LendingClub Corporation (LC) Earnings Call Transcript & Summary

Okay. All right. We'll go ahead and get started. So I'm Steven Wald. I'm one of the payments and fintech analysts here at Morgan Stanley. I'm joined by Tom Casey from LendingClub. Before I start, I'll just read off the disclosure. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk.

All right. So lots of stuff going on at LendingClub. So maybe a quick place to start is how we kind of got here. Tom, do you want to just sort of give us the rundown on how we kind of sort of come through 2019 to this point up to the Radius deal before we dive in on that?

Sure. Well, we had a terrific 2019, continuing on our focus on driving profit and efficiency across our business. We were able to exit the year at about 20% EBITDA margin, which has been a goal that we set out a few years ago at our Investor Day. The most important thing that's probably been driving our profit, though, is where we're seeing it come through the financial statements. We're seeing it come through in the efficiencies in our acquisition area. So you're seeing that come through in contribution margin. Contribution margins are now in the mid-50s, up from the mid-40s. And we're also seeing our ability to leverage our scale in tech and G&A. So we moved about 550 positions from San Francisco area to Salt Lake area, so significant savings there. And we also reduced our footprint, about 90,000 square feet in San Francisco. So we're really starting to leverage our scale, and you're starting to see that come through in the profit for the year. We also broke through GAAP profitability in the fourth quarter. And so again, just another example of where we're really starting to drive margin expansion in the company.

Great. All right. That's a sort of a good jumping-off point there. We've come to the bottom line profitability. And then obviously, with 4Q earnings, you guys came out and announced a pretty watershed acquisition in Radius Bank. Separate of what's been going on in the market, there was -- the tough reaction, I think, on the stock even if the strategy and everything was written out there. Just high level, what do you think the market's missing with the deal? I know we followed up, and you guys have certainly been pretty bold up on this.

Well, there's really 2 important stories. There's clearly a financial story and a consumer story. So let's walk through each one of those. On the financial side, it's a very compelling acquisition. We are effectively vertically integrating our current business into a bank. For example, we have issuing banks today. We estimate that we were able to save about $25 million of costs that we incur today, which come immediately back to our financials. With the bank, you also get the financial benefit of being able to fund some of our activities at much lower costs. And we estimate those to be about $15 million. So just between those 2 alone, saw $40 million of synergies and with EBITDA of $135 million last year and just barely GAAP-profitable, these flow right to the bottom line. And in addition, we also see an opportunity to provide -- an opportunity for us to deploy capital more efficiently. We've got about $900 million of capital today. Even with the acquisition, our tangible book value will be about $800 million, so a significant amount of capital to deploy. We're estimating that we can put about 10% of our volume, which would be randomly selected with volumes on our balance sheet. And we think we can triple the economics that we currently earn today. So pretty significant, very compelling financial pieces to this. But that's only part of the story. The other part of the story is on the consumer side. We are building a consumer franchise on the lending side. These are retail customers coming to us to borrow money. We are using our technology and our scale and our data to deliver savings to them compared to alternatives they have. We see a rapid opportunity on the deposit side to be the same thing. We have an opportunity now to use technology to provide additional savings on banking products and additional improvements in their rates that they earn on their savings compared to more traditional banks. So we see this as a real compelling story for consumers. We're building a very strong consumer franchise, both on the asset side now and on the deposit side. So we're quite excited about the -- bringing Radius into the company.

Fair enough. Maybe sticking with the consumer and the product side. I definitely want to come back to the earnings piece. But in terms of deepening that client relationship, I mean, we've had a few more private names at the conference that are sort of -- and also public ones that have sort of banking alternative features to them or their core franchise is an alternative to banking. How do you feel this new LendingClub Bank is going to differentiate itself among, let's just say, a growing crowded space each year? And especially now that we think about, you were saying -- talking about the savings aspect with rates sort of moving the way that they've been more recently?

Yes. So I think consumer, the general -- the broader trends, the consumers are coming online in -- more and more to find savings and now more functionality with their banking products. So that is a secular trend that we believe we are well positioned to deliver a compelling offering. So in the deposit side, there has been a lot of folks building franchises on the back of deposits. We came at it from a different way. We came at it from the lending side, which we think is more complicated, underwriting, risk management compliance, and we think we can actually do the same thing on the deposit side now. So we feel that there's a pretty significant interest on the part of our members. We went out and surveyed our members and asked them, "Would you be interested in a checking account if we were to offer it?" 90% of them said yes. And so with our NPS scores of up 80 on our -- with our members, we see an enormous opportunity to provide them with another service that they're currently getting from other providers in a seamless way. And so -- again, everyone is trying to use technology to provide better products and services, and we're doing that as well, but we have over 3 million members now to be able to grow off of.

Yes. And as you look into going into that current customer base you have just at LendingClub alone, I think you guys had talked about sort of a more dynamic checking or card-based product where you guys could not only tackle the deposit side that you haven't been able to do so far, but offer more dynamic lending products than what you have currently. Can you talk a little bit about what you see there as the opportunity? What that would look like conceptually?

Yes. We're really excited. I mean if you think about today, consumers are coming to us looking for savings on their credit. We are accessing their deposit accounts at other institutions. And now with the bank account with us, we're going to continue to be able to underwrite them continuously and provide them with savings ongoing to be able to have quick access to their credit. And so it's very, very integrated for us to have this in a very large base to drive from. So for example, we're already doing things like, with our current members, one-click loans where a consumer has been continually underwritten and has access to credit on demand. And so this is another example. There's no new underwriting process. We're continually underwriting them. So we can provide speed and access that they can't do today. So those are the types of things that we're looking at. We're building out what we call our Member Center, which is allowing us to provide additional services of monitoring their credit, making sure that they're paying on time and allowing them to avoid some of the other costs associated with credit. So these are some of the exciting things that we think we can bring technology to bear. And we're excited about the acquisition of Radius to be able to further extend our reach into more general -- or more traditional banking products.

Great. It sounds like crossing into a lot of lanes there in terms of those products. Maybe bringing it back to the LendingClub-specific model. Obviously, you offload your loans today, and becoming a bank, you're going to keep some of those. If you think about these new products, would that be something you would want to keep more for yourself? Or would that be something you would open up to the funnel of the partners you have today?

One thing to keep in mind, we're going to be -- continue to be a marketplace bank. We're not intending to keep a disproportionate amount of our assets. So we've put out in the market that we would be retaining about 10% of our loans. They would be randomized, just like they are for our existing investors. The feedback we've gotten from investors is quite strong. They like the fact that we're going to eat our own cooking. We're going to participate in the value stream at a reasonable level. At the same time, it will also allow current investors to get comfortable with our policies, procedures and controls as well as bring on new investors that are required to do quite a bit of third-party vendor management reviews on us today. So by having regulated by the OCC and the Fed, we think that can actually open up additional investors. So we think this is actually a growth opportunity for us and one that, I think, streamlines our current relationship with investors.

Fair enough. Well, speaking of, like you said, eating your own cooking, and so we're getting ever longer in the cycle here and, obviously, you're changing up your structure. So how should we think about sort of the risk modeling of LendingClub today as a current structure? And how -- whether a cycle downturn? And now looking forward to once you close the deal, what are the differences there? And sort of how should we think about that risk as you start to retain more of that?

So one of the feedbacks we've gotten from investors is that, obviously, folks wanting to understand our resiliency and our liquidity and funding, how we're going to operate through the cycle. And we think that with the combination of LendingClub and Radius, we think that we actually reduce a significant amount of those risks. We get regulatory clarity, as I mentioned. We are now funded with retail deposits, and it also allows us to diversify our revenue streams that we have today. So being able to have a new revenue stream in the form of net interest income is, again, a way to build resiliency through the cycle. It also allows us to balance the platform in a more efficient way. So there's additional benefits from there. But I think that the key issues that the LendingClub has today are quite significantly mitigated with the Radius acquisition. I think as you think about going forward, putting some assets on the balance sheet will allow us to actually be able to have continuous, predictable earnings coming from those loans in short-term dislocations in the market. So it provides a nice resiliency for us.

Got it. Okay. So maybe shifting gears back to the earnings stream. I know it's something that's been quite a point of contention. And certainly, we, as external constituents looking at the stock, we admittedly have had a bit of trouble modeling this in. And it sounds like there's a wide disparity between the cash-on-cash return versus the GAAP earnings. And as you become a bank, the GAAP is going to matter quite a bit, especially as you impact the -- get impacted by CECL. Could you just walk us through how year 1 is going to kind of look? It looks like there's a big disparity there and sort of it gets more in line in year 2 and year 3. How that's going to look on an accretion basis versus...

Yes. So there's definitely a difference between the accounting -- reported accounting GAAP net income and cash. And so what we've tried to do in our quarterly earnings call, we showed the cash benefit of the Radius acquisition. We estimate that, as I mentioned earlier, about $25 million coming from issuing bank savings, another $15 million from wholesale. Those come in pretty quickly. So within the first year, you're going to see that benefit right away. With regard to growing the balance sheet, that's going to be depending on timing and how fast we grow. And as you mentioned, the CECL provisioning aspects are different than the cash charge-off amount. And so it may have a little bit of a J-curve here where your early year -- early quarters are having impacts from provisioning. And then the payback is the net interest income with very low provisioning in the future. So there's definitely that timing difference. But when you look over the horizon, I think if you're modeling us out over the next couple of years, we believe that you would be able to see that $80 million of value to the bottom line within the first 2 years of the company. So I think looking over the horizon, the reason we're focusing on cash is if we're growing the balance sheet faster, that may be more capital deployment in the early years, but improves our profitability in the future years. So it's a balancing act we'll have to drive. But I think it's one that we think -- as we talk to more and more investors, they're starting to understand the real value we're creating here by creating the retail franchise on the asset side, the retail franchise on the liability side and the timing of earnings may be different because of the growth in the balance sheet, but the value creation that we get on a loan is pretty significant. So let me just pause for a sec because today, for every loan we earn today, with every loan we issue, we earn about 2.5 points of what we call contribution margin, right? And that's the transaction fee we earn less the cost of acquiring, okay? So about 2.5 points. When we put a loan on the books, we actually triple the economics. Over the life of a loan, we earn 3x as much as we earn today on 1 loan. So it's very significant economic. Today, we have about $16 billion of servicing portfolio. And at a 5% kind of return, that's $800 million of cash we distribute to the market today. And so being able to take a portion of that and allocate the capital we have in efficient way inside of a bank structure is quite compelling.

Okay. And then just maybe following up on that, right, because like you just said, that sort of J-curve. Obviously, understanding that once we get out to, say, 2022, 2023, you start to see a bit of a clarity there. But you're still going to have Radius coming on the book in that first sort of year. A lot of what's going to be held on the balance sheet is going to be driven by the Radius pieces. As we think about the CECL provisioning and the credit quality of the book and the fact that you're going to mark this one upfront under the old guidelines, how should we think about, A, the noise in terms of how long that part takes to come out for getting the accounting differences with just Radius in terms of how long that will run off, and what that replacement cycle might look like in terms of targeting the Radius customer base, if at all?

Yes. Look, I think the combination of the 2 balance sheets -- well, we'll be clear on what our intentions are at the time to make sure that everyone understands how the balance sheet will evolve. But I think it's -- I think the simple way to think about it is if you take Radius today, we don't see significant changes in their business model. What we see is an ability to accelerate their business model by connecting it to our funnel. Keep in mind today -- last year, we had 14 million applications, people on keys filling out applications. The broader strategic opportunity that we have is to be able to provide mobile products and services inside that marketing funnel. Anything that we can provide, be it expanding credit, deposit products or other credit products like mortgages or student lending, allows us to further penetrate our member base and provide our members with more savings. And so while the asset piece may be driving some short-term income profitability differences between reported and cash, the broader macro fundamentals that we're driving are quite compelling because the ability to build retail franchises, we're not subject to the capital markets, we're not subject to fair value issues on our assets. So we're building something that we believe is very durable.

Okay. All right. Let's switch gears towards getting from deal announcement to getting it closed. Obviously, a number of different companies, including you, have gone in the last year-plus to try and go get a banking license of sorts, and you had a number of different options you could have gone with. So you took a look at the de novo process and decided to go with an acquisition. Just walk us through the thought process. What got you there? What got you there specifically on Radius versus -- I'm sure there were a number of options. I know you guys talked a little bit about why Radius, but sort of why them versus alternatives and why them versus a de novo or even going for something like an ILC as a result?

So I think acquisition has always been our #1 priority. The challenge has been to find something that is for sale and that makes sense. So we spoke to regulators over the last year, frankly, as part of a de novo strategy to say, "Okay. What is the path for us?" We have a lot of the infrastructure in place already. As I tell people, we're kind of -- our costs are like a bank, but we're not earning like a bank. And so for us, when we met the folks at Radius, it was quite unique because there's not many banks in the entire country that have closed their branches and is focused only on deposits and using technology to engage consumers, and we found out that was Radius. And so when we started to talk to them maybe about a partnership, it quickly became much more comprehensive on what we could build together. What they've built, the engagement model that they have with their depositors has been rewarded as one of the best online banks. They have a number of current fintechs that are powered by the back -- on the back of their deposit-generating capabilities. And so it became just a really compelling use of our capital to really change the trajectory of our company and really allow us for this next wave of growth. The team there has been tech-focused for years and has really built some very, very compelling offerings for consumers. And so we're quite excited to offer that type of product in our funnel, being able to offer consumers savings on borrowings by having their deposit accounts with us, being able to continually underwrite to them, being able to provide savings for them at rates that they can't get elsewhere. We have no legacy infrastructure. So our ability to provide more services and more value to depositors is the same exact as we did for our borrowers. We don't have any branches. We don't have any legacies. So our ability to give the borrower a better value has been because of our lower cost technology focus. So we see this as a really compelling thing. And so back to the objective here is, what was the fastest way to do this? And so we looked at de novo and ILCs, and we felt that this was, by far, the best approach for us. It allows us to get to scale faster and allows us to take an existing product and put it into our funnel -- marketing funnel in a more efficient way.

Right. And so when you talk about fastest and most comprehensive and sort of starting off on the best foot in terms of the options, I think one of your peers had talked about potentially being able to get approved on a de novo basis in 2021. So sort of 12 to 15 months is what you guys had outlined when you announced the deal. Why is that conceptually right for you? I mean it sounds like it's maybe a little bit faster than what they were saying. And what are the keys to getting this close? It's a bit unprecedented, so it's hard for us to find the road markers here in terms of what you need to do to ensure that this closes.

So as I said, we have a lot of infrastructure already in the key areas of compliance and regulatory review and risk management, and we're going to continue to build those. I think as part of this review process that we're going through, we'll -- I'm sure we'll continue to put things, infrastructure and audit and controls and credit. But I think, for us, we still believe this is the fastest route for us. As you mentioned, there's a number of others that have been trying to get their charter. It is a challenging process, but we've been up and running for 12 years. And we originated $12.5 billion in loans last year. And so the -- our relationship with the regulators and our relationship with our banking partners has been -- positioned us for this type of opportunity. And so we do think it's a unique situation, having a nonbank buy a bank, but it does require 2 regulators to review and they need to be coordinated. And so it just -- it will take some time, and we're going to move as quickly as we can through it.

Got it. I want to make sure I open the floor and the time in case there are any questions.

Tom, I wanted to ask, as you go through this acquisition and given your history through lots of different iterations in the banking space, what do you think the regulators are going to be looking at most closely and intently to, A, approve the deal and allow you to kind of move forward with the strategy?

I think it falls into the normal areas that they focus on, things like compliance with banking regulations, which we do today, deep credit analytics so they understand that we've got risk management there. Obviously, all the compliance areas with regard to consumer regulations, which, again, we are highly focused on in being compliant. All of our investors want to make sure we're compliant. So I think that will be a focus. I think our growth -- they want to understand our growth profile and our business plan. We've already provided them with a significant amount of information on what our business plan is and how we want to operate. Those are the things that I think they'll be focusing on. And like I said, we're well positioned. We've already put in 3 lines of defense. We already have a lot of our policies and procedures reviewed. Just to give you some perspective, last year, we actually were subject to about 40 audits where our investors are coming in and reviewing our data encryption and our BSA/AML and all the other regulations that are required to do this business in a compliant way. So again, we feel like we are well positioned. I'm sure we'll have some things that we'll need to build up more capabilities to handle the growth, but we're encouraged on the early conversations we've had. We obviously did a lot of work before we announced this transaction, so we're encouraged.

What is your thought on if, let's say, you still do your balance sheet lending as well as marketplace lending, so what is your thought about the corporate governance of how you would -- things that you put on balance sheet and put on the marketplace? And the other thing is -- the second question is from the depositor side. The people I -- people that used to lend money on your platform, how do they see them? How do they see them now that even though, let's say, now they put their money in your deposit base, they still lend to the same because -- indirect to you guys, they still lend to the same group of people. That means -- do you see that they will pull back in a sense, let's say, as they see they want to diversify the risk?

So really, really important to know that any loans that we put on our balance sheet are going to be randomly selected, like all of our investors. So keep in mind today, for example, when we do an asset-backed security, we take a random selection of loans as well and sell those in the capital markets. So there's no cherry-picking of assets. So just to be really clear, our investors are fully aware of that. The way our model works is we get the same random selection as others. With regard to the peer-to-peer lending, the peer-to-peer lending continues to be an important part of our business. It represents about 5% of our volume right now. Right now, we don't see significant changes in that. They currently are buying loans, again, randomly selected that are posted to that platform and then are purchased in what we call participations, so smaller dollar amounts. And we don't see that changing in the short term.

No. I mean I was referring to your -- you discussed a lot about the funnel, like the funnel on the deposit side. I thought about the funnel, let's say, from year 2000. One is the borrower side. The other one is lender side. So I suppose you want to -- by having a banking license, that allows you to deposit, so that means you're leveraging on the existing lender funnel for them to put their money as a asset deposit in your bank.

Yes.

But if you use turnaround and use this deposit money to lend to the same group of borrower again, then what will the consumers -- the lenders see from their side? Because therefore, it doesn't look -- because for them, it seems like more like a financial engineering because they get the same risk exposure but -- because of the fact that now you have -- you stack them differently, it gets them more values and less of...

Yes. So what -- yes, I see. So what you're saying is that we believe that depositors that are going to be attractive to our offering in the funnel, as you referenced, this is just extending the relationship. What we have seen is that consumers that are part of our membership, meaning they've come in, they've done a -- they've been part of the club, they pay down their loan, we're finding that there's a higher frequency for them to come back and do additional loans and save additional dollars. So the engagement is quite high on the lending side. We believe on the deposit side, again, that relationship, we're going to be able to provide them with additional savings, be it overdraft fees or higher savings rates. So if you think about just cap -- cash management, when someone takes out a loan, that doesn't mean they don't have anything on deposit. They may take a piece of the loan that we give them and put it on deposit. They may be managing their short-term cash flow. And so it's really about engagement and providing value to both -- to them, both on their banking products as well as on their savings product. So the evolution will be there. In a situation where they need short-term credit, we provide them credit. But once they pay that down, they may be looking for additional savings or overdraft protection or something like that that changes their profile from a borrower to a depositor.

So I wanted to come back maybe to some of those that was raised around closing the deal and what the regulators are going to be looking for. It sounded like during earnings and follow-ups that profitability was going to be key. And a lot of what you're doing is showing that resilience of the earnings stream. And obviously, 1Q is guided to be sort of neutral to a slight loss. But how key is profitability going to be in 2020 to getting that approval? And how much of that is driving that more conservative 2020 guide versus just general conservatism or the higher bar of customer profitability?

We've been very clear that driving profitability has been critical. And frankly, with regard to our efforts and our disclosures last year about going after de novo banking charter has been driving our focus on profit. And that's why you're seeing our EBITDA margins expanding, hitting the GAAP profitability. As we went into the guide this year, we want to make sure everyone knew that the real value creation here is to be profitable in 2020 and position ourselves to get this charter approved to really position the company for the next wave of growth. So we're not reaching for credit. We're not reaching for growth. We have a very, very strong profile that we ended the year. We think we can continue that profile through 2020. We're still guiding mid-single-digit revenue growth, but we think we're going to get significantly higher than that bottom line growth. So at the midpoint of our guide is about 20% bottom line growth, mid-single digits top line growth. And what that results is a continued focus on efficiencies, conversion efforts and driving the profits to the bottom line and leveraging our scale.

Perfect. Well, I think we're out of time, but I want to thank you for coming.

Thank you very much. Thanks.

Yes. Thanks.