LendingClub Corporation (LC) Earnings Call Transcript & Summary

Good morning, everyone, welcome back. I'm Steven Wald, one of the payments analyst at Morgan Stanley. And for this next one, we have LendingClub with us. We've got Scott Sanborn, the CEO; and Tom Casey, CFO. Thanks to both of you for being with us.

Good morning. Thank you.

Good morning.

Before I get started, I just want to read off the -- and it's important. For important disclosures, please see the Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

Okay. So let's kick this off. Scott and Tom, obviously, it's a very unique period that LendingClub and a lot of other companies in the lending space are going through right now. And you guys have been pretty vocal in terms of your response to -- the pandemic response and disruptions to the economy, both in terms of adjusting your lending criteria, and I believe as of your latest update, reducing lending activity by 90% or so through April on a year-over-year basis, but also taking some planned expense cuts and repositioning of the business. Could we just start, how have things gone through May and into early June? Where do you guys stand relative to some of the areas you outlined for us on those previous plans and announcements in terms of impacts of the business?

Yes. Well, as you indicated, we -- as the kind of impacts of the virus started to emerge, we anticipated a challenging environment, and we did move quickly to position the company, protect the liquidity and enable us to be sort of patient and prudent while the situation unfolded. We pulled back on originations in anticipation of a decline in investor demand and cut a significant piece of our expense base pretty remarkably in about a 6-week period. And yes, as we said in our Q1 earnings call, we expected originations to be down around 90% from Q4 levels, and we're trending in line with that guidance. And we see this as an adjustment period. We think tightening underwriting standards is the prudent thing to do given the magnitude and the speed at which job losses are coming. So until we see a stabilization in that unemployment rate and investors are able to kind of get a handle on some of their own issues that get created in an environment like this, we'll be watching and monitoring and looking for an opportunity to kind of begin to scale again.

Understood. And in terms of some of the other responses you made to the business in terms of -- obviously, you undertook some headcount reductions and repositionings on the business model side of things versus just shutting down lending or reducing lending. How has that gone relative to plan? Is that sort of on time? Have there been any disruptions to that? Can you just give us an update there?

No. It's been -- look, we have a -- given the model, right, branchless, and we set ourselves up to have a high degree of variable cost. There were certain actions that were quite easy to implement. For example, cutting $50 million of marketing expense comes pretty quickly. Clearly, a reduction in force is a more difficult decision to make for any CEO. But given what we anticipated to be somewhat of a prolonged period of uncertainty, we thought it was the right thing to do. In terms of our ability to absorb that, it's gone actually quite well. I mean the -- we were all work-from-home enabled in a very rapid period of time and people are able to work quite productively. And we -- it wasn't just a reduction. There are areas we invested as well. For example, in our servicing, we significantly scaled up and actually added to our capacity there to make sure we're able to protect investor returns and support our members who we knew were going to be needing us in this time period. So I'd say that's all gone pretty smoothly. I mean we triggered the work from home before any of the city mandates came in just to make sure everything would work smoothly and it went so well, we essentially maintained that posture.

That's helpful. And it sounds kind of naturally set up consistently with how you guys have been talking about, shifting the business over the last several years. Like you said, you've upped the amount of expense that's sort of more reflexive and variable just naturally before any of this happened. So maybe if we take a step back and apply some of the things we're seeing more broadly in the economy and data to LendingClub, a lot of the data and survey work out there since April has indicated that people expect this to be a very temporary setback, but also the reopening is quite uneven among states that are reopened or never really closed have been much more robust and resilient versus ones that are closed are feeling the impacts much more severely. I'm curious if that's consistent with or if there's anything that surprised you in your own data or conversations with customers and borrowers in terms of whether that's applicable to what's going on at LendingClub and what that looked like relative to, say, conversations you've had with people who have looked for things like loan deferrals?

Yes. So it is consistent. We've conducted a couple of rounds of research amongst our borrowers, including those who are on hardship plans, and they themselves are quite optimistic. A little more than 2/3 are telling us that when requesting a deferral that they are likely to pay the loans off and fold. They view the setback as temporary. And they're confident in their ability to get back on track if they can be accommodated. Now it's too soon to say if they're right as the -- obviously, the path of the virus is going to determine somewhat the shape of the economic recovery. But that research and our own payment data, right, we're starting to see -- it's, again, still early, but our strategy for the deferral plans was to offer them in 2-month increments and to have alternative to a simple straight deferral available as people are graduating. And the early payment behavior has been encouraging and would seem to support their optimism. The other thing I'd say that we shouldn't forget is the consumer came into this a lot better prepared than into the last recession. The consumer balance sheets were a lot stronger. And we've seen consumer behavior here be quite prudent, right? You're seeing a real pullback in discretionary spend. You're seeing people accumulating savings. So I think they came in better prepared. Their behavior appears to be prudent. And then the last thing I'd add is the government response has been timely and significant and is clearly playing a factor in the strength of the consumer as well.

Yes. That's helpful. And maybe just a quick follow-up to that. The government piece of it, whether indirectly through people retaining their jobs whereas they otherwise might not or directly people receiving stimulus checks or enhanced unemployment. To what extent has that directly flow through to people returning to, I guess, pay their loans versus previously asking for deferrals? Is that something you see in a major way in those conversations? Or is it tougher to see directly because I think a lot of businesses that we've seen so far have not been able to tie this quite so directly to the stimulus?

Well, there are certain things we -- that we can see. For example, some of the research we did amongst our borrowers, for those who did receive any kind of government stimulus, the majority of them, the number one use was to put them towards living expenses. But they did say pretty high up on the list, let's call it top 5, where people were also using it to pay down their debt. And we ourselves saw a bump when the government stimulus checks hit in a small amount of incremental prepayment. So we are seeing that. Probably important to distinguish that the customer base, if you recall, we began moving up credits probably about 18 to 24 months ago. If you look at the loans we booked last year, you're talking about an average FICO of over 700, 706, average income of around $90,000. So our core borrower and the core profile was not sort of squarely in the bull's-eye, if you will, of the group that was so terribly impacted as the closure of the economy started to really drive unemployment.

That's very helpful. And I guess, as you pointed out, you did move up the credit box a bit there over the last several years. And it's encouraging to hear people are prioritizing living expenses and paying down debt over, I don't know, buying the new Nike's or something like that. So that's all very helpful. I guess as we parse it out even further along the lines of the reopening, you talked about expecting -- or remaining consistent with that down 90% for the quarter. But maybe as we look out to the second half of the year or even as early as July, how do you think even parts of the economy could appeal to LendingClub in terms of improving that year-over-year decline? Even if we're not going to get back to even by year-end or something like that, where do you see that path going over the next 3 or 6 months for you guys? And we can talk about the funding side of it later, but I'm just curious in terms of your willingness to reopen it there? And how much of that is tied to the level of reopening in a particular geography?

I think -- look, like everyone, we're excited to see things moving again. However, if you look at what's it going to take as we think about kind of opening up again and scaling originations, key thing is going to be unemployment stabilizing. It's obviously -- you can underwrite in a high unemployment environment. But in a volatile and dynamic one like this, you can verify that somebody had a job today, but will they still have a job in 2 weeks, at the rate we've been going, that obviously poses some incremental risk. That's why we really sharpened our focus to concentrate on our existing members. We switched to 100% verification of income and raised prices to add an additional buffer for investor returns. So if we look at what's it going to take to kind of open things up again, I think it will be a -- as much as we're all eager, I think it will be a gradual process. We've got to see the unemployment stabilize. We've got to see the performance of the back book materialize, which will require people graduating from the Skip-a-Pay plan, so you can see what the full payment history looks like and at least an early read on some of the new vintages. And again, I'd say we're -- we've been doing, obviously, significant amount of analytics on behalf of our investors who are trying to scope their own portfolio credit issues, capital issues. We've been stress testing the portfolios for them. And we feel quite good about both how we believe the back book will hold up. It will clearly be below our pre-COVID expectations, but we believe it will hold up well and generate still a modest return even in this environment. And we're pleased with what we're seeing with the profile of the new borrowers, both in terms of just their overall strength of the profile, but also the early read on behaviors such as first payment default or request for payment deferrals being extremely low. So for us, kind of want to see all of this play out a little bit. And at the same time, our investors all need to get their arms around their own issues, like I mentioned, to make sure they understand their own position before we can really begin to scale. So I think it will take a while. We are starting to see some engagement here. We sold about $70 million in loans off our balance sheet, which is encouraging, and we are having some investors begin to reopen the dialogue around what reengagement would look like, but still early days.

Understood. And I want to come back to the investor piece and the funding piece in a second, but real quickly because you talked about -- obviously, the credit quality expectations you have of your back book and your newer vintages, it was one thing back in February. It's another thing today, and it was another thing in April. Where has that tracked relative to, I guess, the initial read-through you guys were able to make of how you thought things would go? And it sounds like you're saying you still expect a level of profitability on most if not all of your vintages. And I guess I'm curious, you must have come up with some first track sense of where things could trend from here even back in April as unemployment was rising significantly. How is that moving against your expectations as we've come towards the reopening? And then, obviously, the market expectations have evolved. So I'm curious how yours have on a credit quality side.

So obviously, challenging to predict in this environment. But we're using a number of things to kind of help us model a few different scenarios. And while the -- as we mentioned, while the kind of severity of the job losses is high, the expected speed of the recovery, the government support, the kind of consumer, balance sheets coming into this, all we think do help mitigate that impact and our expectations for returns. Now obviously, the -- this is a pretty high-yielding and quite short-duration assets. So you're talking about the vintages that will be most vulnerable to the current environment are going to be those we originated right before, call it, February of 2020. And the further back you go, the more principal and interest you would have already collected. So our view right now is returns will be roughly half what we expected. And we're monitoring this data closely, like I said, and we'll be modeling out the graduation rates from Skip-a-Pay and how unemployment develops. Obviously, the most recent numbers were quite encouraging on that front as well.

That's all very helpful to hear. So let's come back to the funding piece. You were just talking about having some dialogue with your partners in terms of assessing their own capital constraints and whatnot. Maybe let's start with the banks, right? They're sort of 30% to 40% of your originations go to the banks in any given quarter. What are the conversations going? Like now where they going? How did they sound a month ago? Every bank has obviously been constrained by the need to fund PPP and sort of be all hands on deck. And I'm curious what the conversations have evolved into over the last several months? Because you guys have pointed out, not -- most of your funding is not specifically committed to sort of -- you have reliable reputation and long-lasting relationships with these investors over many years?

Yes. Yes. So it's really -- we have different groups of investors who have different issues and opportunities. You've got banks and -- especially those with exposure to small business lending and commercial real estate. As I indicated, they're working through their own issues with capital and credit quality and getting consumed by the making of PPP loans, which is taking both their management time and some balance sheet capacity. They remain interested in returning to our platform. We've delivered solid returns for years. And for many of them, we are a very attractive part of their mix. And for them, the focus has been on kind of examining their portfolios, right, that the conversations are overwhelmingly about how do we think about the impact of rising unemployment, how do we think about the impact of payment deferrals and how are we doing on our servicing levels. They're really thinking about how is their back book going to perform. So we're talking with the key clients there, really almost daily. But they're telling us, they absolutely plan to return. But I think banks will move more slowly. We've got a couple of other groups. We've got what we call marketplace lenders. Those are people who are likely going to move the fastest. They've created vehicles to invest in loans generated by LendingClub and our peers. Their entire business and an ecosystem around them has been built around our credit products. And so they've got principal and interest coming back at them that they want to put to work. They are -- they still have work to do themselves, assessing how they mark the value of their funds and process redemptions and what's happened to their cost of credit and their advance rates. But we're actively communicating our expectations on the portfolio, opportunity for new issuance. And we believe that they'll be able to return as a group somewhat more quickly. And then the last group is asset managers -- the large asset managers. They've got capital. They can purchase in big volumes, but they also have a broad investment mandate and can be very opportunistic. And right now, there's opportunities for them to be had, right? People looking for liquidity, willing to sell at deep discounts. And we're not -- we don't -- we're not in that position. We're not forced to sell. So we'll be patient. And I believe once some of those opportunities calm down, we feel good about getting them back to the platform as well.

Totally understood. And it sounds the way you laid it out, like in some instances, the investors are, let's call it, the brakes of the issue, right? Banks, you said, would be a little bit slower to come back, but asset managers have a lot of capital to move and so they can be nimble. And certainly, with the low rates piece, I'd expect longer term, this is -- and correct me if you feel differently, probably helpful in the way that LendingClub originally expanded so rapidly in a low rate environment at the beginning part of last decade. But in the near term, would you say that for the majority of the funding that you want to do or that's coming to the platform that you'd love to write to that you're more of the brakes or more of the gas in terms of wanting to write the loans in terms of being a steward of capital versus having that capital available to you?

It's pretty -- obviously, the 2 things are related and our ability to prudently underwrite an investor's ability to thoughtfully deploy capital are linked in the challenges in this environment. But in terms of the weighting, I'd say the decline in volumes is roughly 50-50 between what represents credit cuts by us proactively done versus the capital constraints by investors. And you brought up the last recession. You're right. We did very well coming out of that. That's where we leveraged our model and our focus on customer experience to build the whole asset class. When I joined LendingClub in 2010, the annual originations for personal loans were $10 billion. And last year, they were $120 billion, and we were the market leader, doing $12 billion, right? So more than the entire asset class generated in 2010. And when I look at this recession, there are some key differences. One is we have an entire ecosystem of investors who understand the asset class. And secular trends are also more favorable. At the time, back then, we were really trying to drive adoption for consumers, getting them to go online, being willing to provide their financial data. So we think the secular trends are in our favor. And we think coming out of this, having investors who are familiar with us and with the assets, being in a low yield environment, having banks continuing to close branches and consumers willing to go online. And likely, as always, consumers looking for savings, right, which is the core value proposition we provide, looking for a way to create some room in their monthly bills. So we feel like -- while we do expect it to take quite some time, we do feel like we'll be well positioned. And returns coming out of this, they're going to be -- obviously, some of the best returns LendingClub has generated were coming out of the last recession, and we would anticipate a similar profile here. On top of all that, imagine if we have a clean and unencumbered bank balance sheet to lean into. So I think there's a lot we believe that [Audio Gap]

That certainly makes sense. Did I lose you? Are you still there? Just making sure I can hear you. Tom, are you coming through here?

I am. Yes. I'm here. Can you hear me?

Okay. Yes. I can hear you. I'm not sure if Scott has stayed on, but perhaps I'll ask you if he's not able -- if he's not on the line.

Can you hear me?

I can hear you. Can you hear me?

Yes.

Okay. Great. Okay. We're all here. Sorry about that. Technical difficulty at this new age of conferences. So you actually mentioned of the bank balance sheet. Maybe that's a great place to transition towards new low rate environment, new expansion period. You're going after to the Radius deal. And so that opens up a lot of opportunities as you guys talked about back in February. And from when we last spoke, I think it was at our Morgan Stanley TMT conference and then back during earnings, it sounded like the -- or as you viewed it, the goalpost had shifted, reasonably speaking, to away from you need to deliver profitability, which looked like it's going to be tougher to do with the virus disruptions towards just showing that you've got all the processes and risk management of a bank already in place. Any update here from your conversations with regulators or your sense of what the bar is that you need to clear to close the Radius deal in 2021 or is there any shift in your thinking since then?

I'd say broadly speaking, no, you're right. We were very focused on demonstrating that the business could be profitable stand-alone. And obviously, we made very good progress against that last year. The virus has changed the landscape. But we have remained very constructively engaged, continue to feel like the rationale for the deal is strong and we continue to believe that even as much as everything has changed that the economic value here of the deal being able to pay for itself within 2 years remains. So can't imagine a better time to be creating a digital bank than coming out of the recession. We think we'll have less competition as we emerge from the downturn. We won't be encumbered by the branches. So we are very, very focused on meeting the regulatory requirements and working towards completing the acquisition, which we think at the latest will be at the end of Q1 next year.

Okay. That's very helpful in terms of the -- sticking with the updated time line there by end of 1Q. You talked a bit about coming into this, you're feeling less encumbered by competition and you're sort of well positioned coming out of it. And certainly, within your own customer base, you must be learning a lot of lessons and data about what the customers' needs are in a time like this. But I'm curious, between your own customers today and the customers of the Radius side, which I believe is mainly the deposit side you're after, what sort of shifts in behavior you're seeing on both sides in terms of where you could take this new combined entity over the next several years for a product or lending or deposit side expansions to meet those needs and really grow the new bank once you're able to close the deal?

Yes. So the -- I don't want to comment too much on their business. But I guess, some broad themes is what we're seeing is consumers shifting to savings, right? People accumulating savings right now and Radius is seeing a similar behavior, which is obviously encouraging and will set us up well once we get through this process. The other thing we're seeing is they have a reasonably large SBA business. And that -- they have pivoted their energies in this time period to be able to deliver the PPP loans and have really just done a remarkable job and kind of shows the cultural alignment between the 2 companies. They cranked on creating an online process over the weekend as this was unfolding and have done hundreds of millions of dollars in PPP loans, and I think provide both a reinforcement of kind of how the 2 companies think alike in their agility and focus on -- ability to move quickly and focus on the customer need. But also, I think, provides a potential for a really nice balanced portfolio as you look at the combined entities.

So it's interesting to hear in terms of how it diversifies you naturally and talking about the SBA book, which I don't think was quite as dimensioned out in previous discussions. But maybe shifting towards the financial aspect of this. And Tom, you and I spoke about this a few months ago of the volatility in the first year of earnings. And I know you guys haven't really provided too granular look post the virus disruptions to what that could be. But I'm curious how you're thinking about the goals you laid out in February for the deal in the year 2 post close period? Obviously, year 1 was always going to be volatile, and we talked about the differences between the cash and GAAP earnings with the reserving requirements. How are you thinking about the 2022 setup, I guess, year 2 of the deal now if you're able to close next year? And what that will look like given you've now gone through a different environment since you set those goals up?

Yes. I appreciate it. I think the -- everyone understands that the environment has changed significantly. However, we still feel really good about the transaction. The economics that we projected are still intact, although the method has changed, obviously, with rates being so much dramatically lower than even just a few months ago. That's obviously one driving impact. And then obviously, with our ability to portfolio our loans continues to be intact, as Scott mentioned, our ability to grow a personal loan portfolio at this part of the cycle coming out of the COVID situation. So we feel very good about -- on that. Specifically, as we talked, the CECL provisioning will have some short-term impact as we grow the balance sheet. However, on a CECL-adjusted earnings basis, we feel very good about the ongoing value that we'll be creating as we capitalize the bank and grow their balance sheet. So we feel like we're well positioned to do that and still feel very good about the acquisition on track, as Scott mentioned, with regulators and are pushing forward, but feel very, very good about the transaction.

Completely understood. All right. Well, it looks like we're out of time. I don't see any questions on the queue from the webcast. So I want to take the time to thank you, Scott, and thank you, Tom, for jumping on the phone with us. I know it's a unique period, but we appreciate you being with us for the conference.

All right. Thank you.

All right.

Thank you.

And that will wrap up for us for now, and we'll be taking a break here, and we'll come back, I believe, next up in our side of things will be a keynote presentation for the broader financials conference and then Visa from the Fintech Symposium side. Thank you.