LendingClub Corporation - the elephant in the room

June quarter is a strong beat

LC reported a strong set of results in its June quarter financials. Operating leverage and loan repricing have boosted growth in both originations and margins. At $2.8B, the originations set yet another quarterly record and exceeded street's expectations. The company posted $25.7M in June quarter EBITDA (adjusted) versus $15.3M in March. The cash net income (non-GAAP) came in at $14.0M up from $4.6M reported in the March quarter. Both EBITDA and earnings beat consensus estimates significantly. The management did not change the full year guidance for revenue and earnings.

The elephant in the room

The beat is strong and the operating outlook is not bad but the management is being cautious and not raising the outlook. Reiterating the guidance is the sensible thing to do taking into account the downside risks. Legal and regulatory challenges with FTC and SEC, respectively, some of which are dating back to 2016, continue to weigh on investor appetite. There is probably some progress there but not all investors who fled after the fraud scandal and the 2016 resignation of its then chief executive, Renaud Laplanche, are fully convinced. It could conceivably take longer for some creditors to start investing again.

The larger and operational risk lie with the NPLs. LC had previously granted loans too liberally and downplayed the underlying credit quality risk. Strong revenue generation and margin growth driven by relatively low cost of funding masked the asset quality problems in in 2015. From 2016 onward, the company has started reporting significant deterioration in credit quality driven by delinquencies in 2014/15 vintage loans. In response to the spike in early stage delinquencies, the company has started implementing a new credit model using a different set of client analytics. The delinquencies should stabilize over time; and improvement in credit profiles of new borrowers is likely to reduce the overall size of non-performing loans.

New credit model to mitigate bad loan risks

Here is how the management thinks the new credit model will help reverse asset quality deterioration. The business is bringing additional data into client underwriting process to improve assessment of borrowers debt management behavior and capacity.  The management says the new data is orthogonal to the credit bureau and better identify the risk. The data incorporated to the new credit model will ensure the company “…deliver value to investors and provide a stable foundation for growth”. The personal loan market is getting increasingly competitive, only those that are well-positioned in their niche markets or those with realistic marketplace models, data, technology and product investments offering a compelling product to a very broad range of borrowers while delivering an outstanding experience.

About LendingClub

Lending Club is a peer-to-peer lending platform that essentially takes out the banks and other institutions and allows the public to lend and borrow money on interest. Lending Club itself facilitates the transactions by (1) reviewing for approval the loan applications from the borrower, (2) assigning a rank, which is effectively a credit rating, to price the loan and hence deciding on an interest rate, (3) underwriting the approved loan, (4)  putting those loans on its website to be crowd-funded. Lending Club generates revenues by (1) charging a fee to the borrower for the service of underwriting, (2) collecting a portion of each monthly payment.