaling our program in Q2. While it is still early days at this point, both we and Chase continue to be very pleased with the program’s progress and remain on track for a broader rollout.

So whether in our U.S, Canadian or Australian markets, within our direct strategic partner or funding adviser channels or as part of our OnDeck-as-a-Service platform, OnDeck continues to drive strong and responsible growth as we reach and retain more small businesses.

This ongoing effort is enabled by our differentiated value proposition that is singularly focused on offering a complete credit solution through a simple process with outstanding customer service and by the immense data and learning’s housed in our proprietary GROVER database coupled with the predictive power of the OnDeck Score.

That brings us to our portfolio’s provision and 15-day delinquency rates for the quarter, which are two important measures by which we assess the credit quality and performance of our blended portfolio. For Q2, OnDeck’s provision rate remained within our target of 5.5% to 6.5%, which we have achieved for the last five consecutive quarters.

Meanwhile, our portfolio achieved both sequential and year-over-year declines in our 15-day delinquency ratio. These strong credit trends serve as a testament to our ability to continue to scale loans under management by focusing on high-quality originations at responsible growth rates and sustainable economics to OnDeck.

So as we look forward to the remainder of 2016 and the start of 2017, we are confident in our ability to drive disciplined growth of loans under management, balanced by two long-standing priorities; one, high-quality growth that is optimized for marketing spend and credit performance; and two, greater operating leverage as our business continues to scale.

These are the priorities that we outlined during our recent Analyst Day and demonstrated through our Q2 earnings results. And we believe that OnDeck is uniquely positioned to execute on these objectives, given our considerable data and technology advantages, the sophistication of the OnDeck Score and our diversified funding model.

On this last point, as we retain more loans on balance sheet, we continue to build upon our funding capacity. With the closing of our second securitization in May and the recent expansion of our Deutsche Bank facility, we have reinforced our funding model and will continue to diversify and expand our funding sources as the year progresses.

So we entered the second half on solid footing. Despite some uncertainties in the industry, we continue to grow and leverage the diversity of our balance sheet. In addition, we are encouraged by the trends in new customer acquisition, customer acquisition cost and credit performance that we observed in Q2. Customers love our products and our leadership position is being strengthened every day.

With that said, I’ll now turn the call over to Howard to discuss our second quarter financial results in greater detail.

Howard Katzenberg

Thanks, Noah. As Noah discussed, OnDeck’s second quarter operating results were solid and reflected our ongoing commitment to responsibly build loans under management.

By the end of Q2, ending loans under management reached over $1 billion, up 47% over the prior year. This growth was primarily driven by a 41% increase in originations. As Noah mentioned, we continue to optimize our origination volumes, focusing on credit quality, risk-based pricing and other drivers of lifetime value.

With that context, gross revenue in Q2 grew 10% year-over-year to $70 million. This performance came in at the high end of our guidance range and primarily reflected growth of interest income, partially offset by lower gain-on-sale revenue. Interest income reached a record $64 million for the second quarter.

The 27% year-over-year increase reflected record growth in average loans, partially offset by the year-over-year decrease in EIY from 35.9% last year to 33.3% in Q2 this year.

This decline primarily reflected the continuing trend towards lower-cost distribution channels, higher average term loans and lower pricing for repeat customers. That said, for the remainder of the year, we see EIY stabilizing between the 32% and 34% levels.

Meanwhile, gain-on-sale revenue was $3 million in the period, down 76% from Q2 2015. This was driven by both the lower gain on sale rate of 3.5% and our decision to reduce the percentage of loans sold through Marketplace. As I discussed during the Analyst Day, interest remains high from institutional investors located by OnDeck’s loans.

That said, the price they’re willing to pay has declined from historical levels as other issuers increasingly compete to finance their loans and offer higher effective returns to investors.

We believe it’s important to maintain some level of marketplace sales to preserve our important relationships with these investors and to provide additional capital to the business.

So in Q2, we decided to sell 15.6% of our term loans through marketplace. Looking forward over the near term, we expect marketplace sales to remain within the 15% and 25% range, assuming market conditions remain relatively consistent with Q2.

Moving on, we earned $29 million of net revenue in Q2, down 33% from the prior year. The decline primarily reflected our decision to retain more loans on balance sheet this quarter which resulted in lower gain on sale revenue and higher provision expense and funding costs.

Provision expense is $32 million in the second quarter up from $16 million in the prior year due to the growth of our on balance sheet portfolio of Q2 2016.

As a reminder of the accounting impact of the provision expense, note, actual net charge-offs were approximately $12 million less than our provision expense in the period. Our provision rate came in at 6.3% in Q2, within our targeted range of 5.5% to 6.6%, but higher than the respective provision rate in Q2 2015.

The year-over-year increase reflected the fact that provision rate for the second quarter of 2015 benefited from a release of loan loss reserves related to the sale of loans that quarter that were previously designated as held for investment.

More broadly, our credit performance continues to be strong and our cohorts continue to perform within expectations. Reflecting this portfolio strength, our 15-day delinquency rate was 5.3%, a sequential improvement from 5.7% in Q1 and a year-over-year improvement from 8% in Q2 2015. Meanwhile, our ending reserve ratio was 9.3% compared to 9.5% in Q1.

Lastly the net charge-off rate for Q2 was 10.9%, down from 11.4% in Q1 and 14.7% in Q2 of last year. Sequential and year-over-year reduction in our net charge-off rate primarily reflected stable credit performance and the significant growth of our average UPB during the period.

Over the near term, we expect the net charge-off rate to rise from these historically low levels as UPB growth stabilizes and the average age of our on balance sheet portfolio increases.

As always, we will continue monitoring credit performance and economic developments very closely and while we don’t necessarily expect delinquency levels to decline from these historic lows due to structural reasons we remain confident in the credit outlook of our portfolio.

Our cost of funds rate increased sequentially to 6.7% in Q2. As expected this is about 120 basis points higher than the rate in Q1 and reflected approximately $1.6 million of non-cash charges related to the acceleration of deferred debt issuance cost triggered by the recent refinancing of our prior securitization.

Going forward and as a reflection of rising risk premiums in the market, we expect our cost of funds rate to remain around Q2 levels for the remainder of 2016. This is due to our use of the $250 million securitization we closed in May and our expectation that future borrowing costs may arise from that prevailing market rates for existing and possible future funding facilities.

Let’s now pause and relate Q2’s performance to the supplemental measures we outlined at our Analyst Day, which I will touch on throughout the rest of today’s presentation.

As a reminder, we manage our business using many ratios and targets, but these new metrics are three of the most important. In particular, they describe the financial potential of the company, independent of funding strategy and they track the fundamental drivers of margin improvement and operating leverage over time.

So let’s start with OnDeck’s net interest margin after credit losses or what we refer to as our NIMAL, N-I-M-A-L.

This metric equals OnDeck’s interest income less funding cost, less charge-offs for the period divided by average interest earning assets. It describes the earnings quality of our loan book.

For Q2 OnDeck achieved a NIMAL of 18.8%, down from 19.2% last year. The decline primarily reflected the impact of a lower EIY and a higher cost of funds rate, offset by a lower net charge-off rate in the period.

As we progressed through the remainder of 2016, we expect OnDeck’s NIMAL to continue declining largely due to the increasing net charge-off rate expected over the near term as our marketplace mix stabilizes.

That said, while we expect our NIMAL to decline in the near term, we are still on track to achieve the medium and long-term NIMAL targets we outlined in Analyst Day as we optimize the relationship between pricing and credit risk over time.

Now let’s move on to OpEx. In Q2, total OpEx was $48 million up 24% year-over-year and consistent with our strategic plan to advance our industry leadership and continue strengthening our competitive advantages.

The majority of the year-over-year increase reflected two dynamics: The first was a 35% increase in tech and analytics as we continue to invest in our team and OnDeck-as-a-Service capabilities. And the second was a 22% increase in G&A related to supporting overall headcount growth of the company over the last year.

As we discussed during Analyst Day, we think it’s helpful to look at our adjusted expense ratio or AER in evaluating the efficiency of our expense base. As a reminder, AER is equal to total operating expenses excluding stock-based compensation divided by average loans under management.

For Q2, our AER was 16.8% down 360 basis points from Q2 2015. This operating leverage was mostly driven by our ability to optimize marketing spend and achieve economies of scale and G&A.

Going forward, we expect the year-over-year improvements in AER to continue toward both our Q4 2017 and longer term AER objectives as we make the business more efficient and productive over time.

Putting it all together, our Q2 adjusted operating yield, which equals our NIMAL less the AER was a positive 2% up from negative 1.2% last year. We consider this number a good proxy for our potential pre-tax ROA.

As such, we remain encouraged that our ability to achieve the medium term adjusted operating yield target as well as the long-term target of 5.75% to 7% we outlined at Analyst Day.

Overall GAAP net loss attributable to common was negative $18 million while adjusted EBITDA was negative $12 million in Q2. Adjusted EBITDA came in well ahead of our guided range, driven mostly by our focus on cost optimization as loans under management grows.

With respect to our balance sheet, our UPB was $790 million at the end of Q2. This is up 21% sequentially, largely as a result of our decision to continue reducing our market price mix to retain more loans on balance sheet. Going forward growth in UPB will be a very important metric that drives gross revenue.

Reflecting the quarterly growth in UPB our ending funding debt was $554 million, up 19% sequentially. We continue to be very active in bringing more funding capacity on board. Most recently, we closed our second securitization, expanded our credit facility with Deutsche Bank and we have a clear line of sight to closing additional warehouse capacity.

Our ending cash balance is $78 million at the end of Q2. We expected this decline in our cash due to our decision to reduce market place sales. Consistent with this decision we've been investing more of our cash throughout the year to fund the loan growth, in terms of funding the growing residual of our finance portfolio and also funding loans we don’t pledge the debt facilities given starting concentration and eligibility limit.

With regard to the residual, please note that we just went through a unique period of rapidly declining marketplace sales, which resulted in rapidly increasing on-balance sheet UPB growth. Consequently our UPB balance has grown at over twice the rate of loans under management over the last six months.

Now that most of the marketplace mix shift is behind us, however, we should see the rate of on-balance sheet UPB growth decelerating, to more closely match the growth of the broader loan under management portfolio.

As a result our residual should grow at a slower pace going forward and thus our investment of cash as well. And add for our choice to equity fund some origination we will continue optimizing the strategy to manage our cash balance based on our visibility into originations activities, our ability to secure additional funding capacity.

In Q2 we felt good invest in our cash for this purpose given a visibility we had on closing new funding capacity. Also I want to note that during Q2 we invested approximately $7 million to purchase the outstanding loans of two portfolio securitized by five marketplace investors.

We do not need to do this. Our both transactions contain typical cleanup cost provision that could be utilize to allow investors to smoothly exit the transaction as the approach maturity or allowing on debt to earn an unacceptable positive rate of return. The majority of the purchase loans we’re performing, we utilize an independent appraisal to support the overall purchase price.

Combined these factors resulted in an increase in the amount of cash invested to support our loan growth during the quarter. That said, we remain very focused on proactively adding additional funding capacity to support our anticipated growth.

Currently for instance we are actively focusing on expanding our existing facilities raising new facilities pursuing additional securitization and increasing our corporate line of credit. Although no assurance can be given we fully expect to continue to expand and diversify our funding sources to maintain our current level and plan growth of origination.

With that let’s move on to our guidance for the third quarter and full year 2016.

For the third quarter of 2016 we currently anticipate gross revenue between $73 million and $76 million and adjusted EBITDA between negative $9 million and negative $11 million.

For the full year of 2016 we are raising gross revenue guidance to be between $280 million and $290 million and our outlook has also improved for adjusted EBITDA. We now expect adjusted EBITDA to be between negative $35 million and $ NIMAL 43 million.

Above all that we remain committed to responsible growth of loans under management and achievement of our long-term financial targets.

Now let me turn it back Noah.

Noah Breslow

Thank you, Howard. Before I turn the call over to the operator for Q&A, I would like to highlight the key takeaways from this quarter.

We're successfully executing the strategies that we outlined during our recent Analyst Day around responsible growth building out our balance sheet and optimizing our business toward our medium and long-term financial targets.

From a growth standpoint we performed well in Q2, including record originations in gross revenue while maintaining our credit standards and pricing discipline.

As we hold more loans on balance sheet, rapid growth in our unpaid principle balance will lead to increased interest income and enable us to achieve greater operating leverage, and to support this strategy we are actively expanding our sources of liquidity and balance sheet financing.

OnDeck’s continued ability to responsibly grow while also reinforcing our funding model is a reflection of our market leadership. And our leadership has been driven by the competitive advantages that we've discussed here today and over the course of our 1.5 years of being a public company.

Our sophisticated OnDeck’s score and growing database of small businesses, our fully integrated technology platform and our robust growing distribution channels to reach small business owners.

The evidence of these competitive strengths lies squarely in three objective trends. One, the stability of our blended portfolio's credit performance. We have intentionally designed our financial solutions and credit model to conservatively and proactively manage risk while also delivering sustainable loss adjusted returns over time.

Two the caliber and depth of our strategic partnerships, whether it’s a top national bank like JP Morgan Chase or the Commonwealth Bank of Australia or the leading providers of accounting software like Intuit in the United States or MYOB in Australia, OnDeck is the partner of choice for those who are committed to serving their small business customers well; three, the continued growth and diversification of our institutional funding sources.

In the last six months we have closed our second investment grade rating securitization and expanded three warehouse facilities with some of the nation’s leading banks.

In conclusion the fundamental of underlying OnDeck’s business are solid and we continue to be very optimistic for the future. We will continue to leverage our competitive advantages to build upon the strong foundation, reinforcing our financial model, scaling our business and driving improvements in our operating performance over time.

With that, I’ll turn the call over to the operator for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from the line of James Faucette with Morgan Stanley. Your line is open.

Danyal Hussain

Hi, this is Danyal Hussain calling in for James. Just a question on the gain on sales, it look relatively weak compared to I think the outlook you had laid out last quarter?

So one question I had I guess is that spreads had come in this quarter and I think that was one of the reasons for weakness last some around. So maybe you could just talk about what else might be driving some of that weakness from some of the investor?

Noah Breslow

Thanks Danyal. Let me just attack the question from more just a general capital markets update. As I said earlier, demand for our loan assets remain strong and it's not just OnDeck.

I think you see improving demand dynamics really across the online lending industry. I think you can see that as well with some recent securitizations. That said, the risk premiums have definitely resin for investors. They are now demanding more returns for the same level of risk then they did a year ago.

And suddenly spreads rising in the fixed income markets combined with some of the issues that our industry has faced have caused that dynamic to recur and what that means for us is really two things. On the marketplace side as you pointed out, we expect premium and gain on sales to kind of remain I think at lower levels versus where we were a year ago.

And on the funding debt side, as I also mentioned in remarks, we expect our cost to funds to rise. But as we discussed in the past rising borrowing cost don’t break our model, because we have so much spread and we can pass a lot of those increased cost on to borrowers at a very profit neutral way.

Danyal Hussain

Okay. Thank you. And then just a question on origination, so they were relatively strong and last quarter it seemed like some maybe, the caution you had for the year was based on deteriorating credit and then also potentially rising customer acquisition costs. Just wondering where the strength came in this quarter.

Noah Breslow

Yes, I can take that, Daniel. So it was a strong quarter for us particularly around the area of new customer originations, which were up 62% year-on-year. So we really, we like that trend. We think some of that trend was due to improvements we made in our direct marketing and particularly the customers and our ability to target them efficiently with our marketing spend as well as just a slight increase in the overall quality of customers that was applying for an OnDeck loan, which allows us to offer a higher quality loan offers to them.

So we felt good about that but we also, as we noted in the prepared remarks, saw all three of our channels grow year-over-year. So I think you will see a dynamic here at the market unfolds where players with strength, players with the leadership position continue to build on that position. We definitely feel like we did that in Q2.

Danyal Hussain

Perfect. Thank you.

Operator

Your next question comes from the line of Bob Ramsey with FBR. Your line is open.

Kyle Peterson

Hi, guys this is actually Kyle Peterson speaking for Bob today. Quick question, I guess as a follow-up on marketing. I know on the last quarter’s call you guys had said the securitization borrowers are primarily -- buyers who are primarily out of the market. Is that I guess what you guys are still seeing today and I guess might be driving the lower gain on sale margin?

Howard Katzenberg

Yes, that’s true. So that marketplace investor that was doing the securitizations did not buy loans in the quarter. Again, I think there is appetite, but not at the gain on sale levels that’s attractive to us. So certainly, the mix of the buyers has affected the premiums.

Kyle Peterson

Okay. Great. And then I guess just one other follow-up little bit on the funding side. I know you guys did bring the cash balance down quite a bit this quarter. Do you guys have any thoughts on kind of where you guys are comfortable moving now on restricted cash balance on a go-forward basis?

Howard Katzenberg

Let me take that then I think the heart of the question is really about how we’re managing the cash position. So let me explain what’s going on and then really touch on our cash management strategy.

As I mentioned in my remarks, we ended the quarter with $78 million of unrestricted cash and that’s down from the beginning of the year. So what’s going on first, I think it’s important to point out that, that use of cash is not a burn, it’s really investment. In fact our GAAP equity balance is still over $300 million.

But the answer is really quite simply we’re investing in our loan book. When we decided to reduce our marketplace mix in Q1, the implication was we’d have to use more of our cash to fund more loans on balance sheet. And specifically, we needed to fund the residual value of our loan book, which is basically the difference between the value of that loan book and the amount of capital we receive from our lenders. So this decline was anticipated.

Now in terms of how we manage it going forward, first note that we’re managing the business not to raise any additional equity. We don’t need it. After all the residual growth will naturally slow down. So beginning of the year, our UPB has grown over twice the rate of loans under management, given the shift in marketplace.

But now that most of the mix shift is behind us, sequential UPB growth should decelerate from here on now, which will reduce the cash usage. Also note that we're relatively under-levered today with the debt-to-equity ratio of under two to one.

We still have over $100 million of committed capacity in our warehouses and as I mentioned, we have GAAP equity over $300 million. Now the assets back in this equity are very tangible and liquid. So one of the top priorities right now for us is increasing our overall leverage. To do this, we’re currently raising additional debt capacity and are also in process of increasing our corporate line of credit.

In addition to UPB, we can always increase marketplace sales to lock more liquidity. So to sum up, the decline in cash was expected. We have a good handle of it and we have lots of tools to continue managing and optimizing our investment of cash.

Kyle Peterson

All right, great. Thank you very much.

Operator

Your next question comes from the line of Chris Brendler with Stifel. Please go ahead.

Chris Brendler

Hi thanks. Good afternoon, guys. So focus on credit for a second. Can you just talk about the demand that you’re seeing in the delinquency rate, really impressive performance.

Is it mix driven or you actually seeing some step up in origination quality? And along those lines is there any competitive benefit to all the shake out to the online bundling space yet? Thanks.

Howard Katzenberg

Yes, Chris, I think what you’re seeing in terms of the credit performance, which continues to be very strong is really just a function of the maturing that’s gone on over the last year of the OnDeck Score and our risk management capabilities.

From a mix perspective, there hasn’t been any significant change in terms of the quality of the originations that we’re originating. I would point out that because of the marketplace mix shift, we’re just -- the UPB balances are accelerating.

So that’s having an impact on the denominator of the delinquency rate calculation. But even when you correct for that the delinquency levels are really at some of the best levels over the last couple of years. And I think it’s again, it’s a function of just the improving risk management capabilities that we built.

Chris Brendler

Right and also like the reserve percentage of the portfolio has also falling, which is usually indicative of lower credit losses ahead.

Howard Katzenberg

Right.

Chris Brendler

Okay. And then a question will be on the marketplace side. I think you may tend to be conservative in this environment, but it seems like these kinds of markets can overact sometimes. And with underlying credit quality still there and yields still there, do you think there’s a chance that this market comes back and what kind of conversations are you having with the securitization buyers at this point?

Are they lights out? Are they starting to poke around again? And on a similar vein, what kind of conversations are you having with these alternative funding sources in the warehouse lines?

Is that market and that sanity level will better than the securitization market at this point? Do you have more constructive conversations on the funding side?

Howard Katzenberg

So let me just separate the two different types of securitization investors because I think that’s really important. The first I would classify as the investors that invest in our securitizations when OnDeck is the issuer.

Recall we completed our $250 million securitization in the quarter. It was investment-grade rated and it's oversubscribed and it’s a very successful execution. Those investors remain committed in terms of those types of fixed income that should return relationships.

I contrast that with the program we had where we’re selling loans to a marketplace investor and that marketplace investor was then securitizing the loans themselves and then selling off the residual position to primarily hedge funds.

So in that market, I think the bond investors are still very interested given the fixed return. But the residual investors continue to either play on the sidelines or just demand returns that are really in excess of what us or someone else securitizing would like to give.

So I think those dynamics remain pretty consistent with what we had last quarter. But moreover, when I look at just our overall kind of visibility and confidence into bringing on additional capacity at market rates, I think investor interest continues to remain very strong from both warehouse providers and marketplace investors.

Our track record for quality growth and strong credit performance has really solidified our position as the market leader in the eyes of many of these investors. And as such, we’re having many active discussions regarding establishing additional funding capacity.

In particular, we’re in the late stages of finalizing $100 million credit facility and we’re also working on setting up debt facilities for our Canadian and Australian operations and finally we’re looking to significantly upsize our line of credit as well, our corporate line of credit. So there’s a lot of activity and a lot of progress being made.

Chris Brendler

That’s great. Just to clarify, your guidance for funding cost I think is going to be a little higher, is that because the pricing on these new transactions will be a little higher just given the environment, is that fair?

Howard Katzenberg

I think that’s fair. I think also in terms of the use of the products to be funded with the new capacity, today, we have over $100 million of capacity for what I would call our core products with our existing warehouses.

So some of the new warehouses that we’ll be bringing on board are those that are funding newer products like the portfolio in Canada or the portfolio in Australia or some of the larger and longer term data products that are somewhat new to us, but are attracting a lot of customer interest.

So I think it’s one, a function of somewhat rising spreads in the marketplace, but also some of the products that are being used to secure these facilities.

Operator

Your next question comes from the line of Brian Fitzgerald with Jefferies. Your line is open.

Brian Fitzgerald

Thanks. Howard, I know you said this. How much of the EIY move would you attribute to you named things, lower cost distribution channels, average term lengths and repeat loans.

Would you say it was a third, a third, a third, and then, Noah, your line of credit business is expanding. What’s your view of the ramp there? Is it progressing like you would like or as you originally expected? What portion of total originations would it represent and what’s your long-term goal for that product to be in terms of your mix longer term?

Howard Katzenberg

So let me address that EIY question. I think that’s a fairly reasonable assumption although we haven’t implemented any new price increases recently. In fact, what we have implemented is targeted price increases to select populations.

So the number just moves -- naturally just moves around a little bit quarter-over-quarter, but I think the trend is definitely towards stabilization throughout that 32% to 34% number because we do expect it to stabilize at these levels. Now I’ll turn it over to Noah to address the originations question.

Noah Breslow

Yes, thanks, Brian. And on the line of credit products yeah, we’re very pleased with how that product is maturing. So we originally released that product at the end of, it was 2013 and have been growing it in a very measured, disciplined way over the last couple of years.

So at this point, the lock product represents I think it’s 13% of our unpaid principle balance and -- I’m sorry, loans under management and, I’m sorry, UPB and about 14% of our originations volume in the second quarter here, so pretty consistent actually on both measures.

In terms of where we see it going, what we haven’t released in the longer-term guidance to what percent line of credit we think it will be as a percentage of our overall loans or portfolio under management, but I would say steady disciplined growth.

We saw a nice sequential growth in the second quarter. We do anticipate that balances will continue to grow and I think what we’re doing here is really just maturing the products. So getting a better grasp around how we manage outstanding lines. What customers are performing well, what customers aren’t performing as well, kind of clipping and grooming that product a little bit as we get ready to scaled up more in 2017 and 2018.

But certainly it’s an important part of our overall value proposition, which is providing a complete credit solution to our customers for both working capital needs as well as their investment projects.

Brian Fitzgerald

Got it. Thanks guys.

Operator

Your next question comes from the line of Rick Shane with JPMorgan. Your line is open.

Rick Shane

Hey guys. Thanks for taking my questions this afternoon and I think in summary this may just be related to the last question. So in your press release, you provide the total origination number of $589.7 million.

You also described origination of term loans of $506 million and so I was trying to figure out what the differential was and will the footnote that includes UPB term loans will into new origination of $62 million.

Now when I do the math, the difference between $589 million and $506 million is $84 million and you guys are describing $62 million in this footnote. What’s the differential between those two numbers?

And more importantly, it looks like the percent, the gap between that $506 million and $589 million number is increasing over time and I am trying to figure out what's that.

Noah Breslow

Yes, Rick. It’s very much related to the last question. This is Noah. So that gap can be completely explained by the growth of line of credit product. So the total originations number...

Rick Shane

So that rentals the balance taken down.

Noah Breslow

I’m sorry, say that again?

Rick Shane

I’m sorry. The differential then is the utilization of the line of credit and that in fact picked up in the $62 million?

Noah Breslow

Yes. The draws on the line of credit product in the period. So our total originations number equals term loans issued in the period plus line of credit draws in the period. And so that number line of credit is not $83.5 million, which puts exactly to the $590 million and the $506 million.

Rick Shane

Okay. So actually, that you have me and you seem to confuse me again. I would’ve assumed it’s not struck me, it's not hard to build. I would have assumed the differential the $21 million differential was the draw on the facilities and the $62 million is the conversion. But I think I want to make sure I’m comfortable with what those conversions are. What does that $62 million represent per se?

Noah Breslow

Oh, yes. So it’s -- it’s the balance rollover from our renewals that is the $62 million. So when we originate a new loan, that number goes dollar for dollar into our originations number for the quarter.

When we originate a renewal loan, that is also the case. However, there’s a component of the renewal origination that is essentially a rollover of prior balances with OnDeck. So the interest is forgiven and then a new loan is created.

Operator

Your next question comes from the line of Lloyd Walmsley with Deutsche Bank. Please go ahead.

Lloyd Walmsley

Thanks guys. You guys, you talked a lot about increasing your debt capacity, increasing your corporate line of credit and we saw a nice kind of reacceleration in that origination growth.

Just can you give us a sense for how much of your interest and increasing capacity is really looking to replace existing capacity or take advantage of markets where you can or is this really just a fun further acceleration as the competitive environment looks a little better.

And then I guess just as a follow-up on some of the questions around customer acquisition costs falling, can you give us a bit of sense or how much of that is really optimization of your marketing plan versus just a better competitive environment, any further color you can share on that will be further call you can share on that would be appreciated. Thanks

Noah Breslow

Thanks, Lloyd. This is Noah. I can take this one. So the addition of capacity really is to support growth, and I think there’s two dimensions of that. One is sort of just the overall originations growth rate in the business which as you noted accelerated a bit in Q2 and we definitely see some opportunities there going forward.

The second is because of the shift we made in retaining more loans on balance sheet; our UPB is going to grow faster than our originations growth rate. So our UPB grew 57% year-over-year and in a quarter or two, that’s going to put that shift in the rear-view mirror more, you should see UPB track more to our overall originations growth.

But I would say our interest in raising additional capacity really to support basically the higher UPB balances we expect in the coming quarters and as we head into 2017 more than anything else. Bridging that to your second part of the question around customer acquisition. So marketing optimization definitely played, we think, the primary role in the quarter.

So it actually took sales and marketing ex stock-based comp as a percentage of originations, it was 2.7% in Q2, that’s down from 3.4% last year. So we do think the optimization of marketing spend is having an effect.

What I’ll say about the competitive environment is we do see the marketing channels continue to have activity from competitors in them. So I would say that overall activity is stable. What we think is interesting is there’s been an ebb and flow of different players in the market.

So some of the players we saw spending money last year aren’t spending as much money this year. Other players may be are spending a bit more this year and they weren’t spending at all or were spending a little bit less last year.

And so I think that ebb and flow speaks to people are trying to find efficient frontier for marketing spend and I think the good news use from an OnDeck perspective is we feel like we’ve already kind of figured that out to some degree and are now making I think very intelligent data-driven trade-offs based on our actual results about where we spend our marketing dollars and how effective we expect them to be.

Lloyd Walmsley

Thanks guys.

Operator

Your next question comes from the line of Nat Schindler with Bank of America Merrill Lynch. Your line is open.

Jason

This is Jason here for Nat. Just a question on your EIY, you mentioned you think it’s going to stabilize around 32% to 32%. I was wondering, what kind of gives you the confidence that that’s kind of stabilize there?

You just hit an equilibrium point over the types of loans you’re marketing or is there something else going on there? And then just do have any update on how the Canada and Australia business are trending? Thanks.

Howard Katzenberg

Yes, so again, we haven’t made any new decisions or implementations to affect lower pricing. And in fact, for select populations, we are raising pricing. So that’s why I would expect that we would see stabilization in the EIY metric, potentially even increase later in the year. So hope that addresses that question. I’ll turn it over Noah.

Noah Breslow

Yeah. So on the international businesses I think we re-laid some of this on the call. We saw you continued sequential and year-over-year growth in our Canadian business. So we remain very bullish about that.

I think everyone knows the economic environment in Canada isn’t it as strong as it is in the U.S. but our portfolio overall is performing more or less to expectations there. So we feel good about that.

And yeah the overall operation is really growing quite nicely. Australia I think we mentioned in our prepared remarks doubled quarter-over-quarter. Obviously it’s a low base, it's a very new business for us.

We made our first loan last November in Australia. But we see a real opportunity there to grow quickly. We have excellent partnerships, the Commonwealth Bank of Australia, MYOB so leading banks, so leading account software company are great sort of creditability build for that business.

And we are actually seeing some nice traction on our direct marketing as well in Australia, which indicates to me that we have a playbook now that maybe exportable outside the U.S. to other markets as well, because we are seeing attractive customer acquisition processes working over there.

So that’s where we are, very bullish in international and I think as Howard mentioned, we are in the process of getting outside investors start funding the growth of those business because we have been housing those loan books in our equity book thus far.

Jason

Great. Thanks.

Operator

Your next question comes from the line of John Rowan with Janney. Your line is open.

John Rowan

Good afternoon, guys. If I am not mistaken on the Analyst Day you talk about being adjusted EBITDA positive for 2017. Have I mistaken, is that still the case?

Howard Katzenberg

Yes. Not only that I think, we try to reiterate our -- the three targets that we put out for the three metrics on this call and our comfort level -- like Q4 2017.

John Rowan

Okay. And just on credit obviously you talked about improved analytics driving down the credit cost figure but is there anything underlying that within -- forget your analytics, are the business that are borrowing from you doing any better, I try to understand kind of the economic impact of the borrowers? Thank you.

Howard Katzenberg

I read on the economy, it has been pretty consistent with what you see kind of out in the press. We still think a good employment picture, strong U.S. consumer is healthy for small business. We are continuing to see modest growth in our portfolio from an economic perspective.

John Rowan

Okay. Thank you.

Operator

Your next question comes from the line of Michael Tarkan with Compass Point. Please go ahead.

Andrew

Hey guys. Thanks for taking my question. This is actually Andrew on for Mike. First question for you guys. So I know that one of your competitors was on the consumer side, but they received a letter from Colorado regulators regarding lending under the laws in that State. Did you guys get a similar letter and if so do you expect any impact?

Noah Breslow

Yes. Thanks for the question. So from time-to-time we have contact with a variety of state and federal regulatory agencies. In particular Colorado I can’t specifically comment on that one actually. So it may not have applied in our space.

But we generally don’t comment on specific communications with regulators. I think we feel very optimistic and in control of where we are from a regulatory standpoint.

We raised guidance. I think if we felt like there was any imminent impact from a regulator on our business, we would have done something different. So as of now the answer is simply is no. No we don’t anticipate any impacts on our business from regulatory actions.

Andrew

Okay. Thanks and then just one more credit here. So I know that you said things have been holding up, within expectations. But we also heard that two of your securitization breached their lost figures.

Can you give us some color on that and expectations for credit going forward and then also related to that, so are you seeing any signs of stress within pockets of your borrower base? I know you said you are taking up pricing for specific segments of borrower. So any color on that would be great?

Noah Breslow

Yes. Sure, happy to. So first I think, as we said a number of times on the call, the performance of the overall portfolio is strong and there will be static pool, diagrams and charts reflecting our overall portfolio in the 10-Q and we would encourage people to go kind of look at those.

I am happy to comment on the transactions you mentioned, which did actually perform below our expectations and we think there are various specific and isolated reasons why that happened.

And the two areas that drove that were simply one around repayments, customer renewed their loans little bit more quickly than we had anticipated and in a revolving structure that works, okay. Because you can replace those loans with new loans but in static pool structure that impairs the cash flows and investors expect to receive and can impair the performance of a transaction.

We also saw due to the way certain loans were selected for those transactions their credit performance was below expectations. What I’ll say is how do we hold those loans on our balance sheet, they would’ve been breakeven to profitable for us.

But when you take into account the fact that a premium was paid for the loans and then leverage was applied on the other side, that resulted in a transaction that was unsatisfactory from our standpoint.

So that’s kind of where we are. What I would say is that we don’t view the performance of those isolated transactions as indicative of our outlook on future credit performance. I think we feel very strong about the data we’re collecting on the economy, the data we get in our early warning systems that we built.

And as Howard noted, we see just kind of tepid growth environment continuing and the credit performance that we’ve had hitting our target range in the last five quarters consecutively. We believe that we can achieve those targets in the future.

Operator

Your next question comes from the line of Tom White with Macquarie. Your line is open.

Tom White

Thanks for taking my question. Just on the originations growth and specifically the comments about new customer acquisition, I’m just curious, peel back a little bit more what’s driving that?

It looked like you guys, the pace of growth in the sales and marketing line slowed quite a bit. So I just want to parse out I guess to what extent you think that new customer growth is being driven by competitive disruptions?

And also just curious whether do you guys think you’re seeing any impact from disruptions at the more consumer-oriented platforms maybe due to gray areas between sole proprietorships and their borrower base? Thanks.

Howard Katzenberg

Yes. So I think to provide a little bit more color on what we saw in Q2, I think there’s a fewer dimensions to it. One is eliminating spend that isn’t working well for you. And that spend, if you think about it is translating into some of the highest tax that we were experiencing.

So if you can eliminate some of that spend on the margin, you’re not going to lose very many loans and the loans you were losing had tax that were probably not appealing in the first place.

Then with the spend that remains, we’re continually improving our ability to target borrowers. So this GROVER database we talked about in the Analyst Day, we’re tracking all these millions of businesses now whether or not we’re making them a loan or not and we’re getting better at building marketing models that key off of it.

So I think those two things in particular at eliminating some unproductive spends, coupled with targeting the remaining spends better with better statistical models, we think that’s a good thing.

Regarding the competitive environment, like I said, we’re seeing a bit of an ebb and flow. So in the SMB space at least, certain platforms are a little bit less active today than they were a year ago. Others may be are coming on. We’re still seeing stable, we would say, marketing channel spend overall, so stable in SEM, stable in off-line marketing.

I do think there’s a little bit of a potential effect of the consumer side of things and just that you had a very large amount of mail and other solicitations going out to consumers.

And I think as some those platforms pull back, you might see a little bit of overlap maybe at the smaller end of small businesses or people who would’ve looked at barrowing personally are more able to borrow in the name of their business.

And so there might be a little bit of an effect from that, but I wouldn’t call that a first order driver of the quarter’s results.

Tom White

Thank you.

Operator

Your next question comes from the line of Rick Shane with JPMorgan. Please go ahead.

Rick Shane

Hey guys. We got cut off, so I just had one follow-up question. Last quarter, when you provided the revenue guidance, you put it in the context of origination growth year-over-year. That wasn’t in there this quarter.

I’m just curious if there’s anything we should be thinking about there and I apologize if you addressed this on the call I missed it.

Howard Katzenberg

Yes. No, Rick. There’s no hidden message in there. I think last quarter, what we tried to say and I believe we did was it was a one-time guide on originations just to help people orient their models given the shift from marketplace back to balance sheet.

But we didn’t anticipate guiding on originations every quarter thereafter. I think, what you do see in the raised guidance is embedded in that is our outlook on originations. So I would worked out through the model and go from there.

Rick Shane

Okay. Great. Thank you.

Operator

Ladies and gentlemen, thank you for your participation on today’s conference call. This concludes today’s conference call. You may now disconnect.

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