LendingClub Corporation (LC) Q3 2016 Earnings Report, Transcript and Summary

Welcome to the LendingClub Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to James Samford, Head of Investor Relations. Please go ahead.

Thank you. Good morning. Welcome to LendingClub's third quarter 2016 earnings conference call. Joining me today to talk about our results and recent events are Scott Sanborn, President and CEO, and Tom Casey CFO. Before we get started, I'd like to remind everyone that our remarks today will be forward-looking statements and actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are described in today's press release, the related slide presentation on our Investor Relations website and our Form 10-K filed with the SEC on February 22, 2016, and our most recent Form 10-Q filed on August 9, 2016. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's press release. The press release and the accompanying investor presentation are available on our website at ir.lendingclub.com. Unless specifically stated, all references to this quarter relate to the third quarter of 2016 and all sequential comments referred to quarter-over-quarter comments are comparison to the second quarter 2016 and year-over-year comparisons are to the third quarter of 2015. Now I'd like to turn the call over to Scott.

Thank you, James. Good morning, everyone. I'll start by saying that I'm extremely pleased with our third-quarter performance during a fluid time, and with imperfect information, we laid out aggressive goals for our business. And through the commitment of our employees, our customers, and our partners, we've delivered on all of them. To review, in the third quarter, we successfully re-engaged virtually all of our largest investors and saw significant increase in the number of participating investors. We were pleased to welcome banks back to the platform and can report further acceleration of their purchases in Q4. We enable $2 billion in originations, as per plan, firmly maintaining our leadership position. We ended investor incentives on schedule at the end of August, with all investors continuing to purchase. We successfully used only half the level of incentives that we had planned for, an achievement which clearly reinforces the attractiveness of our assets. And as a result of the lower incentives, we delivered $113 million in operating revenue, a 10% increase over Q2 and ahead of our plan. So, all things considered we're very satisfied with our execution. I will now turn to cover a few topics in more detail. Starting with a breakdown of our investor segments. The first group is retail, a unique and powerful asset for LendingClub. Our self-directed retail investor base remained resilient in the quarter, maintaining their investment level and share of the mix versus post-May 9. The second investor segment is managed accounts, which includes a few of the recently launched 40 Act funds. Managed accounts invested over $1 billion this quarter, or 55% of the total volume. This group was able to move quickly and at scale to take advantage of the incentives in July and August. Third, we have the other institutions segment that includes asset managers and insurance companies, hedge funds, and securitization program investors. As a whole, this group rebounded back to their share of Q1 2016 as the institutions worked through their diligence requirements and re-engaged, including some with the help of incentives and others without the need for incentives at all. Our last category is banks, which are critical partners for LendingClub. Combining banks' low cost of capital with LendingClub's low operating costs, enables us to better serve our highest quality borrowers. We dedicated a lot of resources this quarter to supporting banks, as they worked through their complex diligence and regulatory requirements. The rigorous efforts from our audit partners and our internal resources have paid off and resulted in, as of today, nearly all of our key bank partners being back on the platform. I would like to thank our bank partners for their commitment to us and the long-term relationship we're building. We're proud of the work that went into meeting the stringent standards expected by these partners and we see their participation as a key differentiator for LendingClub. Overall, I believe that our strategy for strengthening and diversifying our capital supply is working. And, as we announced today, we have a new addition to our investor mix, as the National Bank of Canada has approved up to $1.3 billion to be deployed on the LendingClub platform over the next year. The investment will be undertaken by Credigy, the bank's US subsidiary, which specializes in consumer finance investments. Credigy entered into this arrangement after careful diligence of LendingClub's credit performance, underwriting, compliance infrastructure, and loan servicing capabilities. The first $325 million is already committed to be deployed on our platform in the coming three months. We see this program as another way we're bolstering the funding visibility and stability that can make us even more resilient in various market conditions. So, all in all, we feel really good about what we've accomplished with our investors. Looking forward to Q4, the important milestones will be increased diversification in general and the scaling of the banks in particular. Specifically, we'd like to see the banks back at approximately a quarter of our volume. Now, I'm going to move on to foundational work. In Q3, we've been focusing considerable organizational energy and made great progress in further bolstering our control environment, which is a key driver of investor confidence. We completed a refresh of our SOC-1 audit, an important validation of our controls. We've significantly strengthened our data change management processes. We've enhanced our end-to-end testing, with technology solutions to automate compliance. We've improved our tools and reporting infrastructure to better serve the needs of investors, and taken together, we believe that these investments we've made in compliance controls and reporting are giving LendingClub a true competitive advantage. Looking ahead to Q4, we're working to remediate tests and clear the material weakness in our controls, which we reported on in Q2. We are strengthening our document storage and validation capabilities and we're rolling out new training on code of conduct and ethics to reinforce the importance of a high compliance culture. Beyond our internal focus, I spent a week in Washington this quarter, meeting with regulators, policymakers, and consumer advocacy groups covering a broad range of topics. I came away optimistic that there is a strong appreciation for the power of responsible innovation to increase access to affordable credit and I look forward to continuing to engage on these topics. Now I'd like to spend some time talking about credit. It's important that all of our stakeholders understand how we monitor and action credit risk in a dynamic environment and how doing so is a competitive advantage for LendingClub. We have an acute sense of responsibility when it comes to credit decisioning and pricing. As facilitators of a marketplace, we have to get it right for both borrowers and investors. Our goal is to target a weighted average return that platform investors will find attractive while generating significant savings for borrowers. Our investors do not look at this as an individual trade but as an asset class that they can invest in for years to come. To generate attractive risk adjusted returns, we are constantly monitoring economic data, loan performance data, investor feedback, marketplace supply and demand dynamics, and other competitive indicators. This is a continuous proactive process that runs against a constantly shifting set of conditions. We test and monitor the results and when necessary, adjust using disciplined, delivered, and data-driven approach. Whenever we make material changes, we transparently communicate them to our investors. Our policy and credit changes have, at times, attracted questions as to the resiliency of our model. Make no mistake; our policy adjustments demonstrate the strength of our model. Traditional finance institutions are making many of the same modifications. The difference is the speed and granularity with which we can make adjustments and the extent of our transparency in disclosing them. As we have discussed, this year, we raised rates four times and tightened credit three times based on trends we were seeing in borrower behavior and investor expectations. In particular, we stopped approving loans to a portion of borrowers that was exhibiting a high propensity to accumulate debt and could have the most exposure to an economic slowdown. The vintages that included these underperforming populations are still expected to deliver solid returns. And we're targeting newly issued vintages as a result of the above-mentioned credit and pricing actions to deliver weighted average annual return of approximately 6%. All in all, we continue to deliver a very attractive investment in this prolonged low-yield environment and investors continue to reward us by investing roughly $2 billion per quarter for the last six consecutive quarters. I'd like to pivot now to talk about employees. In Q3, we significantly boosted our leadership team to position us for 2017 and beyond. We've added Tom Casey, a veteran operator, as our CFO. Tom brings extensive experience and strategic perspective across the entire range of financial functions, including financial accounting, reporting, and planning and analysis. We've added Russ Elmer as our General Counsel. Russ has long been operating at the intersection of finance and technology with his most recent role as Deputy General Counsel and Corporate Secretary at Paypal. And finally, we added Patrick Dunne as our Chief Capital Officer, responsible for further strengthening our investor mix. Patrick brings 25 years of investment experience and has held senior leadership roles at BlackRock, iShares, and Barclays Global Investors. Patrick has already added deep talent to his team, including Valerie Kay from Morgan Stanley, as Senior Vice President and Head of Institutional Investors, and Raman Suri, from BlackRock as Senior Vice President, Head of Retail Investors. This is a first-class leadership team and I'm truly excited by how quickly we've come together. Looking at the LendingClub more broadly, I'm pleased to say that our employees remain highly committed. Two key metrics, turnover, and engagement, are now back to the strong levels we have historically enjoyed. I see this as, first and foremost, a reflection of the depth of commitment of our people to the LendingClub vision and also a confirmation that our communication and retention efforts in Q2 and Q3 have had the desired effect. People are a critical asset in any company and in times of uncertainty, they can make or break an organization. LendingClub is exceptionally blessed to have such a talented, driven, and dedicated group of people to take us into the future. Looking ahead to Q4, we have a few senior roles left to fill in audit, compliance and the borrower team. Now, I'm going to turn our attention to borrowers, a topic we look forward to discussing increasingly and at more length in the future. As you may have seen, we were excited to have the launch of our auto refinance product at the Money20/20 Conference in October. The offering is a huge win for consumers, for investors, and for LendingClub. Starting with the consumer. For most people, their car is the second largest purchase they make and tens of millions of Americans borrow over $0.5 trillion every year to buy cars. The practices and processes of the auto lending industry are not as transparent as we think they should be and many people, especially those getting used car loans, are paying more for their loan than they need to. People negotiate the price of their car, but often not the price of their financing and are unaware of the extra costs out at the dealership. And unlike mortgages, where refinancing is common, people aren't generally aware that they can refinance their car loan to obtain savings. This lack of awareness is partially driven by the fact that auto lenders aren't reaching out to spread the word, as they are restricted by channel conflict and may lack the direct-to-consumer DNA. Just as we did in the unsecured personal loan industry, we are leveraging our technology and core capabilities to put thousands of dollars back into car owners' pockets. We designed the process to deliver a great experience. Notably, it's quick. Within minutes, you receive the offers for which you qualify, and can see the savings versus your current loan. It's convenient, you don't have to visit the dealer or a bank. In fact, you can complete the process online from virtually anywhere. The only paper is in states where we're required to have an ink signature. Otherwise, you can upload your docs online. And it's fair. We don't charge an application fee, origination fee, or a pre-payment penalty. When we can reduce the APR on an auto loan by a few percentage points, we put over $1,000 back into people's pockets. So that's real savings for consumers. For investors, the secured auto loan market is one of the most stable asset classes and it performed exceptionally well in the last recession. Our focus on refinance, where consumers have already demonstrated the willingness and ability to pay represents in especially well performing segments. We look forward to being able to offer to investors more broadly when the time is right. And lastly for LendingClub, auto refinance accomplishes three things. It significantly increases our addressable market. We'll be targeting over $283 billion in used auto loans originated last year, and provides another opportunity for future growth. It adds a resilient secured asset to the mix and it enables us to leverage our core capabilities to further deliver on the brand promise that has allowed us to serve over 1.7 million borrowers to date. We're starting small and will iterate throughout fourth quarter before expanding beyond California. We expect that it will take six to 12 months of experience and optimization before we begin significantly ramping the program. I'll conclude by saying that the power of our business model and the value we deliver to borrowers and investors has never been more clear. Having engaged over the past few months with our investors, shareholders, partners, and employees, and having felt their strong support, as we rebounded from May's events, I am confident that our plan for the fourth quarter and beyond will set the foundation for years to come. With that, I'll turn this over to Tom Casey, our new CFO, to walk you through our results and our outlook. Tom has been on the ground for the last five weeks and is quickly getting up to speed on our financials. He'll take you through our third quarter results and our outlook for the fourth quarter.

Thanks, Scott. Before I review our financial results, I'd like to say how excited I am to be working with Scott and the rest of the management team to guide LendingClub and execute on the incredible opportunity that we have ahead of us. In the month-and-a-half that I've been here, I've witnessed the passion and commitment that has led the Company's rebound and I'm very encouraged by the momentum that we are building. Over the next several months, our focus is on three areas. First, it's increasing the resiliency and balance of our funding mix, including banks. Second, it's continuing to strengthen the team and get into a steady operating rhythm. And third, it's continuing to further strengthen our controls and reporting and remediate test and clear the material weakness stemming from the events reported in the second quarter. As Scott shared, we designed the third quarter to get investors to re-engage with LendingClub and the quarter played out better than expected. We successfully used a series of temporary measures to renew investor confidence, including incentives in July and August that ended, as planned, in September. Importantly, once these incentives expired, investor demand continued in September and represented roughly 30% of our volume in the quarter. With that, let's turn to the quarterly results and our fourth-quarter outlook. My comments today will focus on sequential quarter-over-quarter results, given the disruption that occurred in May. Also, as we've done in the past, all operating expenses discussed exclude stock-based compensation, depreciation, and amortization. In the third quarter, we facilitated $1.97 billion of originations, an increase of 1% sequentially and grew our loan servicing portfolio by 2% sequentially to nearly $11 billion. For the quarter, operating revenues were nearly $113 million; adjusted EBITDA loss was $11 million; GAAP EPS loss was $0.09 a share and adjusted EPS was $0.04 of loss. Both revenue and EBITDA came in well ahead of our guidance ranges, largely because of incentives approximately $11 million were roughly half of what we previously expected. Now, let's dig into some details of our performance and results. Operating revenue increased 10% sequentially in the third quarter to $112.6 million. There are several moving parts here, so let's go through them. Transaction fees of $100.8 million increased 4% sequentially and were up 17 basis points as percentage of originations to 5.11%. Driving the growth was 1% higher volume and grade mix from the lower percentage of bank purchases. Keep in mind, as banks returned to our target level, we would expect transaction yields to be a little lower in Q4. Total servicing and management fees were $18.5 million on a reported basis, or $20.2 million, excluding the fair value of adjustment of $1.7 million. Adjusted servicing and management fees were relatively stable at 19 basis points, compared to 18 basis points in the second quarter. Other revenue came in at negative $6.7 million due to the $11 million of incentives I mentioned earlier that are recorded as contra-revenue. This is an improvement compared to the negative $9 million of other revenues last quarter that included roughly $14 million of incentives. All these items resulted in operating revenue yield of 5.71%, up 47 basis points sequentially. Turning to expenses, sales and marketing expenses in the third quarter were $43.2 million, down from $48.3 million last quarter, as 2Q results included higher advisory fees and severance expenses. Sales and marketing, as a percent of originations, dropped 28 basis points sequentially to 2.19% in the third quarter. As we look into the fourth quarter, keep in mind, Q4 sales and marketing costs have some seasonality and will result in higher marketing costs compared to the third quarter as well as the costs associated with the launch of auto. Origination servicing expenses in the third quarter were $15.3 million, down $4.7 million sequentially, due to lower personnel expenses from our resizing efforts in 2Q, and other third-party origination costs. Origination and servicing expenses, as a percent of originations, were 78 basis points, down 24 basis points quarter over quarter. I would expect these costs to be at a similar level in Q4. Now, let's turn to contribution margin. We measured contribution income and contribution margin by subtracting sales and marketing, and origination and servicing expenses from our operating revenue. For the third quarter, our contribution income was $54 million, up 59% sequentially, as a result of lower incentives and the elimination of other expenses incurred in 2Q I noted previously. Contribution margin was up 15 points quarter over quarter at 48%. Turning to other operating expenses, engineering costs were $19.1 million, roughly in line with the second quarter, as we continued to invest in new products and platform innovation. Other G&A costs remain elevated at $46.1 million, up from $44.4 million in the second quarter, and include the bulk of the unusual expenses related to the events of the second quarter. In the third quarter, we had approximately $15 million of unusual expenses linked to the events of the second quarter, through legal, audit, retention and other fees. While these unusual expenses are expected to continue to be at the elevated levels in Q4, I do expect them to be down from the levels we incurred at 3Q. Adjusted EBITDA for the quarter came in at a loss of $11.1 million, a $19 million improvement compared to the loss of $30.1 million in the second quarter. Excluding incentives of approximately $11 million, and the $15 million of unusual expenses in the third quarter, adjusted EBITDA would have been positive at roughly $14 million. Our GAAP net loss was $36.5 million compared to $81 million in Q2. EPS came in at a loss of $0.09 per diluted share compared to a loss of $0.21 last quarter. The difference between GAAP and adjusted EBITDA was $25.3 million, and includes stock-based compensation of $17.9 million; depreciation and amortization of $6.5 million; and, a $1.7 million impairment to goodwill which was -- which closes out the goodwill test that was open at the end of the last quarter. Stock-based compensation, as a percent of operating revenues, increased sequentially to 16%, up from 13%, due, in part, to grants related to hiring new leadership and the shifting of our 1Q 2017 stock grant into September as part of our commitment to retain top talent across the entire organization. As a result, we expect Q4 stock-based compensation to be roughly $25 million in the fourth quarter. Adjusted net loss, which is GAAP net income, excluding stock-based compensation, and acquisition-related expenses was negative $15.7 million, or negative $0.04 per diluted share during the third quarter compared to a negative $0.09 per diluted share in the last quarter. Now, turning to the balance sheet. As of September 30, we continue to have a very strong balance sheet, with $800 million in cash and securities available-for-sale and no debt. Our total balance sheet assets reached $5.6 billion, with $4.4 billion in loans. With that, let me give you our thoughts about our outlook for the fourth quarter. As indicated in Q2, we plan to hold origination volume in the third quarter and fourth quarter flat at nearly $2 billion. And we're sticking with that plan. We understand that this level of origination puts continued pressure on our reported adjusted EBITDA as we continue to invest in completing all of our compliance controls and investor reporting initiatives. Also impacting our adjusted EBITDA is the elevated legal and advisory costs related to ongoing investigations. We made this choice to complete these efforts and continue to invest despite the short-term impact on EBITDA to position us for longer-term growth ahead. We are entering the fourth quarter with tremendous progress on the investor front and we'll begin to shift financial and human resources to position us for growth in 2017, and this will serve as the foundation from which we will build our 2017 plan. Based on what we know today, for the fourth quarter, we are providing the following outlook. Operating revenue will be in the range of $116 million to $123 million, driven by the $2 billion of originations; adjusted EBITDA loss in the range of $5 million to $15 million, which reflects the operating cost and seasonality I mentioned earlier; and GAAP net loss in the range of minus $38 million to minus $48 million, which reflects the impact of stock-based compensation, shifts I mentioned of roughly $25 million, and depreciation and amortization of $7 million, and $1 million of other net adjustments. I appreciate everyone's time to discuss 3Q results, and I look forward to meeting you as we continue to reach out to investors, as well as the research community over the coming months. With that, let's open up the call for questions. Operator?

Thank you. We’ll now begin the question-and-answer session. [Operator Instructions] Our first question comes from James Faucette of Morgan Stanley. Please go ahead.

Thanks very much. I wanted to ask you just some questions on funding, et cetera. In the quarter, you talked about the lighter incentives. Can you just give a little color, like what happened and why they were lighter incentives? Was this a matter of investor mix or were you able to actively scale them back faster? Just looking for a little bit of insight there.

Yes, it was a combination of those two things, James. Good morning. We, essentially, as the quarter progressed and we were able to get a sense at which the pace people are coming back and were able to build a view into a post-incentive world in September and put, as Tom indicated, a decent amount of volume into September, which was free of incentives. I think we shared a little bit more broadly that throughout the quarter, the mix did shift with banks starting to come back to the platform and increasing share and the other institutions, not all of whom, were using incentives rejoining the platform and gaining share.

Great. And then, just as a follow-up on that, you mentioned that the banks were coming back. And I think you said in your prepared remarks that all of the banks were actively back on the platform. At the same time, the reported mix for banks looks very weak in the quarter. So maybe you can give a little color on how that progressed on a run rate basis. And, I guess in conjunction with that, the National Bank of Canada deal, any color that you can provide there in terms of whether they will be getting some incentives or if we should be booking for other deals similar to that in the pipeline? Thanks a lot.

So, I guess starting first. We had said that virtually all of our bank partners are back. Note that their return has come -- that includes taking us through today. So not all of that was happening in the third quarter; it's really happened into the fourth. The second is the pace at which they returned. There's kind of completing the diligence process and resuming purchasing and then scaling up to their target levels, which will take some time. So I think you see in the materials that we shared that banks went from 12% of the originations to in July, to 15% in September and it's our goal to have them at a quarter of the volume in Q4. Just a question of them coming in and ramping up. On…

Yes, sorry.

Where did I lose you?

Just – you were about to start talking about the National Bank of Canada agreement and, whether there might be other ones in the pipeline, et cetera. Thanks.

Yes, so, as I started to say, we're excited about this partnership. We think they're going to be great long-term partners. Credigy does specialize in consumer finance investments, so I think we'll be a great fit for each other. They will be broad buyers across the platform. We looked at a number of types of arrangements with a variety of partners and our effort to secure a portion of our funding that we had good visibility and predictability to. I think we feel good about where we are now, combining this with our retail base and our other banks so we're not actively pursuing more like this, although we're always open to having conversations with investors. In terms of how to think about it, it's essentially, the program is at market terms. There are additional economics that are very reasonable and we are very pleased with -- that will be triggered only if the full $1.3 billion is deployed, subject to, obviously, various terms and conditions.

That's great. Thank you so much.

Our next question comes from Eric Wasserstrom of Guggenheim. Please go ahead.

Thanks very much. Two questions, please. One is, could you just remind us what your origination mix was in the period by credit grade?

Hey, Eric. This is Tom.

Hi Tom.

Let me just correctly, James, on how much detail we give. For the quarter, the standard -- personal standard loans were about $1.4 billion of the $1.972 billion. That was obviously broken down a little bit further. Custom loans were about $353 million and then we had also some education patient financing of $182 million. So, not sure how much detail, James, we typically give, but that gives you a sense.

Well, I think typically in the standard program, you had broken it out by ABC, et cetera, on both in your deck and on the website. And the information seems to be available. I guess what I mostly getting at is trying to line up what the credit grades were relative to the mix of investors in the period.

Yes, Eric, all of those -- all of the data will be uploaded this morning. So it should hit any time in the next hour or so.

It would probably be easier, Eric, just to get them online rather than me list them off for you.

Sure, sure. I'll look for it. And then secondly, Tom, thanks very much for the explanation on what's driving the fourth quarter guidance, particularly with respect to the topline versus bottom-line impacts of the various cost categories. But as we start to think beyond the fourth quarter, how do you suggest that we conceptualize the operating leverage on a run rate basis?

I think for -- the way we're thinking about it, our contribution margin for the quarter is, as you know, above 50%. And when you think about our adjusted EBITDA margin, when I adjust some of those unusuals I commented, it would be about $14 million, it's probably somewhere in the 12% range of adjusted EBITDA margin. Look, we think that the Company has been able to perform at much higher levels than that but with the growth -- excuse me, the originations of about $2 billion, that obviously put some pressure on us. But with additional growth, we think we can increase our operating margin significantly. One thing I will call out, though, as we continue to invest significantly in other parts of the business, you see auto, for example, being launched. We continue to see areas to further expand our offerings, that will bring that number down a little bit but on a relative basis, the operating leverage is quite high. We just have to decide how much we're going to reinvest in the business and that will, obviously, impact the reported number but we feel very, very good about the margins in this business. Right now, obviously, they are being impacted by some of these unusual expense and expect those to continue in the fourth quarter. As we get into next year, I would expect those to start to come down.

Great. Thanks very much.

Our next question comes from Brad Berning of Craig-Hallum. Please go ahead.

Hey, good morning. One follow-up on Credigy is, despite the $1.3 billion being the trigger, will you need to start to accrue for those early on, even here in the fourth quarter, given their commitment pace would appear to be on pace for that? That would be the first question.

Yes, hi, this is Tom, Brad. We would expect that we would be accruing that as we go, as the purchases are made. And that will be dependent on what their total purchases are for by quarter. As Scott indicated, any final commitment will be determined based upon the final program size.

And, that's obviously included in the revenue guidance already at this point, is how we should think about that?

That is correct. I have included that.

Okay. And then one other follow-up on the longer-term margin-type question. Scott, as you've gone through this transition, you've seen the changes that you've needed to make internally as an organization. And some of the additional compliance, legal things you've done. And how much have you thought about that as being more temporary versus has there been any changes in the margins structure of how you would have thought about the Company over the long-term prior to May? And I'm just curious if you think about those longer-term margins are still quite attainable or if you think there's any modesty to those given any of the changes you had to make to the organization?

Yes, hi Brad. No, we view these investments as primarily or -- in most of these cases, not large structural cross so much as current investments. As I indicated in my script, a lot of what doing is automating every place we can. So things like document storage and validation, and the end-to-end data testing, and the change management processes, that's really all technology-enabled. So while we are increasing the size of the audit and compliance teams, and the scale of LendingClub, those aren't big numbers that will meaningfully move any of the margins.

And then one more follow-up on the autos, please. Can you talk a little bit about investor appetites, so far that you've had? How much are you thinking that you might want to use your own balance sheet over the next couple quarters to get this program going? How should we think about cash usage over the next quarter for it and balancing that with getting investor appetite launched?

Let me handle that, then maybe Scott has some views. I would say that, obviously, early days, as we think to the fourth quarter, so I don't see significant impact there. But this is an area where we do believe with our cash position provides us an opportunity to fund this as we launch and learn. So, I would expect some balance sheet usage in 2017. Not much in the fourth quarter, but we'll have a better read on our progress when we come back to you and talk to you about our fourth-quarter numbers and give you a better outlook or the year. But that's the way we're thinking about it right now.

And I'd add to your question on investors, Brad. I mean, we're already in significant conversations with a number of investors. And it wouldn't be our plan to, as we're looking at that balance sheet, we think it gives us this flexibility near term. The plan is not necessarily to buy and hold but rather, these would be loans we might take a position in now and as we line up investors, we could obviously be in a situation where we move those off the balance sheet.

Understood. Thank you very much.

Our next question comes from Bob Ramsey of FBR. Please go ahead.

Hey, good morning guys. Just a follow-up on the auto product, I'm curious, I think you all -- materials so there's not an origination fee, like you charge on a consumer loan product. What is the revenue profitability model? How does that work on this product as opposed to consumer loans?

Yes, there will be a premium charge to the investors. That's a core driver of the revenue model there.

Okay. So like a market driven gain on sales margin is the way to think about that business?

Correct.

Okay. And, shifting to talk about share-based comp, I know you said you've given good guidance for the fourth quarter. We noticed the diluted share count was up a little over 2% quarter over quarter this quarter. I'm guessing with that share-based comp expense next quarter, we should expect, maybe even a bigger jump in diluted shares outstanding next quarter?

We haven't given specific on that. But I think that the trends we're seeing with the fourth-quarter guidance I provided you is -- should start to normalize as we head into 2017, but for 4Q, the stock-based compensation will be elevated as we've effectively brought in another quarter of cost into the fourth quarter. So, I'd have you normalize it as you get into 2017.

So, normalize the income statement expense line is what you're saying in 2017. Something that's…

That's right. So it's probably more normalized for stock-based compensation.

And is normal back to what you were in the first half of this year or is normal more of an average of the four quarters of 2016?

I would say more normal is the average of 2016.

Okay. And, any thoughts around the diluted share count as you've got the full -- I guess the full grants in the fourth quarter here?

I think it's really going to depend when -- where the stock price is on how much dilution we would -- occur. But I'm not --, we're not speculating on that at this time.

Okay. Any sense given where the stock is today without speculating on the future?

I just don't have a number in front of me. My apologies, Bob. But I wouldn't expect significant changes from one quarter to the next on dilution.

Okay, fair enough. Last question and I'll hop out. Just thinking about the unusual expenses this quarter, I know you all highlighted in the slide deck that there were about $14 million in the expense lines this quarter. I think there were at least quoted $20 million. Is the difference contra-revenues for the incentives or something? I'm just trying to reconcile the $14 million and $20 million and understand where all the pieces are?

Yes, good question, Bob. Just to clarify for everybody. The comments in my scripts were on the effectively non-GAAP version. So that was the $15 million. When you add back stock-based comp in the goodwill impairment, that's the additional $5 million. That's the difference between the $15 million and $20 million. Next question?

Our next question comes from Jed Kelly of Oppenheimer. Please go ahead.

Great. Thanks for taking my question. Can you just discuss any recent changes with the competitive dynamics in the current marketing environment? And what marketing channels have been most effective?

Yes, we haven't seen any material shifts this quarter. I think we've talked about last quarter we had noted that overall markets had certainly -- we'd seen a pullback by many of the competitors. I think we're seeing some continue to struggle. We're seeing some rebound at the current levels that we're at. We're not seeing a material impact to our overall activities.

And then, how much of your tech expenditures are being deployed on maintaining current operation versus developing new initiatives, such as your auto product?

We don't break out that specific piece. But, our technology spend has been pretty consistent as a percent of operating revenue. It was 19% last -- in the second quarter, 17% this quarter. The product has been in development. Scott probably has better perspective probably over the last year so on a quarter over quarter, there's not a big delta there. We have seen the tech increase as a percent but as total dollars, I think it's been somewhere in the $15 million -- $16 million to $20 million over the last few quarters.

Thank you.

Our next question comes from Stephen Ju of Credit Suisse. Please go ahead.

Okay. Thanks guys. So Scott, do you think that the cost of borrower acquisition for the new auto refi product will be materially different versus what already exists on the platform? And I guess related to that, any perspective on how much of an overlap there may be between the auto refi borrowers versus your existing customers? And, I would imagine that where would already be a higher overlap and the only incremental decision for LendingClub is just whether or not you elect to make loans of larger amounts? Thanks.

Yes, so, I think it's too early for us to get a full read on overall acquisition costs but I would note, that this really uses a lot of the same channels and techniques that we've built the core business on and even the value proposition is quite similar which is, you have loan, you're paying too much, we can give you a better one. And so, that's one of the things that we think positions us well in the market. Obviously, cracking that nut will happen over time as we optimize the application experience, the credit box and all the rest. In terms of, let's say, overlap with our current customer base, indeed, that is something we're quite excited about. We've gotten over 1.7 million borrowers and they are absolutely -- they are core revolvers, as I've said, in the industry, meaning, they are users of credit. And, a significant percentage of these people have car loans and will be relevant targets for us to provide more utility. So, that's something we're excited to do as we expand nationwide.

Thank you very much.

Our next question comes from Jefferson Harralson of KBW. Please go ahead.

Hi, thanks guys. I was hoping I could follow up on that. I'm not sure that you have this number, or how you're thinking about it. What do you think that the average yield or average borrower cost would be to the newly refi'd LendingClub auto borrower? And where do you think it's coming from? Is it going from 8% to 6%, 6% to 4%, or --? What -- can you help us think about how the yield changes or what the yields may be?

Yes, I think, if you look at the target that we're going after, which is that used car market, you do tend to see average rates in the 8%s, and our target is to save them between 100 basis points and 300 basis points off of that. Now, we have issued a few loans already. Our first customer we were excited to see that first loan we issued, we saved that customer over 600 basis points off of their cost of credit. So it's really, really material. You put it in consumer terms, it's -- you're saving people a year's worth of free gas or two sets of tires, those kinds of things. So it's real value.

Awesome, thank you. And a follow-up. How are you guys thinking broadly about headcount next year? Is it going to be up? Up a lot? Up some? Up -- for just -- a percentage not required but just how are you thinking about the need to invest and grow your employee base next year?

Hey Jefferson, as I commented in my section, we are trying to position the shift of our resources as we head into 2017. I think it's preliminary for us to start providing any kind of guidance for 2017 outlook but we do see our volumes, obviously this quarter being flat with last quarter, I wouldn't expect significant change in headcount. Where we would see headcount start to change is if -- as we head into 2017, give you some numbers of how it relates to volume outlook. So it's just -- we're just not prepared to give you an outlook on 2017 right now.

Okay. Makes sense. Thanks guys.

This concludes our question-and-answer session, and concludes the conference. Thank you for attending today's presentation. You may now disconnect.