LendingClub Corporation (LC) Earnings Call Transcript & Summary

I'm Arren Cyganovich, I'm the consumer finance analyst at Citi, and we're very pleased to have with us LendingClub. We have Scott Sanborn, the CEO; and the new-ish CFO, Drew LaBenne. So thank you very much for attending.

Maybe first, we could just start off. You've had a lot of changes in the firm over the years. Some big ones or acquiring a bank? Maybe you could just talk a little bit about the evolution of LendingClub and where you are today?

Yes. So company started in 2007. Basic idea then unchanged today was retail banking was sort of the last frontier to be disrupted by technology and pay lendings a data problem and the customer experience is terrible and a product customer-focused tech company should be able to solve those. And we got going and we're able to drive initially with our marketplace model. So the funding provided -- we would acquire the borrowers, do the underwriting, assess risk pricing and then the loans were sold to a broad range of investors, everything from banks and credit unions to asset managers. We're able to grow pretty significantly. We became market leader in the unsecured loan space. And then to your point, 1.5 years ago, we acquired a bank, and the bank has really transformed the financial profile of the business because we still sell about 75% of the loans, but we hold 1/4 of the loans. And the loans we hold, we earn 3x as much on. So that's a new revenue stream, interest income coming off the balance sheet. And we've knocked out a bunch of expenses. We no longer need to use warehouse lines to pool loans. We don't need to pay third-party banks to issue loans for us, we can issue our own loans. So that's the financial side and on the strategic side, gives us the ability to do more for our customers. We've acquired over 4 million customers, very, very satisfied NPS scores, high 70s, low 80s. And so we can do more than help them off of their -- save money on their lending. We can now help them manage their spending as savings.

Great. Maybe just talk about the industry outlook. Obviously, with pandemic is now kind of moving behind us, and we have inflation pressures that are hopefully starting to ease with the most couple -- recent readings. But we still do have some macro uncertainties with the Fed pushing rates up higher. What are you seeing from loan demand? And where do you expect that to trend over the years?

So for us, our core use case for the product is actually refinancing credit card debt. So more than half of the people who have cards don't pay them off. So effectively, they have a loan. It's not a good loan. It's a high rate. It's a high floating rate and credit card balances are back at pre-pandemic levels. There is $1 trillion worth of outstanding credit card debt right now. And interest rates on cards are at record highs. So for us, that's -- you can consider that the core addressable market, it's large and it's growing. So borrower demand is strong. To your point on underwriting, I'd say we have been signaling since about this time last year, some caution on the outlook for consumers just given how much is changing, stimulus running off, inflation starting to kick in. And we had been underwriting, even during the pandemic when things were so benign, we had been underwriting and pricing at -- with pre-pandemic models. And on balance, we're even tighter than that now.

Okay. And then maybe just talk a little bit about how you go out to acquire customers, what the strategy is there? Has it changed post-COVID and from adoption, I guess, digital adoptions accelerated. So how does that impact your business?

Yes. So we're digitally native. Obviously, we don't have -- well, we have one bank branch in Boston, everyone's welcome to visit it. And so we've been online when we -- since we started at the time, we were breaking new ground, people giving their social security number over the Internet was a new thing. So for us, the -- what really was kind of a sea change in driving consumer choice for the pandemic, people going online, now their largest driver pre-pandemic of your bank choice was branch location. Now it's the mobile app, and we've got an award-winning, multi-award-winning mobile banking experience. It's been a great thing for us. Just kind of a broader tailwind and what we find is once people go online, and they realize how easy it is, they also get a sense for -- it's much easier for them to actually compare and we really shine on saving people money and delivering value to the customer. So it's a positive thing for us.

Are you acquiring them primarily through marketplace? How are you going out and attracting...

Yes. So we've got -- I mean, we are pretty sophisticated direct response marketers. So we use at this point, enormous amounts of data to drive marketing, targeting, channel selection, creative selection, pricing, all of these things to drive acquisitions. So we're primarily online but not exclusively. We have -- and our value proposition is generally -- you already have a loan, it's a crappy one, let us save you money. It's going to take you 2 minutes. And we also have an auto refinance product. We save people $80 a month and a typical loan is 5 years. So $80 a month x 60 months, it's a lot of savings.

Great. Maybe you talk a little bit about the growth strategy. I understand that you're pulling back a little bit in this kind of macro environment. But I guess, longer term, how do you envision the growth of the company?

So as I mentioned, that core TAM is large and growing. So for us, continuing to tap that is going to be a primary driver of growth. We also -- personal loans when we entered the market, they weren't really a thing anymore. I think the annual originations, when I joined the company in 2010 for the whole category, was something like $10 billion in last year, that number was more like $150 billion. And we alone this year, will do $12 billion, $13 billion in originations. So that's a growth driver. As we've increased the ease of access to credit through this product, it's also increasing the utility. So people, half of our customers come back to us within 5 years for another loan. And the use case evolves. It will be home improvements. It will fund fertility treatments, tuition for your kid's private school, those kinds of things. So that's -- again, that's all in the core unsecured space. We also are growing this auto refinance business. Primary target we're going after there, it's not new car sales. Those are supported by manufacturers and dealers and generally can get a good rate. We're going after the majority of cars sold in the used car market, where the dealer adds a markup. That is not visible to the customer. So they drive off the lot paying 200, 250 basis points more than their credit risk would indicate. So we can save them on that. So we see over time, the ability to do more with lending and help people up the cost of lending and then also the ability to help people with spending and savings. So hey, great news, we're saving you $80 a month off your car loan. You want us to lower your payment by $80 or do you want us to take $80 a month and put it into a high-yield savings account at the end of your loan, you're going to have $5000 in savings or hey, congratulations you're approved for LendingClub personal loan, if you put into a LendingClub bank account, we'll give you a better rate. So we see an ability to really create a bit of a flywheel around surrounding the customer with products and services.

Do you envision opening up new lending categories down the road? Or right now, just kind of focus on those 2 as you mentioned?

No. Over time, we plan to do more. So the unique thing about our customer, they are prime creditworthy customers average FICO is, call it, 720, 730. Average income is around $110,000, $115,000 a year. So they're very, very creditworthy. What is valuable and unique about them is they overindex for every form of credit. So they are more likely than the average consumer to have a credit card, a mortgage, student loan debt and auto loan debt. And as a broad statement, they're not very well served by their current banking institutions. So we're able to pay them more on their savings, save them more of their loans. And they -- our customers do want to do more with us. So 83% said that they'd like us to be offering them other products and services. So over time, we plan to do that.

Great. Maybe you mentioned being digitally native. How would you describe the tech infrastructure stack when you look at it compared to some of your tech-enabled peers?

Yes. I mean we're -- or from a personal headcount perspective, our engineering group is our largest expense. We build the things that we believe give us the most strategic advantage. So the customer acquisition funnel, the interactions, how we post and deploy our credit models. And we -- but we've been around long enough that we've also invested pretty materially in areas that differentiated us, for example, during the pandemic and servicing or payments capabilities or contact center system. So we've got quite a bit, not just the drives origination, but also that enhances the ability to keep the borrowers current and service them efficiently [indiscernible]

Maybe in terms of credit decision, have you invested in AI and machine learning and where does that stay relevant?

Yes, absolutely. So we have a lot of data. We have over 150 billion cells of data, as I mentioned before, we've got dozens and dozens of models that power all aspects of the experience from the marketing all the way through to how we service loans. And we use the latest techniques to drive attributes to inform those decisions, where you can use some of those new techniques varies like the regulatory -- we're very focused on making sure we are meeting our obligations around compliance and consumers need to know you can't -- when you decline a consumer, you can't say I decline to you because my box spit out the number of 0.064321. And on top of the models, we've also been very clear what we think differentiates us is the judgment of the team we have. The models are only as good as the data that you train them on. The environment we are entering into now, it's not something -- we've been around for 15 years. We haven't seen this. So making sure that you have people that are saying, "Hey, I can't just look backwards. What do I think is going to happen." So a year ago, we said we think the economy is changing, where we think it's changing especially for low-income consumers. We are concerned about their ability, their capacity to pay as inflation kicks in, and we pulled way back. That turned out to be right. And so we're doing the same thing now as we look ahead, just on balance thinking it through resumption of student loan payments, continued persistent inflation. How will that affect people's ability and their obligations.

You mentioned the growth of the personal loan market. There's a lot of kind of newer tech players that have entered the field. What are the current competitive dynamics, I imagine having a bank that's been a [indiscernible]

You could say that again. Yes. So the market have -- one its -- it's always been competitive. When we entered, we were competing primarily with banks and with some fintechs. There was a new wave of fintechs. Then there was a wave of new banks and then another wave of fintech. So many of the big banks, American Express, Wells Fargo, Citi got into the space and then there was a new wave of fintechs. Throughout that whole period, we have been number 1 or 2 in the credit segments that we play in, in terms of total market share. We are pretty difficult to compete with because of just the enormous amounts of data we have, the fact that we've got an installed customer base. And we're able -- with the addition of the bank, we're able to cover from a 600 FICO all the way up -- we got a great product for you. It's going to be funded by an asset manager. And if you're an 800 FICO, we got a great product for you. And it's going to be on LendingClub's balance sheet or sold to one of our credit unions. So our marketing efficiency is significantly better than any of our competition. And in this environment, to your point, if you don't have access to deposits, it's much more challenging to operate.

You mentioned asset managers as being one of the buyers of your loans? Who are the folks that -- in the marketplace that buyers [Indiscernible]

So there's a spectrum of players that cover the spectrum of risk. So you have banks and credit unions that are kind of taking that top of the stack. And then you've got insurance money and some dedicated funds in the middle, and then you've got asset managers and others that are playing kind of at the -- in the higher risk, higher yield segment.

And how has the demand changed over the past 3 months or so?

So what's happening right now is for investors who -- so we have positioned our marketplace to be -- to really minimize dependence on capital markets, people who use high leverage, but certainly, if you're somebody who uses a warehouse line, and that line is priced on the forward-looking expectations of what the Fed is going to do. Your cost of capital has moved up very, very significantly, very, very quickly. The good news for our product, sorry, the good news for our product versus, say, mortgage refinance, is that we are pegged to credit cards, which are floating. So they are moving and will continue to move. But there is a bit of a lag, which is the Fed's moved 400, cards have moved 300. As of Q3, we had moved 200 basis points higher. So if your cost of capital has moved based on where the Fed is going and LendingClub has only moved -- or and the entire competitive set has only moved up roughly 200 to 300 basis points. You're getting some margin compression there that will temporarily affect buyer demand. And this was something we signaled already in Q1. At our earnings call, we said we think this would be a tale of 2 halves. First half, there's a ton of momentum. Second half as rates go up, things will be temporarily [indiscernible] constrained and that's exactly what we're seeing.

Okay. Maybe we can talk a little bit about the net interest margin. You talked about moving a little bit higher quality -- that higher qualities, I guess, put down, push down the yields a little bit on the unsecured loan side. What's the outlook for the NIM, I guess, in the near term? I'll get Drew a question.

I get to talk now?

Yes.

Yes. Right. I think, first of all, we should probably just start with the fact that our NIM is above 8%, right? So I've been in banking a long time, usually NIMs have a 3 handle. So 8% is a pretty healthy place to start. Yes, there's 2 things -- 2 major impacts affecting NIM right now, which will bring it down in the short term, but longer term should correct. So first of all, it's just funding costs. So deposit costs are moving up across the industry. We fund with high-yield savings, so -- which is a higher rate deposit source. But it's also just a very vast pool of liquidity that we can tap into. And as we're growing the bank at a pretty rapid pace, we're definitely paying up on the liability side to do that. The good news is most -- the largest asset on our balance sheet is personal loans, which are yielding 13.5% as of Q3. We are seeing that yield come down in the near term, which is probably a little counterintuitive because Scott just mentioned, we're pricing up 200 basis points, but as you said, we're remixing to a higher quality loan, and we've been doing that over the course of the year, which is bringing down yields in the short term. But we're also seeing prepayment speeds slow down, which has an impact on the accretion of fees into the yield as well. So I think as we go into Q4, we're going to continue seeing that trend and an impact on NIM. As we get into '23, we expect to see those start to -- those impacts level off and hopefully go in the other direction.

You mentioned deposits. When I look at the high-yield savings comparing different folks, you tend to be on the higher side, makes sense, you're growing your balance sheets and you need this -- you need to fund those. Are you still seeing pretty strong demand amongst your deposit product and how -- do you expect that you'll be able to fully fund your growth with projects coming forward?

Yes, yes, sort of pre answered the question. But I think for the online deposit space, for a bank our size, it's almost limitless in terms of its capacity. And I think the larger trend of sleepy deposit money moving to online savings is only accelerating in this environment. And as the -- as rates go up and the differential compared to what larger money center banks are paying increases, we're just seeing the velocity go faster and faster. So for us, we definitely have to pay a higher rate for those deposits, but we don't see any issue with funding the balance sheet now or in the future, knowing that we're going to have to pay a bit of a higher rate to do that in the near term. Longer term, with the banking acquisition, we did acquire commercial deposit franchise, albeit small. So we're going to be making investments to grow other deposit sources, including commercial deposits in the future.

And just an interesting add is for us, if you -- what do we stand for the customers, making smart financial moves, simple and rewarding. So for us, having a LendingClub brand out there really paying a compelling rate with a very easy online funnel for you to move your money and [Indiscernible] 3%, like it's pretty motivating for those people that have got cash sitting around earning 6 basis points.

Right. Yes, definitely. What about a checking type of deposit product? Would you be looking to expanding on that or I don't know if [Indiscernible]

We acquired a bank that had a great product. It's won a ton of awards for best online banking. But -- or if you look at -- we acquired the bank about 1.5 years ago, our first order of business was bringing the lending into the bank, so we could issue our own loans. That was kind of the first bit. And the next piece was getting the deposit -- the funding machine going. So applying LendingClub data science and model development and UX and UI to that. And that's what's allowed us to grow the balance sheet. The next thing we're working on is really adapting the checking experience to be specific for the LendingClub customer. So it's a great product as it is, but it's not specifically tailored for our customer to do some of the things I mentioned, right, have it be integrated have that be integrated into if I'm -- if you came to me to get a personal loan, can I approve you for a checking account? And can you single log into that, see the product. If you came to pay off credit card debt, can I help you track your credit card debt and make it easy for you to monitor it. So those kind of things to build a fully integrated experience and kind of next up on the road map.

Okay. Maybe we could switch to credit. We talked about macro uncertainty, et cetera. What are you seeing in terms of delinquency trends and where do you expect that to go...

Yes. It's, I think, similar to what I'm sure you're seeing elsewhere, which is the pandemic was very, very good to consumers and to the credit portfolios. Obviously, I'm not dismissing but many, many negatives that came with it. But from a pure credit perspective, things were very, very benign. We underwrote and priced through that using pre-pandemic expectations of performance. we're still not back there for that prime portfolio. So things are still outperforming. But as Drew talked about, if you look at things like leading indicators like prepayment rates and cash balances and those things, they are heading back to where they were.

In your reserve ratio, I think, ticked up a little bit in the last quarter. How well are you reserved for potential macro uncertainty?

You know what, there's a lot of pieces in there. Do you want to talk about that?

Yes. Well, first, we're always precisely properly reserved every quarter. So let me start by saying that. Yes. So as Scott said, we've been actually -- so let's break it down to the qualitative and the quantitative piece of reserving. So the quantitative piece, as Scott said, we've been using pre-pandemic loss assumptions all the way through the pandemic. So we're not yet at those levels, but we didn't take into account the overperformance or the better performance in credit during the pandemic into our reserving model. So we kept our quantitative curves that drive provisioning at those pre-pandemic levels. And as Scott said, we're not there yet, but we do expect that we will get there probably in 2023. And then for the qualitative, there's a lot of inputs that go into that Moody's forecast, other impacts or other pieces going to the qualitative as well. We're reserving what we can take because we do expect that the future probably isn't quite as rosy as the past was. So we're taking all the qualitative reserves that we can under CECL and planning for a probably a more difficult environment in the future.

On the capital side, you're very well capitalized at the bank, and you continue to grow. So I'm assuming that's probably #1 use of capital. What's your view of capital on the [indiscernible]

Yes. I mean on the strategy level, coming into this year, we said 3 priorities. One is growing the balance sheet. As I mentioned, we're earning 3x as much on loans we hold versus loans we sell. So it is both highly profitable. It's also just that recurring interest income and that resiliency of that stream, we like, and we want to continue to build that. Second is acquiring new customers. So building, we've got a very, very efficient acquisition engine. We also -- the lifetime value of our customers. We've -- once you're a LendingClub customer, the next time you come back, your experience is even better, right? We've got all the information on you. We know you're going to perform better. We price you accordingly. So it's both an easier experience, but also even better value. And so building, and as we add more products and increase that lifetime value, we want to continue to grow that customer base. And then the third is investing in the technology road map, some of the product initiatives that I talked about. That's at a high level how we're thinking about it.

Yes. And what I'd add to that is just if you look at our capital stack, it's very simple. It's pretty much all common, no preferred, almost no sub debt to speak of. So there are a lot of capital levers that we have in the future in order to enable growth if we choose to pull them. So I like how we're set up from the ability to not only generate capital, but find more capital in the market without necessarily having to dilute existing shareholders.

And what about from an M&A perspective, you bought a bank. Are there any other areas that you'd be looking for, for inorganic growth?

Certainly, anything that would be accretive to our road map, right? I mean we'll always evaluate the build by partner path, anything that could help us deliver more value to customers. Until now, there's been a bit of a valuation mismatch, but those things appear to be correcting more quickly in this environment.

Great. I'm going to go to the room to see if there's any questions. If you have a question, just raise your hand. If not, I'll just keep asking questions. The one thing that I was interested in talking about was the decisioning on 75% selling originations retaining 25%. What are the primary gating factors? Is it primarily just the CECL reserve is so punitive on a personal loan, what would shift that to the [indiscernible]

So coming into the year, we basically said, "Hey, we can be something quite unique. We can be both high growth, right, have a growth rate in line with what you -- we're seeing across the fintech industry with double -- significant double-digit revenue growth, but we can also be profitable." So matching high growth and high profit, we felt would be differentiated. So to do that, to your point, I mean, we took $80 million in CECL reserves last quarter. It's pretty punitive to be growing an unsecured balance sheet at this rate. So we said, hey, the blend is we think we can hold between 20% and 25%, generate a very, very solid profit next to that. If earnings come in stronger, we'll go above that -- we'll go above that amount. And so like last quarter, we did, we held a little over 30% of the loans because we had some performance -- outperformance in the quarter that we reinvested in the balance sheet.

Yes, CECL is not my favorite [indiscernible]

I haven't found anyone who the [indiscernible] who love it. So...

It's really bizarre that you can acquire new loans and have positive things for your business to get some negative to your earnings business and...

I am not recognizing revenue that I actually collected, and I am recognized as losses that haven't happened yet.

Maybe you can talk a little bit about the regulatory environment, the CFPB has been a little bit more vocal in terms of several different consumer finance categories. What's your view on the regulatory environment...

Well, we are, one, I'd say, pleased to be -- to have the charter and to know who our primary regulator is and how an actual direct line of communication there. So that's a big plus. I would say more broadly, for us as we look at the environment. We're one of the good guys, right? Our value proposition is we are saving people money off of their existing debt. It's -- so -- and we've been pretty active for, I would say, we punch above our weight in terms of really taking a view on fair lending, on the use of AI and lending, on consumer protections more broadly. The CFPB is now signaling that they believe they have the authority to regulate fintech. And I think that's good thing for the consumer. And in our case, since we are a bank, will be -- continue to be regulated primarily as the OCC.

So do you feel like as the CFU if you maybe start to bring and provide some additional regulation to the broader fintech that would be a kind of a leveling of the playing field to some extent.

I mean I would tell you that I certainly think the pace at which things are changing, having oversight to understand what are the risk to the system and/or to the consumer, has some value. There's certainly been some pretty dramatic growth in new areas, where not all the frameworks have been established. And so I do think it's changing quickly, right, whether it's BNPL, it's grown very quickly, but there's not yet a consistent standard for how that debt is reported to the bureaus track, obviously, crypto, we don't need to look too far and talk about that. So -- yes.

So we'll comment [Indiscernible] but that's not my area of expertise. From a customer acquisition standpoint, I think the bank high-yield savings has been a nice way to acquire new folks into a lot of these companies that offer that product. And I think it probably is a little bit lower cost acquisition to get those customers. Have you been able to utilize that base and start cross-selling your other products [indiscernible]

We don't see the high-yield savings -- it's a different customer, in that our core customer, if they had $50,000 in deposits, they wouldn't be coming to us for a personal loan. So we do see cross buying behavior already today from our borrowers. So people who have come to us for an auto loan are organically coming to us for a personal loan afterwards. And so we do see, especially as we integrate kind of the models and the data and that experience and ability to do that. But for the high-yield savings customer, it's really their -- the utility for them of our core product are going to be less likely to buy a used car versus a new, they're going to be less likely to have credit card balances.

Yes. That makes sense. What about from a kind of a repeat customer basis, you talked about high Net Promoter Score. Are you seeing a decent amount of customers coming back to you for that second or third [indiscernible]

Yes. Like I mentioned, 50% of our customers come back within 5 years. And the use cases for them evolve. So we do -- and they perform better from credit. So during the pandemic, if you look at -- we've made some of these results public, credit was good for everybody. LendingClub really outperformed the industry pretty significantly. And that was 2 things. One is we really leaned into our repeat base and said, "Listen, we don't exactly know if you remember when COVID first hit, like how bad is this going to get? Where is it going to go? We said we want to be there for our core customer. If they need access to credit, we want to be there for them. So let's preserve our powder for that customer. And then 2 is we over-indexed on servicing, making payment accommodations available and easy to access, because if you recall that spike of unemployment, whether we go to 15% in like a month, I don't remember. And so we really over-indexed and said, we literally within I think, 2 or 3 weeks, we shifted all of our salespeople into servicing, train them all up. We kind of have a built-in cross training. So we shifted them to sales. We made payment plans available online. You could access them. What you saw was versus our competitive set, we had a much higher percentage of people on payment plans. We were very criticized for that until 6 months later when our customers all went back to paying and what our competitors saw was roll rates, charge-offs and delinquencies go up. And so we really value and our customers really value the relationship. They really feel like, okay, LendingClub -- I met LendingClub with an offer of them saving me money and when I needed them, they were there.

So it looks like we're about out of time. Is there any closing comments you want to make in terms of letting people walk away and having a view of the future of LendingClub.

We said it kind of at the top, but I think the benefits of having a bank charter where the environment -- today's environment to be the way it was in the beginning of the year would have been awesome. But it really is showing the strength of this, what I would call, more of a hybrid model, the ability to combine, the scalability and the technology piece on the fintech side, but sort of that resiliency and profit of the bank, I think, is really demonstrating it's worth.

Thank you, Scott. Thank you, Drew, for joining us.