LendingClub Corporation (LC) Earnings Call Transcript & Summary

Thank you very much for joining us this morning here at the Morgan Stanley Fintech Conference. We're very pleased this morning to have LendingClub. And from LendingClub, we have Scott Sanborn, CEO. Thanks for being here. Scott and Drew LaBenne, CFO, it seems like he's very far away over there. But he'll be all right. So before I get started quickly for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. So maybe to kick off here, Scott. For those that are newer to Lending Club and the strategy and the story, can you give us an overview of LendingClub and the value proposition that you're providing the consumers.

Yes. So we started -- first loan was back in 2007, pretty straightforward principles, which was we thought that data and technology and a focus on the customer could actually really disrupt the lending industry, which, as of that point, hadn't seen much change. And that worked, we grew to become the largest originator of personal loans. We've issued more than $85 billion to almost 5 million customers. And our initial model was a marketplace funding model, we have worked with broad range of investors, banks and credit unions for high FICO borrowers and asset managers and insurance money for, let's call it, a riskier, a higher-returning paper but about 2 years ago, we acquired a bank. And now with the addition of the bank, we have our own balance sheet that's participating in the marketplace, and that has significantly enhance the profitability and resiliency of the business model and also allows us to do more for our customers.

Got it. Got it. So let's talk about the end markets. And clearly, there's been a lot of uncertainty across the banking landscape of late. And as you mentioned there, you sell loans to both banks and nonbank institutional investors. How those groups, I guess, respective loan buying patterns evolved recently? How have they responded to the headlines and uncertainty in the baking industry generally?

Yes. So about -- I think it was Q1 last year when it was clear, the rate environment was going to be shifting. We sort of telegraphed that we had anticipated we were through -- we went through a more modest rate environment in 2018 and '19. And so we kind of knew a little bit what to expect and said well -- what we anticipated and what we indeed saw was that asset managers that are pricing off of a forward curve are going to see their cost of capital go way up quickly. And therefore, their appetite was going to be curtailed until we could reprice the assets to deliver that. And so that's what we saw, funding shifted more towards the bank side and the majority of our funding was coming from banks and credit unions. Now with the recent events in banking, I'd say we are -- we would anticipate that the banks have got to really focus on their own capital and liquidity. We might see that appetite temporarily curtailed. But the good news is the assets have been largely repriced. We're seeing capital reform on the asset manager side. So we'd anticipate near term some of that demand shifting back towards the asset managers. I'll note though that, that -- they have a higher return requirement. So there will be some pressure on loan pricing we would anticipate as we make that switch.

Got it. And so then how do you manage -- from your perspective, how do you manage that loan pricing differential? Is it like what are you able to pass on to consumers? And how is that typically reflected?

Yes. So what's been great about the addition, the bank brought a lot of things you would expect. One of the things it did though as well was the role in the marketplace really changed the dynamic. One, as the largest holder of LendingClub loans, it really changes the conversation with investors, right? We're not asking people to buy something that we're not comfortable putting our money into. And it also allows us to be thoughtful about will we take that price or not because you have the option to hold so on a -- you've seen us be buyers. We acquired in the fourth quarter of last year, $1 billion portfolio from one of our former loan buyers who was sold. And so we reacquired that portfolio. So what we've been able to do is kind of evaluate what the right clearing prices we're willing to accept. The other thing we're doing right now is we're actually leveraging some of the bank's capabilities to provide financing for some of our buyers who've had -- who need access to liquidity. So we announced last quarter, we're making certificates available where we're holding the senior note and selling the residuals effectively providing financing for loan buyers.

Got it. Got it. Got it. And what about lending standards themselves? How are you managing those? It seems like on average, we continue to see tightening and businesses are focusing a lot more heavily on expense management. So as you're kind of looking at how you're managing your own business, what you're trying to do on the expense side, what you're trying to do on the lending standards side, how are you feeling like you want to manage those different inputs in terms of originating loans, et cetera?

Yes. So lending standards are certainly tighter. And we -- through the pandemic, we never kind of -- when credit was so benign and everything was great. We never kind of opened up. We kept a pretty disciplined and consistent credit box pricing and all the rest. But as government stimulus started to come down and people's expenses started to come up because both they were able to travel and go to restaurants, but also inflation started hitting. We definitely saw a change in the consumer we -- and we did anticipate it. We actually came out and said, "Hey, we're seeing changes in application behavior. We're seeing changes in prepayment behavior." So we tightened proactively in response to that and have continued to deliver, really outperform the industry. So one of the largest providers in the space, but our delinquencies continue to be below industry averages across all the segments of consumers that we compete in. So that's where we are on credit. Right now, we expect the stuff we're issuing to perform roughly in line with what we saw in 2018 in terms of delinquencies but with a higher return because the pricing to the consumer is higher. On the expense side, we had anticipated, again, last year that with the rate environment we would see some pressure. So earlier this year, in January, we reduced our fixed expenses by about $25 million to $30 million in preparation for, let's call it, a more challenging environment. We've also focused quite a bit on marketing. We've traditionally had amongst the most efficient acquisition cost in the industry. And we're about 30% more efficient today than we were, call it, a year ago. So those are 2 areas where we're really leaning in on the expenses. And we've said we intend to remain profitable through this. We feel like we've got all the levers to do that. We've also invested in a few areas, though, in preparation for a more challenging environment. We've spent about $50 million on our servicing infrastructure over the last 2 to 3 years. We've put in a new loan servicing system, a new contact center system, a new payment capabilities, all to make sure that we were going to be able to support the borrower should things get more challenging.

So can I ask you so if you had anticipated a tougher environment, you highlighted a couple of things that would have made it more difficult, including like banks and kind of how they're...

Do not anticipate all the bank failures.

Yes, I did not anticipate the bank failures, but we've had that. So how would you characterize how -- now how the world has been versus what you were planning for and any incremental adjustments you want to make?

Well, I would say we kind of knew direction of travel, not magnitude, right? So if you put the graph out there of what everybody thinks the rates are going to be and then you overlay what actually happened, let's say, the market was -- has been kind of consistently wrong and they've been consistently higher. So the impact of rates...

Rates have been consistently higher than planned, right, right.

And so that has, for sure, been the case. Let's say, understanding the -- there's no when you're looking at your credit expectations, most of the models, when they're looking at exogenous pressure, they're all focused on unemployment. That's the driver of losses. There hasn't been a lot of data to model off of to say what will inflation do to amend them. So that has required quite a bit of -- there's knowing that something is coming, but then figuring out how to incorporate those signals into your models has been -- I think we averaged, I want to say, a change a day last year, just 250 changes throughout the course of last year to really make sure we were reading these new signals for borrowers and incorporating that into our targeting, our underwriting, our pricing and really staying in front of it. So that's required -- we've got a very flexible infrastructure that allows us to deploy changes quickly to test, but we leveraged that quite extensively last year.

Got it. Got it. Got it.

Yes, I might add. I think when we were coming into this year, Scott, we anticipated the Fed would probably be leveling off and then asset managers will get more active. I think that's played out well. To your point earlier, we didn't expect the banks were going to be going through all this. So I think that probably puts a little incremental pressure on the second half just given versus what we had expected originally.

So when you look at that on that incremental pressure, is that -- I mean, from an OpEx perspective, are you well equipped to deal with that? Or is -- there is some incremental adjustments that you feel like you might want to make there?

No, I'd say right now, we feel pretty good about how we've set the business up. We've got a number of levers still available to us to deploy. So as an example, on marketing, about -- on average, about half of our loan volume on a monthly basis is new customers and half is existing customers. So 50% of our customers come back within 5 years for a second loan. We have the ability to lean into that more, right? Those customers come at 0 acquisition cost and they perform actually better than average on credit. But marketing is so efficient right now, at the moment, we are still acquiring, about half the customers are still new. So that's like a big lever. The amount of loans we retain on the balance sheet and the CECL provision that comes with that is another big lever we have available to us to manage in-period expenses. So today we feel pretty good about how we have set the business up.

Got it. Got it. Got it. So let's talk about your customers and really start with a 2-part question here. On average, what's the credit profile of your customer base generally? And I guess, as the second part of that, how should investors think about the historical delinquency and default rates of your portfolio versus what you're seeing today?

Yes. So the customer -- we serve a broad range of customers. That's one of the ways we're able to deliver such efficient marketing is if you have a 600 FICO, we have a great product for you, and it is probably funded by an asset manager. And if you're an 800 FICO, we have a great product for you and the funding for that might come from a credit union or a bank, including us. But I'd say, on average, who's the customer, if you look at what's on our balance sheet, we're talking about a 730 FICO $115,000 a year income. So these are high income, high FICO borrowers. What they have in common and what makes them such a valuable customer base is they are heavy users of credit. They are more likely than average to have a mortgage or an auto loan or a credit card debt and in all of those cases, those loans are larger. So it's a -- that is a core to our DNA, our ability to serve that customer, save them off the cost of that debt is the value proposition we bring them.

So when you look at like what you retain versus sell, like how are you trying to match that versus the market opportunity that's being presented and how representative is that?

So we've got a segment that's really outside the bank risk appetite, we call that this 600 to 660 FICO score. I'm using FICO just as a common language it's not part of our -- we're not using that in our decisioning. But that is outside the bank's risk appetite, that is exclusively sold through the marketplace. For the bank quality loans, we simply take a random allocation of those loans, the same thing that we're selling through.

Got it. Got it. So there's not -- as somebody would say you're typically not cherry picking or doing anything like that?

No, no, random allocation.

And on the outside of where you're allocating those loans, how do you allocate outside? I mean, are people signed up for just strictly around robin? Or can you talk through that?

Yes, we've got a number of ways people interact with us. There are what we call kind of our scaled orders, which people place a quarterly order, they tell us, we grade the credit. It's a P1 through P5 is our internal language. So they will say, "Hey, I want whatever $60 million of P1 and $40 million of P2 and $40 million of P3." And so we'll take those in and we will, throughout the quarter as loans come in, allocate accordingly. We also have a platform that we enable auctions. So people connect via API. We will list loans, and that's more dynamic bidding, and we use that as -- so all of this is transacted electronically on a platform we call LCX. So there's not a lot of paperwork changing hands. This is all done pretty seamlessly. But the auction platform, what that does for us is it gives us real price discovery. So we can see the loans that people are bidding up. We can see the loans that are going below par. And that is an input that we say, "Hey, why are people paying more for this? Would -- should we -- what are they seeing? Or should we be lowering the price to borrowers to generate more of that? And if people are paying down for something, do we need to raise price to borrowers or tightened credit there." So there's a bit of a feedback loop we get from that, that we think is very valuable and unique.

Got it. Got it. Got it. So let's go back then. I think you mentioned that your DQs, delinquencies, et cetera, were remaining kind of where you had wanted them. But can you talk a little bit about what those historical delinquencies and default rates of your loan portfolio look like? And where are they today versus where do you typically want them to be?

Yes. I mean to -- so where we are today, we basically had a period during the pandemic, where obviously, losses were super, super low. Credit really outperformed. We had a period of normalization as inflation really took a bite out of consumers where we saw especially lower -income, higher-risk consumers saw them get impacted. And now we're back at these levels we had pre -- for a clean vintage pre-pandemic because I'm saying 2018 is there wasn't that tail that was supported by government stimulus. So we're looking at returns to investors in prime, let's call it, 7 -- if we're selling at par, you're talking about returns of 7% or 8%. And in near prime, you're talking about, call it, 10-ish, 10 plus percent near prime returns to investors.

Got it. Got it.

Unlevered, just straight through.

And one of the concerns that we've seen on consumer borrowing generally has been pretty rapid rise in things like delinquencies, et cetera. I mean, are those -- are you being able to manage those to about the same -- the levels that you want? And any adjustments that you've had to make or how do you think about ongoing adjustments there? I mean...

Drew, you want to?

Yes. I mean, I think -- so a couple of pieces of information. So first of all, we've actually been remixing. Scott talked about the grades P1 to P5 we've been proactively remixing our HFI portfolio in the bank to higher credit quality more so just to make sure if the environment does deteriorate, we're holding a higher quality portfolio. In terms of delinquencies and credit performance, we've been performing as we expected, I would say, not without effort. As Scott said, we've been continually updating the credit box that we've been using over the past year. So the underwriting has evolved to ensure -- to make best efforts to ensure that we have the best credit possible as we're going through this cycle. But generally, delinquencies, charge-offs performing as we expected in our models.

Got it. Got it. That's encouraging. So let's talk about the competition. And Scott, you've been at LendingClub and been through various iterations of the business as it has evolved and grown, how do you differentiate from your bank and nonbank competitors in the personal loan space?

Yes. So as I mentioned, we've been doing this a long time, and we have successfully been competing against different waves of either incumbents when we first started, fintech challengers coming in and then a new wave of incumbents coming from banks. I'd say through that entire period, we've maintained leading market share, leading marketing efficiency and delivered really, really well on credit throughout all of that. So why? One is we have an enormous data advantage, right? 16 years of history on $86 billion or $87 billion worth of loans that powers dozens of models across marketing, fraud, underwriting, pricing, servicing all of that and an experience that is highly, highly optimized for different segments of customers to really get them all, all through. We got a really large customer base advantage. As I mentioned, our ability to serve these customers and bring them back, they come to us first to typically to pay off existing credit card debts that we make it super easy, right? It takes 2 minutes and we're saving you money. That creates a lot of affinity and we're the likely next stop if they're going for fertility treatments or doing a home improvement project, they come back again. And so our ability to make that second loan even easier and be available for them has really driven outsized performance as well.

Got it. Got it. On that retention, I thought it was interesting, you're like 50-50, like what does that imply in terms of where you would like to get that? What makes sense? And what is the product lineup or portfolio today versus where you kind of would like it to get, especially if you have an opportunity to find ways to take advantage of the customers or people that are already lending...

Drew, you want to talk about retention, and I'll talk about products?

Yes. Sure. Retention, we've spent the past year plus or really since we acquired the bank, growing the HFI portfolio so that in environments like this, we could be more resistant and have a higher level of recurring revenue. So we look to do that as much as we can within our existing earnings profile. And as Scott mentioned, every loan we retain, we're taking upfront CECL charge, we're deferring the fee. So it's capital intensive to build that portfolio and the marketplace revenue is really what helps that growth.

Yes.

It's a great earnings lever at the same time because if we do feel pressure in other areas, we can pull back on retention and ensure that we're staying profitable through a more adverse environment. So we like having those tools available to us. But at the same time, in this environment, everyone that's predicting some level of recession coming. As I said, we've been remixing to a higher quality portfolio. But as we're looking at the returns available to us we can pretty actively mix what we're putting on portfolio to generate higher returns.

Got it. Got it. Got it.

So on the product front, when we acquired the bank 2 years ago, like step 1 was let's bring all the originating businesses into the bank. So we brought in personal loans, we have a purchase finance business where we help people finance big elective medical procedures that aren't covered by insurance. We pulled that in. We have an auto refinance business, help people save money off of their core loans, we pulled that in. That was kind of the first year. And then last year, we turned our attention towards building the funding mechanism, really ability to attract deposits at scale online and apply all of the discipline we do on the lending side to the deposit side, so that's highly optimized funnel and conversion rates and scoring and all the rest. And those 2 things we've tripled the interest-earning assets on the bank balance sheet over that time period. We've nearly tripled the amount of deposits so bringing about $5 billion over the last 2 years. So today, now what's next, I'd say, first area we're looking at is we have not yet brought to market a checking experience for our core customers. So the customer who comes to us to save money off their debt. They have pretty unique needs of what they want from banking, we think that we can offer a pretty compelling value proposition to say, "Hey, we're saving you $80 a month off your car loan, why don't you let us put it into a LendingClub savings account, which you're approved for right now. And when you're done paying off your car loan, you'll have $5,000 in savings. Or hey, we can save you off of your credit card debt. Why don't you put into a LendingClub checking account and we will help you monitor your credit card debt and stay on top of it going forward." So that's something we're working on. Our pace of investment in that is lower now than we sort of had initially intended coming into the year, but we are going to continue to push forward on that. And then over time, as I mentioned, this customer is disproportionately using all forms of credit. So over time, we would seek to offer them all of those products.

Got it. Got it. Got it. And when you look at things like personal loan versus auto refi, you mentioned like elective, et cetera. What is the -- like is there a difference in potential frequency of lending opportunity there? And once you start to engage on or be able to attract customers on with the checking product, how does that change, do you think?

Yes. So personal loans just to take the -- that's the biggest driver of our revenue. It is not a 1 and done. As I mentioned, customers are coming back for second, third loans. That said, the nature of that relationship is more episodic, right? You come in, we pay off your credit card debt, you pay down the loan, then when you come back, it's either another life event, medical emergency or a divorce and you've racked up credit card debt again or you're doing a project. The addition of the checking account, we see that bring a couple of benefits. One is we get more data. We can really see what's happening in their financial life. And then two, it just ups the interaction level. So instead of coming back once every few years because you need to change your payment date, you're coming back weekly, right? And you coming back weekly and us gathering more data is going to present more opportunities for us to engage with you, add value, help solve other financial challenges.

Got it. Got it. We've got about 10 minutes left here. If there's anybody from the audience that has any questions, please raise your hand, and we'll get you a microphone. Got a question here, [ Jeff ].

Just wondering if you've given any thought into how the end of the student loan moratorium impacts you, what your borrower base looks like? Maybe have you disclose or thought about how much are student borrowers and maybe whether that also represents an opportunity for you as well as it will struggle with cash flow from here?

Yes. So great question. So for those of you not following it, the student loan -- federal student loan repayments after a couple of year moratorium are set to resume end of August or September. So we've got -- about 1/3 of our borrowers have student loans. And about half of those are federal that are not paying. So about 15% or 16% of our borrowers that will see those student loan payments resume. We have been underwriting them with the presumption that these payments would resume. So in our outlook and analysis of capacity to pay, we have been assuming those payments would resume. That said, putting it in a mathematical model and then having a consumer have to make the extra room for a $400 or $500 payment, right? There's still -- there's the theory and then there'll be the practice. So we are certainly preparing and going to help our customers prepare for this to resume and make sure we're there to help kind of support them and get them ready for that. And in terms of opportunity, yes, obviously, we don't currently offer student loan refinance. I don't know that right now the market for lowering people's rates versus what they got is there, but certainly an opportunity to help maybe restructure or re-amortize the payments could be valuable. So that's certainly something that we could look at as a partnership, but we're not in that space right now.

Got it. Any other questions from the audience right now? Thanks for that, [ Jeff ]. So I want to ask, it was interesting the way you started the introduction, Scott on to LendingClub and the long history that you have looking at data and data analytics, I think I don't know that we could get through a conversation like this without asking about AI and the buzz that has both conceptually and just as a buzzword.

Did you ask ChatGPT to write these things.

Yes. No, I did not. I don't think we did, did we? No, we didn't. But that has been obviously a part of your business for quite a while and part of the process. But can you expand on the use of the technology as particularly as it relates to credit risk assessment, fraud detection or other areas you think would move the needle either from a revenue or expense perspective?

Yes. You are correct that advanced analytics techniques have been a core part of our operations really since forever. And given the data intensive nature of the entire business, how we apply that in different places and also given the regulatory intensity of how and where you can apply that does vary. So for example, in fraud, it's a very robust implementation where we've got industry-leading broad performance so our identity theft is low single-digit basis points of our platform. And that's driven by the techniques, the ability to -- is this person real? Is the behavior they're exhibiting authentic. So their we use it, you can in the marketing to make sure you're delivering the right message to the right audience. In underwriting, certainly, for variable -- like developing the variables that you input and what criteria you're going to use, yes. But you can't really run a black box model where some -- system is doing something that you don't know what it's doing and what's coming to that output. So you can use it to help develop your models and identify variables and also in servicing, of course, in things like your chat bots and all of that. So it's used throughout the kind of customer performance life cycle.

Got it. You kind of alluded to it there, as people or as policymakers think about kind of guidelines and just like where it makes sense to introduce some sort of restrictions or constraints on the technology, et cetera. What do you think makes sense versus maybe doesn't?

Yes...

Because there's a lot of -- there could be a lot of policy objectives that may be at odds, right?

Yes. I think one of the contested debates right now is inputs versus output. Should you be focusing on what data goes in at the top or are you more focused on results. We're more advocates for the latter, let's make sure that the output is equitable and fair and let's make sure that the results of this -- but let's use everything we can to increase access to credit, to lower the cost of credit. We didn't really talk about that but one of the things that's clear in the data, and there's been -- this isn't us saying, that there's been multiple federal reserve studies looking at LendingClub and saying, "Hey, we are making credit more affordable and we're making it more accessible than traditional models." That is a very, very positive outcome for the consumer. There's a lot of opportunity still to come there.

Got it. So lastly to wrap up. M&A, you recently completed the acquisition of Radius Corp., how do you contemplate incremental M&A and what types of assets or geographies would you be targeting? And then what are you seeing in the marketplace for private asset multiple specifically? Like kind of where are you looking and where are you targeting? And what are valuations looking like right now?

So we don't need M&A really to drive growth. If you look at our TAM right now, it is the largest it's ever been. So our core use case for the introduction of new customers is, hey, you didn't pay off your credit card last month. That means you have a loan, it's a crappy loan, do this instead, we'll save you money. That -- there is now over $1 trillion in outstanding credit card debt and credit card interest rates are at record high levels. So from that perspective, there is a massive TAM that is building daily right now. That said, given what I just mentioned about our customers, they want to do more with us. We aspire to deliver on that. And so that represents a range of products as well as experiences so there certainly could be opportunities for us to accelerate that road map through M&A. Prices are coming down. So they have come down slowly, but our currency has also come down. So we would be thoughtful. The acquisition with the bank was a no-brainer. The strategic benefits were clear, but the financial benefits were immediate. We knocked out costs. We added a new revenue stream. So we're certainly open to things that can be transformative, but we'll be thoughtful given the state of our own current...

So look, to me, it always seems like there are a couple of different potential acquisition types for the LendingClub is clearly as you said, there could be technology or product related. But on -- back on the bank side, is there anything incremental that you would need to do or with Radius, do you have everything that you need and want from an ability to drive deposit growth and gain efficiencies?

So certainly, diversifying the funding side of the balance sheet is another potential opportunity there. We we've grown primarily we -- the bank we acquired had about $2 billion in deposits. It was a mix of some commercial accounts. They had a big trade union business, which we've kept and are growing but -- or the deposits that we added over the course of the last 18 months have primarily been high-yield savings. That's where the growth has come from. So opportunities to further diversify that side of the balance sheet certainly would be potentially interesting.

Yes. Got it. Well, Drew, Scott, thank you very much for joining us today. Always great to catch up with you, and it's an interesting period, especially as I think I always think about LendingClub as having been one of the leaders in the evolution, and you see other companies that have tried to emulate your model, but I think, ultimately, they end up kind of gravitating towards the path you've already broken. So I appreciate you guys being here today.

Thanks, [ Chad ].

Thanks.